CML5668F

Deductions – General Deductions Formula

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This Week
• Not of a capital nature
● New State Areas
● BP SA
● Warner Lambert
• For the purposes of trade
● Pick n Pay Wholesalers
● Ticktin
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 COMMERCIAL LAW
Deductions
• General Deduction formula – ss11(a) & 23(g)
‘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 so derived—
(a)expenditure and losses actually incurred in the production of
the income, provided such expenditure and losses are not of a
capital nature’
Section 23(g): Prohibits ‘any moneys, claimed as a deduction
from income derived from trade, to the extent to which such
moneys were not laid out or expended for the purposes of trade’ as
a deduction.

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 COMMERCIAL LAW
Deductions
• S11(a) – positive test
• S23(g) – negative test
• Specific requirements for the general deductions formula:
● Trade
● an expenditure or loss
● actually incurred
● in the production of income
● not of a capital nature
● for the purpose of trade.

• During year of assessment

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Not of a Capital Nature
• Two Useful Tests:
1. New State Areas test –
● Is the expenditure part of the cost of performing the income-earning operations? Yes, expenditure if
of a revenue nature and deductible. Expenditure is deductible because it is directly related to the
earning of the TP’s current profits. (Also said as ‘expenditure working the income-producing concern’)
● Is the expenditure part of the cost of establishing or improving the income-earning plant or
machinery, that is its income-earning structure? = capital and not deductible. It is capital because
this expenditure enables the trade to earn profits in the future. (Also said as ‘expenditure made to
acquire an income-producing concern’.)

2. Enduring benefit test – BP SA case

● Will the expenditure bring into existence an asset or advantage for the enduring benefit of the
trade? Yes = capital and not deductible; No = deductible
● How long must the asset or advantage endure in order for it to be capital expenditure?
● It depends on the type of asset/advantage.
● Long-life asset (like a road) = 3 years duration of use is short and not an enduring benefit
● Short-life asset (like a right) = 3 year-long right is an enduring benefit. 5
Not of a capital nature

COMMERCIAL LAW
• New State Areas Ltd 1946 AD
● ‘The problem that arises when deductions are claimed is therefore usually whether the expenditure in
question should properly be regarded as part of the cost of performing the income-earning operations
or as part of the cost of establishing or improving or adding to the income-earning plant or machinery.’
● ‘One must enquire into the true nature of the transaction to determine whether it is capital or revenue.
That true nature is a matter of fact and the purpose of the expenditure is an important factor. If it was
incurred for the purpose of acquiring a capital asset, it is capital expenditure, even if paid in
instalments. If the expenditure is no more than part of the cost incidental to the performance of the
income producing operations, then the expenditure is of a revenue nature.’

• BP SA 2007 (SCA)
● The important aspect here was that the expenditure neither created nor preserved any asset in the taxpayer’s
hands. While not conclusive, this factor was important.
● The SCA cautions that it must stick to an analysis of the terms of the existing contract.

• Warner Lambert 2003 (SCA)

• We note here that both tests were applied – the New State Areas test and the BP SA test.
● Court asked: Was this expenditure part of the TP’s income-earning structure or income-earning activities? (As in
the New State Areas case.)
● Court asked: Did the expenditure create a new asset? (As in the BP SA case.)
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For the purposes of trade

COMMERCIAL LAW
• S23(g) was amended in 1992 from requiring that expenditure be laid out
‘wholly or exclusively for the purposes of trade’ to now allowing for the
deduction ‘to the extent’ that it was for the purposes of trade. Since the
amendment, almost no cases.
Pick n Pay Wholesalers 1987 (A) –
● Majority: Taxpayer had a dual purpose.
● The court refused to accept that he could act in the two capacities with one purpose for the taxpayer
and another for the charity. ‘A man did not change his mind when he changed his hat’.
● The TP had failed to show that it did not have a philanthropic purpose as well as a business purpose.

● Minority: Taxpayer had only one purpose – a trade purpose.

● When the intention and purpose of the taxpayer is to be discerned, it is the intention and purpose of the
directors that had to be identified as they acted in that capacity.

● In determining that purpose, it is important to distinguish the subjective purpose of the taxpayer from the
effect of that purpose.
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For the purposes of trade
Example:
● Let’s imagine that a medical doctor has a friend who lives in the South of France, and
also happens to be the doctor’s patient.
● The friend falls gravely ill, and the medical doctor travels from SA to consult with her
patient. The doctor also stays in the friend’s home for a week while running tests and
examining the patient. While not attending to the patient, the doctor does some sight-
seeing and other tourist activities.
● The medical doctor wants to deduct the cost of her airfare.
What was the purpose of incurring the cost?
● Was the tourist activity in France a reason, however subordinate, for the trip? Or was
the tourist activity the effect, and not the reason, for the trip to France?
If the only reason for the trip was to consult with a patient, and the tourist activity
in France for a week was only the effect, then the cost of the airfare should be
deductible under the general deduction formula as having been expended for the
purposes of trade.
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For the purposes of trade
Deduction of interest on loans from members
• Ticktin 1999 (SCA)
• The deduction was not wholly and exclusively expended for the purposes of trade. The
loan was not used towards sustaining the TP’s income-earning operations – in fact, the
dividend took away the TP’s already earned income.
• ‘There is a clear conceptual distinction between, on the one hand, a case in which a
company in good faith and on the strength of inaccurate financial statements furnished by
employees declares and pays a dividend, but shortly thereafter learns the true financial
position of the company and realises that the dividend should not have been paid, and
that an equivalent sum will have to borrowed to finance the company’s trading activities,
and on the other hand, a case such as the present.’
• This case is not authority for the view that a company can never deduct interest paid on
a loan received from its own members/shareholders.
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