Taxation

ACCESS FOR SUCCESS IN

ACCOUNTING

CHAPTER ONE –
THE INCOME TAX MODEL

Unit 7 – The General Deduction Formula

CONCEPT QUESTIONS

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REGENT BUSINESS SCHOOL
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Concept Question 1
Is the following statement True or False?
An expense is regarded to be “actually incurred” by a taxpayer once it has been
paid.

Suggested Solution 1 Correct Option: False

The amount will be considered to be “actually incurred” as long as the taxpayer has an
unconditional legal obligation to pay the amount.

Concept Question 2
ABC (Pty) Ltd carries on a business as a retailer of gas and petrol lamps. The
company recently sold a lamp to a customer under a guarantee. Unfortunately,
the lamp exploded, causing injuries to the customer. ABC (Pty) Ltd paid
damages to the customer.
Select the correct statements or statements from below:
a. The principle from the CIR v Labat case is applicable to this scenario
b. The selling of gas and petrol lamps as a trade, carries with it an inherent
risk of injuries if one of the lamps explodes
c. The amount incurred by ABC (Pty) Ltd as damages for the accident is
not deductible under the general deduction formula, but a special
deduction may be applicable
d. The amount incurred by ABC (Pty) Ltd as damages for the accident is
deductible under the general deduction formula as it is an inevitable
concomitant of their trade
e. The deduction will be prohibited in terms of the ‘negative test’ as the
damages are not incurred in the production of income of ABC (Pty) Ltd

Suggested Solution 2 Correct Option: b and d

The principle from the Port Elizabeth Electric Tramway Co Ltd v CIR case is applicable to
this scenario

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Concept Question 3

From the expenses listed below, select all the options that are considered to
be expenditure of a capital nature. Note that all expenditure is incurred for the
purposes of trade.
a. Rental expenditure for the use of a fixed property
b. The acquisition of plant and machinery for use in the process of
manufacturing, by a manufacturing entity
c. The purchase of a trademark
d. Salaries and wages paid to employees
e. The purchase of trading stock for resale by a retailer
f. Royalties paid for use of a trademark

Suggested Solution 3 Correct Option: b and c

a. Rental– revenue, as this is expenditure that is regarded as part of the cost of

performing the income-earning operations.
b. Acquisition of manufacturing PPE – capital, as this is part of the cost of establishing
or improving or adding to the income-earning structure of the manufacturing entity. It
is expenditure on items that constitute fixed capital, and creates an enduring benefit
for the taxpayer.
c. Trademark – capital, as the purchase of a trademark is considered to be part of
establishing an income-earning structure. A trademark is an intangible asset and it
creates an enduring benefit for the taxpayer.
d. Salaries and wages – revenue, as such expenditure is regarded as part of the cost of
performing the income-earning operations.
e. Trading stock – revenue, as trading stock constitutes floating capital.
f. Royalties – revenue, as the payment is for the use of a trademark, not to obtain
ownership of the trademark. There is no enduring benefit created.

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Concept Question 4
On 1 January 2023, a taxpayer with a February year-end incurred a rental
expense of R180 000 in advance relating to the 12-months from 1 January
2023 to 31 December 2023, for the lease of a business premises. The lease
agreement requires annual rentals to be paid in advance by 1 January each
year.
Select the correct statement or statements from below:
a. Section 11A is applicable in respect of the deductibility of the
expenses incurred by this taxpayer
b. Section 23H is applicable in respect of the deductibility of the
expenses incurred by this taxpayer
c. Only R30 000 can be claimed in the 2023 year of assessment
d. R180 000 can be claimed in the 2023 year of assessment
e. R180 000 can only be claimed in the 2024 year of assessment

Suggested Solution 4 Correct Option: b and c

A portion of the rental expense has been prepaid, as it relates to a period outside the current
year of assessment. The R180 000 can be broken down as follows:

• Current portion (2023 year of assessment): R180 000/12 x 2 months = R30 000
• Prepaid portion (2024 year of assessment): R180 000/12 x 10 months = R150 000

The current portion of R30 000 may be claimed as a deduction in terms of the general
deduction formula.

In respect of the prepaid portion, section 23H would prohibit the deduction in the 2023 year of
assessment, unless one of the exceptions contained in the provisos apply. In this case, the
underlying benefit will not be received within 6 months after the end of the year of assessment,
neither does this relate to an expense imposed by legislation, nor is the total prepaid expense
below R100 000. Therefore, the R150 000 prepaid portion may not be claimed as a deduction
in the 2023 year of assessment. It is deductible in the 2024 year of assessment.

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Concept Question 5
CQ Ltd incurred pre-trade expenditure of R750 000, of which R500 000 related to
the purchase of a factory building. The company commenced trading on 1 June
2022. CQ Ltd has a February year-end. Taxable income for the 2023 year of
assessment was computed as R150 000, before taking pre-trade expenditure into
account. CQ Ltd is only considered to be engaged in one trade.
Select the correct statement or statements below:
a. Only R500 000 will be allowed as a deduction under section 11A for the
2023 YOA
b. The full R750 000 can be claimed as a deduction under section 11A for
the 2023 YOA
c. Only R150 000 can be claimed as a deduction under section 11A for the
2023 YOA
d. Only R250 000 can be claimed as a deduction under section 11A for the
2023 YOA
e. R0 is allowed as a deduction under section 11A for the 2023 YOA

Suggested Solution 5 Correct Option: c

• Only expenses that would normally qualify for a s11 deduction if incurred once trading
commences, will be allowed as a deduction under s11A. The R500 000 to purchase
the building cannot be claimed as a deduction as it is capital in nature.
• Of the total pre-trade expenditure incurred, only R250 000 (R750 000 – R500 000) may
be deducted in terms of s11A. However, the deduction is limited to the taxable income
derived from the trade in respect of which the expenses were incurred.
• In the 2023 YOA, the s11A deduction is ring-fenced to R150 000, which is the taxable
income for that YOA, prior to the s11A deduction.
• The remaining R100 000 may be claimed as a deduction in the 2024 YOA, subject to
the ring-fencing limitation, which is dependent on the taxable income for the 2024 YOA

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Concept Question 6
Ronald is a sole proprietor and carries on trade as a retailer of office supplies and
stationery. During the 2023 year of assessment, Ronald incurred the following
expenses:
a. R15 000 in respect of a billboard erected on the pavement outside his
business premises;
b. R20 000 for a monthly advertisement in a community newspaper;
c. R2 500 in respect of a fine from the local municipality for erecting the
billboard on the pavement and causing an obstruction, which is against
municipal by-laws; and
d. R1 000 to have the billboard moved inside the boundary of his business
premises.
Select which of the expenses are deductible under the general deduction
formula.

Suggested Solution 6 Correct Option: b

a. The R15 000 in respect of the billboard is an expense of a capital nature, as the
billboard creates an enduring benefit for Ronald’s business. Expenditure of this nature
can be seen as part of the cost of improving or adding to the income-earning structure.
Therefore, no deduction can be claimed in terms of the general deduction formula.
b. The R20 000 relating to the monthly advertisements is a recurring expense of a
revenue nature, as it does not create an enduring benefit for the taxpayer. Since the
expense is regarded to be in the production of income, and all other requirements of
the general deduction formula are met, this expense is considered to be deductible by
Ronald.
c. The fine of R2 500 is prohibited as a deduction in terms of section 23(o), as Ronald
contravened municipal by-laws by erecting the billboard on the pavement.
d. The expense of R1 000 to move the billboard is also regarded to be capital in nature,
as it is closely connected to the income-producing structure rather than the income-
earning operations of Ronald’s business.

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