By Luise Ostler Schoeman Attorneys 2013
Introduction
Whether or not expenses incurred by a taxpayer can be deducted from his/her gross
income will depend on the results of a thorough analysis of the general deduction
formula. The general deduction formula is contained in section 11(a) read with
section 23(g) of the Income Tax Act 58 of 1962 (the Act). While section 11(a)
provides positively for what may be deducted, section 23(g) provides negatively for
what may not be deducted. Therefore, an amount claimed as a deduction must
satisfy both sections. Always bear in mind that deductions can only be claimed
during the year of assessment in which they are incurred.
Essential elements
The essential elements of the general deduction formula may be summarised as
follows:
Carrying on any trade
Deducted from the income
Expenditure and losses
Actually incurred
In the production of income
Not of a capital nature
To the extent not laid out for the purposes of trade.
All these requirements must be met for an expense or loss to be deductible. Failure
to meet any of the requirements will result in a disallowance of the expenditure for
taxation purposes.
Carrying on any trade
The Act permits a deduction only if the taxpayer is engaged in carrying on a trade.
Trade is defined in the Act as follows:
trade includes every profession, trade, business, employment, calling, occupation or
venture, including the letting of any property and the use of or the granting of
permission to use any patent, design, trade mark, copyright or any other property
which is of a similar nature.
Deducted from the income
Income is defined as gross income less exempt income.
Expenditure and losses
There is no significant difference between the term expenditure and the term
losses. In order for a deduction to be made, there must be settlement of a liability, in
cash or otherwise, whether or not the liability may have been incurred voluntarily or
not.
Actually incurred
In the Port Elizabeth Electric Tramway Company v CIR 1936 CPD 241 case,
Watermeyer AJP held that:
The words of the statute are actually incurred not necessarily incurred.
The use of the word actually as contrasted with the word necessarily
may widen the field of deductible expenditure. For instance, one man may
conduct his business inefficiently or extravagantly, actually incurring
expenses which another man does not incur; such expenses, therefore,
are not necessary but they are actually incurred and are therefore
deductible.
This means a liability does not need to have been paid for it to have been incurred
by the taxpayer. As long as the liability has actually been incurred, it may be
deductible. In other words: once it has become due and payable.
In the production of income
In the case of CIR v Genn & Co (Pty) Ltd 1955 (3) SA 293 (A), Schreiner JA held
that:
all expenses attached to the performance of a business operation bona fide performed for the purpose of earning income are deductible, whether
such expenses are necessary for its performance or attached to it by
chance or are bona fide incurred for the more efficient performance of
such operation provided they are so closely connected with it that they
may be regarded as part of the cost of performing it.
Therefore, a link must be established between the expenditure and the trade.
Proving this link can sometimes be very difficult for the taxpayer. This explains the
plethora of case law relating to this particular element of the general deduction
formula.
Not of a capital nature
In terms of section 11(a), expenditure and losses of a capital nature may not be
allowed as a deduction from a taxpayers income even if all the other requirements of
the general deduction formula have been met.
There are numerous tests to determine whether or not expenditure and losses are of
a capital nature. It is accepted that each case needs to be judged on its own facts
when it comes to disputes surrounding this aspect.
One of these tests, and perhaps the one that explains the concept best, is that of an
enduring benefit. If an enduring benefit arises for the taxpayer from the expenditure,
then it will usually be of a capital nature. Examples include the purchase of a factory
or a piece of machinery to be used in the factory.
To the extent not laid out for the purposes of trade
This essential element allows for apportionment in the sense that a deduction may
be allowed to the extent that it relates to trade expenditure and disallowed to the
extent that it does not.
Conclusion
The seemingly complex provisions of the general deduction formula are used to
prevent abuse by taxpayers by making sure only that expenditure and only those
losses actually incurred in connection with the taxpayers business should be
allowed as deductions from his/her taxable income.
Bear in mind, also, that there are particular rules that apply to particular kinds of
expenditure. Therefore, these rules need to be considered in addition to the general
rules outlined in the general deduction formula.
As a taxpayer, if you are uncertain whether particular expenditure will be allowed as
a deduction, you should consult a tax practitioner before incurring the expenditure to
establish what the taxation implications will be.
Luise Ostler Schoeman Attorneys 2013