SUB-NIGEL LTD v CIR 15 SATC 381
Income Tax Gold Mining Company Payment of premiums to insure against loss of profits andcost of standing charges during suspension of operations owing to fire Whether expenditure admissible as deductions in determination of taxable income Sections 11(2) (a), 12(g) and 20,
Act 31 of 1941 Section 2, Act 25 of 1940.
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Case Analysis:
Go placidly amid the noise and haste the demise of section 11(bA)
Disclaimer: Please note that this article is at least 12 months old.
Any information herein was accurate when published on 24 August 2011
Practically unnoticed amid a raft of dramatic proposed changes contained in the Draft Taxation Laws Amendment Bill of 2011 (‘the Draft Bill’) is the deletion of section 11(bA) from the Income Tax Act (‘the Act’). In most years Amendment Bills have not contained anything like the sudden suspension of section 45 or the proposal to re-write our source rules two of a number of dramatic proposals contained in the Draft Bill. It would seem that it is for this reason that a number of other proposals, like the scrapping of section 11(bA), have not elicited comment.
Section 11(bA) applies in respect of interest or finance charges (‘interest’) relating to a wide variety of asset types, prior to the date on which such assets are brought into use in a trade: hence the term ‘pre-production interest’. The interest is accumulated and deducted in a lump sum in the year of assessment in which the asset is brought into use. It would seem from the wording of section 11(bA) that it applies as a deduction provision of last resort: to any pre-production interest ‘not otherwise allowable as a deduction under [the Act]’.
The question is whether there is anything sinister in the proposed deletion of the provision. Is the intention to deny taxpayers a deduction for the interest incurred under such circumstances?
Section 24J allows taxpayers a deduction for interest incurred in respect of an ‘instrument’ as defined in the provision. The definition of ‘instrument’ is very wide indeed and would include loans and the type of financing arrangements typically associated with the acquisition of fixed assets. The other main requirements for deductibility in terms of section 24J are that the interest must be deducted from income derived from the carrying on of a trade and the interest must be incurred in the production of income. Section 24J is the main provision in terms of which interest or finance charges are dealt with in the Act. Section 24J does not contain a requirement that in order for interest to be deductible that the interest must not be of a capital nature. It has been argued that pre-production interest that is incurred on a capital asset is capital in nature as it is part of the cost of creating a source of future income.
Where the taxpayer has commenced trading and incurs pre-production interest relating to the acquisition or construction of an asset to be used in the trade then it would seem as if section 24J would allow a deduction to be claimed. The objection that such expenditure is part of the cost of creating a source of income and is therefore of a capital nature is rendered irrelevant by the wording of section 24J. Moreover, in terms of the decision in Sub-Nigel v CIR 15 SATC 381, for an expense to be incurred ‘in the production of income’ does not mean that income has to be produced immediately after the expense has been incurred, or for that matter that income has to be produced at all. The test is simply whether the expense was incurred for the purpose of producing income. If section 11(bA) is deleted, the only difference will therefore be that the pre-production interest will be deductible in the year(s) of assessment in which it is incurred rather than in a lump sum in the year in which the asset is brought into use.
Where the taxpayer has yet to commence trading and incurs pre-production interest relating to the acquisition or construction of an asset to be used in the trade the question arises as to whether the position is different. In this case it would seem from the wording of section 24J that a deduction of such interest may not be claimed. This is because of the requirement that the interest must be deducted from income derived from the carrying on of a trade. Therefore, if trading has not commenced, at least by the end of the year of assessment, it would seem as if the pre-production interest relating to that year may not be claimed in terms of section 24J. However, in these circumstances the taxpayer may look to section 11A, which allows a deduction of pre-trade expenses generally, not only pre-production interest. The main requirement for deductibility in terms of section 11A is that the expenditure for which a deduction is sought must be expenditure that would have qualified for deduction under various possible provisions of the Act had the expenditure or losses been incurred after trade had commenced. The list of such possible provisions is wide and includes section 24J. It would therefore seem that in these circumstances section 11(bA) is also not necessary as a deduction of pre-production interest may be claimed in terms of section 11A. The wording of section 11A implies that pre-trade expenses will be accumulated and deducted in a lump sum in the year in which trade commences. To this extent the treatment of pre-trade interest in terms of section 11A mirrors the treatment of pre-production interest currently contained in section 11(bA). Further, if the trade in respect of which the interest was incurred never commences, the treatment under both provisions is the same in that the interest is never deductible. In circumstances where trade has commenced but the asset has still not been brought into use, pre-production interest incurred after the commencement of trade would be deducted as incurred under section 24J.
The question of exactly when trading commences is an interesting one. In CSARS v Contour Engineering (Pty) Ltd 61 SATC 447, in circumstances where the taxpayer had no premises, no equipment, no stock and no staff, it was held not to be trading. In the United States case of Richmond Television Corp. V Commissioner 345 F.2d 901 (4th Cir.1965), it was held that even though a taxpayer has made a firm decision to enter into business and over a considerable period of time spent money in preparation for entering that business, the taxpayer still has not engaged in carrying on any trade or business until such time as the business has begun to function as a going concern and performed those activities for which it was organised. However, various decisions of the United States courts have indicated that it is not always necessary for a company to have opened its doors for business before it can be said to be carrying on business. In the UK case of J.&R. O’Kane & Co. v The CIR 12 TC 303 (HL) it was held that the act of keeping open a shop was essential to the carrying on of the business of a seller. SARS has indicated in its Interpretation Note No 33 that it will assess each case on its merits in deciding whether to regard a company as having commenced the carrying on of a trade. It states that much will depend on the nature of the company’s activities.
In summary it can therefore be concluded that the proposed deletion of section 11(bA) from the Act will not be detrimental to taxpayers: either in circumstances where trading has already commenced or where it has not yet commenced.