TAXF372

SU 3 General deduction Formula (GDF)

Silke Chapter 6 https://sars.mylexisnexis.co.za/

SU 3 LEARNING OUTCOMES
On completion of this study unit you should be able to:
 Motivate, with reasons, whether expenses incurred will
be deductible or not (in terms of the GDF);
 Calculate a taxpayer’s taxable income, which integrates
general deductions incurred in the carrying on of a
trade
WHERE ARE WE IN THE FRAMEWORK? SILKE P151
ALSO
FRAMEWORK FOR CALCULATION RCo’s

GROSS INCOME (Inc. General inclusion and Specific inclusions) XXXX

Add: Deemed inclusions in income e.g. s7 or s8(4)(a) xx
Less : Exempt income s10, s10A-C, 12T (xx)
Income XXXX
Less: Allowable deductions
• Deductions and allowances (all s11 “business”, not s11F) (xxx)
• Assessed loss (s20) (xxx)
Add: Amounts included in taxable income (s8(1)(a)) (Only Individuals) xxx
Add : Taxable capital gains (s26A) xxx
Less: s11F contributions (Only Individuals) (xxx)
Less: S18A Donations to PBO (xxx)

Taxable income XXXX

SUMMARY (SILKE 6.1)

Prerequisite : Trade
Only If there are no
specific deduction

Definition
OR Sec 11A Pre trade

GDF

Positive test Negative test

Sec 11(a) Sec 23 (g)

5 Always consider:
Requirements Sec 23 (a) – (r) Sec 23C
Sec 23B Sec 23H
 6.2 S11: IN CARRYING ON A TRADE:
 s11(a) : Can deduct  S 23(g): Cannot deduct

1. Expenditure & losses  Even if comply with

requirements of s11(a)
2. Actually incurred
3. In year of assessment
 Cost must be incurred in
(Case law)
“for purposes of a trade”
4. In production of income
5. Not of a capital nature  See list per next slides

 Have to comply with all  NEGATIVE TEST

s11(a) components to get
deduction
 POSITIVE TEST
 6.2 MEANING OF "CARRYING ON A
TRADE"
S1 = Trade include:
 Sec 11 of the Income Tax Act: Every profession, trade ,
 “Carrying on a trade”
business, services, occupation,
letting of property etc.
 Burgess v CIR
The definition of “trade” should be given a wide interpretation. It was also pointed out that
the definition is not necessary exhaustive.

 C: SARS v Scribante Construction

This case showed that loans from the shareholders (can be and) in this case were used for
the purposes of trade and in fact produced income (outside interest) directly and indirectly.

 Warner Lambert SA ( Pty ) Ltd v C: SARS

The court agreed with the taxpayer that the reason for incurring the legally required social
responsibility expenditure was crucial to its trade.

Thus: Every
 Section 1 and Burgess - defines “Trade” independent active
function that
 But section 11 requires “Carrying on” of a trade generates income =
a separate trade
 TO DETERMINE WHETHER A TRADE I S CARRIED ON THE DO N BSTE VD OPERATING CHARACTERISTICS INVESTIGATED, NAMELY:
CONTINUITY; AND
PROFIT MOTIVE.
CONTINUITY AND PROFI T MOTIVE PREREQUISITE.

ITC 1476 (1982):

DOING A V INDUSTRY NEEDS AN ACTIVE STEP ALSO INVOLVES.

6.2 MEANING OF "CARRYING ON A TRADE"

 Two Good indications of “Carrying on a trade:

 Continuity of activities
 Long term objective to generate profit
 “Active step” = more than just watching passive investment

 But Passive income (Non-trade income):

 Ex. Interest received (except if Moneylender)
Dividends received
Annuities / Pensions
 Not considered to be “carrying on a trade”
 Note: SARS in process to withdraw Practice Note 31 which allowed
expenditure incurred in the production of the interest to the extent that it
does not exceed such interest income
6.2.1 PRE-TRADE EXPENDITURE AND LOSSES (S11A)
s11A : Costs incurred before trade
 Pre-trade expenses are deductible if it would comply with requirements of s11(a) but no
trade is carried on yet

Deduct s11A costs in total in

YoA that trade commenced
limited to income from same
s11A Requirements: trade
a) Trade must now be carried on

b) Expenses/losses must have been incurred before the commencement of the trade.

c) Expenses/losses must have been incurred in preparation for the carrying on of that trade.

d) Expenses/losses must be otherwise deductible in terms of

s11(a)-(w), 11B, 11D of 24J.
e) Expenses/losses = not previously claimed or allowed as deduction.
 If Deductions exceeds Income carry cost to next year against same trade (ring
fenced)
 SARS Interpretation note 51 (issue 3) (just for noting)

 Silke Ex 6.1 (next slide)

8
 EXAMPLE: PRE-TRADE EXPENDITURE (S11A)

2023
2023

2023

2023

2023 to 2023

9
EXAMPLE SOLUTION: PRE-TRADE EXPENDITURE (S11A)

10
6.3 General Deduction Formula (GDF) s11(a) and
s23(g)
Port Elizabeth Tramway Co Ltd v CIR stated that sec 11(a) and sec
23(g) must be read together.

Sec 23(g): “...any moneys, claimed as an deduction from income

derived from trade, to the extent to which such moneys were not laid
out or expended for the purposes of trade.“

NB Thus GDF Elements:

1. Expenditure and losses
2. Actually incurred
3. During the year of assessment (case law)
4. In the production of income
5. Not of a capital nature
6. Either partially or fully expended for the purposes of trade (s23(g))
 6.3.1 EXPENDITURE AND LOSSES

Joffe & Co (Pty) Ltd v CIR

 Losses= “usually an involuntary deprivation”, whereas
 expenditure = “usually means a voluntary payment of money”

Port Elizabeth Electric Tramway Co Ltd v CIR

 ‘Losses’ refers to “losses of floating capital employed in the
trade which produces the income”
 6.3.2 ACTUALLY INCURRED
 Edgars Stores v CIR: Only expenditure in respect of which the taxpayer has
incurred an unconditional legal obligation during the year of assessment in
question may be deducted.

 Nationale Pers v KBI: If there is no definite and absolute liability during the
YOA to pay an amount, expenditure has not been actually incurred.

 CIR v Golden Dumps (Pty) Ltd: Where at the end of the tax year a deduction is
claimed, the outcome of the dispute is undermined, it cannot be said that the
liability has been actually incurred.

 CSARS v Labat
Expenditure refers to the action of spending, paying or use of funds (a movement in
assets).
E.g Expenditure is NOT actually incurred if a company issues shares when it
obtained a new asset in exchange for those shares (existing assets are not
diminished) [other parts of the Act now provides relief]
6.3.3 “DURING YEAR OF ASSESSMENT”

 NB “during YoA” = must claim deductions in

correct YoA in which it was incurred

 Still subject to s23H (see slides below) and 24M(4th

year)

 Ex 6.3
6.3.4 “IN THE PRODUCTION OF INCOME”

NB Port Elizabeth Electric Tramway Co Ltd v CIR:

“In the production of income” means actions causing costs must be
closely related to the income earning activities

NB Joffe & Co (Pty) Ltd v CIR:

The expenditure must be a necessary concomitant of the business
activities (i.e. business causes the expense)

Sub-Nigel Ltd v CIR:

The income may be earned only in future years, but as long as
the expenditure has been laid out for the purpose of earning that
income, it is deductible. (e.g. insurance premiums)
6.3.4 “IN THE PRODUCTION OF INCOME”
Provider v COT:
Expenditure to induce employees to enter or stay in service is deductible

CSARS v Mobile Telephone Networks Holdings (Pty) Ltd

Apportionment of expenses between those generating income or exempt income
must be fair and reasonable e.g for investment company base it on size of
investments in dividends and interest (costs was for audit fees)

CSARS v BP South Africa (Pty) Ltd (2006)

The taxpayer proved that it needed the borrowing to fund its operational and
capital expenditure in the subsequent year, rather than to fund the dividend. The
interest on this borrowing was held to be deductible.
 6.3.4 “IN THE PRODUCTION OF INCOME”

THUS Remember that Expenditure

 Must be incurred in the production of income
 If i.r.o. exempt income, (e.g. dividends) then not deductible
 Must be closely-connected risk of the trade

Ex 6.4 - 6.5
 6.3.5 “NOT OF A CAPITAL NATURE”

“Not of capital nature”: depends on facts and circumstances.

New State Areas v CIR:

 Costs of Floating capital / Income producing operations = s11(a) =
revenue in nature
 Costs of Fixed capital / Income production structures = capital in
nature = s12 or s13 allowances

CSARS v BP South Africa (Pty) Ltd (2006)

 Costs to perform Income producing operations = Revenue in nature
 Costs to add to Income production structure (a machine) = Capital in
nature
 6.3.5 “NOT OF A CAPITAL NATURE”

Rand Mines (Mining & Services) Ltd v CIR

 Costs incurred to obtain contract to manage mine = costs for
income earning structure / right = capital in nature

NB: BP Southern Africa (Pty) Ltd v CSARS (2007)

 NB: If costs create or lead to enduring benefit = capital in
nature
 Enduring = longevity but each case has own merits
 6.3.5 “NOT OF A CAPITAL NATURE”

 Examples of “capital in nature” expenditure / losses

(thus no s11(a)):
 Fixed assets
 Goodwill
 Issuing of Share capital (e.g. legal fees etc.)
 Transfer fees for a liquor licence
 Permanent advertising (e.g furniture exhibition area)
 Losses on fixed assets (building fire)
 Bad debts (except if credit provider)
 Investment losses
6.4 PREPAID EXPENSES (S23H)
SEC 23 H – LIMITS DEDUCTION OF PREPAID EXPENDITURE

s23H applies if:

 Expense is s 11(a), 11(c), 11(d) , 11(w) or 11A deductible
but it…
 relates to goods or services that will not all be supplied
during the current YoA

Then expense must be apportioned for YoA

Ex 6.6 and 6.7

 PREPAID EXPENDITURE – S 23H
Prepaid expenses are still 100% deductible in the current year if the
goods/services which related to the expenditure:

 Will be supplied/rendered < 6 months after the end of the tax year
OR
Cost where s 24K and s24L is applicable (leave out)
OR
 Liability due to legislation
 eg. legislation determines that property tax has to be paid in advance)

OR
 If aggregate of all prepaid expenditure < R100 000 (what is left after the other
tests above)
EXAMPLE: PREPAID EXPENDITURE

2023

2023
2023
2023

2023
EXAMPLE SOLUTION: PREPAID EXPENDITURE
 S23: DEDUCTIONS DISALLOWED
 S 23(a): Maintaining taxpayer/family (food and clothes) 
 S 23(b): Domestic or pvt expenses** (e.g rent, travel, medical, private life)
 S 23(c): Insured expenses or losses (If insurance pay-out is not GI or Recoupment)
 S 23(d): Taxes and penalties (tax & any penalties per SARS Acts)
 S 23(e): Income capitalised to fund (e.g certain provisions)
 S 23(f): Produce exempt income
 S 23(g): Not incurred for purpose of trade
 S 23(h): Notional interest  
 S 23(i): Deducted from retirement/withdrawal benefit from funds (SU of Retirement funds)
 S 23(k): Labour brokers / PSP (silke 19.5.6 SU on Co’s )
 S 23 (l): restraint of trade (except where s11(cA))
 S 23(m): Salaried employees** (silke 7.4 of SU Individuals)
 S 23(n): Assets related to exempt govt grants (Leave out)
 S23(o): Fines or bribes (in terms of an RSA Act or law)
 S23(p): Insurance policies ceded to employee, director etc. (Leave out)
 S23(q): Cost incurred in the production of foreign dividends
 S23(r) Premiums in respect of insurance policies against illness, injury, disability,
unemployment or death of that person (but proceeds exempt s10(1)(gl))

**Unless premises specifically equipped, exclusively used and duties mainly (or mainly commission earner) at home
office. Read with s23(m). Done later with SU Individuals.
6.6 – 6.9 REVISION
 s23B prohibits double deductions (n/a to capital
allowances)

 Excessive business expenditure (s23(g))- matter of facts

- Question is one of tax evasion – Commissioner may
disallow e.g excessive salary expenditure

 s23C on VAT. If VAT is claimable then expenditure must

be claimed ex-VAT

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SPECIFIC TRANSACTIONS 6.10

6.10.1 Advertisements:
 If advertising creates an asset of permanent nature or
enduring benefit it is capital of nature

 Must comply with general deduction formula and

depends if it is utilising assets in a permanent nature
(which is capital in nature)

 E.g.
 Product launch – enduring benefit (capital)
 Billboards – permanent ads - capital
 TV & radio: Production cost – capital
 Screening cost – income nature
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6.10.2 COPYRIGHTS, INVENTIONS, PATENTS,
TRADEMARKS AND KNOW-HOW

 Cost in the development = capital

 And only deductible in terms of s11(gB),
s11(gC) & s11D
 Royalties, rent paid = Not capital in nature =
deducible (BPSA-case)

29
6.10.3 DAMAGES AND COMPENSATION

 Test of “In production of income” is applied

 Damages resulted from:

 Activitywhich is Inherent risk = deductible
 Negligence not typically deductible

 Joffe- case

30
6.10.4 EDUCATION AND CONTINUING EDUCATION

 Obtaining/improving qualification = capital

 Professional person in practice = Maintaining knowledge =

revenue (attendance of seminars)

31
 6.10.6 GOODWILL
• An amount payable for the goodwill of a business = capital
UNLESS
• Taxpayer buys and sells businesses for profit

6.10.9 LOSSES: FIRE, THEFT AND

EMBEZZLEMENT
Loss due to theft / damage:
• Capital assets losses – non deductible s11(a), capital of nature, (but see s11(o) later)
• Trading stock losses – SARS allows deduction ito loss not recoverable from
insurance (through s22)
• Cash losses –
• deductible, except if theft by director / owner
• must be unavoidable consequence of trade

32
INTEREST
 Test first for s24J (4th year work)
 Must be close relationship between interest & income
producing trade
 If Purpose of loan for financing of income producing trade –
deductible even if for capital asset

6.10.8 LEGAL COSTS

 Must be close relationship to income producing trade / follows
compensation’s nature
 When Capital in nature: Not deductible if goal is to protect current
source of income / right to income.
 s11(c) also allows legal cost iro claim/dispute and not of capital
nature
SU 3 GENERAL DEDUCTIONS

HOMEWORK FOR NEXT WEEK

• Do SU 3 GDF quiz - 15 marks True/False, 2 attempts.
• SU 3 Class Question 1 (In class / Own time)

MORE REVISION?
• SU 3 Class Question 2
• Other SU’s questions
• QSAT 2023: 3.12, 3.13