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General deduction formula, concrete, bonus, insurance, wdgars, shares,…
General deduction formula
Trade test
Preamble to section 11: “ For the purpose of determining the taxable income derived by any person from carrying on any trade, there shall be allowed as deductions from the income of such person derived…”
Section 1 definition of ‘trade’ include: every profession, trade, business, employment, calling, occupation or venture, including the letting of any property and the use of any patent/ design/ trademark/ copyright
• Two requirements:
a trade to be carried on; and
income to be derived from such trade.
Court Cases
Carrying on a Trade
Burgess v CIR
Facts of case
The taxpayer borrowed money from the bank and invested in a short term investment company as part of a scheme. He wanted to deduct the losses from the scheme.
Judges decision
The main purpose of the scheme was to make a profit. Trade has a wider interpretation including where a person takes risks with the object of making a profit.
Principle
A
wide
interpretation should be given to trade
In the production of income
Joffe and Co
Facts of case
A company carried on a concrete engineering business. A concrete hood, which the company was supervising, collapsed; killing a workman. It was determined in the court case that the company was negligent and had to pay damages to the workman’s deceased widow. The Commissioner disallowed the company’s claim for compensation and the legal costs incurred.
Judges decision
Negligent actions were not deemed a necessary part of an engineering trade and were not incurred, amongst other things, for the purpose of producing income
Principle
If something is not an inevitable concomitant of the business operations it is not deductible. Negligence resulted in the roof collapsing and is thus not an inevitable part of trade and not incurred in the production of income
positive test (certain requirements)
•(a) “expenditure and losses actually incurred in the production of the income, provided such expenditure and losses are not of a capital nature”;
Requires:
expenditure and losses
actually incurred
during the year of assessment
in the production of income
not of a capital nature
court cases
Expenditure and losses
Joffe and Co
Facts of case
A company carried on a concrete engineering business. A concrete hood, which the company was supervising, collapsed; killing a workman. It was determined in the court case that the company was negligent and had to pay damages to the workman’s deceased widow. The Commissioner disallowed the company’s claim for compensation and the legal costs incurred.
Judges decision
Negligent actions were not deemed a necessary part of an engineering trade and were not incurred, amongst other things, for the purpose of producing income
Principle
If something is not an inevitable concomitant of the business operations it is not deductible. Negligence resulted in the roof collapsing and is thus not an inevitable part of trade and not incurred in the production of income
Port Elizabeth
Tramway
Facts of case
A driver employed by the taxpayer died as a result of injuries sustained from an accident that occurred while working. The taxpayer had to pay damages to the widow of the employee. The taxpayer also incurred legal costs resisting the claim. The commissioner disallowed both deductions
Judges decision
Taxpayer’s business to employ drivers. Therefore, it is expected that liabilities will be incurred to compensate employees. Thus the compensation paid is deductible and naturally in the production of income. Legal costs were not part of the income-earning operations and that deduction was disallowed.
Principle
What is the purpose of the expense?
How closely connected is that expense to the production of income?
:
Actually incurred
Nasionale Pers Bpk v KBI
Facts of case
The taxpayer claimed a provision for bonuses as a deduction. The amount was only payable at a future date. The provision was raised for the liability as a result of the employees working for a full year and becoming entitled to their bonus.
Judges decision
The bonus was payable on a future date (in another year of assessment) provided the employee were still in the employ of the company. This is an uncertain future event, and the expense can only be actually incurred on this future date.
Principle
If a payment is contingent upon the happening of an uncertain future event, the expense and corresponding liability can only be actually incurred once the conditions are met.
CIR v Edgars Stores Ltd
Facts of case
The taxpayer leased premises to conduct its business. There was a basic monthly rental and an annual rental based on turnover. The taxpayer estimated the annual amount and claimed it as deduction.
Judges decision
The obligation to pay turnover rental is contingent until the turnover is determined and cannot be deducted until it is determined.
Principle
An expense can only be deducted once there is an
unconditional legal obligation to pay the expense.
During the year of assessment
Sub Nigel Ltd v CIR
Facts of case
A taxpayer company paid insurance premiums on a loss of profits insurance policy. The insurance policy will only pay out in future, if certain events took place.
Judges decision
The premiums were incurred to ensure income was earned in the case certain events happened.The fact that no income had actually been produced was irrelevant. The expense was laid out for the purpose of providing income and should be deducted in the year incurred.
Principle
An expense must be deducted in the year of assessment that it is incurred, even if it will only produce income in future years. I.e. the matching principle is irrelevant. An expense has to be claimed in the year that it is incurred. It cannot be claimed in later years.
CIR v Golden Dumps (Pty) Ltd
Facts of case
The taxpayer and a former employee were involved in a 4 year dispute over the delivery of shares promised by the taxpayer. The taxpayer claimed the cost of the shares as a deduction.
Judges decision
Only when the claim is upheld by the court will a liability arise. If the outcome of a dispute is undetermined, it cannot be said that a liability has been actually incurred.
Principle
Where an obligation to pay an amount is in dispute, the expense can only be actually incurred when the dispute is settled with regards to the obligation and the amount thereof.
In the production
of income
.
In the production
of income
.
Not of a capital nature
New State Areas Ltd v CIR
Facts of case
A taxpayer was required to install a new sewerage system on its premises as well as on land outside its property. The system was installed at the cost of the local authority but the taxpayer had to repay the cost in monthly instalments (relating to the system on the premises and the system outside). The Commissioner disallowed the deduction of both amounts.
Judges decision
The instalments relating to the system on the premises were capital as they related to the acquisition of an asset which remained the property of the company. The instalments relating to the system outside the premises were not a permanent asset of the company. They were incurred due to the right of use of the system belonging to the local authority. Therefore these costs were deductible.
principle
Fixed (capital) vs. Floating capital (revenue)
Cost of establishing/ improving/adding income earning plant (fixed capital) is capital in nature and therefore not deductible vs Cost of performing income-earning operations (floating capital) which is revenue in nature and therefore deductible
Rand Mines
Facts of case
A mine management company incurred an expense to acquire a contract to manage a mine in the same group of companies. SARS disallowed the deduction.
Judges decision
The management contract did not generate income in itself, yet created the opportunity to generate income. This cost was therefore related to the income earning structure and capital in nature. The cost was incurred to create a capital structure, not to work the capital structure.
Principle
Expenditure incurred to obtain an income earning right or structure will be capital in nature
Cost incurred to create a capital structure = capital
Cost incurred to work the capital structure = revenue
References: Court Cases - Intro to Tax. PDF General deduction -slides
