Taxation

ACCESS FOR SUCCESS IN

ACCOUNTING

CHAPTER ONE –
THE INCOME TAX MODEL
Unit 7 – The General Deduction Formula

TUTORIAL SOLUTIONS

Copyright © 2023
REGENT BUSINESS SCHOOL
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Graded Questions on Questions on SA Tax 2023 (Parsons)

Focus area Income Tax in South ([S] indicated below means the solution is
Africa 2023 (Mitchell) found in the book)
General Deduction
6.6, 6.13 3.6, 3.9, 3.11, 3.12
Formula

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SUGGESTED SOLUTION TO EXERCISE 6.6

1 Page only
Damages or compensation
Before damages and compensation paid will be deductible in the determination of taxable income the following two considerations must
both be satisfied:
First, there must be a close connection (nexus) between the trade or business carried on and the cause of the liability for damages.
And secondly, the negligence must have been an inevitable concomitant of that trade.
Applying the above two considerations to the six situations listed below, the following conclusions are reached:
Fred Ford
Fred Ford may not deduct his damages and the legal costs he incurred in the determination of his taxable income. Before he could enjoy
a deduction in the determination of his taxable income he would have to establish that his driver’s act in damaging David Dent’s car,
was the inevitable, or practically inevitable, result of his contract with David Dent or of the business he carried on. The facts of this issue
do not justify that conclusion (Weinberg v CIR (1946 CPD 429, 14 SATC 210)).
Beefy Lamb
The compensation paid by Beefy Lamb to Dianne Cutter will not be deductible in the determination of his taxable income, since negligence
of this nature is not an inevitable concomitant of the business of a delicatessen. He may not therefore deduct the damages he paid to her
in the determination of his taxable income.
Ticky Bird
In ITC 1002 ((1963) 25 SATC 231) the amount paid by an accountant to protect his good name as a professional man was deductible in
the determination of his taxable income. The argument was that the settlement was induced by a desire to avoid legal proceedings and
undesirable publicity, that may have arisen out of his poor administration of the affairs of a client. This was sufficiently closely linked
to his business operations.
Ticky Bird may therefore deduct the amount she incurred in the determination of her taxable income.
Trustmore & Co
Compensation paid by Trustmore & Co to a client as a consequence of the misappropriation of funds by Lucy Klepto, an employee of
the partnership, is not deductible in the determination of its taxable income (ITC 894 ((1959) 23 SATC 475)).
Walker and Seymour (Pty) Limited
If a guarantee is given so as to secure the work that earns the income, then the guarantee carries with it the inherent risk that the income
to be earned may be diminished by the cost of fulfilling the guarantee. A cost of this nature is expenditure incurred in the production of
the income and is deductible in the determination of taxable income.
Walker and Seymour (Pty) Limited would be able to deduct the compensation it incurred in the determination of its taxable income since
the risk was incurred by it when it secured the contract.
Speedy Gonzalis
Fines incurred in the carrying out of business operations cannot be regarded as constituting expenditure incurred in the production of the
income and thus cannot be deducted in the determination of taxable income.
Speedy Gonzalis’s employer cannot deduct the fines incurred for both speeding and parking offences in the determination of its taxable
income (ITC 1199 ((1973) 36 SATC 16) and ITC 1490 ((1990) 53 SATC 108)).
In any event, the deduction of certain fines in the determination of taxable income in prohibited by the provisions of section 23(o)(ii).
Further information
Reference to Silke in § 7.27 should be made for further examples on the deduction of damages and compensation payments in the
determination of taxable income.

**2023**

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SUGGESTED SOLUTION TO EXERCISE 6.13

Page 1 of 2 pages
Trevor Sellmore
Entertainment expenditure is deductible in the determination of taxable income under section 11(a) if it can be proved that the
expenditure
• was incurred directly in the production of the income,
• not of a capital nature, and
• has been expended for the purpose of trade (section 23(g) refers).
Although Trevor Sellmore receives commissions, he does not earn his income from ‘remuneration’ as defined. He is carrying on an
independent trade. The insurers who pay him do not control the manner in which his duties are performed nor do they control his hours
of work. In addition, he is not paid by them on a daily, weekly or monthly basis.
Since Trevor Sellmore’s income is not from remuneration, the provisions of section 23(m) are also inapplicable. They apply only when
the income earned is derived from the remuneration of a person in employment or an office holder (other than an agent or representative
whose remuneration is normally derived mainly in the form of commissions).
• The R9 540 expended by Trevor Sellmore on lunches, etcetera, is deductible in the determination of his taxable income under
section 11(a). Only amounts incurred directly in the production of his income were charged to this club account. These can be
substantiated from his diary and club accounts.
• Because Trevor Sellmore’s trade is the selling of insurance, this entails the meeting of business contacts. The related expenditure is
incurred directly in the course of his trade. But to be deductible in the determination of his taxable income under the provisions of
section 11(a), they must be incurred in the production of his income. And since the club subscriptions of R7 920 were not incurred
directly in the production of his income they are not deductible in the determination of his taxable income under section 11(a).
• One-third of Trevor Sellmore’s personal liquor account is also not deductible in the determination of his taxable income under
section 11(a), since it was not incurred directly in the production of his income. It would be extremely difficult for him to prove a
direct link between the R6 120 expenditure he incurred and the income that may be produced by it.
The provisions of section 23(g) also apply to Trevor Sellmore and if the expenditure was not incurred for the purpose of trade it would
not be deductible in the determination of taxable income. But to the extent that an apportionment can be made, he will enjoy a deduction
in the determination of his taxable income for the trade portion of expenditure that has been incurred for a dual purpose.
Gavin Fairway
Since Gavin Fairway is a
‘agent or representative whose remuneration is normally derived mainly in the form of commissions based on his . . . sales or the
turnover attributable to him’
his entertainment expenditure may be deducted in the determination of his taxable income under the provisions of section 11(a)
(section 23(m) refers).
Under the provisions of section 11(a), the R6 000 annual subscription, the R18 000 golf costs, and the R11 500 entertainment expenses
incurred by Gavin Fairway will be deductible in the determination of his taxable income.
But Gavin Fairway’s R20 000 entrance fee to the Lush Golf Club, being of a capital nature will not be deductible in the determination
of his taxable income.
Taxable income
Commissions 195 500
Less section 11(a) deduction (R6 000 + R18 000 + R11 000) 35 000
160 500
Add entertainment allowance 24 000
Taxable income 184 500
Salmon and Trout
Expenditure incurred on entertainment may, to the extent that it is incurred for the purposes of trade, be deducted in the determination
of taxable income under the provisions of section 11(a). This provision caters for non-capital expenditure incurred in the production of
the income. But entertainment expenditure that is not deductible under section 11(a), is not deductible under any other provisions in the
determination of taxable income.
Roe Salmon and Cod Trout are not deriving their income from remuneration. They are carrying on their trade independently of the
persons who pay them the fees they charge. Since they are not earning ‘remuneration’ as defined, the provisions of section 23(m) do not
apply to them. Their entertainment expenditure is deductible in the determination of their taxable incomes.
Pinkie Salmon earns ‘remuneration’ as defined. She earns her income in the form of commissions. But then since her ‘remuneration’ is
normally derived mainly in the form of commissions, she will not be subject to the provisions of section 23(m).

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SUGGESTED SOLUTION TO EXERCISE 6.13

Page 2 of 2 pages
Section 23(m) prohibits the deduction in the determination of taxable income of entertainment expenditure unless the remuneration has
been normally derived mainly in the form of commissions. And then since Pinkie Salmon’s remuneration has been derived solely in the
form of commissions, she may consider her entertainment expenditure incurred for deduction in the determination of her taxable income
under the provisions of section 11(a), the general deduction formula.

Gift Ofthegab
Expenditure incurred on entertainment will, to the extent that it is incurred in the production of the income, be deducted in the
determination of taxable income under the provisions of section 11(a). This provision caters for non-capital trade expenditure incurred
in the production of the income.
Gift Ofthegab will be able to deduct in the determination of his taxable income the annual subscriptions paid to the BMW Drivers Club
and to the Durban Yuppie Club, and the amounts paid for meals and refreshments at these two clubs under the provisions of section 11(a)
and section 23(g) (the general deduction formula). Therefore he will deduct in the determination of his taxable income, in total, R52 400
(R1 000 + R2 400 + R27 000 + R22 000) under the provisions of section 11(a).
No expenditure incurred by Gift Ofthegab at, or in relation to, the School Old Boys Club will be deductible in the determination of his
taxable income since it is of a domestic nature (section 23(a) and (b)).
Gift Ofthegab’s club subscriptions of R1 200 paid to the Roy Hesketh Motor Racing Club and the R7 200 incurred on meals and
refreshments, amounting to R8 400 (R1 200 + R7 200) in total, should also deductible in the determination of his taxable income under
section 11(a). But an entrance fee is capital in nature, and therefore the R4 000 incurred on it will not be deductible in the determination
of his taxable income.
Entertainment expenses deductible in the determination of his taxable income
BMW Drivers Club and the Durban Yuppie Club (section 11(a) (see above)) 52 400
Roy Hesketh Motor Racing Club (section 11(a) (see above)) 8 400
60 800
Taxable income
Commission less related expenditure 1 848 000
Less entertainment expenditure (section 11(a)) 60 800
Taxable income 1 787 200

**2023**

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CHAPTER 3 : GENERAL DEDUCTION FORMULA

SOLUTION 3.6

1, While the deduction of fines imposed are generally against public policy, in this case the fine is deductible, as it is (4)
not imposed by legislation and it is an inevitable concomitant of Wizard’s income-earning activities i.e. in
horseracing there may be times where the jockey cannot keep the mount on a straight course with resultant
interference. S23(o)(ii) prohibits the deduction of fines for any unlawful activity and would cover fines imposed by
legislation. It is submitted that Wizard Whipp will be able to deduct the fine.

2, The campaign and election expenses were incurred to secure his seat (the income generating asset), which is
capital in nature, and the related expenditure is therefore not deductible (New State Areas ).

No specific deductions exist for expenditure of this type and so no deduction is permitted. (3)

3, The groceries are used for both trade and non-trade purposes. The cost should be apportioned and only the (5)
portion relating to the experimental-type meals is deductible (s23(g)). The onus of proving the apportionment
would rest with Betty. If Betty derives 'remuneration' from her articles s23(m) would prohibit a deduction.

4, The purpose of the borrowing was to generate income and the interest incurred from the date the flats were made (4)
available for letting will therefore be deductible under s24J as it was incurred in the production of income (Allied
Building Society ). However the interest incurred before flats were available for letting may be deducted in terms
of s11A on the assumption that Cluster Homes had not commenced trading before the flats were let. The s11A
deduction is deferred and claimed in a lump sum in the year in which the trade commences. The remaining interest
could be claimed in terms of s24J i.e. interest incurred after trading had commenced.

5, Although the trip is a vacation for Maha and his friend, it is not a vacation taken by the employer. It is important (3)
to distinguish the employer from the employee. Moodley Manufacturing have incurred an expense in respect of
the cost of employment of one of its employees. The expense is incurred in the production of income (employees
produce income for the employer) and is not of a capital nature. The full amount is deductible in terms of s11(a).

6, George is a resident of the Republic and is taxed on his worldwide income (including his Zambian income). (3)
Expenditure incurred in the production of this income is deductible. Note that section 20 prohibits the set-off of
non-South African losses against South African income. (The Zambian losses if any, would be ring-fenced). The
R50 000 should therefore be utilised against income from his Zambian farm, and any net loss carried forward for
use against future taxable income from outside South Africa.

7, The R2 000 is a “once-off expense from which future benefits will flow” (George Forest Timbers ), being the (6)
restoration of a capital asset. It is capital in nature as it adds to the income-earning structure of the taxpayer,
therefore it is not deductible. The R250 monthly payment is incurred to maintain her income-earning structure
and, therefore, not of a capital nature and may be deducted. There is an argument that the deduction may
constitute expenditure on the maintenance of the taxpayer and so be disallowed in terms of s23(a). If Fanny
derives 'remuneration' from her modelling, the expenditure will not be deductible against this income in terms of
s23(m).

8, The subscription is used for both trade and non-trade purposes. The cost should be apportioned and only the trade (3)
portion deducted for income tax purposes (s23(g)). A 50:50 split may be appropriate.

9, The computer and printer are capital assets and the cost of purchasing them is not deductible under s11(a). (A (4)
s11(e) write off for capital assets would apply). The cost of paper and printer cartridges may be deducted as they
are incurred in the production of income and are not capital in nature.

10, The fines may be incurred in the production of income. However since the fines are imposed by legislation, (3)
(unlawful to overload transport vehicles) the deduction will not be permitted (refer s 23(o)).
(38)

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CHAPTER 3 : GENERAL DEDUCTION FORMULA

SOLUTION 3.9

Case Studies
1, The travelling expenses are expenses incurred for the purpose of acquiring a capital asset. They are therefore (2)
regarded as being of a capital nature and are not tax deductible in terms of s11(a).

2, The advertising expenditure is non-capital expenditure actually incurred during the year of assessment in the (3)
production of the income and it is therefore deductible in full. It is not necessary that the income must be produced
in the year when the expenditure was incurred. Therefore, the expense qualifies for deduction in terms of the
general deduction formula.

Not part of required: However s23H will apply to allow as a deduction each year the proportion of the expenditure
for which benefits have accrued. As the amount is not less than R100 000 and the benefit extends more than 6
months after year-end, the deduction can only be claimed in respect of the portion relating to services rendered in
each year.

3, The deduction of R3 600 from income would not be allowed because the cost incurred in placing a child in a day (3)
nursery was not incurred in carrying on the business of a typist. It is therefore not deductible in terms of section
11(a). Furthermore, because it is a domestic or private expense it is also not allowed as a deduction from income in
terms of s23(a).

4, The subscription to the income tax service incurred by Percival Caster represents trade subscriptions. These are (3)
deductible from income in terms of the general deduction formula, being laid out for the purpose of earning his
trade income and not of a capital nature.

5, Travelling expenses between a taxpayers home and his business are not trade expenses (they are private). Travel (3)
between an office and clients is clearly a trade related expense. The situation is more complex where the travel is
between one business and another separate business which is not related to the first. It is submitted that SARS will
probably regard such travel as not being trade related and will consequently not allow a deduction.

6, Where a taxpayer's business is conducted from two places, and one of these is chosen by the taxpayer for his own (4)
private (or domestic) reasons, the inter-place travelling expenses cannot be said to be in the production of the
income - see CIR v de Villiers . Yet if the exigencies of the taxpayer's business compel the taxpayer to conduct part
of his professional activities from home, then the expenditure will be deductible in terms of section 11(a), being non-
capital trade expenditure incurred as part of the taxpayer's income-earning operations.

The private kilometres travelled by a 'judge' or a 'constitutional court judge' between the judge's place of residence
and the court over which the judge presides, must be deemed to be kilometres travelled for business purposes in
terms of par 7(8A) of the Seventh Schedule.

7, The Alsatian has been purchased for trade purposes (to perform the duties of a watchdog). The R3 000 paid for the (4)
purchase of the dog is a capital expense - a one-time expense from which an enduring benefit will flow.

The monthly cost of maintaining the dog (R600 to feed him each month) does not create an enduring benefit, and is
an expense which is a necessary concomitant of the taxpayer's trade, and is therefore deductible.

The R3 400 veterinary surgeon's account are expenses which are likely to recur from time to time and therefore will
also be deductible for normal tax purposes.

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SOLUTION 3.9 continued

8, Income is produced by the performance of a series of acts, and attendant upon these acts are expenses. These (4)
expenses are deductible expenses, provided they are so closely linked to these acts as to be regarded as part of the
cost of performing them. It must be expected that Flora Bloom will from time to time incur expenditure
compensating her driver when he is bitten by dogs while delivering her flower orders. This type of expense is
closely linked to any business involved in delivering goods to homes. The medical expenses of R13 500 would be
allowed as a deduction.

The R1 000 she paid to him towards new clothing was not necessarily incurred. But the words of the statute are
'actually incurred' and not 'necessarily incurred' and as Flora Bloom actually paid Simon the amount it will therefore
be allowed as a deduction.
(26)

CHAPTER 3 : GENERAL DEDUCTION FORMULA

SOLUTION 3.11

Mr Dusty Noble
Taxpayers are taxed on the earlier of receipt or accrual. Therefore Dusty would be taxed on the R300 000 in his 2022 (3)
year of assessment, as he became unconditionally entitled to this amount on 12 July 2021, unless the delay in payment
related to some action (or non-action) by Dusty in the intervening period.

Although this amount is of a capital nature (being a compensation for loss of the taxpayer’s right to trade freely), it is
specifically included in the definition of gross income, para (cB) (Previously in terms of para (cA)).

Dusty became unconditionally obligated to pay damages of R100 000 when the court handed down its decision on (3)
19 February 2023, and therefore the amount was incurred on this date (Golden Dumps ). The question that needs to be
answered in order to determine whether or not Dusty can get a section 11(a) deduction for the R100 000 is whether the
amount is in the production of Dusty’s income and whether it was laid out for the purposes of trade.

The amount is not capital in nature, nor is it a repayment of restraint deductible in terms of s11(nB) (note: it is (2)
submitted that s11(nB) should be amended to refer to gross income para (cB) as well as para (cA)), since Dusty
remains subject to the restraint and has not enhanced his income-earning structure (New State Areas ) or obtained any
enduring benefit (British Insulated and Helsby Cables ).

It is submitted that, since the repayment is so closely connected to Dusty’s business operations, it is in the production of (3)
his income (see Port Elizabeth Electric Tramway ) and was also laid out for the purposes of trade. The repayment was
incurred solely because Dusty was attempting to earn income and trade.

The amount is therefore deductible in terms of s11(a). (1)

(12)

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CHAPTER 3 : GENERAL DEDUCTION FORMULA

SOLUTION 3.12

Lawn Limited
PART 1 R
Sales gross income 336 000 (1)

Purchases s11(a) ( 147 000) (1)

Compensation paid to If it can be shown that the amount was paid in terms of an employment 0 (2)
dependants contract or established practice of the employer the amount may be accepted as
(R150 000) incurred in the production of income (Provider ). In the absence of such
evidence, this payment does not have the nature of an inevitable concomitant
of taxpayer's trade / risk of happening separable from the trade. (PE Electric
Tramways, Joffe, Rendle ).

Prepaid expenses s11(a). S23H does not apply as service to be received in first 6 months of next ( 184 000) (2)
(R184 000) year of assessment of Lawn Ltd. The fact that it is above R100 000 is
irrelevant.

VAT penalties No deduction - prohibited by 23(d) and not in the production of income 0 (1)

Lawnmowers Recovery of cost of trading stock already deducted in terms of 11(a) (therefore 6 000 (2)
no further deduction when destroyed). Also, s23(c) specifically prohibits any
loss or expenditure to the extent it is recoverable under any contract of
insurance. Recoupment in terms of s8(4)(a) arising from compensation
received.

Compensation receipt Lost sales, revenue nature (Burmah Steamship ) 180 000 (2)
Portion relating to bad publicity, capital nature (R232 000) 0 (1)

Taxable income 191 000

PART 2
i) FALSE S23(b). The area of the domestic premises has to be used exclusively and regularly for (3)
business and specifically equipped for purposes of the taxpayers trade. Also, her duties have
to be performed mainly at home or, if she is an agent or representative earning mainly
commission, mainly otherwise than in an office provided by her employer.

(i.e. No deduction from income)

ii) FALSE The case concerned the general deduction definition, (not gross income), regarding whether (2)
payment was of a capital nature.
(17)

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