LEARNING UNIT 5
Learning
unit
5
INTRODUCTION
LEARNING OUTCOMES
PRESCRIBED STUDY MATERIAL FOR THIS
LEARNING UNIT
CONTENT OF LEARNING UNIT
5.1 Background
5.2 Carrying on a trade
5.3 The general deduction formula
5.3.1 Expenditure and losses
5.3.2 Actually incurred
5.3.3 Year of assessment
5.3.4 In the production of income
5.3.5 Not of a capital nature
5.3.6 Laid out or expended for the purposes
of trade
5.4
5.5
Prohibited deductions
Specific transactions
General
5.6
5.7
Summary
Questions
deduction
WRAP-UP QUIZ
formula
LITERATURE CONSULTED
INCOME TAX FRAMEWORK
(COMPANIES AND CLOSE CORPORATIONS)
R
Profit or loss as reflected on the xxxx (Learning unit 2,3
statement of comprehensive and 5)
income
Debit adjustments xxxx
Less: - Non-taxable amounts credited to the statement (xxxx) (Learning unit 4)
of profit or loss
Less: - Deductions/Allowances available for tax (xxxx) (Learning unit 6 and
purposes that were not claimed in the statement of 7)
profit or loss
Credit adjustments xxxx
Add: - Non-deductible amounts debited to the xxxx (Learning unit 9)
statement of profit or loss
Add: - Amounts not credited to the statement of xxxx (Learning unit 2)
profit or loss
Add: - Allowances/deductions granted in xxxx (Learning unit 6)
previous year of assessment that are
reversed in the current year of
assessment
Add: - Recoupment of allowances or expenses xxxx (Learning unit 7)
previously allowed as deductions
Add: - Amount to be specifically included in the xxxx
determination of taxable income before
(Learning unit 3)
s18A donations
Taxable capital gains xxxx (Learning unit 8)
Add:
Less: Assessed losses brought forward from (xxxx) (Learning unit 6)
previous years of assessment
Less: Section 18A donations (xxxx) (Learning unit 6)
Gives: Taxable income xxxx
xxxx (Learning unit 9)
Normal tax (27% or per SBC tax table)
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INCOME TAX FRAMEWORK
(NATURAL PERSONS / INDIVIDUALS)
R R
Gross income xxxx (Learning unit 2)
General definition
Specific inclusions xxxx (Learning unit 3)
Less: Exempt income (xxxx) (Learning unit 4)
Gives: Income (Subtotal 1) xxxx (Learning unit 10)
Less: Deductions
General deductions (xxxx) (Learning unit 5)
“Other” allowable expenses (xxxx) (Learning unit 10)
Subtotal 2 xxxx
Less: Assessed loss (xxxx) (Learning unit 6)
Subtotal 3 xxxx
Add: Other amounts included xxxx (Learning unit 11)
Subtotal 4 xxxx
Add: Taxable capital gain xxxx (Learning unit 8)
Subtotal 5 xxxx
Less: Retirement fund contributions (xxxx) (Learning unit 10)
Subtotal 6 xxxx
Less: Section 18A Donations (xxxx) (Learning unit 10)
Gives: Taxable income xxxx (Learning unit 10)
Normal tax (per the tax tables) xxxx (Learning unit 10)
Less: Section 6(2) and 6quat rebates (xxxx)
Add: Additional tax xxxx
Less: Section 6A and 6B tax credits (xxxx)
Gives Normal tax payable xxxx (Learning unit 10)
Less: PAYE (xxxx) (Learning unit 14)
Less: Provisional tax (xxxx) (Learning unit 14)
Less: Withholding tax (Non-residents) (section 35A) (xxxx) (Learning unit 13)
Normal tax due by or to natural
person (A) xxxx
Withholding tax (Non-residents) (ss 47A-47K,
49A-49H and 50A-50H)) xxxx
Withholding tax on dividends xxxx (Learning unit 9)
Withholding tax payable (B) xxxx
Donations tax payable (C) xxxx (Learning unit 16)
Gives: Total tax payable (A + B + C) xxxx
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INTRODUCTION
A big retail company, Pick & Wear, selling branded clothing at outlets in all the major cities, incurs
expenses related to running the business. Sometimes the company pays the private expenses
of its directors, and the company's accountant, Mr Bean Counter, allocates these expenses to the
relevant expense accounts in the general ledger.
What would happen if Pick & Wear could claim any expenditure incurred as a
taxable deduction, regardless of whether such expenditure was for private or
business purposes?
The issue here is about the general deduction formula governing the deduction of
expenditure incurred by a taxpayer in carrying on a trade in the production of income.
The taxpayer would ideally want to claim all expenses as tax-deductible expenditure,
but not all expenses necessarily qualify as tax-deductible expenditure. The taxpayer
must convince SARS that a certain expense does in fact qualify as a tax-deductible
expense. SARS, on the other hand, would like to limit the deductions that a taxpayer
may claim as tax-deductible expenses, thus increasing the tax liability of the
taxpayer.
In this learning unit, you will learn when will an expense qualify as a deduction in the taxable
income calculation of a taxpayer. If you refer to the income tax framework above, you will see
that this learning unit relates to the first category of allowable deductions, namely the general
deduction formula (Section 11(a) read with section 23).
LEARNING OUTCOMES
After completing this learning unit, you must be able to:
➢ list the requirements of the general deduction formula and apply the formula to a
practical situation.
➢ discuss whether an expenditure will be deductible according to the general deduction formula.
➢ explain the working of section 23 (i.e., deductions not allowed in the determination of taxable
income) and how it affects deductions.
PRESCRIBED STUDY MATERIAL FOR THIS LEARNING UNIT
Study Chapter 7 in the prescribed textbook.
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CONTENT OF LEARNING UNIT
5.1 BACKGROUND Textbook section: 7.1
Allowable deductions represent the deductions of expenses incurred by the taxpayer “from
carrying on any trade,” which, in terms of the Income Tax Act No. 58 of 1962 (“the Act”), may
qualify as deductions. These allowable deductions are deducted from "income" in the income tax
framework. The result of this calculation (i.e., income less allowable deductions) is taxable
income.
Section 11 of the Act makes provision for the general deduction formula according to which most
of the operating expenses incurred by the taxpayer during the operation of an enterprise may
qualify as allowable deductions.
5.2 CARRYING ON A TRADE (section 1) Textbook section: 7.2
Section 11 of the Act covers general trade-related expenses and some of the specific expenses.
For any expenses to be deductible in terms of section 11, the taxpayer must be carrying on a
“trade”. It is important to be aware that the definition of “trade” is very wide, extending beyond
running a business to include activities such as carrying on a profession as well as being em-
ployed. It is also important to note that passive investment activities are not included in the
definition of “trade.” This means that where expenses are incurred in earning investment income,
it will not be deductible according to the general deduction formula. Passive investments
generate returns such as interest and dividends.
Where the taxpayer carries on more than one trade, all income or losses for each trade are
usually added together (aggregated) to calculate taxable income.
Familiarise yourself with the implications for the concept of “carrying on a trade” where there is
no profit motive, as outlined in Burgess v CIR 55 SATC 185.
5.3 THE GENERAL DEDUCTION FORMULA
Textbook section: 7.3
(sections 11(a) and 23)
The general deduction formula (section 11(a)- positive test) stipulates that:
• expenditure and losses; and
• that have actually been incurred; and
(meaning that they have been paid or that a liability/obligation to pay exists)
• that have arisen during the year of assessment; and
• that have been incurred in the production of income; and
(meaning that the income-producing action that gave rise to the expenditure was closely
connected to the income-producing activities)
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• that are not of a capital nature
(meaning that the expenditure/loss is more closely related to the income-earning operation
than to the income-earning structure)
shall be allowed as deductions, provided that:
• a trade is carried on by the taxpayer and expenditure was laid out or expended for purposes
of trade; and
• income is to be derived from such trade.
Take note:
All the components of the general deduction formula must be present/ be met
for an expense/loss to be deductible.
Section 23(g) (negative test) of the Act should also be adhered to when applying the general
deduction formula. This section prohibits the deduction of:
• any moneys from income derived from trade to the extent that such moneys were not laid out
or expended for the purposes of trade (meaning not closely connected to the trade carried on)
The general deduction formula comprises two elements, namely the positive test with
which an expense must comply, and the section 23 negative test that may disqualify/
prohibit a deduction from being an allowable deduction. These two elements must
always be applied in conjunction with each other to establish the deductibility of
expenditure.
For example, a stock loss suffered by an enterprise, which is subsequently com-
pensated for by an insurance payment, may in all respects be deductible according
to the general deduction formula (positive test). However, it will be disqualified as a
deduction in terms of section 23(c) since the loss has been recovered under an insu-
rance contract (negative test).
Remember that the general deduction formula is more applicable to taxpayers who own a busi-
ness. This is because the restrictions placed on salaried taxpayers in terms of section 23(m),
causes persons who earn remuneration in the form of only salaries, fringe benefits and
allowances to in most cases not be able to deduct expenditure in terms of the general deduction
formula.
Furthermore, specific provisions in the Act may allow specific expenditure as allowable deduc-
tions, although the expenditure might not be deductible according to the general deduction for-
mula. In this regard, it is important to note that, where the Act makes specific provision for a
specific deduction of expenditure (for example, bad debts written off), the general deduction for-
mula may not be used to deduct such expenditure as an allowable deduction, and only the specific
section in the Act may be used. The Act also prohibits the double deduction of the same expense
in terms of more than one provision of the Act.
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Questions on the general deduction formula will usually be discussion-type
questions. If necessary, you will have to discuss each component of the defini-
tion of the general deduction formula, in order to establish whether an amount
constitutes an allowable deduction or not.
You will need to learn the name as well as the principle (conclusion) of each of the tax court
cases relating to the general deduction formula components/criteria as outlined in the prescribed
textbook. In the examination, you will be required to list the name and principle under the
appropriate criteria for the general deduction formula when considering whether an amount will
be deductible according to the general deduction formula.
Take note:
It is not necessary to learn the numbers added next to the court case names. For
example, “Burgess case” is acceptable in place for “Burgess v CIR 55 SATC 185”
In the below sections, you will be taken through each requirement/ component of the general
deduction formula (s11(a) read with s23).
5.3.1 Expenditure and losses Textbook section: 7.3.1
Study section 7.3.1 in the prescribed textbook.
When working through the section, note that deductible expenditure is not restricted to expendi-
ture in cash, but includes the outlay of amounts in a form other than cash. Therefore, if a shop-
keeper offers an asset – instead of cash – as payment for new stock, then the market value of
the asset will be deductible. Where a taxpayer has acquired an asset through an inheritance or
donation and then subsequently uses it to pay for something, then the market value of such asset
will be allowed as a deduction.
5.3.2 Actually incurred Textbook section: 7.3.2
Study section 7.3.2 in the prescribed textbook.
A taxpayer may deduct expenses that have actually been paid as well as amounts that are being
owed (i.e., amounts for which a liability exists).
The liability for the expense must be unconditional, which means that it must not depend on
some future event happening. Where an event must first take place, before an expense becomes
payable, the expense will be deductible for tax purposes only in the year in which the event
actually takes place.
Assume, for example, that at the end of February (the end of the current year of assessment),
employer X has a contractual agreement to pay employee Y a bonus of R10 000 if, by the end
of March the following year, employee Y reaches a particular sales target. The liability of R10 000
is still conditional at the end of February (i.e., end of the current year of assessment) – because
employer X cannot be certain that the employee will in fact reach the sales target by the due date
of March. Therefore, the expense of R10 000 will not have been actually incurred at the end
of February.
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5.3.3 Year of assessment Textbook section: 7.3.3
Study section 7.3.3 in the prescribed textbook.
In general, only expenditure that is incurred during a particular year of assessment is deductible
in that year of assessment. Expenditure incurred in one year of assessment is therefore not
deductible in later (or prior) years of assessment. The accounting concept of matching does not
apply to the deductibility of expenditure for tax purposes.
5.3.4 In the production of income Textbook section: 7.3.4
Study section 7.3.4 in the prescribed textbook.
When attempting to deduct an expense, this requirement and the next one is usually the "trouble-
some" requirements to prove.
There are numerous court decisions that have hinged on the term "in the production
of income". You do not need to be able to give account of specific court cases, but
you must understand the principles present in each case and be able to apply these
principles to short case studies. The landmark case that dealt with this issue was
Port Elizabeth Electric Tramway Co Ltd v CIR 8 SATC 13. The court held that, in
order to be deductible, expenditure must be so closely connected to the cost of
performing the income-earning operations of the business that it would be
reasonable to regard it as part of the cost of performing the operation. See also
CSARS v BP South Africa (Pty) Ltd 68 SATC 229.
Also familiarise yourself with the principles established in the following cases:
• CIR v De Beers Holdings 46 SATC 47 (carrying on a trade)
• Joffe & Co (Pty) Ltd v CIR 13 SATC 354 (deductibility of compensation payments)
• Caltex Oil (SA) Ltd v SIR 37 SATC 1 (actually incurred)
• Sub-Nigel Ltd v CIR 15 SATC 381 (expenditure that produces income in a later year of
assessment is deductible)
• CIR v Drakensberg Garden Hotel (Pty) Ltd 23 SATC 251 (interest paid on a loan to acquire
shares can be deductible)
• W F Johnstone & Co Ltd v CIR 17 SATC 235 (expenditure paid in the current year in
recognition of services rendered in prior years is not deductible)
• CIR v Nemojim (Pty) Ltd 45 SATC 241; CSARS v Mobile Telephone Networks Holdings (Pty)
Ltd (966/12) [2014] ZASCA 4 (apportionment of expenditure incurred for different purposes)
• Other court cases in the prescribed textbook
Ensure that you know how specific expenses and losses are dealt with in terms of the general
deduction formula, in particular fines, losses because of theft, social responsibility payments,
recurring expenditure such as audit fees and ex gratia payments.
Ensure that you understand the “in production of income” requirement and remember that “in-
come” is defined in the Act as “gross income” less “exempt income.” As a result, expenditure
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that relates to exempt income (such as dividend income) will, by definition, is not deductible.
5.3.5 Not of a capital nature Textbook section: 7.3.5
Study section 7.3.5 in the prescribed textbook.
Capital expenditure is not deductible in terms of the general deduction formula.
You must know how to apply the factors that the courts have laid down to assist in deciding
whether an amount is of a capital or a revenue nature. Remember that the result of the factors
will give an indication only of whether an amount is of a capital nature or not. Each case must
be decided based on its own unique circumstances. These factors involve the following
questions:
• What is the true nature of the transaction?
• How closely connected is the expense to the income-earning operations (revenue) or income-
earning structure (capital)?
• Does the expense create an asset or advantage with an enduring benefit?
• Does the expense relate to fixed or floating capital?
• Was the expenditure "once and for all"?
• What is the nature of the business being carried on?
If an expense is of a capital nature, it may not be deducted for income tax purposes in terms of
section 11(a). However, you must keep in mind that the rest of section 11 up to section 19 does
make provision for specific deductions.
Remember that when you are arguing whether an expense is of a capital nature,
your conclusion may not always be perfectly correct, but if your reasons in
arriving at your conclusion are logically explained and supported by relevant
facts from both the Act and court cases, marks will be awarded.
Group Activity 1:
Complete this activity in the Group Activities forum.
Information
To determine whether an expense is of a capital or not, the courts have laid down certain
principles or norms in deciding the matter.
Required
List these principals or norms, together with a relevant tax court case(s) and related
principle(s) applicable in deciding whether expenditure is of a capital nature or not.
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5.3.6 Laid out or expended for the pur-
Textbook section: 7.3.6
poses of trade
Study section 7.3.6 in the prescribed textbook.
All the above requirements must be met for an amount to be deductible. Section 23 must then
be consulted to see if any of the amounts are not allowed because they are listed as prohibited
deductions in section 23 of the Act.
“Trade” is a term that is defined in the Act and therefore expenses that are only for the purpose
of trade will be considered for deduction. This means that where an expense is not for trade
purposes, it cannot be deducted from income. Alternatively, where an amount is for both trade
and other purposes, it will then be apportioned between trade and the other purpose. The trade
portion of the expense may then be deducted for income tax purposes if it complies with all the
other requirements.
For example, Mr Abe attends a business conference in Cape Town for two days and stays on
for the weekend (three additional days). The total cost of the trip amounts to R10 000. He may
consider deducting R4 000 (R10 000/5 days x 2 days) for income tax purposes. Remember that
all the other requirements must also be met before he may deduct this amount.
There are various appropriate bases for this splitting (apportionment) of the expense between
trade purposes and other purposes.
Self-assessment Activity 1:
Complete this activity in the Self-assessment Activities forum.
Information
Joel Andrews is the managing director of Tax Hub (Pty) Ltd. After there had been broken into one
of the company’s offices on several occasions, Joel purchased a watchdog. He paid R10 000 for
the dog and spent R1 000 a month on its food.
Required
Determine whether the amounts above will be deductible from the taxable income of Tax Hub
(Pty) Ltd for the current year of assessment.
5.4 PROHIBITED DEDUCTIONS
Textbook section: 7.4
(section 23)
Study section 7.4 in the prescribed textbook.
Certain expenses will comply with all the requirements set out in section 11(a), but SARS is
unwilling to allow them as deductions for tax purposes, because (as you will notice) in most of
the cases listed in section 23 (the negative test), the expenses do not further the aims of income
tax collection.
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Make sure that you know which expenses are not deductible for income tax
purposes, as listed in section 23. Remember that these expenses will never be
deductible, even if they do fulfil the requirements of the general deduction formula.
Group Activity 2:
Complete this activity in the Group Activities forum.
Information
Even though an expense may qualify as a deduction in terms of section 11(a), it may
nevertheless be disallowed as a deduction by another section in the Act.
Required:
List (in summary) the expenses that are not deductible for income tax purposes according to
section 23. Further state the conditions that need to be met where applicable.
Apply the following format:
No Section number Expenditure Summary of condition(s)
1. E.g., s23(a) Private maintenance Cost incurred in maintaining the taxpayer,
expenditure their family member or establishment is
not deductible.
2.
3.
4.
5.5 SPECIFIC TRANSACTIONS Textbook section: 7.5
Study section 7.5 in the prescribed textbook.
In terms of the definition provided in section 1 of the Income Tax Act, any employed taxpayer is
“trading”. However, salaried taxpayers are, in terms of section 23(m), prevented from deducting
any section 11 expenditure – except for certain specific expenses.
In learning unit 10, we will cover the limited number of section 11 expenses that a salaried tax-
payer may deduct. We will also study the section 18A deduction (donations) in learning units 6
and 10, that is not affected by the section 23(m) prohibition.
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5.6 SUMMARY Textbook section: 7.6
All the components or requirements that make up the ‘general deduction formula’ must be pre-
sent/ met for an expense to be deductible.
5.7 QUESTIONS Textbook section: 7.7
Work through the practical exam type questions in Learning unit 5. The solutions
to these practical exam type questions will only be made available later during
the course. This reiterates the importance of attempting these questions on your
own, as this will help you to ascertain whether you understand all the topics that
were discussed.
The questions in the tests and the exam will also be based on the application of this theory.
WRAP-UP QUIZ
Once you have worked through all the questions in the textbook and Study guide and completed
all the learning activities under Learning unit 5, you must complete the Wrap-up Quiz and receive
a pass mark of at least 50%, before you can continue with Learning unit 6.
LITERATURE CONSULTED
1. Income Tax Act No. 58 of 1962
2. www.sars.gov.za
3. A Student's Approach to Taxation in South Africa (2024)
4. SILKE - South African Income Tax (2024)
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