LEARNING UNIT 6

Learning
unit

INTRODUCTION

LEARNING OUTCOMES
6
PRESCRIBED STUDY MATERIAL FOR THIS
LEARNING UNIT

CONTENT OF LEARNING UNIT

6.1 Background
6.2 Foreign exchange transactions
6.3 Trading stock
6.4 Employee-related expenses
6.5 Deductions relating to trade debtors and similar
matters
6.6 Other expenses
6.7.1 Legal expenses
6.7.2 Donations
6.7.3 Future expenditure on contracts
6.7.4 The accrual and incurral of interest
6.7 Double deductions
6.8 Value-added tax (VAT)
6.9 Prepaid expenses
6.10 Pre-trade expenditure
6.11 Assessed losses
6.12 Summary
6.13 Questions Special
WRAP-UP QUIZ deductions
LITERATURE CONSULTED
 2

INTRODUCTION

In learning unit 5, we learnt that a taxpayer, after meeting specific requirements, might claim a de-
duction according to the general deduction formula in respect of expenses actually incurred in the
production of income and in the carrying on of a trade. Not all expenses incurred meet the
requirements of the general deduction formula. Certain expenses may be excluded because they
are capital in nature or that they have not been incurred in the production of income. While such
expenses may be deductible in terms of special deductions allowed in terms of the Income Tax Act
No. 58 of 1962 (‘the Act’), others may not be deductible at all.

INCOME TAX FRAMEWORK

COMPANIES AND CLOSE
CORPORATIONS
R R
Profit or loss as reflected on the
statement of comprehensive (learning unit 2,3 and
income xxxxxxx 5)
Debit adjustments
- Non-taxable amounts credited to the statement of
Less: profit or loss (xxxxx) (learning unit 4)
- Allowances available for tax purposes that were
Less: not claimed in the statement of profit or loss (xxxxx) (learning unit 7)
Credit adjustments xxxxxx
- Non-deductible amounts debited to the
Add: statement of profit or loss xxxx (learning unit 9)
- Amounts not credited to the statement of xxxx (learning unit 2)
Add: profit or loss
- Allowances/deductions granted in xxxx (learning unit 6)
previous year of assessment that are xxxx
reversed in the current year of
Add: assessment
- Recoupment of allowances or expenses xxxx (learning unit 7)
Add: previously allowed as deductions
- Amount specifically to be included in the
Add: determination of taxable income before xxxx
Section18A donations
Add: Taxable capital gains xxxxxx (learning unit 8)
Assessed losses brought forward from
Less: previous years of assessment (xxxxxx) (learning unit 6)
Less: Section 18A donations (xxxxxx) (learning unit 6)
gives: Taxable income xxxxxx
Normal tax (27% or 28% or per Small
Business Corporation [SBC] tax table) xxxxxx (learning unit 9)

In this learning unit, we discuss some of these special deductions as contained in the Act. The
diagram above demonstrates exactly where we are in the taxable income calculation framework.
 3

TAX RATE CHANGE

Take note:

The 2022 budget speech announced that the corporate income tax rate would be reduced to
27% (from 28%) for all companies and close corporations with a year of assessment ending
on or after 31 March 2023.

LEARNING OUTCOMES

After completing this learning unit, you should be able to:

➢ Apply the trading stock provisions to a taxable income calculation.

➢ Calculate the expenses which are deductible in terms of the Act.
➢ Discuss the expenses which are deductible in terms of the Act, with reference to relevant
legislation and case law.

PRESCRIBED MATERIAL FOR THIS LEARNING UNIT

Study Chapter 8 in the prescribed textbook.

CONTENT OF LEARNING UNIT

6.1 BACKGROUND Textbook section: 8.1

In this learning unit, you will learn about special deductions. You may already be familiar with these
deductions from TAX2601, but in this module, you will be required to know more detail with respect
to the deductions. Tax legislation changes every year and some of the sections of the Act may have
undergone changes since you studied TAX2601. It is therefore very important that you revisit these
sections and give them the same level of attention that you give to the sections not covered in
TAX2601 and that are new to you.

6.2 FOREIGN EXCHANGE TRANSACTION

Textbook section: 8.2
(section 1, 24I and 25D)

Foreign exchange transactions typically involve the purchase of an asset or trading stock from an
overseas supplier, with payment being made in a foreign currency. The expenditure or loss incurred
must be translated or converted to South African currency (rand) to determine the amount of the
deduction (such as trading stock acquired which will be deductible under section 11(a)) or to
determine the cost of the capital asset on which a capital allowance can be claimed.
When converting the exchange item (the foreign debt or foreign creditor), a foreign exchange gain
or loss can arise. It is important to identify the following dates for the purposes of determining the
said gain or loss:
 4

• Transaction date: At this date, the debt is actually incurred (when it accrues).
• Translation date: This is any year end after the transaction date and prior to the realisation date.
• Realisation date: At this date, the transaction is finally concluded (i.e. the foreign amount is paid).
The foreign exchange profit/loss will be the difference between the amount as at the realisation date
and the amount as at the transaction date. However, if the year of assessment ends before the
foreign amount has been paid, then the foreign exchange profit/loss will be the difference between
the amount as at the translation date and the amount as at the transaction date. Another foreign
exchange profit/loss will be realised in the following year and it is calculated as the difference
between the amount as at the realisation date and the amount as at the translation date.

Self-assessment Activity 1:

Complete this activity in the Self-assessment Activities forum.

Information

Tax Hub (Pty) Ltd’s year of assessment ends on the last day of March. On 1 December 2022
Free on Board (FOB) the company purchased a new and unused manufacturing machine from
a supplier in another country for a foreign currency (FC) amount of FC100 000.

The machine will be delivered at the company’s premises on 26 March 2023 and brought into use
on the same day. The machine will be used in the approved manufacturing process of Tax Hub
(Pty) Ltd. The purchase consideration was settled in full on 30 June 2022.

Assume that the spot rate on the relevant dates are as follows:
• 1 December 2022 FC = R6.70
• 31 March 2023 FC = R6.84
• 30 June 2023 FC = R6.75

Assume that the average exchange rate for the 2023 year of assessment is as follows:
FC1 = R6.90

Required

Calculate the exchange differences of Tax Hub (Pty) Ltd for the 2023 and 2024 years of
assessment.

6.3 TRADING STOCK (sections 1 and 22) Textbook section: 8.3

In TAX2601, we learnt that section 22(1) of the Act specifically provides that closing stock is income
in the hands of the enterprise, and it must be added to gross income. Conversely, section 22(2)
provides that opening stock may be deducted as an expense. TAX2601 also covered the following
sections with respect to trading stock:
 5

• cost of trading stock

• stock acquired for no consideration
• private and domestic consumption of stock

In this module, we expand on the subject and introduce new topics such as section 23F (anti-avoi-
dance provision), section 19 (debt reduction), section 9C (share dealers) and so on. It is therefore
important that you work through these sections to familiarise yourself with the new content.

Take note of the “Remember” section at the bottom of example 8.11. Not only
does it relate to example 8.11, but it is also a summary of the trading stock sec-
tions that you have just studied.

6.4 EMPLOYEE-RELATED EXPENSES

Textbook section: 8.4
(sections 11(l), 11(m),11(cA), 12H and 7B)

The Act provides for certain other employee-related expenses that may not necessarily be deduc-
tible according to the general deduction formula. You might have come across some of the sections
when studying TAX2601. However, in this module, we cover these sections in more detail. As
advised earlier, it is vital that you devote the same amount of time and effort to these sections as
you do to the sections not covered in TAX2601.

All employer contributions made to an approved pension, provident or retirement

annuity fund will be deductible in full in terms of section 11(l). These include
contributions made for current employees as well as for retired employees. How-
ever, the contributions made by the employer will be taxed as a fringe benefit in
the hands of the employee.

When dealing with a section 11(cA) (restraint of trade) deduction, consider the
following:

Is the restraint for a period of less than three years?

• If the answer is no, the deduction will be the amount received divided by
the number of years during which the restraint of trade will apply. (The
deduction is therefore claimed over the period of the restraint.)
• If the answer is yes, the deduction will be the amount received divided by
three. (The deduction is therefore claimed over three years.)

Do not forget that, irrespective of the terms of section 23B (prohibition of double
deductions), allowances under section 12H (learnership agreements) are as
follows:
• an annual allowance on a registered learnership agreement AND
• a completion allowance of a registered learnership agreement.

In addition, do not forget that different amounts apply, depending on whether a

person entering the learnership agreement has a disability as defined or not, as
well as the level of the qualification a learner holds of the National Qualifications
Framework (NQF).
 6

For a learnership agreement entered on/after 1 October 2016, the deduction

for a person without a disability as defined will be as follows:

• Annual and completion allowance (for learnership agreements of less than

24 months):
o For a learner who holds a qualification of the NQF levels 1 to 6, the
annual allowance and the completion allowance will be R40 000.
o For a learner who holds a qualification of the NQF levels 7 to 10, the
annual allowance and completion allowance will be R20 000.

For a learnership agreement entered on/after 1 October 2016, the deduction

for a person with a disability as defined will be as follows (for learnership
agreements of less than 24 months):
• Annual and completion allowance (for learnership agreements of less than
24 months):
o For a learner who holds a qualification of the NQF levels 1 to 6, the
annual allowance and completion allowance will be R60 000.
o For a learner who holds a qualification of the NQF levels 7 to 10, the
annual allowance and completion allowance will be R50 000.

‘Variable remuneration’ is widely defined to include, inter alia, overtime pay, bonus or
commission as contemplated in the definition of ‘remuneration’ of the Fourth Schedule
of the Act and leave pay.

This section addresses the situation where there is a timing difference between the accrual and
the actual payment of the variable remuneration (Section 7B).

6.5 DEDUCTIONS RELATING TO TRADE

DEBTORS AND SIMILAR MATTERS Textbook section: 8.5
(sections 11(i), 11(j) and 24)

Under certain transactions involving the sale of trading stock under a suspensive sale agreement,
the whole amount, excluding finance charges, is deemed to be included in the taxpayer's gross
income at the time of entering into the agreement. Section 24 grants the taxpayer a debtor's
allowance which in essence results in the taxpayer to be taxed on the profit under the instalment
credit agreement as the taxpayer receives the cash instalments.

When a debtor cannot pay his/her account and his/her debt is written off, the debt is then allowed
as a deduction. In accounting, the same principle is normally also applied. Sales are recognised as
gross income as soon as the transaction takes place, even though the money has not yet been
received, and the amount is deducted again as an expense if the debtor cannot pay his/her account
and his/her debt is written off.

The amount of an irrecoverable debt, which is deducted as an expense in the statement of com-
prehensive income, is normally allowed as a deduction at the same amount for income tax purposes
(if the amount was never taxable as gross income, no deduction may be claimed in terms of section
11(i) for normal tax purposes). However, this is not the case with “doubtful debts”, as they are not
considered an expense.

The doubtful debt deduction is a tax allowance. Allowances such as these create a difference
between the net profit for accounting purposes and taxable income.
 7

As from 1 January 2019 the allowance that can be claimed in respect of doubtful debts will be split
up between companies applying International Financial Reporting Standards (IFRS) 9 and compa-
nies not applying IFRS 9 accounting standards for financial reporting purposes.

For companies applying IFRS 9, where the companies will not have a lifetime expected credit loss
in respect of their debtors, the allowance will be 25% of the loss allowance relating to impairment.
For companies not applying IFRS 9, the allowance will be 40% of the debt that has been in arrears
for 120 days or more and 25% of the debt that has been in arrears for 60 days or more.

There is another example for companies applying IFRS 9 where the companies will have a lifetime
expected credit loss in respect of their debtors (e.g. banks), but for the purposes of this module, you
can ignore this example.

A reminder from TAX2601 that bears repeating: Do not confuse section 11(i) with
section 11(j) – one is a deduction for debts that have gone bad (i.e. that are not
recoverable), while the other is a deduction of the provision made by the taxpayer
for debts that are doubtful.

Remember to apply the doubtful debt deduction to the list of doubtful debts only,
and not to the full debtors’ balance. If a doubtful debt deduction is claimed in one
year, it must be added back to income in the following year.

Remember to exclude finance charges and VAT (if VAT was levied on the trans-
action) when calculating a section 24 debtors’ allowance.

6.6 OTHER EXPENSES Textbook section: 8.6

6.6.1 Legal expenses (section 11(c) Textbook section: 8.6.1

You may remember this deduction from TAX2601. Legal expenses are, for example, the fees attor-
neys charge when appearing in court and the costs of preparing legal documents such as lease
contracts.

It is important to know which legal expenses are deductible and which are not.
Keep the following general rule in mind: If the expense, which caused the legal
expense, is deductible, the legal expense is also deductible and vice versa.

6.6.2 Donations (section 18A) Textbook section: 8.6.2

Section 18A(3A) deals with immovable property of a capital nature that is donated. The formula A
= B + (C x D) will be used to calculate the deduction.

Remember that a donation deduction can only be allowed if it is supported by a

section 18A receipt/certificate issued by the recipient of the donation.
 8

Did you notice that when an amount is disallowed as a deduction, because the
donation exceeds the 10% allowable deduction, the disallowed amount can be
carried forward to the next year of assessment and it will be deemed a donation
actually paid in that year?

There is no specific sequence in which the items in the tax framework for
companies need to be considered, except the section 18A deduction for
donations to public benefit organisations. This deduction must always be the
last deduction for a company due to the limitation placed on the deductible
amount by the section.

6.6.3 Future expenditure on contracts (section

Textbook section: 8.6.3
24C)

Long-term contracts, for example, the building of a new factory or office building, may have a dura-
tion of a couple of years. A taxpayer building a new building, as in the example, often receives an
amount at the start of the contract to finance future expenses that will be incurred. Section 24C
provides for some deductions to be made against this income to prevent the taxpayer from having
to pay tax on the amount received and consequently, not having money to pay for the actual ex-
penses.

Did you see that the business is effectively paying tax only on the profit portion
of the amount received? Remember that the section 24C allowance received in
the current year must be added back in the following year and that a new allow-
ance must then be calculated and deducted.

6.6.4 The accrual and incurral of interest

Textbook section: 8.6.4
(section 24J)

After working through this section in the prescribed textbook, you will have
noted the following:
• The provisions of the section are not applicable to savings accounts, call
accounts (deposits) and fixed deposits invested for 12 months or less.
• The section deals only with the timing of the accrual or incurral of interest
in connection with a qualifying instrument.
• It provides that interest should be accrued or incurred on a day-to-day
basis.
• The section enjoys precedence over the actual timing of the payment
(incurral) and receipt of interest.
• The section does not influence the decision on the deductibility or non-
deductibility of the interest paid.
• In the case where section 24J is applicable (hence, an ‘issuer’ of an
‘instrument’, the deductibility of the interest paid is regulated from the
borrower’s perspective by the ‘trade’ and ‘in the production of income’
requirement as contained in section 24J(2). It does not have the
requirement of not of a capital nature.
• Should the taxpayer not meet the above requirements, thus, not an
‘issuer’ of an ‘instrument’, then section 24J is not applicable and the
general deduction formula will be considered to determine whether the
interest is deductible.
 9

6.7 DOUBLE DEDUCTIONS (section 23B) Textbook section: 8.7

This section is there to prohibit a taxpayer from claiming an allowance or a deduction by taking into
account more than one provision in the Act.

6.8 VALUE-ADDED TAX (VAT) (section 23C) Textbook section: 8.8

Where a taxpayer is entitled to claim an input tax deduction for a specific transaction, the amount of
VAT must be excluded from the cost of the asset or from the expenditure for income tax purposes.

6.9 PREPAID EXPENSES (section 23H) Textbook section: 8.9

In TAX2601, we learnt that section 23H of the Act limits the amount that may be deducted relating
to a prepaid expense. The deduction is limited to the amount that relates to the goods or services
actually supplied during the year of assessment – therefore, the prepaid expense is not allowed as
a deduction.

This limit will not apply (in other words, the prepaid expense will be allowed as a deduction) if the
prepaid amount relates to goods or services that are to be rendered within six months after year
end, OR where the total of all the prepaid expenses does not exceed R100 000. In other words, if
only one of the limits is applicable, then the prepaid portion will be deductible, but if both limits apply
(> 6 months and > R100 000), the prepaid portion will not be deductible.

Self-assessment Activity 2:

Complete this activity in the Self-assessment Activities forum.

Information

Tax Hub (Pty) Ltd’s year ended 31 March 2023. The company made the following payments
before year-end:

• Rent of R105 000 for the period 1 January 2023 to 31 December 2023.
• Maintenance services contract of R600 000 for the period 1 June 2022 to
31 May 2023.

Required

Calculate the allowable deduction for the two payments above for the year of assessment ending
on 31 March 2023.
 10

6.10 PRE-TRADE EXPENDITURE (section 11A) Textbook section: 8.10

Note that the types of expenses that are allowed as a deduction must be costs
that would have been deductible had trade commenced. Therefore, costs of a
capital nature will not be deductible.

6.11 ASSESSED LOSSES (section 20) Textbook section: 8.11

An assessed tax loss arises when the deductions of a taxpayer exceed the income of a taxpayer
for a specific year of assessment. If a taxpayer subsequently produces income that is more than
the deductions allowed in that subsequent year, an assessed loss could be deducted against the
income, to the extent that the amount of such set-off does not exceed the higher of R1 million and
80% of the amount of taxable income (before taking the assessed loss into account).

6.12 SUMMARY Textbook section: 8.12 & 8.13

In this chapter, certain business deductions are discussed for which special provision has been
made in the Act.

6.13 QUESTIONS Textbook section: 8.14

Work through the practical exam type questions in Learning unit 6. 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 completed the activities in the
Study Guide, you must complete the Wrap-up Quiz on Learning unit 6 on myUnisa.

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 (2022)

4. SILKE - South African Income Tax (2022)