ALLOWABLE

DEDUCTIONS Lecture 4
 ALLOWABLE DEDUCTIONS
4.1 Allowable deductions [Section 15]
These are amounts that the Commissioner would allow to be deducted from the
gross income so as to arrive at the taxable income.
Section 15 of the ITA provides a guide that helps to identify expenses which are
allowable for tax purposes.
The general deduction formula gives a general guide as to the type of expenses
that are allowed for tax purposes.
The specific deduction formula provides guidance on the specific expenses
which can be deducted and how they should be deducted.
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4.2 General deduction formula
These are general principles which give guidance on whether an expense is
deductible.
Each and every taxpayer’s expenditure should be tested against this formula
before being treated as deductible.
Section 15(2)(a) of the Income Tax Act [Chapter 23:06] gives the general
deduction formula which states that:
The deductions allowed shall be—
Expenditure and losses to the extent to which they are incurred for the
purposes of trade or in the production of the income except to the extent to
which they are expenditure or losses of a capital nature.
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(a) Expenditure and losses actually incurred
Only expenditure and losses incurred by a taxpayer are deductible.
Expenditure is incurred intentionally by a taxpayer.
A loss is an involuntary expense, incurred unintentionally and fortuitously; an example is when a
taxpayer fails to recover an amount owed by a debtor (bad debt).
The expenditure or loss must have been actually incurred.
Incurring an expense does not mean the expense must have been paid for but includes a liability
which have been assumed.
Notional expenses such as provisions for depreciation, provision for director’s fees etc. are not
deductible.
The obligation must be an unconditional legal obligation (Edgars Stores Ltd V Commissioner For
Inland Revenue 50 SATC 81 (A) – 1988)
If a payment is conditional on the happening of an event, whether suspensive or resolutive, the
expense is only actually incurred once the condition has been met.
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Important points!!!
There’s no deductions for contingency provisions, transfers to reserves.
NO deductions for items in dispute- SEE, COMMISSIONER FOR INLAND
REVENUE v GOLDEN DUMPS (PTY) LTD 55 SATC 198 (A) - 1993
NO deductions for notional losses or opportunity costs-
NO deductions for unrealized losses.
Unquantifiable expenditure is deductible in the year it is quantifiable.
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(b) Incurred for the purpose of trade

Only expenditure or losses associated with the taxpayer’s trade is deductible.

Trade refers to the ordinary income earning activities of taxpayer.

 ALLOWABLE DEDUCTIONS
The courts apply the following tests in order to establishing whether expenditure
was incurred in the course of the taxpayer’s trade.
a) Artificial or contrived structures-a trade must involve genuine and planned
activities that a taxpayer does.
b) Financial or other risks involved- A taxpayer has to risk something with the
objective of making profit.
c) The profit motive-the primary motive of undertaking a trade should be to
make profit
d) Continuity of the activities-although not very important in the case of a
company, the principle is important in the case of an individual.
e) Active business, NOT passive- a trade results in active income not passive
income such as interest or dividends.
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(c) In the production of income
The phrase seeks to cover expenditure which is incurred in the production of
income which is however not directly linked with the taxpayer’s trade.
The courts are known to apply the following tests:
i. Closely connected test / inevitable expenditure
The test postulated is to enquire whether the purpose of the expenditure is to
produce income and if so was it necessary for the performance of the act
which generates the income or even attached to it by chance and was the
expense so closely connected with the income earned that it may be regarded
as part of the cost of performing it. See, Port Elizabeth Electric Tramway
Company Ltd V Commissioner For Inland Revenue 8 SATC 13.
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Expenditure must be:
a necessary expense in order to perform the act intended to generate income.
Attached to the act by chance.
Bone fide incurred for the more efficient performance of the act.

The case of JOFFE & CO (PTY) LTD v COMMISSIONER FOR INLAND

REVENUE 13 SATC 354 (A) – 1945 amplified the meaning of the phrase in
the production of income. The following principles were added:
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The expense should not be incurred as a result of the taxpayer’s negligence for
it to be deducted.
Expenses incurred which are not related to the taxable income may not be
deducted e.g;
dividend income from a local company is exempt (Not income) so any
expenses incurred with respect to the earning of the dividend can’t get a
deduction.
The purpose of the expense must be to produce income, even if no income was
made.
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(d) Expenditure and losses of capital nature

Distinguishing between capital and revenue expenditure is not a simple task.
The capital-revenue distinction is surrounded with complexities.
Over the years; the courts have applied the following tests among other tests, to
explain the nature of expenditure.
1. Income-earning structure vs. income-earning operations test
Expenditure associated with income earning-structure is capital, expenditure incurred
on income earning operations is revenue.
2. Expenditure incurred in creating or acquiring an income producing concern,
machine or structure-Expenditure on acquiring an income producing concern is capital.
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3. Expenditure incurred in creating an enduring benefit or advantage to a taxpayer-
expenditure meant to producing lasting benefit to a taxpayer is capital in nature.

4. Recurrence nature of expenditure/ “once and for all” test- once off expenditure is
usually capital in nature while recurrent expenditure is revenue in nature.

5. Expenditure on Fixed or floating capital- floating capital is revenue expenditure

and fixed capital is capital expenditure.
Floating capital changes form while earning income while fixed capital keeps its
form while earning income.
.
 PROHIBITED DEDUCTIONS

PROHIBITED DEDUCTIONS: SECTION 16 OF THE INCOME TAX

ACT [CHAPTER 23:06]
This section specifies the expenses which should not be deducted in calculating
taxable income.
The section is a favourite of examiners but most students fail to grasp that and
are, as a result found wanting.
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DETAILS OF SPECIFIC PROHIBITED DEDUCTIONS
Section 16 Paragraph 1
(a) Cost of incurred by a taxpayer in maintaining himself, his family or his
establishment.
Example: cost incurred by a taxpayer on food, school fees, clothing of himself or his
family.
(b) Private expenses- which includes the cost of travelling between his home and the
place at which he carries on a trade and, in the case of a taxpayer who carries on two
or more trades which are distinct in nature, between the places at which such trades
are carried on.
(c) Any loss or expense which is recoverable from an insurance contract or indemnity.
Example: ABC ltd has its car accident damaged; the value of the car at date of
damage was $15000. The company received $10 000 only from Eagle insurance. The
loss claimable as deduction is only $5000 (unrecovered)
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(d) Tax levied upon the income of a taxpayer or interest on overdue tax payable
thereon.
What this paragraph simply mean is that no tax on other tax head can be claimed
against another tax head, for instance, VAT, PAYE penalty etc suffered by a taxpayer
cannot be allowed as deduction.
(e) Transfers to reserves – profit which has been transferred to reserves is not
deductible.
In corporate accounting there are transfers to which can be made from profit and
loss account to reserves an example is a transfer to a general reserve. Such transfers
are not expenditures fit for deduction.
(f) Expenditure or loss including assessed losses, incurred in the production of income
which is exempt from tax.
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(g) Unapproved contribution made by a taxpayer to a fund established for the
purpose of providing pensions, annuities or sickness, accident or unemployment
or other benefits for employees or the widows, children, dependants or nominees
of deceased employees or for all or any of those purposes, except to the extent
permitted in the sixth schedule.
Only contributions to funds approved or registered in accordance with laid
down procedures are deductible, subject to imposed limits.
(h) Interest which might have been earned on any capital employed in trade. This
is an opportunity cost as a result of opportunity lost when capital is tied up, say in
stocks or debtors.
(i) The rent of, or cost of repairs to, any premises not occupied for the purposes
of trade, or any dwelling house or domestic premises, except such part thereof as
may be occupied for the purposes of trade.
(j) Cost of securing sole selling rights. An example is when company A pays
Company B a certain sum of money so that company B sells only A’s products.
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(k) An amount in excess of US $10 000, for 2015 Tax Year, paid for leasing a
passenger motor vehicle(PMV).
The reason for this limitation is obviously that; it is not rationale for a person to
incur more in hiring a car (PMV) than it could have spent in buying the car outright.
Remember the deemed cost of a PMV is $10 000.
(l) The cost of any shares awarded by a company to an employee or director.
(m) Any expenditure incurred by any taxpayer on entertainment whether directly or
by the provision of any allowance to any employee including a director to incur
expenditure or entertainment on behalf of the taxpayer.
This is commonly examined, expenditures incurred on say, Christmas parties or
Christmas hampers is not allowable to the employer.
(n) Expenditure incurred in the production of any income arising from stocks or
shares of any company. Foreign dividends accruing to a Zimbabwean resident is
taxable gross, no deductions are allowable in respect of those income.
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(o) Expenditure incurred in the production of income consisting of interest payable
by a bank, finance house , discount house or building society on any loan or deposit
with such institutions.
The reason for this prohibition is that the interest from financial institutions is
exempt from further tax.
A withholding tax is deducted at source and the interest is not subject to further
tax.
(p) Provisions for anticipated or contingent losses or expenditure.
It is accepted accounting principles of deducting provisions as expenses, examples
of provisions are: provisions for depreciations, provisions for bad debts, provisions
for refunds on customers. Such provisions are prohibited under this paragraph.
(q) Expenditure incurred in earning foreign dividends.
(r) Mining Royalties - With effect from 1 January 2015, royalties paid during the
year of assessment will no longer be tax deductible.
 SPECIFIC ALLOWABLE DEDUCTIONS

These are covered by

section 15(2)(b) and will be
covered under employment
income taxation and
taxation of companies.
 SPECIFIC ALLOWABLE
DEDUCTIONS
AAA Ltd has a 31 December year end.
For the following expenditure, calculate the deductions available for a company that has a profit of
$10,000,000 before taking into account the items mentioned below
Carrying on a trade
• The company bought shares in A Ltd, a company listed on the ZSE, for $100,000 as an investment. The
company paid $10,000 interest on a loan specifically taken out to buy these shares. They received $5,000
dividends from these shares.
Expenditure and losses
• The company wrote off depreciation of $120,000 during the year.
Actually incurred
Caltex case application
• The company promised to give the sales manager a new BMW 7 series if he exceeded sales targets for the
year. The BMW would be given on 31 January of the next year. The sales target was exceeded in September
when the cost of the car would be $600,000. At year end, the car price was $625,000. • In the previous year, a
similar competition was held. The car cost $400,000 at year end. The company eventually paid $420,000 for
the car before giving it to the top salesman.
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Edgars case application

• The company had a lease at Sandton City shopping centre. In March of each year,
the company pays a top up of rent. The company has an annual rental of $480,000
for the shop. If the company turnover for the shop is greater than $10,000,000, the
company pays 5% of turnover for each $1 of turnover above $10,000,000 for the
year March to February. At the end of December, turnover was $9,800,000 for the
Sandton shop. By the end of February, turnover was $11,500,000. • The company
had a lease at Eastgate shopping centre. In March of each year, the company pays a
top up of rent. The company has an annual rental of $360,000 for the shop. If the
company turnover for the shop is greater than $7,000,000 for the year, the company
pays 5% of turnover for each $1 of turnover above $7,000,000 for the year March
to February. At the end of December, turnover was $8,000,000 for the Eastgate
shop. By the end of February, turnover was $10,800,000.
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DEDUCTIONS
• The Eastgate shop pays a bonus to its manager. Turnover from 1 January till 31 December was $11,000,000
for the year. The manager is paid a bonus of 4% of turnover above $10,000,000 for the year January to
December. The company only established turnover for the year on 15 January, 15 days after year end.
Nasionale Pers case application
• The company has a manufacturing division. The division pays a bonus at the end of June each year the
equivalent of a 13th cheque. If an employee is not working for the company in June, they do not qualify for a
bonus. The provision at 31 December was correctly calculated at $100,000. • The company has a sales
division. The division pays a bonus at the end of June each year the equivalent of a 13th cheque. If an
employee leaves, the employee is paid pro rata his bonus for the number of months worked until the date of
leaving. The provision at 31 December was correctly calculated at $120,000.
Golden Dumps case application
• The company was involved in legal dispute 1. If they lose the dispute, $1,000,000 in damages would to be
paid out. (This $1,000,000 would be tax deductible). The lawyer considers that the company has a fair
chance of winning the case. • The company was involved in a legal dispute 2. If they lose the dispute,
$1,500,000 in damages would to be paid out. (This $1,500,000 would be tax deductible). The lawyer
considers that the company has no chance of winning the case and has recommended to management to
settle out of court. Management has ignored the lawyers advice to date.
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DEDUCTIONS
Other application of unconditionally actually incurred
• The company asked a security company to guard their business premises from 15
December till 8 January. They promised to pay an amount of $100,000 to ADT Ltd, a
security company should no stock be stolen over this period. If stock is stolen, the
market value of stock stolen will be taken off the $100,000 price. As at 31 December, no
stock had been stolen.
During the year of assessment
The company forgot to claim a $20,000 consulting fee in the previous tax year.
In the production of income
Sub Nigel v CIR
• The company received $80,000 income last year in advance from B Ltd. The company
incurred $34,000 of expenditure in rendering the services for B Ltd in the current year.
All $80,000 was recognised as gross income in the previous tax year. • The company
incurred $42,000 in expenditure in terms of a new product line that the company started.
The new product line has not yet started producing income from the new product line.
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PE Tramway case
A bus driver was transporting company staff to the factory. There was an accident due to driver error and 3 staff
members were killed and 12 people were injured. The company paid $132,000 in compensation to employees in
respect of the accident. The bus driver had the correct license and the bus was roadworthy.
Joffe case
• The company was involved in the digging of a tunnel. The tunnel was reinforced with an inferior grade of
concrete. The tunnel collapsed killing 2 people. The company paid $120,000 in compensation to the families of
the 2 people.
Not of a capital nature
New State areas case
• The company started a new factory. Sewerage points needed to be connected to the municipal sewerage points.
The council paid for the sewerage work and to recover amounts paid from 1 November: o Charged $2,000 a
month to the company for 60 months to recover costs of sewerage laid down on the company premises.
BPSA V CSARS
• The company obtained the right to open fast food stores from “Taco Hell”, a successful USA fast food chain.
Royalties of $100,000 were paid during the year.
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DEDUCTIONS
Rand Mines v CIR
• The company paid $5,000,000 to take over a contract to manage 72
franchise stores for a fast food chain. The contract was for 6 years and was
estimated to earn approximately $3,000,000 a year for the company.
To the extent of trade
Warner Lambert v CSARS and Nemojim v CIR
• The company donated a BMW 325i car (costing $400,000) to St Sami
school as a prize in the school raffle. They had a dual reason for doing this.
They wanted to advertise the name of the company and they also had a
philanthropic reason. Neither reason was more dominant than the other.
The company did not have an established track record donating to third
parties.
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DEDUCTIONS
Insured losses
• The company incurred $400,000 in a compensation claim for an employee injured in an accident at work. This
accident happened from time to time at work and was usually unavoidable. The claim had been insured against.
$300,000 was received from the insurance as compensation for the payment to the employee.
Tax paid
• The company paid $400,000 in tax during the year.
Reserve transfers
• The company transferred $300,000 from retained income to general reserve
Expenses used to produce exempt income
• The company incurred $20,000 in expenditure to generate local dividend income.
Expenses deductible to the extent of trade
• The company paid $20,000 expenses for something that was 40% for the company and 60% for a shareholder
of the company that did not work for the company.
Corrupt activity or break the law
The company received $30,000 in fines for overloading trucks. The overloading of trucks meant that the
company could deliver more product thereby increasing profitability. • $230,000 was paid as a bribe to
generate business.