Tax 3701

Notes Pack
Lecturers:
S. Lever
E. Hove

Shop U21, Stoneridge Centre, 1 Stoneridge Drive, Greenstone Park, Edenvale, Johannesburg, 1610
Postnet Suite #448, Private Bag x10010, Edenvale, 1610 • www.ebs.co.za • Company Registration 2012/018470/0
 CHAPTER 1
VALUE ADDED TAX

Contents
1. INTRODUCTION TO VAT ...................................................................................................................... 3
1.2 REGISTRATION AND CATEGORIES OF VAT .................................................................................... 5
1.3 OTHER ISSUES ............................................................................................................................... 7
1.3.1BASES OF TAXATION ............................................................................................................... 7
1.3.2 SUBMISSION OF RETURNS ..................................................................................................... 7
1.3.3 YEAR RULE .............................................................................................................................. 8
1.3.4 ARE VAT INVOICES NECESSARY TO CLAIM INPUT VAT?......................................................... 8
1.3.5 DE MINIMUS RULE ................................................................................................................. 9
1.3.6 DISCUSSION OF ENTERPRISE .................................................................................................. 9
1.3.7 HOW NOT TO MAKE MISTAKES IN A VAT QUESTION .......................................................... 11
1.4 TYPES OF VAT .............................................................................................................................. 12
1.4.1 VAT DASH SHEET .................................................................................................................. 13
1.5 HOW TO APPROACH A VAT QUESTION....................................................................................... 17
1.5.1 TYPES OF QUESTIONS........................................................................................................... 18
2. NEW AND SECOND HAND GOODS .................................................................................................... 22
3. ENTERTAINMENT .............................................................................................................................. 27
4. MOTOR CARS .................................................................................................................................... 30
5. IMPORTATION ................................................................................................................................... 37
6. EXPORTS ............................................................................................................................................ 40
7. ACCOMODATION .............................................................................................................................. 43
8. FIXED PROPERTY ............................................................................................................................... 46
9. SHORT TERM INSURANCE PAYOUTS ................................................................................................. 53
10. LEASES ............................................................................................................................................. 57
11. BAD DEBTS ...................................................................................................................................... 59
12. FRINGE BENEFITS ............................................................................................................................ 60
13. OVERPAYMENT ............................................................................................................................... 67
14. CONNECTED PERSONS .................................................................................................................... 70

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15. TRANSPORT ..................................................................................................................................... 72
16. APPORTIONMENT OF VAT .............................................................................................................. 74
17. CHANGE IN USE ............................................................................................................................... 79
18. DISPOSAL OF ASSETS WHERE LESS THAN 100% CLAIMED .............................................................. 87
19. GOING CONCERN ............................................................................................................................ 90
20. CESSATION OF BUSINESS ................................................................................................................ 93
21. GENERAL ......................................................................................................................................... 96

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1. INTRODUCTION TO VAT

VAT can be summarised in the statement below. Thus, if a student ever comes across something
that they cannot understand, they should apply the diagram below.

There needs to be a supply. Only vendors have to

charge VAT.
All sales will lead to a supply. An example of this is
when trading stock is sold, there is a supply of goods. Thus when a normal
person sells their car to
However VAT can still be charged in the absence of a a 2nd hand car dealer, no
sale. An example of this is when a company gives a VAT is charged as that
computer as a fringe benefit to an employee. There is person is not registered
no sale, but there is a supply. There will be VAT as a as a VAT vendor.
supply has taken place.
However when the car
dealer sells the car, VAT
VAT IS LEVIED ON THE SUPPLY OF GOODS AND SERVICES BY A VENDOR will be charged as the
dealer is a VAT vendor
If there is no good or a service, there cannot be VAT. and required to charge
Thus not all expenses will have VAT. VAT.

There will be VAT on trading stock as it is a good.

There will also be VAT on audit fees as it is a service.

But there will be no VAT on depreciation as there is no

provision of a good or a service.

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Illustration A

Rose Loslyf is a prostitute who earns 2M a year. She is a registered vat vendor that trades from her
home.

She issues a tax invoice to Horny Ltd, for the entertainment services provided by her when 2 of their
executives were out of town on a business trip. The invoice includes R3,000 for sleeping with 2 staff
members of staff and R40 for the use of condoms.

Can a vat input be claimed?

Suggested solution

There is:

 a supply
 of goods (condom) or services (the act of prostitution)
 by a vendor (she is registered as a vat vendor)

The vat input can be claimed (however note entertainment rules later in the notes)

Illustration B

A Ltd gives an employee the use of a company car. Are there any vat implications?

Suggested solution

There is

 a supply (note that you do not need a sale - just a supply)

 of a good (the car)
 by a vendor

There will be vat accounted for.

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1.2 REGISTRATION AND CATEGORIES OF VAT

REGISTRATION

When a taxpayer has or is likely to have taxable supplies exceeding R1,000,000, they need to register
for VAT.

Exceptional transactions may take the turnover above R1,000,000. This will not facilitate the
registration for VAT. Exceptional transactions include:

 sale of assets due to the cessation of business

 sale of assets due to a permanent reduction in the scale of an enterprise
 the replacement of any plant or capital asset used by an enterprise,
 sale of assets due to circumstances of a temporary nature.

A vendor can voluntary register for VAT if the turnover exceeds R50,000 for a year.

Once registered, SARS will then allocate a VAT category.

A student cannot answer a VAT question without knowing what the VAT category is. VAT returns
may be submitted monthly, 2 monthly, 4 monthly, 6 monthly or 12 monthly.

CATEGORIES OF VAT

A = 2 monthly (Jan, Mar, May, Etc) for business turnover 1,5 million to 30 million

B = 2 monthly (Feb, Apr, Jun, Etc) for business turnover 1,5 million to 30 million

C = monthly for business with turnover exceeding 30 million.

D = 6 monthly (Feb, Aug) for farmers with turnover under 1,5 million

E = 12 monthly for group that do not trade outside their group of companies.

F = 4 monthly (Feb, Jun, Oct) for business with turnover under 1,5 million

Practical advice to a student

If a question gives information for the period November to February, and the question states that
the vendor is a category B vat vendor, and that a student should discuss the February vat return, the
student should note:

 that only discuss transactions from January and February

 as the vat return is a 2 month vat return (know a category B vendor is 2 monthly)

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Illustration A

A person had turnover of R610,000 for the past year. In the current year, he has had turnover of
R90,000 a month for the first 2 months of this next year. What are the VAT implications.

Suggested solution

The person must register for VAT as the likely turnover will exceed R1,000,000 for the year.

R90,000 x 12months = R1,080,000

Illustration B

A Ltd is not registered for VAT purposes. A Ltd has a turnover of R70,000 per month in a normal
month. This month saw A Ltd sell their commercial fixed property for R400,000. Must A Ltd register
for VAT as their taxable supplies now exceed R1,000,000 for the year?

Suggested solution

There is no need to register for VAT as the sale of fixed property is an exceptional transaction. The
amount of turnover is unlikely to exceed R1,000,000 in the future.

R70,000 x 12months = R840,000

Illustration C

Which of the following vendors would have to register for VAT? The following turnovers are for a
period of 12 months.

a) Taxable supplies of R970,000 and exempt supplies of R70,000

b) Taxable supplies of R1,020,000 including an abnormal amount of R60,000 that was from
replacement of a capital asset.
c) Exempt supplies of R1,200,000
d) Taxable supplies of R1,120,000
e) Standard rated supplies of R900,000, zero-rated supplies of R200,000 and exempt supplies of
R500,000
Suggested solution

a) Would not register

b) Would not register
c) Would not register
d) Would register
e) Would register as the total VATable supplies (standard rated and zero rated), exceed R1million.

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1.3 OTHER ISSUES

1.3.1BASES OF TAXATION

There are 2 bases that can be used by an enterprise. These are the

 Payments and
 Invoice basis.

Payments basis determines that VAT is accounted for on payment.

Invoice basis determines that VAT is accounted for on the earlier of invoice or payment

Individuals can be on payments basis if VATable supplies < R2,500,000 PER ANNUM

Companies, CC’s always on invoice basis.

Practical advice to a student

In an exam, if the person (company, trust, individual) has turnover of taxable supplies exceeding
R1,000,000, then obviously the person is registered for VAT. The question does not need to tell you
this. Also human beings only can be registered on the payments basis, thus a company can be
assumed to be registered on the invoice basis without telling you. Also an individual with taxable
supplies over 2,5M will also be on the invoice basis.

Also consider:

 If turnover is over 30M, they submit vat returns monthly

 Under 30M, probably will be a 2 monthly vat return
 Farmers can register for 6 monthly return (Category D)
 Under 1,5M may be category F (4 month return)

1.3.2 SUBMISSION OF RETURNS

VAT returns must be submitted by the 25th day of the month after the month to which the VAT
return relates. Thus the February VAT return must be submitted by the 25th of March.

If a return is submitted via efiling, it may be submitted up till the last working day of the month after
the month in question.

Thus if March 31 is a Sunday, the February VAT return may be submitted until 29 March on efiling.

There is a 10% penalty for late submission. In addition interest is charged on late payment.

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1.3.3 YEAR RULE

If a vendor forgets to claim VAT, such input VAT may be claimed within 5 years of the date that it
was originally supposed to be claimed.

Illustration A
A Ltd commenced trading during the current month and registered for VAT purposes. As A Ltd is a
company, SARS will only register the company on an invoice basis.
R11,400 is sold on credit and is still owing at the end of the month. R22,800 was sold for cash and
has been collected.
Purchases were made and R5,700 purchases were paid for in cash. R17,100 purchases were made on
credit during the month. All amounts include VAT.
a) Calculate the amount of VAT to be paid to SARS.
b) Calculate the amount of VAT to be paid to SARS if this was an individual registered on the
payment basis.
Suggested solution
Part a
Credit sales (R11,400 X 15/115) R1,487
Cash sales (R22,800 X 15/115) R2,974
Total VAT output R4,461
Cash purchases (R5,700 X 15/115) R 743
Credit purchases (R17,100 X 15/115) R2,230
Total VAT input R2,973
The net amount payable to SARS is R4,461 – R2,973 =R 1,488.
Part b
Credit sales R Nil
Cash sales (R22,800 X 15/115) R2,974
Total VAT output R2,974

Cash purchases (R5,700 X 15/115) R 743

Credit purchases R Nil
Total VAT input R 743

The net amount payable to SARS is R2,974 – R743 = R2,231.

1.3.4 ARE VAT INVOICES NECESSARY TO CLAIM INPUT VAT?

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VAT invoices made out to the vendor are necessary to claim input VAT.

If a company pays the telephone bill of an employee who is required to use his home telephone for
business calls, no input VAT can be claimed as the bill is not made out to the vendor involved, but to
the employee.

If a supply is less than R50, a VAT invoice need not be issued. If a supply exceeds R50, but is less than
R3,000, the following should appear on a VAT invoice:

 The words “ tax invoice” need to printed in a prominent place,

 The suppliers’ name, address and VAT registration number,
 The serial number and date of the tax invoice
 An accurate description of the supply of goods or services made
 The value of the supply, separately showing the tax and the consideration excluding VAT,
In addition, each VAT invoice must have its own serialized invoice number and be denoted in Rands.

If a supply exceeds R3,000, the following must also be reflected on the VAT invoice:
 The name of the recipient
 The address of the recipient, and
 The quantity or volume of goods or services supplied.

If a debit or credit note is issued, similar rules apply and some link to a previous purchase must also
be present on the document.

1.3.5 DE MINIMUS RULE

If a vendor is supplied a good or service that is used 95% or more for taxable supplies, 100% may be
claimed in respect of this supply. Thus if a taxpayer buys a computer that is 96% used for taxable
supplies, and is used 4% for exempt supplies, 100% of the input VAT is claimable.

Thus if a taxpayer buys a computer that is 94% used for taxable supplies, and is used 6% for exempt
supplies,94% of the input VAT is claimable.

1.3.6 DISCUSSION OF ENTERPRISE

A number of activities do not amount to the carrying on of an enterprise. These include :

 services rendered by an employee to his employer, or by the holder of any office in performing
the duties of his office, e.g. a salary or wage-earner or a company director;
 private or recreational pursuits or hobbies;
 private transactions, e.g. the occasional sale of domestic or household articles, furnishings,
personal effects, or private motor vehicles;
 activities to the extent that exempt supplies are made;
Thus a person earning a salary is not subject to VAT.

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Illustration A

A Ltd bought a computer for R11,400 that was to be used in the administration department. The
company uses the computer 97% for the factory and approx 3% of the time for the letting of
residential accommodation on the factory site to staff.

It is understood that the factory is vatable but residential accommodation is exempt from VAT.

What are the vat implications? Will these change if the computer is used 20% for residential
accommodation?

Suggested solution

The de minimus rule allows A Ltd to claim R11,400 X 100% X 15/115 despite not using the computer
fully for vatable purposes. 95% or more vat usage are rounded up to 100%.

If the computer was 80% for vat, only 80% X R11,400 X 15/115 could be claimed as a vat input. (80%
is less than 95% and as such cannot be rounded up)

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 1.3.7 HOW NOT TO MAKE MISTAKES IN A VAT QUESTION

CONSIDERATION 1 CONSIDERATION 2

ARE ALL THE AMOUNTS IN THE QUESTION WHAT IS THE VAT CATEGORY OF THE VENDOR. IT
INCLUSIVE OF VAT OR EXCUSIVE OF VAT. COULD BE MONTHLY, 2 MONTHLY, 4 MONTHLY
OR 12 MONTHLY.
IF INCLUSIVE OF VAT, VAT IS CALCULATED BY
DOING THE FOLLOWING CALCULATION – LOOK AT THE DATES GIVEN IN THE QUESTION
AMOUNT x 15/115 AND ONLY INCLUDE VAT FOR THOSE MONTHS
THAT ARE NEEDED.
IF AMOUNTS EXCLUDE VAT, VAT IS CALCULATED
BY DOING THE FOLLOWING CALCULATION – WHERE AN ITEM IS NOT IN THIS VAT PERIOD,
AMOUNT x 15% CLEARLY STATE THIS WHEN DOING THE
SOLUTION AS MARKS ARE ALLOCATED FOR THIS.

CONSIDERATIONS BEFORE DOING VAT QUESTIONS

CONSIDERATION 3 CONSIDERATION 4

IS THE VENDOR REGISTERED ON A PAYMENTS WHAT HAS BEEN PROVIDED IN THE QUESTION, A
BASIS OR INVOICE BASIS. GENERAL LEDGER OR A CASHBOOK.

COMPANIES AND CC’S ARE ALWAYS ON AN IF A CASHBOOK IS PROVIDED AND THE ENTITY IS
INVOICE BASIS. QUESTIONS OFTEN DO NOT REGISTERED ON AN INVOICE BASIS, REMEMBER
STATE THE BASIS APPLIED IF THE ENTITY IS A TO INCLUDE INVOICE ITEMS NOT IN THE
CORPORATE ENTITY. CASHBOOK INTO THE VAT CALC.

FOR INDIVIDUALS, THE QUESTION NORMALLY SIMILARLY, IF A GENERAL LEDGER IS GIVEN,

STATES THE BASIS. ITEMS NOT YET PAID FOR WOULD BE EXLUDED
FROM THE VAT CALC IF REGISTERED ON
PAYMENTS BASIS.

Some questions have apportionment of VAT. A question will state that 80% is VATable and 20%
is not VATable.

Apportionment of VAT may have to take place in these questions. This is discussed in more
detail later.

Note if an item is 95% or more VAT, it is rounded up to 100%.

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1.4 TYPES OF VAT

VAT is levied on supply of goods and services by a vendor. There are three categories for VAT

15% 0% EXEMPT

ZERO RATE

It is important to understand that both standard rated supplies (at 15%) and zero rated supplies (at
0%) are subject to VAT (or VATable), but just at different rates. Exempt supplies are not subject to
VAT.

The difference between zero rate and exempt is that a zero rate supplier will charge VAT output on
sale of the good at a rate of 0%, but can claim VAT input on items paid for where 15% VAT is
charged.

Thus a petrol station sells petrol which is zero rated and will:

 Charge VAT at 0% on sale of the petrol

 Claim VAT at 0% on buying petrol
 Claim VAT at 15% for rent on the petrol station (provided he gets a VAT invoice from the VAT
vendor who is renting the petrol station)

FOR EXAM TECHNIQUE, CONSIDER THIS

Students should learn all zero rate and exempt items. A dash sheet has been provided showing
all items that have no VAT. Everything else will have VAT at 15% provided it is a good or service
provided by a vendor.

The following 2 steps should be followed:

1. Is it on the dash sheet? If yes, no VAT. Students must provide a reason for the Rnil VAT,
stating whether it is zero-rated or exempt.
2. If not on the dash sheet, is it a good or service supplied by a vendor? If yes, VAT at 15%

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1.4.1 VAT DASH SHEET

In many instances, there is no VAT charged on a transaction. In UNISA questions, the mark is often
not allocated for the dash (representing no VAT), but for the reason given as to why there is no VAT.
This summary explains why no VAT is charged on many items.

Nature of expenditure Reason why there is no VAT

Fuel including diesel and petrol Zero rated

Salaries and wages No VAT on salaries and wages as they are not considered to be
an enterprise

Direct exports Zero rated

Certain indirect exports May be zero rated

An indirect export is where goods are exported by a 3rd party,
and not by the seller. It should be noted that indirect exports
are not zero rated unless proof is provided to the selling
vendor that the goods have been exported. Then the sale can
be zero rated.

International air flights by Zero rated

passengers such as a Johannesburg
to London flight. Ancillary costs
also included like insurance.

Service rendered outside SA Zero rated

Sale of a going concern Zero rated

Kruger rands Zero rated

Unwrought gold Zero rated

Brown bread Zero rated

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 Maize meal Zero rated

Unprocessed fruit and vegetables Zero rated

Property rates Zero rated

Interest Exempt financial service

It should be noted that bank charges attract VAT as there is a
service provided by the bank unlike interest where there is no
good/service provided.

Giving or repaying of a loan Exempt financial service

Purchase or sale of shares or other Exempt financial service

financial instruments

Long term assurance such as life Exempt financial service

insurance, endowments, dread It should be noted that VAT can be claimed on short term
disease policies and disability insurance. Thus if you insure your car or house, VAT can be
policies claimed.

Residential accommodation Exempt

Note VAT will be charged on commercial accommodation such
as hotels.

Transportation of fare paying Exempt

passengers by road or rail Note international air travel of passengers is zero rated and
local air flights are VATable.

Educational services Exempt

There will still be VAT on training.

Motor car Input VAT denied on acquisition

Entertainment such as food or Input VAT denied

beverages provided to staff or
clients, coffee machines, staff
canteens, water vending machines,
any equipment used in a staff
kitchen
Club subscriptions Input VAT denied

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 Maize meal, samp, mealie rice, Zero rated
dried silo mealies (excluding
popcorn), dried beans, lentils,
pilchards, sardinella, unflavoured
milk powder, dairy powder blend,
rice, uncooked untreated fruit and
vegetables, vegetable oil (except
olive oil), milk, cultured milk,
brown wheaten meal, eggs, and
edible legumes.

Motor car sold No input claimed on acquisition due to input VAT denial, no
VAT on disposal

Various fringe benefits received Holiday accommodation FB – entertainment

have no VAT. The fringe benefit Residential accommodation FB – exempt
and the reason for no VAT is in the Any cash allowance – No good or service (cash given)
next block Share incentive scheme – Financial service exempt
Low interest loan – Financial service exempt
Payment of employees debt – No VAT claimable as invoice not
made out to VAT vendor

No VAT when voucher is sold as no good or service. When

Vouchers eg Gift voucher voucher is used as payment, there is VAT on the item sold.

Illustration A
A Petrol station sells petrol and pays R11,500 rent a month for the property that the petrol station is
on. R100,000 sales were made during the month. R80,000 petrol was purchased. R40,000 was sold
from the quick shop at the petrol station. R30,000 was bought from VAT vendors for the quick shop
(assume all purchases are VATable). What are the VAT implications?
Suggested solution
No output VAT is charged on the petrol sold as this is a zero rated sale.
Output VAT of 15/115 X R40,000 would be charged on the quick shop sales.
No input VAT is claimable on the purchase of petrol as this is a zero rated transaction.
Input VAT can be claimed on the rental and the purchases for the quick shop. R1,500 (15/115 X
R11,500) input VAT is claimed on the rent. R3,913 (15/115 X R30,000) input VAT is claimed on the
quick shop purchases.

Illustration B
Assume that educational institutions are exempt for VAT purposes.
Educational fees are charged of R100,000. No VAT is charged on the supply of educational services.
Rent of R10,000 plus R1,500 VAT is paid for premises.

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What are the VAT implications?
Suggested solution
No VAT return need be submitted as no VAT can be charged by the educational institution nor can
any input VAT be claimed by the educational institution. The educational will pay the VAT which is
included in the premises as it cannot claim it as its business is exempt.

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 1.5 HOW TO APPROACH A VAT QUESTION

Is the income/expense found on the vat dash sheet?

No Yes

The amount is not exempt, nor is it zero rated. The amount There is no vat on the
will be subject to VAT provided the following apply: income/expense and no vat
need be accounted for in the
 There is a supply accounting records nor on the
 Of goods or services vat return
 From a vendor

Consider whether there is a special value of supply rule, or whether there is a special time of supply
rule for the income/expenditure involved. Special rules are discussed in diagrams 9 onwards.

No special rules, normal rules Special rules apply

apply Use the diagrams later on in this chapter to learn
Use normal rules where there are special rules.

Invoice basis These special rules may apply to the value of supply. An
example of this is for a finance lease. There is no selling
Value of supply is the amount on the price for a machine under a finance lease and as such
invoice the open market value of the machine is used.

Time of supply is earlier of payment or These special rules may also apply to the time of
invoice supply. An example of this is when there are coin
operated vending machines. It is very difficult to
Payments basis
determine when a cold drink is bought from a machine
The amount paid is the value of supply so there is a special time of supply rule. Vat is only
accounted for when the money is removed from the
Time of supply is when payment is made vending machine

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1.5.1 TYPES OF QUESTIONS

There are three types of questions traditionally asked for VAT. These are:

 VAT returns
 Journal entries and
 Discussion questions

Before carrying on with specialised VAT interpretation, this section will discuss these types of
questions.

VAT RETURNS

VAT returns are filled in by completing VAT output and VAT input sections of a VAT return.

VAT payable = VAT output – VAT input.

JOURNAL ENTRIES

Journal entries can be asked for VAT. Questions may either be do the journal entry, or do the
correcting journal entry.

Unisa do not mark the journal if there is no narration. (Consider - How do they know the journal is
the one for exports unless you tell them. Maybe there was a lucky guess or a lucky mistake)

DISCUSSION QUESTIONS

Discussion questions are often asked.

Students should identify all aspects that need to be addressed in a question and then answer the
question based on the marks allocated.

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Illustration A

VAT RETURN

The following is the income statement for the 2 months ended April for Novice (Pty) Ltd, a company
with a June year end, that submits VAT returns every 2 months. All amounts shown include VAT,
where applicable.

Income
Local sales 1,150,000
Export sales 300,000
Interest received 50,000
1,490,000

Expenditure
Salaries 400,000
Interest paid 20,000
Raw materials purchased (all VATable) 342,000
Overheads (all VATable) 115,000
876,000

Calculate the VAT payable or refundable for the 2 month period ended April.

Suggested solution

Output VAT
Local sales 1,150,000 x 15/115 150,000
Export sales (zero rate) 0
Interest received (Exempt financial services) 0
150,000

Input VAT
Salaries (not an enterprise) 0
Interest paid (Exempt financial service) 0
Raw material purchased 342,000 x 15/115 44,609
Overheads 115,000 x 15/115 15,000
59,609

Net VAT payable 150,000 – 59,609 90,391

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VAT JOURNAL ENTRIES

Illustration B

Raw materials were purchased for R115,000 including VAT. The amount was paid for in cash. What
journal entry needs to be processed?

Suggested solution

Dr Raw materials stock 100,000

Dr VAT input 15,000

Cr Cash 115,000

Narration – Raw materials journal

Illustration C

Raw materials were purchased for R115,000. The amount was paid for in cash. The following journal
was passed:

Dr Raw materials stock 100,000

Dr VAT input 15,000

Cr Cash 115,000

It was later established that the raw materials were purchased from a non vendor.

What journal entry needs to be processed to correct the entry?

Suggested solution

Dr Raw materials stock 15,000

Cr VAT input 15,000

Narration – Correction of raw materials original journal entry

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HOW TO ANSWER DISCUSSION QUESTIONS

A company bought trading stock for R11,500 including VAT on 12 March and then gave it as fringe benefit
to staff on 4 April when the selling price was R13,000 including VAT. They submit monthly vat returns.
The company does not know how to account for vat. What approach should you follow? (Trading stock is
deemed to be given out at lower of cost in records or open market value)
Suggested solution
1. Identify the transactions
 The company purchased trading stock (Transaction 1)
 The company gave a fringe benefit to staff (Transaction 2)
2. Look at the mark allocation and decide how many marks to allocate to each section
 If the question is out of 5 marks, perhaps 3 points should be written for each transaction
3. Apply diagram 7 for each item of income and expense to determine vat treatment to understand
what the answer will be and so that you can plan your answer.
4. For discussion purposes, pay particular attention to whether there is a special rule for value of supply
or time of supply, or do normal vat rules apply. Explain what the rule is (This step is probably not
needed if there are 1 or 2 marks available per transaction. In that case go directly to point 5)
 The purchase of stock is subject to normal vat rules.
 The giving of trading stock to an employee is a fringe benefit for tax purposes.
 Fringe benefits have special rules for vat.
 When calculating value of supply, vat is calculated on the lower of cost or open market value
for trading stock given to an employee.
 When determining the time of supply for fringe benefits, vat is recognised in the period the
fringe benefit is reflected on the payslip.
5. Apply the rule to the facts provided in the question, answering what the actual value of supply and
time of supply are and also indicate whether this is input vat or output vat.
 Transaction 1 – Time of supply is 12 March, thus in March Vat return
 Transaction 1 – Value of supply is 11,500 including vat, thus 11,500 X 15/115 = R1,500 input
vat
 Transaction 2 – Time of supply is 4 April thus in April vat return
 Transaction 2 - Value of supply is lower of cost or market value which is R10,000. Thus vat is
10,000 X 15/115 = R1,304 output tax as you have supplied the trading stock to an employee.
6. Include any other considerations
 These may include any documents to be retained
 This may include tax planning
 Often you will not do anything in this regard. The number of marks in a question will guide
you.
7. Conclude
 Transaction 1 - R1,500 input vat will be recorded in the March vat return
 Transaction 2 – R1,304 output tax will be recorded in the April vat return

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 2. NEW AND SECOND HAND GOODS
NEW GOODS

Purchased from a vendor Purchased from a non vendor

As the enterprise will receive a tax As the enterprise does not receive a tax
invoice from the vendor, the invoice, no input vat can be claimed.
enterprise will claim input vat
provided all other requirements Notional input vat can only be claimed
for 2nd hand goods. This is not a second
have been met.
hand good.

2ND HAND GOODS – A SECOND HAND GOOD IS DEFINED AS A GOOD THAT HAS BEEN PREVIOUSLY
USED EXCLUDING ANIMALS AND COINS

Purchased from Purchased from

a VAT vendor non vendor

Normal VAT rules apply

Payments basis Invoice basis Notional input vat can be claimed

even though there is no tax invoice
Value of supply is upon Value of supply is the
payment amount on the invoice Time of supply is when the amount
is paid
The amount paid is the
value of supply Value of supply is lower of cost or
Time of supply is earlier
market value X 15/115
Time of supply is when of payment or invoice
payment is made

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Notional input VAT cannot be claimed on animals and coins. They are excluded from the definition of
a 2nd hand good.

Intangibles are considered to be services by the vat act.

Thus if a royalty (which is an intangible) is bought from a non vendor, no notional input can be
claimed as a royalty is not a “good” as defined.

Documentation required in respect of the claiming of notional input tax on second hand goods from
a non vendor is

 name and identity number of the person making the non taxable supply and the identity number
must be verified to an identity document
 if the supplier is not a natural person, the identity number of the legal representative of the
company that sold the goods and the company’s registration number must be kept.
 A photocopy of the identity document and / or registration document/letterhead of the
company is required to be kept.
 The date on which the goods are to be acquired needs to be kept.
 The description of the goods needs to be kept.
 The quantity or volume of goods needs to be kept.
 The consideration for the supply must be kept.
 a statement from the supplier that the supply is not a taxable supply

In addition, a statement of the supplier is required to state that this is a non vatable supply.

For a discussion question, the following structure could be used to answer a question.

1. A second hand good is a good previously used excluding animals + coins

2. Thus ………… is a 2nd hand good as it was previously used.
3. There are special vat rules for 2nd hand goods purchased from non vendors.
4. Value of supply is lower of cost or market value X 15/115
5. Cost = ………………… Market Value …………………thus use ……………….
6. Time of supply is when payment is made.
7. ………………..paid on ……yyyy DATE thus ……………… X 15/115
8. VAT input claim of ….value…. X 15/115 in ….month…. VAT return.
9. Documents to be retained are ..................... (If marks available warrant such discussion – If
out of 4 marks, then don’t discuss this unless asked to. If out of 12 marks, discuss this)

SUMMARY
Time of supply Value of supply
Second hand goods Normal time rules apply as this is the acquisition Normal value rules apply as this is an acquisition
acquired from a vendor from a vendor from a vendor
Second hand goods Input VAT can only be claimed when the Notional input VAT claimable which is the lesser
acquired from a non payment has been made. of consideration in money or
vendor the open market value of the goods

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Illustration A

A non vendor is going bankrupt. The non vendor sells new electric blankets. He sells R30,000 worth
of stock to a vendor. In addition, he sells a second hand delivery vehicle to the same vendor for
R20,000. A VW Golf is also sold to the vendor for R10,000. The vendor pays cash for the goods
immediately.

(a) What would the tax implications be for the vendor that bought the goods?
(b) Would the situation change if the open market value of the delivery vehicle was R17,100 and
was bought from a person that is not connected to the enterprise.

Suggested solution

Part a
Delivery vehicle

The tax fraction is applied to the delivery vehicle as this is a sale of a second hand good. Input tax of
15/115 X R20,000 = R2,609 may be claimed by the vendor even though no VAT was charged to him.
It must be claimed using the payments basis.

Stock

No VAT can be claimed on the purchase of stock as the stock is not a second hand good. Remember,
Notional Input Vat is only claimed on second hand goods from non vendors.

Citi Golf

No VAT can be claimed on the second hand Citi Golf as even though it is a second hand good. This
does not change the fact that you cannot claim VAT on a passenger vehicle.

Part b
The lower of open market value (R17,100) and cost (R20,000) is used. Thus input VAT of 15/115 X
R17,100 = R2,230 may be claimed.

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Illustration B

A Ltd, a used car dealer, buys a second hand motor vehicle from Mr B for R50,000. The R50,000 is
payable R10,000 on February 18, R15,000 on March 15, and R25,000 on April 20. A Ltd submits
monthly VAT returns. The amounts owing were paid on the due dates.

What will the VAT implications be for A Ltd?

Suggested solution

The passenger car purchased is a second hand vehicle. Usually VAT cannot be claimed on passenger
cars, but in this case, the vehicle forms part of A Ltd’s trading stock and as such VAT can be claimed.

The purchase of the car is paid off in instalments and VAT can only be claimed on second hand goods
when payment is made for the second hand good.

Thus the following amounts can be claimed in their respective months:

February – 15/115 X R10,000 = R1,304.

March – 15/115 X R15,000 = R1,957.

April – 15/115 X R25,000 = R3,260.

Illustration C
A company that is a registered vendor buys a second hand delivery vehicle from a second hand car
dealer that is a registered VAT vendor. The vehicle cost R40,000 which is payable using four in four
instalments commencing monthly on the 1st of March.

What are the VAT implications of the above?

Suggested solution

The entire VAT input tax of 15/115 X 40,000 = R5,217.39 may be claimed on the 1st of March
provided a VAT invoice has been obtained.

The special timing rules for purchases of second hand goods do not apply as the goods were
acquired from a vendor. This transaction is not on second hand goods bought from a non-vendor.

It is the normal input VAT that is claimed and not notional input VAT.

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Illustration D

Antiques and Collectibles(Pty) Ltd, a company with R60,000,000 turnover bought a large Victorian
dollhouse from Mrs Stern, a 85 year old widow for R20,000 plus 10% of the final selling price ex VAT
on 15 January. They paid the R20,000 on 17 January. The dollhouse had been her 3rd birthday
present. They were of the view that they could sell the dollhouse for R50,000 in SA when they
acquired it

The company had always sold antiques within the Republic, but for the first time exported this
dollhouse to an English client in Devon County in the United Kingdom. The selling price of the
dollhouse was R80,000 on 3 February. They received payment on 3 February via bank transfer and
paid an additional R8,000 to Mrs Stern in terms of the agreement.

In addition, they sold 6 antique Victorian dolls for R50,000 that they had purchased from another
antique dealer for R34,200 including VAT. These dolls were acquired on 6 March. The dealer was
paid for the goods on 16 May.

Discuss the VAT input implications of the above. Assume that returns are submitted monthly.

Suggested solution

Note – This is a Pty Ltd company and as such will be registered on the invoice basis. In addition we
should note that as turnover exceeds R30,000,000, vat returns will be submitted monthly.

The dollhouse is a 2nd hand good, as it is a good that has been previously used. (1)

Notional input VAT can be claimed on 2nd hand goods acquired from non vendors. (1)

The value of supply is the lower of cost or open market value. (1)

Cost is R28,000 and the open market value is R50,000 upon acquisition, thus VAT will be R28,000 X
15/115 = R3,652. (1)

The time of supply is when payment is made. (1)

R20,000 X 15/115 = R2,609 and could be accounted for in the January VAT return (1)

R8,000 X 15/115 = R1 043 can be claimed in the February VAT return. (1)

VAT input of R34,200 X 15/115 = R4,461 may be claimed in the March VAT return on the acquisition
of the dolls from the vendor. It is irrelevant when the goods are paid for as these dolls were acquired
from a vat vendor. (1)

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3. ENTERTAINMENT

ENTERTAINMENT

In business of entertainment Not in business of entertainment

eg. Restaurant or conference
giver

Charge VAT on
entertainment supplied + Out of town for own staff and Other
claim VAT on purchases self employed persons (i.e.
independent contractors Input VAT denied
If you supply working for company)
entertainment to own
staff, input VAT denied
Claim input
VAT

Students should note that this section does not prohibit the charging of vat. It just denies the user of the
good or service a vat input claim. Thus if a vendor pays R1,140 for tickets to the theatre, they will pay
R1,000,000 plus R150 vat to the theatre.

The vat act just prohibits the company from claiming the R150 as input vat. Input vat claims are denied for
entertainment.

ENTERTAINMENT includes food, beverages, accommodation, staff canteens (including all furniture +
equipment), theatre, movies etc.

Staff canteens may be considered to be for the provision of entertainment. Consider the following:

 If a staff canteen is run on a subsidised basis by the company, employees are acquiring food at a
discount, and as such all assets within the canteen will be considered to be for the provision of
entertainment
 If the staff canteen is run as a separate business with no subsidies taken into account for staff,
then the rules above for a restaurant will be used.
 Normally staff canteens are subsidised by the company.

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Illustration A

A Ltd is a company that manufactures lawnmowers. Which of the following will be entertainment?
Can input VAT be claimed?

1. Coffee and milk to give to its staff

2. Water machine for clients
3. Microwave oven used in the kitchen
4. Furniture bought for a staff canteen
5. Supper with a client in town

Suggested solution

All of the above are entertainment.

No input VAT can be claimed on any of the above as an input VAT claim is denied.

Illustration B

A Ltd is a company that runs a restaurant and conference venue. Which of the following will be
entertainment? Can input VAT be claimed?

1. Food bought for the restaurant

2. Oven bought for the kitchen
3. Coffee for a conference
4. Food given to staff

Suggested solution

All of the above are entertainment.

As the company is in the business of providing entertainment, input VAT can be claimed for items 1
to 3.

Input VAT is denied for 4 as entertainment cannot be claimed for provision of food and beverages to
staff.

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Illustration C
A company runs a training course out of town. There are 20 employees that are out of town, 3
employees that are not out of town and 2 course co-ordinators. Co-ordinator 1 is not employed by
the company, but is employed by KPMG. Co-ordinator 2 is a self employed specialist. All staff
members and co-ordinators stay in a hotel. The partner also had a meal with a client whilst out of
town. The following costs (all vatable) are incurred:

 Consulting fees of R22,800

 Hotel bill including food of R57,000
 Food bill of R1,200. Partner (who is out of town) ate R700 and client ate R500
 Training venue hire of R17,100
What input VAT can be claimed?
Suggested solution
Consulting fees – This is not entertainment but training. Input VAT of 22,800 X 15/115 claimable as
input VAT
Hotel bill (incl food)– This is entertainment. Can claim for out of town staff members, and self
employed consultants. Claim for 21/25 X R57,000 X 15/115 as input VAT
Food bill – This is entertainment. Can claim for partner not client. The partner is out of town. Claim
700 X 15/115 as input VAT.
Training venue – This is not entertainment but training. Input VAT of 17,100 X 15/115 claimable as
input VAT

Illustration D

Ace Travel Agent runs a bus service from Johannesburg to Cape Town. They sell a ticket for R500
that includes a meal. The company spends R20 on providing the meal and includes R40 extra onto
the ticket for the meal. What are the vat implications? Note that transport by road or rail is an
exempt supply.

Suggested solution

If the ticket is an all in one ticket (for the meal and for the bus ride), no output vat will be included in
the ticket as this is an exempt supply. The vat on the purchase of food for R20 may not be claimed as
this is the provision of entertainment to a client. This is for 2 reasons. First no vat can be claimed
when an exempt supply is provided. Secondly input vat is denied on the provision of entertainment
to clients.

It should be noted that if the meal is billed separately from the ticket, it could be argued that they
are running an entertainment business to procure profit and then both output vat will be charged
and input vat can be claimed.

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4. MOTOR CARS

SUPPLY OF MOTOR CARS + OTHER VEHICLES

Motor car Not a motor car

This is a vehicle where passenger space This is a vehicle where load space > passenger
> load space space

Cannot claim input VAT as input vat Can claim input VAT
cannot be claimed on the purchase of a
motor car. Cars > 3500 kgs

Examples of such vehicles include Examples of such vehicles include

Passenger car Bakkies
Double cab Extended cab bakkie (Cab and ½ )
Station wagon Minibus/ Bus > 16 seats
Minibus which has less than or equal to Special purpose vehicles such as game viewing
16 seats vehicles, hearses, ambulances, F1 racing cars

Vat is still charged by motor car dealers on the sale of a car. This is because they are selling trading stock.

If a company buys the motor car, and they are not a motor car dealer, they will not be able to claim input
vat on the car as input vat cannot be claimed on the acquisition of a car.

They also do not charge vat when they sell the car. This is due to the fact that the company could not claim
input vat when the vehicle was acquired (as input vat is denied) and as a result will not charge vat on the
disposal of the motor car (unless the motor car has become trading stock)

In vehicles where the load space is greater than passenger space and in special purpose vehicles, input var
can be claimed on acquisition, and output vat will be charged on disposal.

Also note that vat is charged by Avis when you rent a car from them, but input vat cannot be claimed as
input vat is denied on the supply of a motor car. Whether you buy a car or hire a car, input vat is denied.

Input vat is denied on the supply of the motor car. You can claim input vat on insurance and maintenance
for the car. Fuel cannot be claimed as an input vat as fuel sales are zero rated and as such vat will be zero.

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Illustration A
M Ltd buy a BMW 3 series car for use by their managing director for R228,000 (R200,000 plus
R28,000 VAT). Can input VAT be claimed on the purchase of the motor car?
Suggested solution
No input VAT may be claimed on the purchase of the motor car.

Illustration B
A motor dealership buy 10 Toyota corollas from the factory for R100,000 plus R15,000 VAT each.
Can an input VAT be claimed on the purchase of the motor cars if the cars were bought for the
purposes of resale by the dealer?
Suggested solution
The input VAT may be claimed by the dealer on the purchase of the motor cars as the cars were
bought as trading stock.

Illustration C
A second hand car dealer buys a motor car as part of its trading stock from a non vendor for
R57,000. Can an input VAT be claimed on the acquisition of the motor car?
Suggested solution
Notional input VAT can be claimed on the purchase as the motor car is considered to be trading
stock of the vendor and not a “motor car” used by the vendor.
Input vat of R57,000 X 15/115 = R7,435 may be claimed as a notional input when the second hand
car dealer actually pays for the car (2nd hand goods rules)

Illustration D
A car is hired by a company from a vat vendor. Costs were incurred as follows:
 Hiring of car R5,700
 Petrol used of R900
 Short term insurance of R800
 Life insurance for the driver of R400
Can an input VAT be claimed on the expenses above?
Suggested solution
No VAT can be claimed on the hiring of the car as input tax is denied on the provision of passenger
motor cars.
Petrol is zero rated
VAT can be claimed for insurance of 800 X 15/115.
Life insurance is exempt.

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Illustration E
A bakkie is hired by a company from a vat vendor. Costs were incurred as follows:
 Hiring of car R5,700
 Petrol used of R900
 Short term insurance of R800
 Life insurance for the driver of R400
Can an input VAT be claimed on the expenses above?
Suggested solution
R5,700 X 15/115 = R743 can be claimed on the hiring of the bakkie as a bakkie is not a motor car as
defined.
Petrol is zero rated
VAT can be claimed for insurance of 800 X 15/115.
Life insurance is exempt.

Illustration F

A Ltd had the following in their current VAT period.

 purchase of a 14 seater bus for R400,000

 insurance on the car for R1,000
 petrol paid on the car for R800
What are the VAT implications of the above?
Suggested solution
No VAT can be claimed on the purchase of a 14 seater bus. Buses with 16 or less seats are motor
cars as defined. Input vat is denied on the acquisition of a motor car.
VAT of 15/115 X R1,000 = R130.43 may be claimed on the insurance.
As petrol is zero rated, no VAT may be claimed on petrol as no VAT is charged on petrol.

Illustration G
A company bought a twenty four seater bus for the purpose of conveying workers to work for
R200,000. Can a VAT input credit be claimed on the bus?
Suggested solution
VAT of 15/115 X R200,000 = R26,086.96 may be claimed as the microbus has more than 16 seats.

Illustration H

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A company bought a caravan for the exclusive entertainment of its directors. The caravan cost
R57,000.
What are the VAT implications of the above?
Suggested solution
A caravan is not a motor car as defined and as such VAT can usually be claimed on a caravan.
However in this case there is no VAT claim as the caravan was purchased to provide entertainment
to directors
There is a question as to whether there is output VAT on the provision of the caravan to the
directors. As this is the provision of entertainment, no output VAT results on the fringe benefit
received by the directors.

Care should be taken when dealing with game viewing vehicles and hearses. You cannot go out and
look at the range of hearses/game viewing vehicles at your local motor dealership. These cars are
bought then converted or in some instances, the dealer offers to sell you them after they themselves
have converted them.

The following table summarises the time and value of supply rules for these vehicles as these
vehicles have to be converted, and are not traditionally purchased as is.

Time of supply Value of supply

Game viewing The time of supply is when these The value of supply is the open
vehicles and hearses assets are acquired, or if market value of the consideration.
converted, when the conversion
takes place.

There are extra requirements that need to be in place before a VAT input claim can be made for
game viewing vehicles. These are:

 constructed or permanently converted for

 the carriage of seven or more passengers
 for the exclusive use of game viewing
 in national parks, game reserves, sanctuaries and safari areas

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Illustration H
You own a game farm in a national park. You acquire a bakkie and six months later convert it into a
game viewing vehicle with space for 10 passengers.
What are the tax implications of the following apply:
a) The above facts apply
b) The bakkie was acquired and six months later the conversion was for a 5 seater game viewing
vehicle
c) The bakkie was acquired immediately converted into a 5 seater game viewing vehicle
d) Would the solution to part a change if you owned a game farm that was not in a national park,
game reserves, sanctuaries and safari areas.
e) Would your solution to part a change if it was a game viewing vehicle that was used to look at
fish during a sardine run, rather than wild game animals. In addition, the vehicle was converted
immediately upon buying it.
Suggested solution
Part a
When the bakkie is acquired, it is not a motor car as defined and input VAT is claimed.
When the car is converted into a “game viewing vehicle” as defined, input VAT can be claimed on the
cost of the conversion as well.
Part b
When the bakkie is acquired, it is not a motor car as defined and input VAT is claimed.
When the car is converted into a “game viewing vehicle” as defined, input VAT cannot be claimed on
the conversion of the bakkie to a “motor car” as defined.
Part c
Although the bakkie was not constructed wholly or mainly for the carriage of passengers, it was
however immediately converted for this purpose. It therefore falls within the definition of a ‘motor
car’.
However, the definition of a “motor car”’ excludes a game viewing vehicle which is exclusively used
for game viewing in national parks, game reserves, sanctuaries or safari areas.
The vehicle is however not a game viewing vehicle as defined as it has less than 7 seats and as such
no input VAT can be claimed.
Part d
If the game viewing vehicle is not used in a national park, game reserves, sanctuaries or safari areas,
no input VAT can be claimed on the conversion. The original claim may still be made on acquiring the
bakkie.

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Part e
Although the bakkie was not constructed wholly or mainly for the carriage of passengers, it was
however immediately converted for this purpose. It therefore falls within the definition of a ‘motor
car’.
However, the definition of a “motor car”’ excludes a game viewing vehicle which is exclusively used
for game viewing in national parks, game reserves, sanctuaries or safari areas.
It would seem that fish viewing is not game viewing. It follows therefore that the converted fish-
viewing bakkie is not excluded from the definition of ‘motor car’. It is a motor car. Thus no input
could be claimed on buying the bakkie or on its conversion.

Illustration I
Undertakers Ltd carries on an undertakers business. They are an “A” category VAT vendor that
submits VAT returns 2 monthly commencing in Jan, March, etc Due to the scarcity of hearses, it is
investigating the option of purchasing five black station wagons from a local motor dealer and then
converting them into hearses.
Each station wagon will cost R164 160 (R144 000 plus VAT of R20 160). The motor dealer has offered
to ‘convert’ the station wagons into hearses by removing all the seats except for the front seats.
For this conversion the motor dealer will charge a conversion fee of R10 260 (R9 000 plus VAT of R1
260) per station wagon.
You are required
a) Undertakers Limited, a registered VAT vendor, would like to know what the VAT consequences
are of the purchase and the conversion of each station wagon.
b) How would the solution change if the station wagons were bought in one tax period and then
converted 2 months later. The market value on the day before the conversion took place was
(R140 000 excluding VAT).

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Suggested solution
The issue / problem is whether the hearse constitutes the supply of a “motor car”, in which case the
input tax relating to the “motor car” will be denied in terms of section 17(2)(c).
However, certain types of vehicles are specifically excluded from the definition of a motor car.
The elements of the paragraph (f) exclusion that must be considered are:

 any vehicle -> a station wagon would be one

 constructed as or permanently converted into a hearse for the transport of deceased persons ->
it was not constructed as a hearse, but the motor dealer will convert them
 and used exclusively for that purpose -> there is no information in the question that indicate
that the “vehicles” will be used for other purposes and therefore
The hearse is not a motor car as defined and therefore Undertakers Ltd will be entitled to claim the
input tax in respect of the acquisition (R20 160 each) and conversion cost (R1 260 each) of these
vehicles.
Part b
Upon acquisition, they bought 5 station wagons and did not convert them to hearses. A station
wagon is included in the definition of a “motor car”. Input tax on the purchase will be denied.
Upon conversion, the station wagons are deemed to be supplied to the vendor in the tax period that
it was converted to hearses. A section 18(9) input tax deduction will be allowed in terms of section
16(3).
The deduction will be the lesser of:
15/115 x adjusted cost = 15/115 x (R164 160 x 5) = R107 061, or
15/115 x open market value = 15/115 x ((R140 000 + 15%) x 5) = R105 000.
Therefore, R105 000.
An input tax claim will be allowed for the conversion cost, being: - (R10 260 x 15/115 = R1 338) x 5 =
R6 691.

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 5. IMPORTATION
IMPORTATION OF GOODS
Even though you do not receive a VAT invoice, you can claim VAT on the importation of goods.

Output VAT is paid to SARS at the point of entry into SA and then claimed as a VAT input in a VAT
return, if applicable.

IMPORTATION OF GOODS

Import from Botswana, Import from non BSLN country

Swaziland, Lesotho, Namibia VAT = customs duty value
+ 10% customs duty value
VAT = customs duty value x 15% + import surcharges
XXXXX
X 15%

Note that if goods are stored in a bonded warehouse, import vat only needs be paid when they are
removed from that warehouse using the greater of (customs duty value +10% + import surcharges)
or the amount paid for the goods.

IMPORTED SERVICES
Note when services are imported, output VAT is only paid when imported by a non VAT vendor or by
a vendor for purposes other than making taxable supplies. In other words, VAT Is not payable if the
services are imported and fully utilized in the making of taxable supplies. No vat need be accounted if
the tax invoice is for less than R100.

SUMMARY
Time of supply Value of supply
Import of goods The time of importation is when the goods physically enter Imports from BSLN countries is 15% X (Value for
SA. VAT is collected by customs at the designated entry point customs duty purposes + Any duty levied in terms
(border post, harbour, airport) into SA. of the customs and excise act)

Imports from non BSLN countries is 15% X (Value

for customs duty purposes + 10% of the value for
customs duty purposes + any duty levied in terms
of the customs and excise act)
Import of services The time of supply is the earlier of when an invoice is issued The value of supply is the greater of the value of
or when payment is made. the consideration and the open market value of
the service.
VAT is payable within 30 days only to the extent that an
imported service is utilised or consumed outside of the
making of a vatable service.

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Illustration A
An importer imports goods into SA that attract VAT of R15,000. These are goods for resale.
What are the taxation implications if:
(a) the importer is a VAT vendor, and
(b) if the importer is not a VAT vendor.
Suggested solution
Part a
The importer will have to account for R15,000 output VAT to SARS when the goods are imported.
This will be paid when the goods are cleared through customs and will not be reflected on the VAT
return.
However the importer will claim a R15,000 VAT input credit when submitting his next VAT return.
Part b
The importer will have to account for R15,000 output VAT to SARS when the goods are imported.
This will be paid when the goods are cleared through customs and will not be reflected on the VAT
return.
No input VAT will be claimed as the importer is not a VAT vendor.

Illustration B
Goods are imported from the United States. The goods cost $20,000 and are placed on a ship FOB
when the exchange rate is $1 = R8.
The goods reach customs when the exchange rate is $1 =R9.
There are import surcharges of R2,000.
What amount of output VAT will be accounted for on the above transaction. How will the solution
change if the import was from Swaziland?
Suggested solution
The goods have a customs duty value of R180,000 ($20,000 X 9 – rate ruling when arriving at
customs)
Customs duty value R180,000
10% of customs duty value R 18,000
Import surcharges R 2,000
R200,000
The VAT on the transaction will be R200,000 X 15% = R30,000.
If the goods were imported from Swaziland, which is a BSLN country, the VAT would be R180,000 X
15% = R27,000.

It should be noted that intangibles are not defined as goods but as services.

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Thus a TV programme shown by MNET would be an intangible good acquired by MNET. And one
should note that such intangibles are not imported through customs.

Illustration C

MNET bought the latest series of “My wife’s ex girlfriend is hot”, a popular TV series from Fox
Studios in America paying R1,000,000 to use it. The series is downloaded by them off the Fox studios
website after an appropriate password is given.

In addition, they download R30,000 worth of music from a website that will be used to play to staff
and customers in their buildings.

What are the vat implications?

Suggested solution

The series purchased is used for the purpose of making taxable supplies. Vat is charged on decoder
subscriptions. Thus Mnet would do nothing on importing this service. (Consider that they would
have claimed R1,000,000 X 15/115 input and paid the same amount in output on acquisition. Thus
SARS says do nothing)

R30,000 X 15/115 should be declared as a vat output on purchasing the music as vat input would be
denied on the purchase of entertainment. (As there is not a net nil amount, the output vat on
importation must be disclosed.)

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 6. EXPORTS
EXPORTS

Direct exports Indirect exports Export of 2nd hand good

acquired from non
vendor
Zero rate

Output VAT charged

Exporter gives all the export Don’t have export
equal to notional input
documentation to you documentation
VAT claimed on 2nd
hand good.

VAT CHARGED
ZERO RATE

DISCUSSION OF EXPORT OF A 2ND HAND GOOD

ACQUIRED FROM A NON VENDOR
A LTD buys an antique table from non vendor for R10 000
Notional input of 10 000 x 15/115 = 1 304 claimed
Exported to the USA to a collector at a cost of R220 000.
Output VAT of 1 304 levied (equal to input claim)
NOTE: The Output VAT will always equal the notional input VAT claimed when purchased even if
the asset is exported at less than the original purchase price. The logic behind this is as follows:

 Buy good for R115. Claim R15 from SARS – Sars bank account is -15
 Export good (usually zero rated), thus SARS says that you must pay back the R15 so that
the SA fiscus is not out of money.

SUMMARY
Time of supply Value of supply
Exports (General) General rules Supply is zero rated except for exports of 2nd hand goods
upon which notional input tax has been claimed
Exports of 2nd hand goods upon which General rules The value of supply is the purchase price of the goods to the
notional input tax was claimed vendor X 15/115
Illustration A

A Ltd sell machines and have two invoices to process:

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 An invoice to a local purchaser for R10,000 excluding VAT and
 An invoice to an overseas purchaser for R20,000 excluding VAT. The goods are to be exported by
the company itself.
What amounts will be owing by each creditor after the machines have been supplied?

Suggested solution

The local purchaser will owe R11,400 after VAT at 15% has been charged. Local supplies attract VAT
at a rate of 15%.

The foreign purchaser will owe R20,000 as VAT is charged at a rate of 0% for exported goods. This is
zero rated as it is a direct export (an export that was taken overseas by the company itself)

Illustration B
A client passed the following journal entry for an export of goods to the USA. The client agreed to
pay R57,000 for goods to be supplied, which would be an indirect export. The company that
delivered the goods overseas provided the SA company with proof that the goods were exported.
Dr Receivables 57,000
Cr Sales R50,000
Cr Output VAT R 7,000
What journal entry, if any should be passed in the accounting records to correct this entry?
Suggested solution
This is an indirect export. The 3rd party taking the goods overseas has provided the company will all
documentation proving that the goods have left SA. Thus the sale may be zero rated. The journal
entry to correct this is:
Dr Output VAT R7,000
Cr Sales R7,000
Narration – Vat cannot be charged on the sale of goods overseas.

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Illustration C

A Sandton City jewellery shop sells jewellery to a foreign visitor from his shop in Sandton City. The
foreigner tells the Sandton shop that he is a foreigner and he is going to take the jewellery back
home with him overseas. She needs the jewellery for a function to take place at the Sandton
Convention Centre.

Should the Sandton shop charge the seller VAT?

Suggested solution

VAT should be charged on the goods at a rate of 15%.

This is an indirect export. However the customer is taking the goods overseas.
Vat will be charged by the jewellery shop and then this vat may be claimed back from customs
authorities at the place of departure from SA.

Illustration D

Mr A is a 2nd hand car dealer and buys an old car for R22,800 from a non vendor In January. In
March, this car is sold to a car collector in Canada for R100,000. Mr A is a category B vat vendor.

What are the vat implications?

Category B vendors submit vat returns on a 2 monthly basis and will submit returns in February and
April for this question.

Upon acquisition in January, notional input vat may be claimed of R2,800 on the acquisition of 2nd
hand goods from a non vendor. This is done notwithstanding the fact this is a car. As the car is
trading stock to a car dealer, vat is claimable on the car.

Thus R2,800 input vat will be claimed in the February vat return.

Upon exporting the goods, the sale would normally be zero rated. There is however a special value
of supply rule for exported goods when a notional input credit has been claimed on them. Output
vat equal to the notional input vat claimed will be accounted for.

Thus there is an output vat of R2,800 in the April vat return.

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 7. ACCOMODATION

ACCOMODATION

Commercial Residential
accommodation accommodation

Exempt

Office rent Hotel

Factory rent

VAT will be For the room Other services eg.

charged at Meals, Telephone
15%

VAT at 15%

Stay > 28 days Stay <=28 days

VAT = 60% X 15% VAT = 15%

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Illustration A
Residential property is let by a vendor to another vendor for R2,280 a month. What are the VAT
implications?
Suggested solution
No VAT may be charged or claimed as this is an exempt supply.

Illustration B
A factory is rented by a vendor to another vendor for R30,000 a month. What are the VAT
implications?
Suggested solution
A vat invoice will be issued.
Output VAT of R3,913 (15/115 X R30,000) is charged by the selling vendor. This paid across to SARS.
The buyer can claim an input VAT of R3,913.

Illustration C
A factory is rented by a non vendor to another vendor for R22,800 a month. What are the VAT
implications?
Suggested solution
A vat invoice will not be issued. The non vendor who owns the building is not registered for vat.
Assuming this is the only income received by the non vendor, the annual rental is far below the
threshold for vat registration.
No output vat is charged.
No input vat can be claimed in the absence of an invoice (this is not a 2nd hand good acquired from a
non vendor which is the one time a notional input can be claimed from a non vendor in the absence
of a tax invoice)

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Illustration D
A Ltd needed to accommodate a staff member in a hotel for 70 days. The fee is R500 per day and it
was agreed up front that the employee would stay in the hotel for 60 days. The food and telephone
bill was R4,000.
You are required:
a) What amount of VAT will charged?
b) How would the solution change if you did not know in advance how long you would stay at the
hotel
c) If the company paying the bill did not pay R1,000 and this was written off as a bad debt, how
much input can be claimed on the bad debt for part b
Suggested solution
Part a
Input VAT of 60% X 15/115 X R500 X 70 will be claimed on the accommodation. 60% is used as the
stay is greater than 28 days.
The 60% cannot be used for the meals. R4,000 X 15/115 X 100% = R522 will be charged and claimed
for.
Part b
28 X R500 X 15/115 = R1 826 charged for the first 28 days
42 X R500 X 15/115 X 60% = R1,644 charged for the remainder of the stay.
Part c
(1,826+1,644)/(500X70) = 9,91%X R1,000 = R99.10 vat input claim on bad debt.

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 8. FIXED PROPERTY
PROPERTY

Property dealer Not a property dealer

There is vat charged on all

residential and commercial
property as these properties
are all trading stock of the Commercial Residential
property dealer. property property

No VAT
transfer duty

Bought from a vendor Bought from

a non vendor

VAT is levied on payments basis New building 2ND hand building

Value of supply is the amount paid X

15/115 Transfer duty paid, no vat Transfer duty paid. Claim notional input
implications. Cannot VAT. Second hand good purchased from
Time of supply is earlier of payment or claim notional input vat non vendor. Can only claim vat on
registration in deeds office as not a 2nd hand good registration in deeds registry

When a fixed property is acquired, either vat or transfer duty has to be paid, never both.

Vat is considered first. Thus when a developer sells a residential home to a buyer, vat is charged as this is the sale of trading stock by a
vendor to a purchaser. If the property is bought for R2,000,000, 15/115 X R2,000,000 will be the vat portion of the purchase price. (Note
there can be vat on the sale of residential property). There will be no transfer duty as vat has been paid.

Consider a residential property sold by a person other than a developer. There is no vat on the disposal of residential property, and as such
transfer duty will be paid by the purchaser.

SUMMARY
Time of supply Value of supply
Fixed property acquired The earlier of date of registration in the deeds Input and output should be accounted for to the extent
from a vendor office or date of any payment for the supply payment/registration has been made
Fixed property acquired Notional input VAT can only be claimed once No output VAT as sold by a non vendor. Notional input VAT
from a non vendor (2nd hand the fixed property is registered in the name of claim by buyer by applying 15/115 X lower of consideration
goods) the vendor. Once it has been registered in the paid or open market value.
name of the vendor, the notional input VAT can If building not 100% use for taxable supplies, then X %used for
only be claimed to the extent that payment has taxable supplies.
been made.

Transfer duty is calculated as follows from 23 February 2011:

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0% on the first R600,000
3% when exceeding R600,000 but less than R1,000,000
5% when exceeding R1,000,000 but not R1,500,000
8% when exceeding R1,500,000

Illustration A
Mr A wants to buy a residential property that is worth R1,100,000 from a non vendor.
He is unsure whether to put it into his name, or into his trust.
What are the transfer duty implications?
Suggested solution
Both natural persons and legal persons will pay the same transfer duty from 23 February 2011.
The transfer duty that will have to be paid is: R1,100,000 x 5% = R55,000

Illustration B
A developer develops 10 townhouse units and sells the units for R200,000 each.
What are the VAT implications?
Suggested solution
Even though they are residential units, the property developer will have to account for VAT of
R26,087 (15/115 X R200,000).
Vat on property is accounted for a payments basis by a vat vendor. The vat output will be reflected
in the vat return in the period that the payment is received.
No transfer duty will have to be paid as VAT has been levied on the transaction.
Remember: The townhouses are treated as stock for the developer and the developer will have to
account for vat on stock. If the developer developed the townhouses for the purposes of letting
them to tenants there would have been no VAT implications as the townhouses would have been
residential property and exempt from VAT.

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Illustration C

A Ltd is a registered VAT vendor. A Ltd is not a property dealer. B Ltd is not registered for VAT. A Ltd
sell two properties to B Ltd:

 Property 1 is a factory sold for R1,150,000.

 Property B is a residential property sold for R570,000.
You are required to:
a) What are the VAT implications for both A Ltd and B Ltd?
b) How would the vat implications change if A Ltd were a property developer registered on the
invoice basis and B Ltd were a vat vendor registered on the invoice basis

Suggested solution

Part a

A Ltd VAT implications

A Ltd is a registered VAT vendor. VAT will be levied on the sale of the factory as it is the sale of a
commercial property by a VAT vendor.

Thus VAT of 15/115 X R1,150,000 = R150,000 will recorded as an output tax on sale. This will only be
recorded as the price is received as property transaction vat is accounted for on a payments basis

The sale of residential property does not attract VAT. Even though the company is a vendor,
residential property is an exempt supply.

B Ltd VAT implications

B Ltd is not a VAT vendor and cannot claim any input VAT.B Ltd will have to pay transfer duty on the
purchase of the residential property as there was no VAT levied on the residential property (due to it
being a residential property).

However, as the selling price is less than R600,000, there will not be any transfer duty.

The factory is commercial property and there is, therefore, VAT levied on it.

As there was output VAT charged when selling the property there will not be any transfer duty.
Output vat is recorded in the period that payment is received.

B Ltd cannot claim the input VAT as it is not a VAT vendor.

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Part b

Seller (who is a developer)

As the seller is a property developer, both properties constitute trading stock. Vat will be charged on
the sale of both properties, both the commercial and the residential property.

As vendors account for vat on fixed property using the payments basis, the output vat will be
recorded in the period payment is received.

Buyer (who is a vendor)

The buyer is a vat vendor. As vat is charged on the sale of both properties, no transfer duty is
payable.

Input vat is claimed on the commercial property in the period the properties are paid for. (even
though the buyer bis registered on an invoice basis)

Even though vat was charged on the residential property, input vat cannot be claimed on the
residential property as B Ltd is not a dealer in land, and residential property is exempt from vat for
non land dealers.

Illustration D

A Ltd buys a second hand commercial property from a non VAT vendor for R1,200,000 in April and
took immediate occupation. A Ltd paid R60,000 transfer duty (5% X R1,200,000) in July when the
property was transferred into A Ltd’s possession.

What are the VAT implications?

Suggested solution

A Ltd may claim a notional input VAT amount of 15/115 X R1,200,000 = R156,521.

This amount can only be claimed once the property has been registered in the name of A Ltd and to
the extent that the purchase price has been paid.

Please note: In prior years the notional input VAT amount was limited to the transfer duty paid. This
is no longer the case.

Furthermore, in prior years the notional input VAT could be claimed the moment that the transfer duty
had been paid, irrespective of the extent to which the purchase price had been paid. This is no longer
the case, as noted above.

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Illustration E

Mr A builds a small factory and sells it for R700,000 to V Ltd. Mr A is not registered for VAT. The
building has never been used before. V Ltd is registered for VAT. The property documents selling the
land were signed in February and transfer duty of R20,000 was paid in May.

What are the VAT implications?

Suggested solution

There is no vat payable as the seller is a non vendor.

Transfer duty of R20,000 has been paid by V Ltd.

If a transaction involves a non vendor selling to a vendor, the only manner in which input VAT can be
claimed on the purchase of goods from the non vendor is if there is a notional input tax on second
hand goods.

No notional VAT can be claimed as this is the sale of a new (not second hand) property.

Illustration F

A vendor acquires a commercial property from a non vendor for R1,500,000. Assume that the transfer
duty paid on 1 April (when the property was registered in the name of the A) was R75,000. The house
is paid for in 2 equal installments of R250,000 on 1 March and 1 June. No other amounts were paid in
the current year. R1,000,000 was still outstanding. What can be claimed as a VAT input? The vendor
is registered on the payments basis and submits returns monthly.

Suggested solution

Notional input VAT is R1,500,000 X 15/115 = R195,652

The notional input VAT can only be claimed once the property is registered in the name of the vendor
(thus on 1 April) and only to the extent that the purchase price had been paid.
On 1 April R250,000 of the purchase price has been paid and notional input VAT is calculated as
R250,000 x 15/115 = R32,608

A further amount of R32,608 can be claimed on 1 June.

Illustration G

A vendor acquires a commercial property from a non vendor for R1,500,000. Assume that the transfer
duty paid on 1 April (when the property was registered in the name of the A) was R75,000.

A bond was registered over the property on 15 May and the property is being paid off over 240
months at a rate of R20,000 a month. No other amounts were paid in the current year ended 30 June.
R1,000,000 was still outstanding. What can be claimed as a VAT input? The vendor is registered on
the payments basis and submits returns monthly.

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Suggested solution

Notional input VAT is R1,500,000 X 15/115 = R195,652

The notional input VAT can only be claimed once the property is registered in the name of the vendor
(thus on 1 April) and only to the extent that the purchase price had been paid. As a bond has been
registered, the property has in fact been paid for in full.

The full R195,652 can be claimed on 15 May.

Illustration H

A Ltd and B Ltd are both VAT vendors. Neither is a property developer. Both are registered for vat on
the invoice basis.

A Ltd bought a commercial building for R2,000,000 including VAT from B Ltd.

On 2 February, a contract was signed by both parties and R100,000 deposit was paid. The deal was
subject to a bond being approved by a bank. The bank approved finance on 5 March, and the
property was registered into B Ltd’s name on 17 May.

What are the VAT implications for B Ltd.

Suggested solution

Vat vendors account for commercial fixed property transactions on a payments basis, irrespective of
whether they are registered on an invoice or payments basis

There are no VAT implications for February. Even though the deposit has been paid, the deal has not
been finalised as the bond is yet to be approved.

In March, when the bond is approved, R100,000 X 15/115 VAT input can be claimed.

In May, when the property is registered into B Ltd’s name, the remaining R1,900,000 X 15/115 can
be claimed.

Illustration I

A company registered as a VAT vendor buys a commercial property from a VAT vendor for R115,000
including VAT. The land is used only 70% for the purposes of making taxable supplies.

What are the VAT implications. Would the VAT implications change if the property was a second
hand property bought from a non-vendor and transfer duty of R11,500 had been paid.

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Suggested solution

If the property was acquired from a vendor, a VAT input may be claimed on the property.

The input claim is limited to the percentage that is used for the purposes of making taxable supplies.
Thus 70% X R15,000 = R10,500 will be claimed as an input credit.

If the property was acquired second hand from a non-vendor, 70% X R11,500 may be claimed at the
time that the property is registered in the name of the company and to extent that the purchase
price has been paid.

Illustration J

A Ltd build residential townhouse complexes. They sell a townhouse to B Ltd for R342,000. B Ltd
wish to use the townhouse for housing their production manager. Both companies are registered for
VAT vendors.

What are the VAT implications for both vendors?

Suggested solution

A Ltd will account for output VAT of 15/115 X R342,000 = R44,609.

No input VAT can be claimed by A Ltd as the property will be used for residential purposes.

Illustration K
A vendor buys a factory building for R1,000,000 from a non-vendor on 15 January. Transfer duty of
R80,000 is paid in February. Only R200,000 of the purchase price has been paid to the non-vendor at
the time transfer duty is paid. The remaining R800,000 is paid to the non-vendor in April. The vendor
submits monthly VAT returns.
What are the VAT implications.
Suggested solution
The notional input tax that may be claimed is 15/115 X R1,000,000 = R130,435.
The notional input VAT may only be claimed once the property is registered in the name of the
vendor and then only to the extent that the purchase price has been paid.
In February notional input VAT of R200,000 x 15/115 = R26,086 may be claimed. An amount of
R800,000 x 15/115 = R104,348 may be claimed in April.

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9. SHORT TERM INSURANCE PAYOUTS
INSURANCE

Insurance Insurance
payment claim payouts

Life, dread Short term As the payment for life insurance,

disease, insurance dread disease and disability claims
disability are exempt, any payouts in this
insurance Claim VAT regard will also be exempt from vat
input
Exempt

Insurance company payout for short

Insurance company term insurance such as car insurance
replace asset

No VAT implications. Enterprise

is in the same position as
before

Other asset Motor car or

entertainment asset
This is a deemed supply value.
VAT is the amount paid out X No VAT claimed on
15/115 acquisition

Time of supply is when insurance Thus no VAT on

company pays out or agrees to insurance payout
SUMMARY pay out

Time of supply Value of supply

Indemnity payments The date of receipt of payment by the vendor, Consideration in money X 15/115
or date paid to the other person (if the
insurance company pays someone else

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Illustration A

There are two claims that have been made by a company.

Trading stock worth R100,000 was stolen in a robbery and the insurance company paid out R90,000.

A key man life insurance policy was claimed on as a senior director had been killed by the robbers.
R800,000 was paid to the company.

Are the two indemnity payments subject to VAT?

Suggested solution

The theft of stock has VAT implications as it is a short term insurance policy. Output VAT of R90,000
X 15/115 will be accounted for.

The key man assurance policy has no VAT implications, and life assurance payments are exempt
from VAT.

Illustration B

Mr B is a chartered accountant that renders professional services to clients. He has an office at this
house and is registered for VAT purposes.

Robbers broke into his house and stole his computer (a business asset that he had claimed VAT on
when buying it) and also his TV in his lounge (a private asset that was not part of his business)

The insurance company paid R11,500 for the computer and R5,700 for the TV.

Does Mr B need to account for any output tax on any of the indemnity payments?

Suggested solution

The indemnity payment on the computer needs to be accounted for as output VAT as the computer
is a business asset of a vendor upon which input VAT was originally claimed. 15/115 X R11,500 =
R1,400 output VAT will have to be accounted for.

There is no VAT on the private asset not used by the vendor in the furtherance of his enterprise.

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Illustration C
A company had a machine stolen that was worth R100,000. The insurance company replaced the
machine.
What are the VAT implications?
Suggested solution
There will be no VAT implications on the transaction. The company is in the same position as before
the machine was stolen. There is no output VAT on reinstatement of goods.

Illustration D
A company was paid R50,000 by an insurance company to replace a motor vehicle passenger vehicle
that was stolen from the company.
What are the VAT implications?
Suggested solution
As the company did not claim VAT when the car was purchased, it need not account for any output
tax when the insurance company pays out for the car. (Section 8(8)).

Illustration E
A company was robbed and the insurance company made the following payments in respect of the
policy of insurance.

 A payment of R100,000 in respect of a passenger vehicle taken by the robbers that was not
located after the robbery
 A payment of R10,000 used to repair another passenger motor vehicle the robbers hit when
trying to escape.
 A payment of R50,000 for a bakkie that the robbers stole.
 The robbers stole a fax machine and the insurance company replaced the machine with a new
one at a cost of R3,000.
What are the VAT implications of the above?

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Suggested solution
The following are the VAT effects:

 No VAT on the R100,000 to replace the passenger vehicle taken as there was no VAT claimed
upon acquisition.
 VAT output of R10,000 X 15/115 will be accounted for on the repair. In terms of VAT principle,
although no VAT is claimed on the acquisition of the motor vehicle, VAT may be claimed on the
repairs and as such, a VAT output will be accounted for on a repair.
 VAT output of R50,000 X 15/115 will be accounted for as VAT would have initially been claimed
on the acquisition of the bakkie.
 As the fax machine has been given to re-instate the good that was taken, there are no VAT
implications in this regard.

Illustration F
A Ltd is renting out a building and damage is caused to the building’s fittings by flood. The damage
was R5,700 and A Ltd made a claim against its insurance company.
The insurance company paid the landlord directly for the damages.
What are the VAT implications?
Suggested solution
A deemed supply is made to the landlord and output VAT of 15/115 X R5,700 = R743 is to be
accounted for by A Ltd as it is their insurance policy.

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10. LEASES
LEASES

Instalment credit agreement Rental agreement (could be

(could be finance lease, hire operating lease)
purchase or suspensive sale)

Motor car or Other asset claim

Other asset claim VAT
entertainment asset VAT on each lease
upfront
instalment
Input VAT denied
Value of supply = open
market value X 15/115

Time of supply =
earlier of date of
payment or when
goods are delivered

SUMMARY
Time of supply Value of supply
Finance lease/instalment Time of supply is the earlier of the time of The value of supply is the cash value excluding
credit agreement delivery or when the payment is received any finance costs
Rental agreements Earlier of when payment becomes due or when The value of supply rule is the normal rule being
payment is made value = cash consideration or if there is a barter
transaction, value = open market value of the
barter good obtained.

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Illustration A

A Ltd approach Investec to finance a machine. The machine would cost R228,000 including VAT in an
arm’s length transaction. Investec leases out a machine which cost R200,000, had VAT of R28,000
and interest of R72,000 and was payable in 30 instalments of R10,000 each.

The machine was delivered on 26 June and the first instalment was paid on 5 August. At the end of
the lease, the machine will belong to A Ltd and A Ltd accepts the full risk of destruction or loss of the
machine.

What are the VAT implications of the above?

Suggested solution

The lease agreement falls within the definition of an “instalment credit agreement”

VAT is levied on the transaction as section 8(10) deems it to be a supply of goods.

The time of supply will be the earlier of the time of delivery or the time that any payment of
consideration has been received.

As the machine was delivered on 26 June, the full input tax can be claimed in the tax period that
ends on 31 July.

The amount of the input tax is 15/115 x R228 000 = R29 739

There is no VAT on finance charges as it is an exempt supply (financial service are exempt from VAT).

No VAT can be claimed on the individual lease payments.

Illustration B

C Ltd rents out a fax machine on a monthly basis from B Ltd at a rate of R570 per month. The lease
can be cancelled if three months notice is given by C Ltd to B Ltd. The asset has a useful life of 5
years. Both C Ltd and B Ltd fill out VAT returns on a monthly basis.

What are the VAT implications of the above?

Suggested solution

The lease is not an instalment credit as defined. The lease will thus be treated as an operating lease.

B Ltd will account for output VAT of R570 X 15/115 = R74.

C Ltd will account for input VAT of R74. VAT will be accounted for on a monthly basis.

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11. BAD DEBTS

BAD DEBTS

Local sales Exports Staff loan Interest

VAT zero rate exempt charged
exempt
Illustration A

A Ltd writes off the following bad debts. For which debts can input VAT be claimed for?

 Local trade debtors of R38,200 which includes R4,000 interest charged on overdue accounts
 Overseas trade debtors of R57,000
 Staff loan written off of R40,000

Suggested solution

The R4,000 interest written off has no VAT implication; financial services are exempt from VAT.

R34,200 X 15/115 = R4,460 VAT input can be claimed on writing off the remaining trade debtor.

No VAT was charged on the export, thus there is no VAT input on the write off of the bad debt.

Loans are financial services and as such there is no VAT input on the write-off of a staff loan
(exempt)

It should be noted that input vat cannot be claimed on bad debt write-offs between two group
companies owned 100% by the same company or between a wholly owned subsidiary and its
holding company.

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 12. FRINGE BENEFITS
FRINGE BENEFITS

VAT on these fringe benefits No VAT on these fringe benefits

Give asset to employee Travel allowance Entertainment allowance
Give service to employee Subsistence allowance Low interest loan
Give company car to employee Housing subsidy Payment employee debt
Time of supply is when fringe Meals Residential accommodation
benefit is recorded for employee
Share option gains Holiday accommodation

Medical aid contribution

Give asset to employee

Trading Bought to Other

stock give to Remember VAT on amount paid by Employee +
employee additional VAT on fringe benefit
Lower of
cost/ MV COST Thus if an employee is given an asset with a value
of R1,000 for R400, there will be VAT of R400 X
-amount -amount Market value
15/115 on the sale and on 600 X 15/115 on the
paid paid -Amount paid fringe benefit.
Company car
On a motor car [(0, 3% x COST EX VAT)-85(if employee pays maintenance)] X 15/115 X no months
If not a motor car, substitute 0, 3% with 0, 6% (such as with a bakkie)
Time of supply Value of supply
Fringe benefits other than The time of supply is the time at which the The cash equivalent of the benefit for normal tax
use of a motor vehicle benefits becomes liable for employees tax purposes in terms of the 7th schedule to the income tax
act
Use of a motor vehicle The time of supply is the time at which the If input tax was denied on the acquisition of the motor
benefits becomes liable for employees tax vehicle, the value of supply is 0,3% X determined value
of the motor vehicle per month.

If input tax was not denied on the acquisition of the

motor vehicle, the value of supply is 0,6% X determined
value of the motor vehicle per month.

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Illustration A
A company gave one of its employees the following as part of their monthly salary package:
a) a subsistence allowance of R4,000, an entertainment allowance of R600, and a travel allowance
of R2,000.
b) A low interest loan to buy a car.
c) A subsidy of R1,000 per month for his house
d) Paying of his monthly telephone account as he is required to make business calls from home
e) Lunch in a canteen at work
f) A house to be used as residential accommodation for his son whilst a student at UCT
g) 1,000 share options given to him each year
h) 2 days at holiday accommodation of their choice for each month worked.
Does VAT need to be accounted for on any parts of the salary package above?
Suggested solution
There is a supply to an employee. As there is a supply, we need to establish whether there is any
output VAT on any of the supplies.
No output VAT needs to be accounted on any of the above.
The allowances are the supply of money (a financial service).
The low interest loan is an exempt financial service
The subsidy given is a supply of money ( a financial service)
The payment of an employee’s telephone account is a financial service. In addition to this, the
telephone bill/invoice will be made out to the employee and the company will be unable to claim
VAT on this
The meal provided is entertainment as defined. No VAT is claimed on buying food for staff and as
such there is no output VAT on the fringe benefit
Residential accommodation is an exempt supply.
Share options are a financial service.
Holiday accommodation is entertainment as defined.

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Illustration B
A Ltd give an employee a table worth R570. The table cost R3,000 and is currently recorded in the
accounting records at a book value of R1,000. What are the VAT implications?
Suggested solution
The company is deemed to have supplied a table to the employee and R74 VAT (15/115 X R570) will
be accounted for as output tax.

Illustration C
An employee is given an asset by the employer. The asset has a value of R228. The employee paid
R171 for the asset.
What are the VAT implications? The employer is registered for VAT.
Suggested solution
The sale of the asset is a supply that is subject to VAT. VAT of R171 X 15/115 =R22 will be levied on
the supply.
There is also a fringe benefit as the asset has been supplied for an amount less than market value.
The amount of the fringe benefit is R57 (R228 – R171).
Output VAT will be levied on the fringe benefit (because the company has supplied a table to an
employee) of R57 X 15/115 = R7.
NOTE THE FOLLOWING: The total output VAT amount is thus value of the asset multiplied by the
VAT fraction. It should still be shown separately.

Illustration D
A Ltd bought a table for their canteen three years ago. No input VAT was claimed on the table as the
table was purchased for use by the staff in the canteen. This is considered to be a provision of
entertainment to staff members.
A Ltd give an employee a table worth R570. What are the VAT implications?
Suggested solution
The company is deemed to have supplied a table to the employee.
However as no VAT was claimed when purchasing the table, no VAT need be accounted on the
supply of the table to the employee.

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Illustration E
A company acquires a microwave for use in the staff kitchen for R2,000.
You are required:
a) can VAT be claimed on the microwave?
b) if the microwave is given to an employee when its value is R1,500, what will the VAT implications
be?
c) if a new microwave was purchased for R1,710 cash for the specific purpose of giving to an
employee and given to an employee, what will the VAT implications be?
Suggested solution
Part a
No VAT can be claimed on the microwave purchase as this is the provision of entertainment.
Part b
No output VAT is charged on the supply to the employee as no input VAT was claimed when buying
the microwave.
Part c
Input VAT of R210 was claimed on the purchase of the microwave.
The journal entry is
Dr Microwave 1,500
Dr Input VAT 210
Cr Cash 1,710
When the asset is given to the employee, the following journal entry will be passed:
Dr Staff expense 1,696
Cr Output VAT 1,500 X 15/115 196
Cr Microwave 1,500
Note that input VAT and output VAT are different.
NOTE: In part c the microwave is not viewed as entertainment as the purpose for the purchase was
to provide it to an employee.

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Illustration F
A Ltd gave his top sales employee a free trip to the US and the plane ticket cost R8,000. What are the
VAT implications.
Suggested solution
The purchase of an overseas air ticket is a zero rated supply. Thus no input vat can be claimed on the
zero rated supply acquired by the enterprise.
The fringe benefit given will attract no output VAT as it was derived from a zero rated supply.

Illustration G
A company gave an employee a notebook computer to use at work. The employee only uses the
notebook for work. What are the VAT implications?
Suggested solution
Assets given to staff members where use of the assets outside of working hours is incidental to use
are nil fringe benefits.
As there is no fringe benefit for income tax purposes, there is no output tax on a nil supply.

Illustration H
A Ltd purchases a motor vehicle, which is a motor car, for R102 600 (including R12 600 VAT).
A Ltd is not entitled to claim an input tax credit in respect of the acquisition of the motor car.
An employee is granted the right to use the motor car, and the vendor bears the full cost of
maintaining the motor car.
The employee is granted the right to use the motor car as from 15 November of the current year. A
Ltd has a two month VAT period ending February, April, etc.
a) What are the VAT implications for the February VAT return?
b) How would the solution change if the employee is obliged to maintain the vehicle.
Suggested solution
Part a
The calculation of the output VAT payable by the vendor on the supply of the fringe benefit is
calculated as follows:
[(102,600 – 12,600) x 0.3%] x 15/115 x 2months = R99.31

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Part b
The calculation of the VAT payable by the vendor on the supply of the fringe benefit is calculated as
follows :
[((102,600 – 12,600) x 0.3%) – R85] x 15/115 x 2months = R48.26
Thus R48.26 will be put into the VAT return as output VAT on the supply of the motor vehicle from
the employer to the employee.

Illustration I
A Ltd sold a computer with a value of R10,000 and a book value of R5,000 to an employee for
R6,000. The employee paid cash for the computer. The original cost of the computer was R15,000.
What are the VAT implications of the above? What journal entries will be passed by A Ltd in this
regard.
Suggested solution
A Ltd will account for output tax on the sale of 15/115 X R6,000 = R782.60.
In addition, there will be output tax on the fringe benefit given of R4,000 (R10,000 – R6,000). Output
VAT of 15/115 X R4,000 = R521.74 needs to be accounted for.
The journal entries passed will be as follows:
Dr Bank R 6,000.00
Dr Accumulated depreciation R10,000.00
Cr Output VAT R 782.60
Cr Fixed assets computers at cost R15,000.00
Cr Profit on sale of fixed assets R 217.40
Recording sale of asset

Dr Salaries and wages R 491.23

Cr Output VAT R 491.23
Output VAT on the fringe benefit amount

Illustration J
A vendor acquired a bakkie (not a double cab) for R57,000 from a non vendor on 1 December. The
amount was paid up front. The bakkie was given to a salesman as his new car. The company paid for
all fuel and maintenance. What are the VAT implications for the February VAT return? The vendor is
a category F vendor (4 monthly)

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Suggested solution
A second hand goods deemed input credit of 15/115 X R57,000 = R7,434 will be granted and may be
claimed by the vendor.
A fringe benefit output tax of R117.39[R50,000 (R57,000 – R7,000) X 0,6% X 3 months X 15/115] will
also be accounted for on a monthly basis.

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13. OVERPAYMENT
OVERPAYMENT

OVERPAYMENT

VAT output if not repaid within 4 months. If repaid over 4 months later, VAT input claim on
repayment.

EG. Sell 1, 140 on 10 Jan 2010 (monthly VAT vendor)

Paid 2, 140 on 15 Feb 2010.

Refund 1, 000 on 27 November 2010

Output = 1 150 x 15/115 in Jan return

Output = 1 000 X 15/115 IN June return

Input = 1 000 x 15/115 in November return

GOODS NOT PAID WITHIN 12 MONTHS

GOODS NOT PAID WITHIN 12 MONTHS

CLAIM INPUT ON ACQUISITION

Charge output on amount outstanding if not paid within 12 months of VAT RETURN input

EG. Buy stock for 22 800 on 15 Jan 2019 (monthly VAT vendor) paid R5 700. Have never paid
remaining 17 100

Input = 22 800 x 15/115 in Jan 2019 return.

Output = 17 100 x 15/115 in Feb 2020 return

NOTE: The 12 months is calculated from the end of the month in which the debt becomes payable.

NOTE: The above is not applicable to amounts outstanding between group companies where there is
a 100% shareholding.

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Illustration A

A Ltd buys goods for R10,000 plus VAT of R1,500 on 12 January. On 31 January, the accountant pays
B Ltd R11,500 for the goods. The accounts assistant also paid the amount on 10 February. A Ltd and
B Ltd have 2 month VAT periods ending February, April, etc.

B Ltd never refunded the amount until 15 November.

What are the VAT implications for the above for B Ltd?

Suggested solution

B Ltd will account for an output in the February return of R1,500.

As the overpayment has not been refunded within 4 months, another R1,500 will be accounted for
by B Ltd as an output in June return (should have been refunded by 10 June).

When the amount is finally refunded in November, an input claim of R1,500 can be claimed by B Ltd
in its December VAT return.

Illustration B
A Ltd bought goods worth R30,000 from B Ltd and claimed an input VAT of R3,000 on 1 January
20X1.

A Ltd was supposed to pay for the debt within 30 days. However due to a disagreement did not pay
the amount due. The amount was paid on 1 April 20X2. A Ltd submits VAT returns monthly

What are the VAT implications?

Suggested solution

In the January 20X1 return, a VAT input of R3,000 will be claimed.

In the February 20X2 return, an output tax of R3,000 will be paid in respect of this transaction. (Wait
12 months, record in month 13) This output reverses the input tax claimed and not paid within 12
months.

In the April 20X2 return, an input tax of R3,000 will be claimed in respect of this transaction.

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Illustration C

When doing the debtors reconciliations, an overpayment was detected. The details are as follows:

DEF Limited was invoiced for an amount of R300 000 (including VAT) on 31 January 2012. Heuertag
Limited paid the amount on 15 February 2012. On the same day a fire destroyed all the computers in
the creditors department of DEF Limited. At the time of the fire, no computer back up had been made
of any transactions recorded on 15 February 2012. As DEF Limited could find no record of the
payment made, they paid the account again on 20 February 2012.

Heuertag’s auditors identified the overpayment made by DEF Limited during the audit, which was
performed in June/July 2012. As a result this overpayment of R300 000 was repaid on 15 July 2012.

The managing director of Heuertag wants you to discuss the VAT implications for the company of the
overpayment of R300 000, as well as the repayment of the amount to the debtor.

Suggested solution

An excessive payment of R300 000 was received on 20 February 2012. As the overpayment was not
refunded within a 4 month period (therefore by 20 June 2012)

The overpayment is deemed to be consideration for the supply of a service and output tax of
R300,000 x 15/115 = R39 130 (section 10(26)) should be accounted for in the tax period in which the
4 month period ends (20 June 2012) therefore in the tax period 30 June 2012 (section 8(27)).
In the tax period that the R300 000 is repaid, therefore July 2012, a deemed input can be claimed of
the tax fraction on the overpayment repaid, therefore 15/115xR300,000=R39 130 (section 16(3)(m)).

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14. CONNECTED PERSONS
CONNECTED PERSONS

Vendor Non Vendor to

to vendor non vendor
vendor to or vendor to
vendor not 100%
vendor
Normal
Use 2nd Value of
rules
hand supply is
goods greater of
rules actual cost or
open market
value
Notional
Time of
input VAT.
supply is
Remember when goods
timing and are removed
value or if not
removed
when goods
are made
available.

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Illustration A

Company A and Company B are connected persons. Company A sells a machine worth R10,000 to
Company B for R5,000. Both companies are VAT vendors.

At what amount will the VAT be accounted for?

Suggested solution

As they are both registered for VAT, VAT is calculated by both parties on the R5,000 selling price.

Company A will account for R614 output VAT and Company B will account for R614 input VAT.

Illustration B

Company A and Company B are connected persons. Company A sells a machine worth R10,000 to
Company B for R5,000. Company A is registered for VAT, and company B is not registered for VAT.

a) At what amount will the VAT be accounted for?

b) How would the solution change if Company B was registered for VAT but could only claim 40% of
VAT for taxable supplies.
Suggested solution

Part a

Company A will account for VAT on the R10,000 open market value of the machine.

Part b

Company A will account for VAT on the R10,000 open market value of the machine.

Company B will claim R5,000 X 15/115 X 40% VAT.

Remember! Input VAT is always calculated on the lesser of market value or the consideration.

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15. TRANSPORT

International Transport by road or rail of fare paying Other including

transport of passengers will be an exempt supply. local air transport,
passengers will Note any luggage taken by the Local sea transport
be a zero rated passengers will also be exempt if will attract VAT at
supply goods transport fees are charged. 15%.

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Illustration A

Which of the following would be exempt?

1. Buying a bus to transport employees to the factory

2. Buying of a bus by Greyhound to carry fare paying passengers
3. Buying bus coupons for staff
4. Hiring a bus to Greyhound, who will use the bus to transport fare paying passengers
5. Transport in an ambulance
6. Tour through Cape wine lands for 3 days including accommodation. Bus transport portion is
included in total all in one exclusive price.
7. Tour through Cape wine lands for 3 days including accommodation. Bus transport portion is
charged for separately.

Suggested solution

1. Not exempt as the employees are not fare paying, VAT at 15% can be claimed on acquisition of
the bus (remember to consider the number of seats)
2. Exempt as used to carry fare paying passengers by the company who owns the bus
3. Exempt as these coupons are for fare paying customers transported by road or rail
4. Not exempt as the bus is hired out. What the bus is used for is irrelevant for the supplier of the
bus. It is up to the person renting the bus to determine what it will be used for. Person who
owns the bus is not using the bus to carry fare paying passengers but is using the bus to get
rental income. VAT at 15%
5. Exempt service
6. Not exempt as this is a tour sold, not transport by road or rail alone. Thus whole tour is at 15%.
7. Bus transport is exempt. Tour cost is not exempt and VAT at 15% charged for the tour.

Illustration B
For each of the following examples, discuss whether VAT will be levied on the transaction at a
standard rate. All of the tickets were bought from inside SA.
a) Johannesburg to Cape Town
b) Johannesburg - Cape Town – Rio De Janeiro
c) Washington DC - Cape Town
d) Rome – Paris
Suggested solution
a) VAT at 15%
b) VAT at 0% - The Johannesburg to Cape Town leg of the flight is considered to be part of the
international transport (it is part of the flight)
c) VAT at 0%
d) VAT at 0%

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16. APPORTIONMENT OF VAT

Certain organisations have both taxable and exempt supplies.

In such cases this may lead to apportionment of input VAT.

Remember the de minimus rule where 95% and higher is rounded up to 100%.

Type of
organisation

Organisation Organisation makes both vatable and Organisation makes

makes vatable exempt supplies. An example of this is an exempt supplies
supplies of 95% or enterprise that two lines of business, a only. An educational
more (NB 95% factory (which is vatable) and residential institution is an
rounded up to accommodation (which is exempt) example of this
100%) An example
of this is a factory If something is bought for the factory, This institution is
selling shoes input vat is claimed. not registered for
VAT. Thus no vat
Claim 100% input If something is bought for residential can be claimed by
accommodation, no vat can be claimed as
on vatable supplies this institution.
received the item is purchased for the purpose of
making exempt supplies.

If something is bought for both the factory

and the residential accommodation (such
as a computer for a bookkeeper that does
the books for the factory and residential
accommodation), input vat can be claimed
to the extent that the computer is used for
taxable supplies. Thus if the computer is
used 60% for the factory and 40% for
residential accommodation, 60% of the
input vat on the acquisition of the
computer can be claimed as input vat.

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Illustration A

Assume for the purposes of this example that short term insurance is subject to the charging of VAT
and long term assurance does not attract VAT.

A Ltd sells both short-term insurance and life assurance. Life assurance is sold 40% of the time and
short- term insurance is sold 60% of the time. SARS accepts these percentages.

The following purchases are made:

 A computer is bought for the insurance company costing R3,420 including R420 VAT. This
computer is used for both the long term and short term business.
 Stationery is bought for R1,150, including R150 VAT for the long term assurance business.
 Postage of R570 including R70 VAT is incurred for the short term insurance business.
What are the VAT implications of the above?

Suggested solution

Computer

Only 60% of the VAT may be claimed totalling R252 i.e. 60% X R420. This is because the computer is
used for both taxable and non taxable supplies.

Stationery

No VAT may be claimed as no VAT is charged on long term assurance supplies which is an exempt
business.

Postage

R70 VAT may be claimed as an input tax as the postage is incurred solely on the short term insurance
business that makes only VATable supplies.

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Illustration B

A taxpayer runs a business that sells beer both locally and abroad. The company also provides
residential accommodation to staff.

In the past the following taxable supplies have taken place:

 60% of sales are local beer sales that have VAT charged at 15%
 30% of sales are export beer that have VAT charged at 0%
 10% of sales are residential accommodation letting fees that are exempt from VAT. Employees
stay in the residential accommodation.

The following transactions took place:

 A lawnmower was purchased for the residential accommodation for R11,400 from a vendor.
 A bus was purchased from a vendor to transport persons from the residential accommodation to
the factory for R570,000 from a vendor.
 An unused computer was purchased from a vendor for R4,560 including VAT by the accounts
department that was used for beer sales and residential accommodation .
 Another new computer was purchased from a non vendor for R5,700. This computer was used
only in the factory.

What are the VAT consequences of the above?

Suggested solution

No input VAT can be claimed on the lawnmower as it is used for an exempt supply only.

The bus is used only for vatable supplies (as it is used for the factory) and as such R570,000 X 15/115
= R74,348 may be claimed as input VAT for VAT purposes.

The computer is used for both taxable (60% + 30%) supplies and exempt supplies. Where VAT is
charged at 0%, as it is for exports, this is still a taxable supply.

Thus 90% X R4,560 X 15/115 = R535 VAT input can be claimed. The de minimus rule will not apply as
the claim is less than 95% of total VAT.

No VAT can be claimed on the second unused computer even though it is used in the factory. There
is no VAT invoice for this new good purchased from a non vendor .

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Illustration D
A company has two lines of business being sales of goods and the letting of residential property.
Approximately 60% of the company’s sales are to local customers, 10% are to export customers, and
30% of the sales are rentals of residential property. The Commissioner has used the turnover basis of
apportionment to arrive at an appropriate input tax ratio of 70%.
The following income relates to a two month period of the company. All amounts include vat where
applicable.
Sales and income
Local sales R1,500,000
Export sales R 400,000
Interest charged on overdue accounts R 40,000
Rentals R 300,000
Interest received R 20,000
Expenses
Salaries and wages R 40,000
Purchase of a lawnmower used exclusively for res accom R 3,000
Purchase of computer to be used in the accounts dept R 21,000
Services charged by courier for stock sold overseas R 12,000
Bank charges R 5,700
Interest paid on mortgage bonds for residential property R 10,000
Interest paid on mortgage bond on factory R 8,000
Purchase coffee machine for staff R 900
Purchase bus (note 1) R 190,000
Bad debts (note 2) R 5,000
Purchase of raw materials used in the factory R 244,286
Note 1
A bus was purchased to convey staff from the factory to the residential accommodation and vice
versa.
Note 2
Bad debts were written off as follows:
Factory sales – R4,000
Residential rentals – R1,000
You are required to calculate the amount of vat to be paid over to the Receiver over this tax period.

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Suggested solution
Output
Local sales (15/115 X 1,500,000) R195,652
Export sales(zero rated) R nil
Interest charged on overdue accounts (exempt – financial service) R nil
Residential rentals (exempt) R nil
Interest received (exempt – financial service) R nil
Insurance computer (15/115 X 11,400 X 70%) R 1,041
Insurance lawnmower (exempt) R nil
-------------
Total output vat R195,693
Input Vat
Salaries and wages (no supply therefore no input vat) R nil
Purchase lawnmower (used only for exempt supplies no input credit) R nil
Purchase computer (15/115 X R21,000 X 70%) R 1,917
Courier charges (15/115 X R12,000 – can claim input for expenses
relating to zero rated supply) R 1,565
Bank charges (15/115 X 5,700 X 70%) R 520
Interest paid mortgage bond residential property (exempt fin service) R nil
Interest paid mortgage bond factory (exempt financial service) R nil
Purchase of a coffee machine for staff (entertainment exempt) R nil
Purchase of bus (15/115 X R190,000) R 24,783
Bad debts – factory sales (15/115 X R4,000) R 522
Bad debts – residential rentals (exempt supply) R nil
Purchases of goods R 30,000
-------------
Input vat R 59,307

Net vat due to Receiver R136,386

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 17. CHANGE IN USE
CHANGE IN USE

TOTAL CHANGE OF USE PARTIAL CHANGE OF USE

Either NON VAT – VAT or VAT – NON VAT VATABLE SUPPLY STAYS AS A VATABLE SUPPLY,
BUT PERCENTAGE APPLICABLE TO THE
Examples include VATABLE SUPPLY CHANGES.
100% - 0% or 0%- 100% Examples include:
0%- 40% or 60%- 0% 40%-70% or 100%-20% or 35%-60%
This applies to all assets for any amount of change in use. The cost of the asset must >= R40,000
The time of supply is immediate, thus account for VAT on date The change in use must be >= 10%
of change of use.
The time of the supply is in the year end VAT
OUTPUT VAT return.
Value of supply = INPUT & OUTPUT VAT
% change X market value X 15/115 Value of supply =
INPUT VAT % change X lower of cost or market value (incl
Value of supply = % change X lower of cost or market value VAT X 15/115

NOTE: Look at the differences in accounting for output VAT between partial and complete change of
use. For complete change of use, the market value is used to determine output VAT. For partial
change in use the lower of cost or market value is used to determine the output VAT.

Also consider the following:

 If there is a total change in use, you know immediately that an enterprise has changed intention
from vatable use to non vatable use or vice versa. The total change in use is done immediately
using the value on that date.
 There may be partial changes in use every month. Consider an insurer that sells assurance (life,
dread disease which is exempt) and short term insurance (householders, car insurance which is
vatable). The mix may differ from month tpo month. February may be high assurance as people
buy RAF’s to save tax. December might be high short term insurance as people are unwilling to
go on holiday without insurance. It is impractical to keep on adjusting vat. This we adjust vat
once a year using the average percentage of vatable supplies for the year, only for items that
cost more than R40,000 and only if the percentage moves more than 10%.

NOTE ON CHANGES IN LEGISLATION:

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Developers

Developers of residential units typically develop residential properties with the view of selling these
units. As these residential units are typically viewed as the developer’s stock, input VAT deductions
can be claimed.

The global economic crisis has, however, resulted in situations where developers may be forced to
rent these units for a period of time until they are able to find buyers for the properties. In the past
this has lead to a change in use adjustment as the property is no longer being used as stock but
rather as residential property. This would have resulted in the developers paying output VAT based
on the market value (as per diagram above).

S18B was introduced to the VAT Act to provide temporary relief to developers who are forced to let
out the units during an interim period. The letting of the property will not be viewed as a change in
use (and there will thus not be any Output VAT adjustment) for a period of 36 months. If the
developer continues to let out the property for a period exceeding 36 months, the property will be
treated as if there had been a change in use and the developer will have to account for Output VAT.
If the property is let out for 36 months or less before being sold there will be no need to account for
Output VAT.

See illustration F

2nd hand goods – Notional input limited to transfer duty

Prior to January 2012, notional input claims on 2nd hand commercial fixed property were limited to
transfer duty paid.

It is possible that there will be a change in use in one of these properties. Note the change in use will
still be limited to transfer duty. See illustration g.

Thus consider a block of flats was acquired in 2009 from a non vendor for R10,000,000 and R800,000
transfer duty was paid. The flats were used for 12 monthly residential letting until this year when
there was a change in use to commercial letting and the flats were now used as holiday flats for daily
rental. The current market value is R13,000,000.

This would be a total change in use.

Normally input would be claimed on 10,000,000 (lower of 10M and 13M) X 15/115 X 100% change
for 2nd hand goods. But as the flats were acquired prior to 2012, this claim is limited to transfer duty
of R800,000.

Also consider if the same building was used 40% for commercial letting from the beginning. In 2009,
R800,000 X 40% = R320,000 vat would have been claimed. On the whole block of flats being used for
commercial letting, vat input of 60% X 10,000,000 X 15/115 = R782,609.

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Illustration A

Mr A is a pharmacist and runs Greens Pharmacy as a sole trader. He is B category VAT vendor. VAT
returns are submitted two monthly.

He buys 100 boxes of Lip Ice for R570 including R70 VAT. The vendor claims R70 as an input tax.

After meeting a pretty girl who invited him for a drink, he took one box of Lip Ice home for private
use on 15 June.

What are the VAT implications if the box of Lip Ice is normally sold for R9.12?

Suggested solution

This is a total change in use. The Lip Ice were acquired for business purposes, but one box has now
been used for private purposes.

The vendor will have to include R1.19 as an output tax (R9.12 X 15/115) if he takes one of the boxes
home for private use.

Note the following:

 There is no minimum amount for total change in use

 This is a total change in use as the use has changed from business use to private use (vatable to
non vatable)
 For total changes in use, they are accounted for in the period that they occur. This will be
recorded in the June VAT return.

Illustration B

A company buys a group of holiday flats for R1,250,000 including VAT. They claim the full VAT as
they decide to continue letting out the flats for short periods to holiday-goers.

Two years later they decide to let out the flats for residential purposes. (The letting out of flats for
residential purposes is not subject to VAT). What are the VAT implications if the value of the flats is
now R1,710,000.

Suggested solution

This is a total change in use (vatable to exempt)

If the value of the complex is now R1,710,000, output tax of 15/115 X R1,710,000 must be accounted
for i.e. R223,043.

Illustration C
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A person buys a house for R228,000 for private purposes. Transfer duty of R10,000 was paid. Two
years later, when the value of the house is R250,000, he decides to convert the house into a
restaurant. What are the VAT implications?

Suggested solution

Note that is a second hand good and notional input VAT can be claimed as if bought from a non
vendor.

Notional input tax may be claimed of 15/115 X R228,000 = R29,739.

The R28,000 will be claimed immediately as this is a total change in use.

It should be noted that various companies offer both vatable supplies and exempt supplies.

Illustration D

A new company is formed that offers continuing professional development courses (vatable
supplies) and educational services (exempt supplies) in January. The year end is October. The
company has been registered to submit monthly VAT returns.

The company’s budgeted income statement showed the following:

Estimated professional training turnover R 6,000,000

Estimated educational turnover R 4,000,000

Budgeted total turnover R10,000,000

SARS accepted the budget.

The company bought a commercial building that would be used for offering all courses. The building
cost R3,420,000 from a VAT vendor.

Classroom equipment costing R570,000 was bought to furnish classrooms. Classrooms are used for
both professional training and educational services.

Office equipment costing R114,000 was bought for the educational department, whilst office
equipment costing R171,000 was bought for the consulting department.

A mainframe computer costing R28,500 was purchased that was used for both business lines.

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During the year, actual turnover was as follows:

Actual professional training turnover R 3,000,000

Actual educational turnover R 12,000,000

Actual total turnover R15,000,000

Market values at year end were:

 Building R5,000,000
 Classroom equipment R300,000
 Office equipment – professional consulting R110,000
 Office equipment – education R80,000
 Computer mainframe R20,000

Discuss the VAT input implications of the assets acquired, and any subsequent adjustments.

Suggested solution

The company is 60% vatable and 40% exempt. The budget submitted to SARS will be used to
establish an initial VAT apportionment percentage, if SARS accepts the budget.

The following VAT inputs will be claimed:

 Commercial property – 3,420,000 X 15/115 X 60% (Used for both VATable and exempt supplies)
 Classroom equipment – 570,000 X 15/115 X 60% (Used for both VATable and exempt supplies)
 Office equipment – Education courses no VAT input as this is an exempt supply
 Office equipment – Professional courses 171,000 X 15/115 (No apportionment as all VATable)
 Computer – 28,500 X 15/115 X 60% (Used for both VATable and exempt supplies)

All the above will be accounted for in the January VAT return.

At the end of the year, the actual turnover shows that the company had 20% taxable supplies and
80% exempt supplies (3M/15M is VATable).

There is thus a 40% change in use. (60% to 20%). As the change in use is more than 10%, a change in
use will be accounted for in the VAT period that the year- end VAT return falls. This is the October
VAT return. Changes in use will only be done for apportioned assets that cost >= R40,000.

The following change in use adjustments will be processed for the October VAT return as outputs.

 Building 40% change X (lower of R3,420,000 or R5,000,000) X 15/115

 Classroom equipment 40% change X (lower of R300,000 or R570,000) X 15/115
 Office equipment – Not apportioned thus not adjusted
 Computer mainframe – Cost less than R40,000 thus no adjustment

Illustration E
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A Ltd is a company that rents out residential and commercial property. At the end of last year,
commercial rentals were 80% and residential rentals were 20%.

A Ltd has a February year end. Last year, a computer mainframe costing R600,000 was purchased to
maintain all rentals and 600,000 X 15/115 X 80% was claimed as input VAT.

On 15 September, all residential property was sold when the computer was worth R375,000.

At year end the computer was worth R342,000.

What are the VAT implications for the current year?

Suggested solution

This is a partial change in use. The company has changed from 80% VATable to 100% VATable.

No change in use adjustment is processed in September when the change took place. Partial changes
in use are only processed at year end.

At year end, as there is a change in use in excess of 10% and the cost of the computer exceeds
R40,000, a change in use VAT input adjustment of R342,000 X 15/115 X 20% will be processed.

Illustration F

A property developer built 20 cluster houses costing R20,000,000 with the intention of selling them.

The property market deteriorated, and the company could not sell any units.

The company rented out 14 units under long term residential contracts of 12 months, and rented
out the others as holiday accommodation.

Market value was R1,200,000 per unit on the date the intention changed.

You are required:

a) What are the VAT implications?

b) What will happen at the end of 36 months if the properties remain unsold and are now worth
R30,000,000.

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Suggested solution

Part a

s18B provides property developers with a grace period of 36 months during which they can rent out
units whilst still retaining the intention to sell them as developer. The 14 residential units rented
under long term residential contracts will thus not represent a change in use as 12 months is still
within the 36 months grace period.

The units rented out as holiday accommodation will still be used for vatable supplies as holiday
accommodation is commercial accommodation which is vatable. No adjustment is required.

Part b

At the end of 36 months, there will be a change in use from business to residential use and output
vat of R30,000,000 X 15/115 X 14/20 will be paid across.

No adjustment will be made to the to the units for holiday flat use. Vat is chargeable on the letting
of holiday flats

Illustration G

An enterprise that rents out properties has the following transactions during the year. The
enterprise submits vat returns monthly and has a March 31 2012 year end. The company has up till
the commencement of the current year had 70% vatable supplies for commercial rentals and 30%
residential rentals. At year end, the rate changed to 83% commercial rentals.

1. Bought building 2nd hand from non vendor on 20 December for R1,000,000. Purchase price was
paid on 22 January, transfer duty of R50,000 paid on 15 February 2012, and registered into the
company’s name on 3 March.
2. Building bought for residential use in 2008. Cost R2,000,000 and transfer duty of R160,000 was
paid. Building now 60% used from 1 November for commercial use. Building worth 2,400,000 at
1 November and R2,500,000 at year end.
3. Commercial building acquired from non vendor that cost R3,000,000 in 1998 on which transfer
duty of R300,000 was claimed as input. Sold this year for R8,000,000 on 5 February. R2,000,000
non refundable deposit paid on 15 February with the balance payable on registering the
property in the name of the buyer. The registration had not taken place at year end.
4. Head office of the company acquired in 2005 for R4,000,000 and transfer duty of R400,000 paid.
The head office was worth R6,000,000 at year end.
5. The company bought a building that was an office block in the city centre for R500,000. They
claimed the R50,000 transfer duty as notional input vat. They decided to convert the whole
building into residential apartments on 1 July when the building was worth R7,000,000. They
spent an additional amount of R2,000,000 converting the building to residential units in August.

For each transaction, indicate the time and value of supply for vat purposes.

Suggested solution

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1. Notional input vat may only be claimed once the property has been registered into the name of
the enterprise, and then only to the extent that the property has been paid for. Thus R1,000,000
X 15/115 input claimed in the March vat return
2. Consider the following:

The 70% apportionment amount is ignored as the percentage vat use has been identified
specifically. The 70% is for items such as a computer bought for use the accounts
department. This item will be subject to 70% vat claim as it is used for the organisatiojn as a
whole.

Total change in use as goes from non vatable to vatable. 60% X 2,000,000 (lower of 2M and
2,4M) X 15/115 = R156,521, limited to 60% X R160,000 = R96,000 input. This will be claimed
in the November vat return.

3. Output vat of R2,000,000 X 15/115. This will be recorded in the Feb vat return. Output vat
recorded at earlier of payment or registration in the deeds office.
4. Partial change at year end. Moved by more than 10% (13%) and building cost >= R40,000. Thus
13% X 4,000,000 (lower of 4M and 6M) X 15/115 limited to 13% X R400,000 = R52,000.
5. This is a total change in use from vatable use to non-vatable use (residential is not vatable).
R7,000,000 X 15/115 X 100% will be charged as output vat on the change in use. The extra
R2,000,000 in costs cannot be claimed as they are expended to create residential
accommodation.

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18. DISPOSAL OF ASSETS WHERE LESS THAN
100% CLAIMED

Output vat is charged at 100% except for insurance

Given as fringe claims and fringe benefits.
benefit
For enterprises where less than 100% vat claimed
OR when the asset was acquired, this is unfair.

Insurance claim Thus SARS makes taxpayers charge output vat at

100% and claim the input vat they have not yet
claimed on disposal

Output = % claimed x value x 15/115

OTHER
Bought for R115,000 including vat and claimed
40% vat. OUTPUT VAT

Destroyed in fire and insurance company paid Selling price X 100% x 15/115
out R120,000 including VAT. INPUT VAT
Input claim – 115,000 X 15/115 X 40% = 6,000 Lower of cost/market value x
(input vat claimed when acquired) % not yet claimed X 15/115
Output = 40% X 120,000 X 15/115 = 6,261.
(output vat on disposal. This is when the EG. Bought good and claimed
insurance company undertakes to pay) 30% VAT on 115 000 cost.
When market value 171 000,
asset sold for R171,000

Output = 171 000 x 15/115

Input = 70% x 115 000 x 15/115

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Illustration A
A company purchases an asset for R115,000 including VAT. The company uses the asset 40% for the
purposes of making taxable supplies.
You are required:
a) indicate how much input tax could be claimed when buying the asset, and
b) indicate how the VAT would be accounted for if the asset was sold for R171,000 at a later date.
Assume that the 40% usage has not changed.
c) Would the situation change if the asset was destroyed and insurance paid out R171,000 for the
same asset.
d) would this case be different if the asset was second hand fixed property and the property was
acquired for R115,000 from a non-vendor and transfer duty of R11,500 was paid. The asset is
now sold for R171,000.
Suggested solution
Part a
R6,000 (R115,000 X 15/115 X 40%) VAT would be claimed when the asset is bought. The remaining
R9,000 is denied an input credit.
Part b
As the asset is sold (not a fringe benefit or an insurance claim), there will be an output tax levied at
100% of the supply. Thus R171,000 X 15/115 = R22,304 will be accounted for as output VAT.
As 100% output VAT has been recorded, the remaining 60% input VAT can now be claimed.
An input tax adjustment will be made for the lesser of :
 15/115 X 171,000 X 60% or
 15/115 X 115,000 X 60%
Thus an input tax of R9,000 which was denied when the asset was first bought is now allowed as an
input tax credit.
Part c
If the asset was destroyed and an insurance claim was received, output VAT would be accounted for
using the 40% VAT input claimed. (Less than 100% can only be used for insurance and fringe
benefits). Output VAT of R171,000 X 40% X 15/115 will be accounted for.
Part d
When the property was purchased the company/vendor would have claimed notional input VAT of
R115,000 x 40% x 15/115 = R6,000.
When selling the property output VAT of R171,000 x 15/115 = R22,304 will be paid and the
percentage of input VAT not previously claimed can be claimed on the lower of the cost or the
market value.
Input VAT: R115,000 x 60% x 15/115 = 9,000
Illustration B

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Mr A works Libertarian Life insurance company. The company has 60% VATable short term insurance
supplies, and 40% life assurance supplies. A computer was bought for the MD costing R11,500 and
input VAT of 60% X R11,500 X 15/115 was claimed on the asset as the MD worked on both the life
and short term insurance business. The MD resigned in March and the computer was given to Mr A,
a company employee as a bonus.

The computer is now used solely for Mr A’s private benefit and is owned by Mr A. The computer was
worth R7,980 when given to Mr A. What are the VAT implications of the above?

Suggested solution

The giving of a computer to a staff member is a fringe benefit.

Output VAT of R7,980 X 60% X 15/115 needs to be accounted for on the computer when it is given
as a fringe benefit.

Illustration C

Fred Basset Ltd runs a dog food manufacturing company. They bought their factory in 1980 for
R2,000,000. Transfer duty of R200,000 was paid.
As VAT was only introduced in 1991, no VAT inputs were ever claimed upon acquisition as the sale
was subject to GST (General Sales Tax)
In the current year, Fred Basset Ltd decided to move to larger premises and the existing factory was
sold for R11,500,000 including VAT.
You are required
a) What are the VAT implications?
b) What would the vat implications be if the building was bought in 2002 and the building was used
60% for the purposes of making vatable supplies.
Suggested solution
Part a
Output VAT of R11,500,000 X 15/115 X 100% = R1,500,000 will be accounted.
Input VAT cannot be claimed for assets under the old General Sales Tax system.
Part b
Input vat of 40% X 2,000,000 limited to 40% X R200,000 transfer duty may be claimed on sale.
The output vat calculation will not change. As the building was acquired prior to 2012, only the
transfer duty portion may be claimed on disposal for a building disposed of where less than 100% of
the vat was claimed on acquisition.

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19. GOING CONCERN

1. Seller must be VAT vendor.

2. Purchase must be VAT vendor.
3. All assets necessary for going concern must be supplied.
4. Tax invoice must have VAT at 0%.
5. Agreement must state VAT at 0%.
6. Agreement must state going concern sale.
7. The operation must be an income earning activity on date of transfer. (Thus if a shopping
centre is sold, the centre must be occupied at least 50% at the date of sale by persons paying
rent otherwise it will not be an income earning activity) (If a building is sold to a person who
is currently renting the building, this will not be an income earning activity as the rent
received will stop when the renter becomes the owner of the building)

Vendor to Vendor to
100% vendor 60% vendor

Zero rate sale Output for seller = NIL

BUT

Buyer shows output of

cost x (100% - 60%) x 15%

Note: It is not the VAT fraction that is applied.

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Discussion
A Ltd wants to sell his business. The selling price of the business is R100 plus R15 VAT. The business
was sold as a going concern.

If the sale was not zero rated, R15 VAT would be collected as an output tax and R15 would be
claimed on acquisition as an input tax.

The situation is a 100% setoff of the input and output taxes. Thus SARS allows this transaction to be
zero rated.

Discussion

Taking the above discussion one step further, imagine that the purchaser was only going to use the
asset 70% for the making of taxable supplies.

In this case, if the sale was not zero rated, the seller would pay R15 output VAT to SARS and the
purchaser would only claim R15 X 70% = R10.50.

SARS would collect R15 – R10.50 = R4.50 from this transaction. It is not in SARS best interest to zero
rate this whole transaction as SARS loses money.

From a cash flow perspective, the seller, if the transaction was not zero rated, would collect R15
from the buyer (as it is part of the selling price) and pay R15 across to SARS.

The buyer would pay R15 to the seller and only claim R10.50 from SARS. The buyer would be R4.50
out of pocket.

Thus SARS asks the buyer to account for output VAT of R4.50. This is one of the few times that
output VAT is charged when buying an asset.

Illustration A

A Ltd buys a going concern business and the sale is zero rated.

The cost of acquiring all the assets is R250,000 of which R80,000 is for a motor car as defined.

The assets are used 70% for the purposes of VAT.

How much VAT must be paid by the buyer to SARS?

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Suggested solution

Total cost R250,000

Less: Cost of car (R80,000)

Assets subject to VAT R170,000

X 30% use

Amount used for taxable supplies R51,000

X 15%

Amount of output to be accounted for R 7,650

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20. CESSATION OF BUSINESS

When a business is ceased, all assets are deemed to be sold at the lower of cost or market value as
at the date of cessation of the business.

When a sole trader dies, the business could be carried on by the estate. That business will retain a
similar VAT number and business will carry on.

If a partnership changes, such as when a new partner is admitted, the partnership VAT calculation
carry on as normal.

It should be noted as to whether the business being closed is registered on a payments or invoice
basis. If recorded on a payments basis, there will be VAT on debtors and creditors at the date the
business ceases. (For invoice basis, debtors and creditors VAT has been accounted for already)

SUMMARY
Time of supply Value of supply
Cessation of business – The time of supply is immediately before the The value of supply is the lower of cost or open
voluntary person ceased to be a vendor market value
Cessation of business – The time of supply is immediately before the The value of supply is the lower of cost or open
death and estate does not person ceased to be a vendor market value
carry on business
Cessation of business – N/A N/A
Death but business carried
on in estate

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Illustration A

Mr A registered as a vendor and bought a computer for R11,500. He tried to trade and three months
later ceased to trade and deregistered. The computer was kept by Mr A for private purposes. The
market value of the computer at the date he ceased to be a vendor was R9,120.

What are the VAT implications?

Suggested solution

Mr A will claim an input VAT of R1,500 (R11,500 X 15/115) when he buys the computer.

On ceasing to trade, an output VAT of R1,190 (R9,120 X 15/115) will be accounted for the computer.
The computer is deemed to be sold at the lesser of cost and open market value.

Illustration B

A Ltd registered as a vendor and bought goods and fixed assets and claimed input VAT on such
purchases.

The company ceases to be a vendor and deregisters for VAT. At the date of deregistration, the
company had stock with a cost excluding VAT of R20,000 and an open market value of R25,000
including VAT. The company also had a delivery vehicle with a cost of R20,000 and an open market
value of R15,000 including VAT.

What are the VAT implications?

Suggested solution

The company will account for VAT on all assets still owned at 15/115 X the lesser of:

 R23,000 (R20,000 + 15%) and

 R25,000
for stock and

 R20,000 and
 R15,000
for the delivery vehicle.

Output VAT of 23,000 X 15/115 = R3,000 will be accounted for the stock and 15,000 X 15/115 =
R1,956 for the delivery vehicle.

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Illustration C
Mr A runs a business that is registered for VAT. He decides to close the business down and owns the
following assets:

Cost incl VAT Value today

Passenger vehicle R115,000 R75,000

Stock R 57,500 R68,400

Computer R 11,500 R 3,420

What are the VAT implications?

Suggested solution

The person is deemed to have sold all the goods upon ceasing to be a vendor.

Thus an output of R57,500 X 15/115 will be charged on the stock, and 15/115 X R3,420 on the
computer.

However no VAT output need be charged in respect of the passenger vehicle as no input was
claimed as the VAT input was denied.

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21. GENERAL
1. Financial services are exempt from the levying of VAT. Financial services include
a. Currency exchange
b. Share issues
c. Purchase and sale of shares
d. Giving a loan
e. Interest received
f. Interest paid
2. For deposits, VAT calculated when entitled to deposit.
3. For door to door sales, the input VAT and the output VAT must be accounted for on the 6th
day if no cancellation of the agreement has been requested by the purchaser.
4. For lay bye sales, if consideration < R10,000 VAT calculated on delivery.
5. For lay bye sales, if consideration > R10,000 VAT calculated on each payment.
6. Repossession of goods will lead to VAT input claim on the amount outstanding on the date
of repossession. The VAT input claim is based on the amount outstanding excluding finance
charges.
7. Prizes given out have special rules. Input VAT may only be claimed in the period the prize is
handed out and not when acquired. Output will be accounted for when the prize is handed
out.
8. Bad debt recovered rules are similar to bad debt rules. Bad debts recovered will be an
output.
9. For settlement discount, output VAT calculated on discount received.
10. There is no VAT adjustment for trade discounts.
11. For coin operated machines, VAT accounted for when cash taken out machine.
12. For betting transactions, VAT accounted for on payment.
13. For auctions, normal rules. There is a asset sold and auction commission. If the seller is a VAT
vendor, there will be VAT on the selling price. If the auctioneer is a VAT vendor, there will be
VAT on the auction commission.

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Illustration A

A person converts R10,000 into $1,600 with a bank. The bank charges him a transaction fee of R228
for the conversion of the currency. Is any VAT levied on the transaction?

Suggested solution

The conversion of currency from rands to dollars is a financial service and thus exempt from VAT.
VAT of 15% will be levied on the transaction fee and the bank will account for R228 X 15/115 as VAT.

Illustration B

A deposit of R50,000 was required by a landlord prior to A Ltd occupying commercial rental property
on 1 January 20X5. The landlord was registered for VAT.

Six months later on 3 July 20X5, A Ltd went into liquidation and the landlord applied the R22,800
deposit against rental for the month.

What are the VAT implications if both the landlord and A Ltd are monthly vendors?

Suggested solution

The giving of the deposit originally does not attract VAT. There are no VAT implications for the
January VAT period.

In the July VAT period, when the deposit is applied against the rental, there is a VAT charge and the
landlord will account for R22,800 X 15/115 = R2,974 as an output. A Ltd can claim a R2,974 input.

The remaining deposit not yet used will not be subject to VAT until it is applied against future
rentals.

Illustration C

A door to door vacuum cleaner salesman sells a vacuum cleaner to A Ltd, a VAT vendor for R2,000
plus R280 VAT on 28 January. In which VAT return will the input be recorded by A Ltd if the vacuum
cleaner is not returned? A Ltd submit VAT returns monthly.

Suggested solution

The purchase will be reflected in the February VAT return. The VAT must be accounted for on the
sixth day that the vacuum cleaner is not returned.

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Illustration D

A person buys an asset for R1,000 + VAT of R150 in terms of a lay-bye sale on 1 July. A R500 deposit
is made, and the remainder is payable in 6 monthly instalments monthly on 31 July.

The asset is collected after the last payment is made. When will VAT be accounted for if the last
payment was made on 31 December?

Suggested solution

The VAT will have to be included in the December tax return submitted in January (since delivery of
the asset to the buyer takes place in December, when all the lay-bye instalments have been paid).

Illustration E

A person who was paying off R7,000 on a lay-bye sale cancelled the sale, and the vendor retained
R500 of the amount paid to date. The R500 was paid on 13 March and the sale was cancelled on 16
July.

What is the time of supply?

Suggested solution

The vendor will have to account for VAT on the R500 at the date of cancellation, if VAT has not yet
been accounted for on that amount.

Illustration F
A Ltd sells goods to B Ltd for R11,500. Goods are to be paid off over time.

A Ltd accounted for an output credit of R1,500 and B Ltd accounted for an input credit of R1,500.

When R3,420 was owing, B Ltd could not pay for the goods, the goods were repossessed. The goods
were worth R6,000 on the date that they were repossessed.

What are the VAT implications?

Suggested solution

B Ltd will account for an output tax of R446 (R3,420 X 15/115) on the goods that been repossessed
from them.

A Ltd will account for an input credit.

The transactions will be accounted for on the date the goods were repossessed.

Illustration G
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A company is owed R6,000. The amount for the original sale is R5,750 and interest of R300 has been
charged.

The client is no longer able to pay his debt and the company repossesses the goods when their
estimated worth was R3,000. The company sells the goods for R2,500.

What are the VAT implications?

Suggested solution

The company that repossesses the goods will account for an input VAT of 15/115 X R5,750 = 750
upon repossessing the goods.

There is no VAT adjustment on the interest charged as this was a financial service.

The company will account for an output VAT of 15/115 X R2,500 = R326 upon selling the goods that
were repossessed.

Illustration H

A casino acquires a car as a prize to be given out. Because the car dealer is given some advertising
promotion, the casino gets the car for R70,000 plus VAT of R10,500 rather than the original cost of
R100,000 plus R15,000.

The car is acquired on 15 March and is to be awarded as a prize on September 30. The casino
submits VAT returns monthly. The car has stood on the floor for the 6 months the competition has
run.

What are the VAT implications.

Suggested solution

A VAT input of R10,500 will be claimed in the September VAT return. Input VAT is only claimed when
the prize is awarded.

Illustration I

Debtor A defaults. The amount of the original sale was R115. The company accounted for output of
R15. When written off the company claimed R15 as input VAT. R57 is now collected on the
outstanding amount.

What are the VAT implications?

Suggested solution

When the bad debt is written off, the company will now claim the R15 back (net cash flow would
then be zero).
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If the debtor ends up paying R57, R7 must now be accounted for as output tax.

Illustration J

A Ltd buys goods for R11,500 from a supplier. The amount is due to be paid in 60 days time. If the
amount is paid within 30 days, a 2% settlement discount is granted. What are the VAT implications?

Suggested solution

When the goods are bought, a R1,500 (15/115 X R11,500) input credit was claimed.

The company only paid R11,270 (R11,500 x 98%). The amount of the discount is R228. Output VAT of
R30 (15/115 X R230) will be accounted for on the settlement discount claimed.

Illustration K

Mr and Mrs A are shopping for a bed. They see a bed that they like that costs R10,000. They decide
the bed is too expensive and whilst they are walking out of the shop, the salesman states that he will
give them a trade discount of 30%.

They pay R7,000 for the bed and take it.

What are the VAT implications for the seller?

Suggested solution

The seller will account for output VAT on R7,000. The trade discount is not reflected anywhere.

For VAT purposes, this is not R10,000 less R3,000 discount.

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 CHAPTER 2
TURNOVER TAX
Contents
1. Turnover tax ....................................................................................................................................................... 2
1.1 Benefits of registering for turnover tax ........................................................................................................ 3
1.2 Qualifying entities ........................................................................................................................................ 3
1.2.1 Requirements for a Microbusiness ........................................................................................................ 3
1.2.2 Enterprises incorporated in the middle of the year .............................................................................. 4
1.2.3 Microbusinesses year of assessment ..................................................................................................... 5
1.3 Taxable turnover .......................................................................................................................................... 6
1.4 Other considerations .................................................................................................................................... 8
1.4.1 Tax payments ......................................................................................................................................... 8
1.5 Application of Micro businesses................................................................................................................... 8

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1. Turnover tax

Turnover tax is a tax that is levied on the amount of turnover (sales) that a taxpayer makes.

Turnover is used as many small businesses cannot afford to pay a bookkeeper to draft a full set of accounts.
However, a business can always keep a list of daily sales. In order to increase the number of tax payers, tax
incentives have been introduced for certain types of companies. One such incentive is granted to entities that
qualify as Micro Businesses. Such companies or taxpayers are only taxed on their turnover.

The following rates are applicable to the taxable turnover of a micro business:

On the first R335 000 0%

R335 001 to R500 000 1% of each R1 above R335 000

R500 001 to R750 000 R1 650 + 2% of amount above R500 000

R750 001 to R1 000 000 R6 650 + 3% of amount above R750 000

ILLUSTRATION – BASIC TURNOVER TAX

Alpha CC is registered as a micro business for tax. There are sales of R400, 000 and expenses of R150, 000 in
the current tax year.

Calculate the amount of turnover tax for the year.

SUGGESTED SOLUTION

Tax payable is 1% X (400,000 – 335,000) = R650

Note – A company would pay tax of 28% X (R200, 000 – 50,000) = R42,000.

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1.1 Benefits of registering for turnover tax

There are a number of benefits to registering for turnover tax

 Tax rates used are low (see the illustration done previously)
 Tax on Micro Businesses is based on turnover, therefore profits not subject to tax.
o A qualifying company only has to record turnover and need not calculate profits,
 Simplified record keeping
o There is no need to record expenses incurred, as tax is only payable on turnover.
 Accruals are not taken into account in the tax calculation.

1.2 Qualifying entities

1.2.1 Requirements for a Microbusiness

Not every enterprise can register as a micro business. There are a number of requirements that have to be
met.

Microbusinesses should meet all of the following conditions:

 Taxpayer must be a close corporation, private company, corporative or natural person

 Shareholders of companies should be natural persons
 Shareholders should not hold shares in any other company (note the exceptions.)
 Public Benefit Organisations cannot be a micro-business
 If more than 20% of the turnover is investment income or professional services, the tax payer cannot
be a microbusiness.
 The entity should have qualifying turnover less than R1million for the year; and
 The year-end should be 28/29 February.

An entity has qualifying turnover, if the turnover is:

 Total receipts
 From the carrying on business activities
 Excluding any amount of a capital nature
 Excluding certain amounts exempt from tax; and
 Less than R1million for the tax year.

ILLUSTRATIVE EXAMPLE

John Block and his brother are the only shareholders of Block (Pty) Ltd which is a Microbusiness as defined.

The company was incorporated in the previous year of assessment.

The only income they have is from selling second hand iphones which they bought on e-bay.

They only accept cash from customers, which amounted to R540 000 for the current year of assessment.

Determine whether or not Block (Pty) Ltd h a s q u a l i f y i n g t u r n o v er .

SUGGESTED SOLUTION

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Turnover is less than R1million for the tax year.

Turnover is total receipts from the carrying on of business activities.

Turnover does not include any amount capital in nature.

Therefore, the entity has qualifying turn over.

1.2.2 Enterprises incorporated in the middle of the year

The qualifying turnover limit of R1million is applicable for a 12-month period.

If a Microbusiness is incorporated in the middle of the year, the qualifying turnover of should be apportioned
based on the months the enterprise was operating.

ILLUSTRATIVE EXAMPLE

John Block and his brother are the only shareholders of Block (Pty) Ltd.

The company was incorporated in the current year of assessment and has only traded for 9 months.

The only income they have is from selling second hand iphones which they bought on e-bay.

They only accept cash from customers, which amounted to R840 000 for the current year of assessment.

Determine whether or not Block (Pty) Ltd will have qualifying turnover.

SUGGESTED SOLUTION

Taxable turnover earned in 9 months = 840 000

Qualifying taxable turnover for 12 months = 1 000 000

The turnover limit for Micro businesses for a 12-month period is R1 000 000.

Therefore, if a company trades for a period less than 12 months the limit has to be apportioned accordingly.

Therefore, for the turnover limit for 9 months of trading = 1 000 000 x 9/12

= 750 000

Therefore, the turnover made of R840 000 in 9 months exceeds the limit.

The company is not a Micro business as defined.

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1.2.3 Microbusinesses year of assessment

Only enterprises whose year of assessment is the last day of February can be registered as Microbusinesses.

ILLUSTRATIVE EXAMPLE

John Block and his brother are the only shareholders of Block (Pty) Ltd.

John and his brother dont have any kind of other shareholding.

The only income they have is from selling second hand iphones which they bought on e-bay.

They made the following sales, cash sales R540 000 and credit sales R205 000 for the current
year of assessment ending 31 December.

Determine whether or not Block (Pty) Ltd is a microbusiness.

SUGGESTED SOLUTION

Turnover is less than R1million for the tax year.

Turnover is total receipts from the carrying on of business activities.

Turnover does not include any amount capital in nature.

However, the year end is not February. Therefore, the company is not a micro business

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1.3 Taxable turnover

Tax payable for Microbusinesses is based on a concept called taxable turnover.

Taxable turnover is the amount that is used to determine the tax payable by the Microbusiness per the tax
table. Taxable turnover is calculated as follows:

Revenue received

From carrying on business activities

In South Africa

PLUS

100% Investment income

50% disposal of capital assets used mainly

for business purposes

LESS

Amounts received prior to registration

Amounts received as a refund from SARS

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ILLUSTRATIVE EXAMPLE

John Block and his brother are the only shareholders of Block (Pty) Ltd.

The company was incorporated last year. The only income they have is from selling second hand iphones
which they bought on e-bay.

The company is registered with SARS as a micro business

The following are the only transactions for the current year of assessment

 On 1 September they sold their ultra safe super computer used mainly for business for R16, 000.
 Cash sales amounted to R532 000 for the year
 Credit sales amounted to R151 000 for the year

During the year, the company received 3 500 in interest (investment income).

Determine the taxable turnover of Block (Pty) Ltd.

SUGGESTED SOLUTION

Taxable turnover is

Revenue 532 000

Plus: 50% of capital amounts (50%x16 000) 8 000

Plus: 100% investment income 3 500

Taxable turnover 543 500

When the investment income is dividends, then the amount will be exempt for all tax payers.

ILLUSTRATIVE EXAMPLE

John Block and his brother are the only shareholders of Block (Pty) Ltd.

The company was incorporated last year. The only income they have is from selling second hand iphones
which they bought on e-bay.

The company is registered with SARS as a micro business

The following are the only transactions for the current year of assessment

 On 1 September they sold their ultra safe super computer used mainly for business for R16, 000.
 Cash sales amounted to R532 000 for the year
 Credit sales amounted to R151 000 for the year

During the year, the company received 3 500 in dividends (investment income).

Determine the taxable turnover of Block (Pty) Ltd.

SUGGESTED SOLUTION

Taxable turnover is
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Revenue 532 000

Plus: 50% of capital amounts (50%x16 000) 8 000

Plus: 100% investment income – dividends exempt 0

Taxable turnover 540 000

If the taxpayer is a natural person, investment from dividends and interest up to R23 800 will be exempt.

1.4 Other considerations

1.4.1 Tax payments

Microbusinesses are not subject to provisional payments

However, Microbusiness pay tax twice based on estimate.

 31 August – half of estimated tax payable on estimate

 28 February – estimate less amount paid in August.

1.5 Application of Micro businesses

ILLUSTRATIVE EXAMPLE

Mr Entrepreneur (“Mr E”) left his job and started his microbusiness Entrepreneur X (Pty) Ltd.

Mr E does not have shares in other businesses.

Mr E converted his study into an office at a cost of R50, 000 and does not offer personal services as defined.

In October, Mr E disposed some assets mainly used for business worth R90, 000.

Revenue for the year from the carrying on of business activities amounted to R370 000.

During this period Mr E received dividends of R8 000.

Calculate E’s tax payable in the current year of assessment.

SUGGESTED SOLUTION

Requirement Application
1. Qualifying turnover Yes, Less than limit of R1million
2. Taxable turnover Revenue (370 000) + 50% disposal of capital asset
(R45 000) + 0 (dividends are exempt) = R415 000
3. Year end 28 February
4. Shareholders of natural persons Yes
5. Shareholders do not hold shares in other Yes
private companies
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 6. Personal services or investment income No
exceeds 20%

Conclusion

Therefore, Mr E is a micro business.

Taxable turnover = 415 000

Tax payable = (415 000 – 335 001) x 1% = 800

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CHAPTER 3
GROSS INCOME

Table of Contents
1. INTRODUCTION ........................................................................................................................................................ 3
1.1 COMPONENTS OF THE GROSS INCOME DEFINITION WHEN A RESIDENT HAS RECEIVED THE GROSS INCOME . 3
1.2 COMPONENTS OF THE GROSS INCOME DEFINITION WHEN A NON RESIDENT HAS RECEIVED THE GROSS
INCOME .................................................................................................................................................................... 3
2. COMPANIES RESIDENT IN SOUTH AFRICA ................................................................................................................ 3
3. DISCUSSION OF THE COMPONENTS OF THE GROSS INCOME DEFINITION FOR SA RESIDENTS................................ 4
3.1 COMPONENT 1 - YEAR OF ASSESSMENT............................................................................................................. 4
3.2 COMPONENT 2 - TOTAL AMOUNT IN CASH OR OTHERWISE .............................................................................. 4
3.3 COMPONENT 3 - RECEIVED BY OR ACCRUED TO ................................................................................................ 5
3.3.1 MEANING OF RECEIVED BY OR ACCRUED TO .............................................................................................. 5
3.3.2 DISCOUNTED AMOUNTS .............................................................................................................................. 8
3.3.3 ILLEGAL TRANSACTIONS .............................................................................................................................. 9
3.3.4 CESSION ....................................................................................................................................................... 9
3.4 RULES FOR RESIDENTS AND NON RESIDENTS ................................................................................................... 10
3.4.1 RESIDENT OF SOUTH AFRICA ..................................................................................................................... 10
3.4.2 NON RESIDENT ............................................................................................................................................... 10
3.5 COMPONENT 5 - NOT OF A CAPITAL NATURE .................................................................................................. 11
4. SPECIFIC TYPES OF TRANSACTIONS ........................................................................................................................ 18
4.1 DAMAGES AND COMPENSATION ..................................................................................................................... 18
4.2 GAMBLING, LOTTERIES AND PRIZES ................................................................................................................. 19
4.3 SHARES DEEMED TO BE CAPITAL IN TERMS OF SECTION 9C ............................................................................ 19
4.3.1 SHARES HELD FOR LESS THAN 3 YEARS ..................................................................................................... 19
4.3.2 SHARES HELD FOR 3 OR MORE YEARS – SECTION 9C ................................................................................ 20
5. SPECIAL INCLUSIONS ............................................................................................................................................... 22
5.1 ANNUITIES ............................................................................................................................................................ 23
5.1.1 ANNUITIES RECEIVED BY NON RESIDENTS .................................................... Error! Bookmark not defined.
5.2 SERVICES RENDERED ......................................................................................................................................... 25
5.3 RESTRAINT OF TRADE PAYMENTS..................................................................................................................... 26
5.4 LEASE PREMIUMS ............................................................................................................................................. 26
5.5 KNOW-HOW PAYMENTS ................................................................................................................................... 27
5.6 LEASEHOLD IMPROVEMENTS ........................................................................................................................... 27
5.7 MANUFACTURED OR ASSEMBLED TRADING STOCK USED AS A FIXED ASSET .................................................. 29
5.8 DIVIDENDS ........................................................................................................................................................ 29
5.9 KEY-MAN POLICIES ............................................................................................................................................ 29
5.10 RECOUPMENTS AND OTHER INCLUSIONS ...................................................................................................... 30
6. EXEMPT INCOME .................................................................................................................................................... 31
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6.1 LOCAL DIVIDENDS ............................................................................................................................................. 31

7. FOREIGN DIVIDENDS ............................................................................................................................................... 33
7.1 APPLICATION FOR RESIDENTS........................................................................................................................... 33
7.2 FOREIGN DIVIDEND DEFINITION ....................................................................................................................... 33
7.3 DIVIDEND EXEMPTIONS .................................................................................................................................... 34

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1. INTRODUCTION
The gross income definition differs between residents of South Africa and non-residents.

1.1 COMPONENTS OF THE GROSS INCOME DEFINITION WHEN A RESIDENT HAS

RECEIVED THE GROSS INCOME
 in relation to the year or period of assessment;
 in the case of any resident;
 the total amount;
 in cash or otherwise;
 received by or accrued to or in favour of such resident;
 on worldwide amounts received
 excluding receipts or accruals of a capital nature;
 including all special inclusions (a) to (n) per section 1 gross income definition.

There is no specification as to whether the income needs to come from South Africa. South African residents are
taxed worldwide income.

1.2 COMPONENTS OF THE GROSS INCOME DEFINITION WHEN A NON RESIDENT

HAS RECEIVED THE GROSS INCOME
 in relation to the year or period of assessment;
 in the case of any person;
 the total amount;
 in cash or otherwise;
 received by or accrued to or in favour of such person;
 from a source within or deemed to be within the Republic;
 excluding receipts or accruals of a capital nature;
 including all special inclusions (a) to (n) per section 1 gross income definition.

Non-residents are taxed only on income sourced or deemed to be sourced in South Africa.

2. COMPANIES RESIDENT IN SOUTH AFRICA

For person other than natural persons, they are resident in South Africa if they are:
 Incorporated, established or formed in the Republic, or
 Which has its place of effective management in South Africa

ILLUSTRATION – RESIDENCE OF A COMPANY

For the following companies, state whether they are “resident” in South Africa or not
1. A company that was registered in SA and has its place of effective management in SA
2. A company that was registered in SA and has its place of effective management outside SA
3. A company that was registered overseas and has its place of effective management in SA
4. A company that was registered overseas and has its place of effective management outside SA

SUGGESTED SOLUTION

1. Resident
2. Resident
3. Resident
4. Non-Resident

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3. DISCUSSION OF THE COMPONENTS OF THE GROSS INCOME

DEFINITION FOR SA RESIDENTS
The gross income definition can be separated into many separately identifiable parts. For an item to constitute
gross income, all requirements must be met. The onus is on taxpayer to prove something is not gross income

If one of the components is not met, an item will not constitute gross income unless it is specifically included in
gross income.

The components are:

1. in relation to the year or period of assessment;
2. the total amount in cash or otherwise;
3. received by or accrued to or in favour of such resident;
4. excluding receipts or accruals of a capital nature;
5. including all special inclusions (a) to (n) per section 1 gross income definition.

Note that none of the requirements state that an amount received need be from legal operations.

The proceeds of criminal activity will also be subject to taxation in the form of the gross income definition.

3.1 COMPONENT 1 - YEAR OF ASSESSMENT

The taxpayer is taxed in the year that the gross income becomes taxable.

The taxpayer cannot defer the gross income to a later year.

3.2 COMPONENT 2 - TOTAL AMOUNT IN CASH OR OTHERWISE

GENERAL RULE- TOTAL AMOUNT

Total Amount means the value of any form of property that has a monetary value

GENERAL RULE – IN CASH OR OTHERWISE

If the sale is in monetary terms, use the amount there-in. (Note that goods sold way below fair market value may
lead to a donations tax or tax avoidance implications)

If the consideration is not in the form of money, value at fair market value (Lace Proprietary Mines case)

If an interest free or low interest loan is given, the amount is calculated by applying the average outstanding
amount X (Prime rate – rate paid).

ILLUSTRATION – APPLICATION OF TOTAL AMOUNT IN CASH OR OTHERWISE

Calculate the amount of gross income for the following:

1. Goods were sold for R10,000
2. Goods with an approximate market value of R10,000 are sold in return for receiving an asset worth R9,700.
3. R1,000,000 loan given by person to a developer. Developer allows person to stay for free in a unit from 7
March of the current year. Loan repayable with no interest upon death of the taxpayer. Prime rate was 10%.

Assume a 365 day year, and round all amounts to the nearest rand.

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SUGGESTED SOLUTION

1. R10,000
2. R9,700
3. R1,000,000 X 10% X 359/365 = R98,356 gross income (Individual’s tax year runs from 1 March to last day of
February.

3.3 COMPONENT 3 - RECEIVED BY OR ACCRUED TO

An amount can either be received by, or accrue to a taxpayer. It is necessary to understand the meaning of:
 Received by, and
 Accrued to

3.3.1 MEANING OF RECEIVED BY OR ACCRUED TO

The meaning of in “received by” has been discussed in a number of court cases.

Geldenhuys v CIR and confirmed by CIR v Cape Consumers (Pty) Ltd

An amount is only “received” by a taxpayer if it is received by him “on his own behalf and for his own benefit”.

ILLUSTRATION – RECEIVED FOR OWN BENEFIT AND IMPACT OF DEPOSITS ON GROSS INCOME

An agent rents out houses on behalf of owners.

For finding a tenant, the agent collects and keeps the first month’s rent. If the owner wishes the agent to collect
rentals each month, then as a collection fee, the agent keeps 10% of the rental each month and pays 90% across
to the principal.

In the current tax year, a deposit of R4,000 is collected and 5 months’ rent of R4,000 a month is collected. The
deposit is placed in a trust account that is separate from the account that the rentals are put in.

What are the “receipt” implications.

SUGGESTED SOLUTION

The collection of the deposit is a receipt on behalf of the principal, but as the amount is refundable, it will not be
for the principal’s benefit. No amount is included into gross income.

The 5 months of rent collected will be collected on behalf of the principal will be a “receipt” in the hands of the
principal. (All 100% received by the principal – Ignore the amount actually paid across to the principal)

The payment of the first month’s rent as well as 10% of the monthly rent to the agent may constitute a deduction
in the hands of the principal. This is discussed in the chapter on the general deduction formula.

Note that even though the 90% is received by the principal, all 100% is included into gross income, with a
deduction for costs.

The total rental collected will not be gross income in the hands of the agent as although it has been received by
the agent, it has not been received for the benefit of the agent. Only the amount retained by the agent will be
included in the gross income of the agent.

The agency fees collected (the first month’s rent and 10% of subsequent months) will be gross income in the
hands of the agent as it is received by the agent.

ILLUSTRATION – PAYMENTS RECEIVED IN ADVANCE

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Mr A is retrenched on 1 February 20X1 and received 3 months’ pay of R6 000 in lieu of notice. When will the
amount be included in income?

SUGGESTED SOLUTION

Mr A will include the R6 000 in income on 1 February 20X1 which is the day of receipt. The amount has been
received by him and is for his benefit. It can never be refundable as this is a retrenchment amount.

ILLUSTRATION – PAYMENTS RECEIVED IN ADVANCE

Mr A is employed to do 200 hours of work for A Ltd over the next 3 months at R30 per hour. He received 3
month’s pay of R6,000 in advance. When will the amount be included in income?

SUGGESTED SOLUTION

Even though Mr A receives the amount in advance, he has not received it for his own benefit.

If he does not perform the 200 hours of work, A Ltd will be entitled to claim a refund of the prepayment.

The amount will become gross income as he works on an hourly basis. R30 per hour worked will become gross
income when the work is performed.

The meaning of in “accrued to” has been discussed in a number of court cases.

Note that taxation is on the earlier of receipt for on benefit, or accrual.

Mooi v CIR and CIR v Peoples Stores

Accrued means to become unconditionally entitled to

OTHER CONSIDERATIONS

CIR v Delfos
A taxpayer cannot be taxed twice, once on accrual and then again on receipt or vice versa
Silverglen case
The Receiver has to include the amount received or accrued at the earliest time, not when he wishes to

ILLUSTRATION – RECEIPT AND ACCRUAL CONSIDERATIONS

Mr A receives directors fees for attending meetings for the 28 February 20X1 year of assessment.

These were voted to him on 15 January 20X1.

The fees were received on 1 July 20X1

The directors fees are not set by the company but may be conferred from time to time at the discretion of the
company.

Discuss in which year would the directors fees be included in his income?

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SUGGESTED SOLUTION

The amount will be included into gross income at the earlier of receipt or accrual.

The director became entitled to fees on 15 January 20X1.

Receipt of the fees for his own benefit was only on 1 July 20X1.

Accrual is before receipt.

A person cannot be taxed twice, once on accrual and once on receipt. (Delfos case)

The person is taxed on the earlier of receipt or accrual. (Silverglen case)

The directors fees would be included in income in the February 20X1 year of assessment as this is when he
became unconditionally entitled to them.

ILLUSTRATION – BANK LOANS

A person gets a R100,000 loan from a bank. Will this R100,000 constitute gross income?

SUGGESTED SOLUTION

The amount has been received, but it is not for the benefit of the person as he has to pay the amount back.

The person is also not unconditionally entitled to the amount.

The amount is not gross income as it has neither been “received” nor does it “accrue” to the person.

ILLUSTRATION - OVERPAYMENTS

A Ltd receives a duplicate payment from a debtor. Instead of telling that debtor that he has overpaid his debt, A
Ltd merely transfers the overpayment from the debtors account to the sales account in the ledger. Would this
overpayment constitute gross income in the books of A Ltd?

SUGGESTED SOLUTION

There is a receipt of an amount.

However, the receipt must be for the taxpayer’s own use and benefit if it is to be included in gross income. The
receipt is not for their own benefit.

A Ltd are also not unconditionally entitled to such amount. If the debtor asks for the money back, the amount
must be repaid to her until such time as the overpayment prescribes (which will be 5 years after payment).

Therefore the overpayment will not be included in A Ltd’s gross income.

The amount may be recouped if never paid and the debt is prescribed. (See the section on recoupments later).

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ILLUSTRATION – UNCONDITIONAL ENTITLEMENT

Mr A is going overseas and needs someone to look after his house. Mr. B agrees to look after his house. Mr B will
be paid R10,000 for house-sitting, less an amount equal to any damages to the house or property caused while Mr
A is away. Mr A agrees to pay Mr B the amount when he returns.

Mr A returns on 6 March 20X1. Mr B hands back the house on March 6 with no damages therein. Mr A then pays
Mr B the full R10,000 on March 7.

When will the income be included in the taxable income of Mr B?

SUGGESTED SOLUTION

Mr B cannot claim that he is “unconditionally entitled to” the R10,000 until he gives the keys back to Mr A. He will
only include the amount into income as at 6 March 20X1.

He will thus be taxed on the amount received in the 20X2 assessment which will cover the period from 1 March
20X1 to 28 February 20X2.

ILLUSTRATION– RENT RECEIVED IN ADVANCE

Mr A rents out his townhouse. Rent is payable monthly in advance. He receives the rent cheque for March 20X1
on 28 February 20X1. He deposits the amount into his bank on 3 March 20X1. When will the amount be included
in the taxpayer’s gross income?

SUGGESTED SOLUTION

The amount will be included in the taxpayer’s gross income on the earlier date of receipt or accrual.

Receipt took place on 28 February 20X1. Entitlement only took place on 1 March for March rent.

Gross income will be recorded on the 28th of February 20X1.

He will thus include the rent for March 20X1 in his 20X1 year tax return for the period 1 March 20X0 to 28
February 20X1.

3.3.2 DISCOUNTED AMOUNTS

Peoples Stores case

Proceeds cannot be discounted to present values

ILLUSTRATION – PRESENT VALUES CANNOT BE USED FOR TAX

A Ltd sell R1,000,000 worth of goods. This is only payable in 10 months’ time. The present value of the R1,000,000
in 10 months’ time is R900,000. What amount will be included in gross income?

SUGGESTED SOLUTION

The amounts received cannot be discounted in terms of the Act. (Peoples Stores v CIR)

R1,000,000 will be included into gross income.

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3.3.3 ILLEGAL TRANSACTIONS

There are a number of cases that deal with receipts and accruals of illegal transactions.
CIR v Delagoa Bay Cigarette Co
In determining whether an amount is “income” or not, no account must be taken of the fact that the activity
involved was illegal, immoral or ultra vires
MP Finance Group CC (In Liquidation) v CSARS
It was held that the amounts paid to the illegal scheme were accepted by the operators of the scheme with the
intention of retaining them for their own benefit and notwithstanding that in law, they were immediately
repayable (because they were illegal), they constituted receipts within the meaning of the Income Tax Act.

ILLUSTRATION – ILLEGAL TRANSACTIONS

A thief steals R1,000 cash and a diamond ring worth R5,000. The thief owns a jewelry shop and sells the diamond
ring for R3,000.

What are the taxation implications of the above?

SUGGESTED SOLUTION

The unilateral taking of an item does not constitute receipt. Thus neither the R1,000 nor the R5,000 will be
included in gross income.

However the thief runs a business selling stolen jewelry. In determining whether an amount is “income” or not, no
account must be taken of the fact that the activity involved was illegal, immoral or ultra vires (CIR v Delagoa Bay
Cigarette Co)
The R3,000 received on sale of the ring will be included in gross income as it was sold in pursuance of gross income
in a business.

ILLUSTRATION – THEFT FROM A BUSINESS

A company sells R21,000 in a day. An employee steals R3,000 cash at the end of the day and R18,000 is banked.
How much will be included in gross income?

SUGGESTED SOLUTION

The amount of R21,000 will be included in gross income as it was received by the company for its own benefit. In
addition, it was entitled to the R21,000 from its customers.

The amount of R3,000 will not be included in the gross income of the thief. A unilateral taking of money is not
gross income.

3.3.4 CESSION

CIR v Witwatersrand Association of Racing Clubs

Once an amount has been beneficially received by or accrued to a taxpayer, he is taxed on such amount even
though he may have an obligation to pay it over to some other person. Where a taxpayer divests himself of
income prior to it accruing to him by ceding the right to future income, the income accrues to the cessionary
rather than the taxpayer. In tax terms, such an arrangement is referred to as “antecedently” divesting oneself of
income.

If a person cedes income to a third party, considerations should be given as to whether a person is entitled to the
income before ceding the income. If the person was entitled to the gross income per cession, the amount will be
taxed in the hands of the initial recipient.

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ILLUSTRATION – CESSION OF INCOME

The local race course is having a race meeting for the benefit of a local charity.

They announce that all profits from the meeting will go to child welfare.

An amount of R1,000,000 profit is made at the race meeting. The race course give this money over to Child
Welfare.

Will the amount of R1 000 000 be included in the gross income of the race course if :
a) no contract was signed between the race course and Child Welfare;
b) a contract was signed between the race course and child welfare stipulating that all profits from the meeting
were to go to Child Welfare. This contract was signed before the race meeting.

SUGGESTED SOLUTION

Part a

The race course is not obliged to hand the money over to Child Welfare as there has been no contract signed
between the parties.

Thus the race course has received the amount for its own benefit. They have embarked on a scheme of
profitmaking and received money from this.

The amount will have to be included in its gross income.

Part b

The amount received by the race course is not for its own benefit as it has signed a contractual agreement and is
acting as an agent for Child Welfare

It will not form part of gross income for Child Welfare.

ILLUSTRATION – PAYING SALARY TO SOMEONE ELSE

Mr Cede earns a salary of R100,000. Instead of paying him, the company pays his loan shark. What are the tax
implications?

SUGGESTED SOLUTION

The R100,000 is still included in Mr Cede’s gross income.

3.4 RULES FOR RESIDENTS AND NON RESIDENTS

3.4.1 RESIDENT OF SOUTH AFRICA

Residents are taxed on their worldwide income. All gross income, no matter the source, is included in gross
income.

3.4.2 NON RESIDENT

Non residents are taxed on amounts
 from a SA source or
 deemed to be from a SA source.

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Section 9 of the Act deems many items to be sourced in South Africa. These will be dealt with specifically.

3.4.2.1 FROM A SA SOURCE

Case law has ruled that “ the source of receipts, received as income, is not the quarter whence they come but the
originating cause of their being received as income.”

A two tier test was laid down namely:

1. what is the originating cause of the income i.e. what gives rise to the income? and
2. what is the location of the originating cause i.e. being the source of the income.

To help determine source in these circumstances, courts have laid down various approached to determine source
 The capital test
o The capital test says that the place where a company employs its capital is the true source of
income.
 The activities test
o The activities test says that the place where the activity is carried out leading to income is the
place where the income is sourced.
 The place where the contract was signed (Used for annuities)

ILLUSTRATION – APPLICATION OF THE LEVER BROTHERS CASE

A person walks into Sandton City and goes to a tailor. The tailor is a non-resident. He has come to South Africa
from India on a 1 year working visa. The tailor shortens three pairs of pants and charges R210 for the work done.
Where is the true source of the income?

SUGGESTED SOLUTION

 What is the originating cause of the income? - The shortening of the three pairs of pants by the tailor.
 What is the location of the originating cause - South Africa as the sale takes place in Sandton.

The true source will be within South Africa and as such the tailor, a non-resident, will include the R210 into his
gross income.

3.4.2.1 DEEMED FROM A SA SOURCE

Section 9 of the Act deems many items to be sourced in South Africa. These will be dealt with specifically in other
sections.

3.5 COMPONENT 5 - NOT OF A CAPITAL NATURE

Only items of income that are not capital in nature are included in gross income in terms of the gross income
definition. It is necessary to understand the meaning of “capital in nature”.

Items of a revenue nature will be treated as gross income if all other gross income requirements are present.

Items of a capital nature will not be treated as gross income.

It is necessary to understand the following

o The courts have decided a few cases that can generally be applied to most types of income.
o There are some cases that deal with specific types of income
o Objective factors need to be taken into account.
o The onus of proff is on the taxpayer to prove an amount is not capital.

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CASES THAT CAN BE APPLIED IN MOST INSTANCES TO DETERMINE CAPITAL OR REVENUE

Courts have adopted the following general approach to ascertain whether an amount is capital in nature.
 What is the intention of the taxpayer? (Stott case)
o For a company, this would be the intention of the directors (CIR v Richmond) or the people
controlling the company (SIR v Trust Bank)
o For a natural person, what the individual taxpayer says his intention is will be important.
 For services rendered and goods sold, is the intention a scheme of profitmaking? (SIR v Trust Bank of SA)
case)
o Scheme of profitmaking is revenue in nature and included in gross income
o Not a scheme of profitmaking is capital in nature
 For assets held and disposed of, does the asset represent the tree (capital) or fruit (revenue). (Visser case)
o A house bought for rental purposes will be the tree and the rentals received letting out the
property would be the fruit. The rentals received are included in gross income, but the sale of
the house would be capital in nature.
 A taxpayer may realize an asset to his/her/their best advantage (Stott case, Brea West case)
o Where a realisation company does no more than realise its asset to best advantage, the
proceeds of the sale will not be revenue in nature, but capital. However, the realisation
company must ensure that it does not go beyond the mere realisation and embark on a trade or
scheme of profit-making, thereby “crossing the Rubicon”.
o Applying this case
 A taxpayer can wait to get the best possible price for an asset and still treat the
transaction as capital.
 A person waiting 12 months to get the best possible price when selling his residence will
still be able to treat the transaction as capital, provided they do not act in other ways in
a scheme of profitmaking.
 Consider a person selling a piece of land that has been held for 20 years. The seller split
the land into 35 plots and sold each plot individually to generate a higher selling price.
This will still be capital.
 The intention on acquisition, the intention whilst holding the asset and the intention on disposal will be
taken into account when determining whether the income is capital or revenue. (Natal Estates case)
o Intention may change over the course of holding the asset.
o If an asset is originally held as a capital asset, intention may change to a revenue nature upon
disposal. In such a case, the item would be treated as revenue.
o Consider a person selling a piece of land that has been held for 20 years. The seller split the land
into 35 plots. The seller proclaimed a township and provided an electricity connection and
sewerage infrastructure to each plot. Each plot is then sold to generate a higher selling price. At
some stage the intention has changed from capital to revenue, and the amount will be treated
as gross income.
o The court used the phrase that the taxpayer “had crossed the Rubicon” and gone onto a
“scheme of profit making” in deciding the answer that the profits were of a revenue nature.
 Where an asset is held for a dual motive that is both capital and revenue and neither is dominant, this will
be treated as a revenue transaction (COT v Levy)

OBJECTIVE FACTORS

Objective factors are important matters that are different in each case that provide an indication as to whether
the intention is revenue in nature or capital in nature. Specific considerations include:
o Manner of acquisition i.e. inheritance of an asset will probably be capital, buying an asset on credit where you
cannot pay repayments will probably be revenue
o Frequency of the transaction i.e. the more often a taxpayer buys or sells an asset, the more likely it is to be
revenue in nature.
o Income flow i.e. did you acquire the tree to produce fruit or did you acquire the fruit with the intention of
resale.
o Finance i.e. an asset acquired with your own funds is more likely to be capital than an asset acquired with loan
funds.
o Manner of disposal i.e. fortuitous sale will be capital, extensive advertising before sale will possible be
revenue.

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o Length of time the asset sold was held i.e. the longer the asset is held, the more likely it will be that the asset
is of a capital nature.
o Continuity i.e. the more often a taxpayer buys and sells a particular asset, the more likely he is involved in a
scheme of profit-making.
o The nature of the taxpayer’s business will be influential as if the sale is outside of his ordinary business, the
sale may be of a capital nature.
o Activities of the taxpayer as regards the asset up to the time the asset is sold.
o Nature of the asset disposed of i.e. if the asset is acquired as a source of income, the asset may be considered
to be capital in nature.
o Reason for the sale.
o Legal nature of the transaction i.e. if an amount is received for allowing someone to use an asset, this will be
gross income but sale of a capital asset will not be gross income.
o Accounting treatment of the sale

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LOOK AT

OBJECTIVE FACTORS SUBJECTIVE FACTORS

* Manner of acquisition i.e. inheritance of an asset will Court cases have said that a judge must always
probably be capital, buying an asset on credit where look at the following:
you cannot pay repayments will probably be revenue
* Frequency of the transaction i.e. the more often a What is the intention of the taxpayer?
taxpayer buys or sells an asset, the more likely it is to (Stott case)
be revenue in nature.
* Income flow i.e. did you acquire the tree to produce Tree vs fruit considerations. The tree is capital
fruit or did you acquire the fruit with the intention of and the fruit is revenue i.e. gross income
resale. (Visser case)
* Finance i.e. an asset acquired with your own funds is
more likely to be capital than an asset acquired with Is the intention a scheme of profit making? If it is,
loan funds. it will be revenue i.e. gross income
* Manner of disposal i.e. fortuitous sale will be capital, (Pick n Pay case)
extensive advertising before sale will possible be
revenue. A taxpayer may realize the asset to his/her/its
* Length of time the asset sold was held i.e. the longer best advantage and it will still be capital (Stott
the asset is held, the more likely it will be that the case)
asset is of a capital nature.
* Continuity i.e. the more often a taxpayer buys and Intention at acquisition, during holding and at
sells a particular asset, the more likely he is involved sale must be considered to determine whether a
in a scheme of profit-making. taxpayer has changed intention (Natal Estates)
* The nature of the taxpayer’s business will be
influential as if the sale is outside of his ordinary If the taxpayer has dual motives (Revenue and
business, the sale may be of a capital nature. capital) and neither is more dominant, the
* Activities of the taxpayer as regards the asset up to revenue motive will prevail
the time the asset is sold. (COT v Levy)
* Nature of the asset disposed of i.e. if the asset is
acquired as a source of income, the asset may be If there is a change in intention, a profit alone is
considered to be capital in nature. not evidence that it is revenue in nature.
* Reason for the sale. Something more is required. (Berea West Estates
* Legal nature of the transaction i.e. if an amount is v SIR)
received for allowing someone to use an asset, this
will be gross income but sale of a capital asset will
not be gross income.
* Accounting treatment of the sale

NB: In determining whether an amount is capital in nature, a taxpayer uses both subjective and objective
factors in combination.

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APPLICATION OF CAPITAL NATURE

Mint (Pty) Ltd has been carrying on the business of growing herbs for many years on the land, which it owns. This
is the only business of the company. During the 2005 year of assessment, Mint (Pty) Ltd bought an additional farm
from a deceased estate at a favourable price.

At the time, the company did not need the additional land, but decided to hold it until it was required for planting
herbs at a later stage. As a result, of the economic recession, the company decided that it no longer required the
land for future use and sold the farm in February 2014 as land suitable for livestock farming. The amount was
received in cash by Mint (Pty) Ltd on 5 March 2014.

Required: Would the amount received from the sale of the farm be included in gross income for Mint (Pty) Ltd
for the year of assessment ended 31 March 2014?

Solution:

The total amount - Yes

In cash or otherwise - Yes
Received by or accrued to or in favour of the resident - Yes
During the year of assessment - Yes
and not of a capital nature – ?

By running through all the criteria, it can be quickly seen that a cash amount was received, during the year of
assessment.

What needs to be decided is whether the amount is of a capital nature or not.

In order to determine whether an amount received by a taxpayer is of a capital nature, you need to apply the
subjective and objective tests and base them on all the facts to determine the nature of the amount.

Manner of acquisition – The property was acquired by means of a market-related transaction.

Intention on acquisition – The taxpayer's intention was to acquire the farm as an income-producing asset (an
investment intention).

Change of intention – The fact that the taxpayer acquired the farm knowing that he could sell it at a profit is not a
clear indication that the asset was acquired with a speculative intention (in other words, buying an asset at a
favourable price for the purpose of selling it shortly afterwards at a profit). In addition, the fact that it has decided
to sell the farm would not automatically indicate a change in the taxpayer's intention.

Period for which the asset was held – The company held the asset for almost eight years.
Nature of the asset disposed of – The asset is a farm, which can be used as an income-producing asset in Mint
(Pty) Ltd.’s business.

Conclusion

On the given facts, it can be argued by Mint (Pty) Ltd that it acquired the farm with the intention of developing it
as a produce farm. Owing to the economic recession, however, this did not transpire, and since the land was
surplus to its requirements, a decision was then made to sell the property. The sale of the property amounted to
the sale of a capital asset and not the sale of a revenue in nature asset. The proceeds would therefore be of a
capital nature and not included in gross income.

Source (Unisa Tutorial Letter 102/3/2014)

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Specifics

Compensation or damages
o To determine capital or revenue when compensation is paid, determine which hole is being filled (lose an arm
is capital, lose profits is revenue)
Shares
When shares have been held for at least 3 years, their disposal is treated as capital in nature per section 9C of the
Act.

CAPITAL VS REVENUE QUICK EXAMPLES

For the following indicate whether the amounts so received are capital or revenue in nature

1. A company received compensation for goods being delivered in respect of lost sales.
2. Harold got a cash payout after his arm was cut off at work
3. A company got paid out for stock and a warehouse building after a fire. No allowances were ever claimed on
the building.
4. Jeremy won the lottery. He has 1 ticket a week.
5. Mrs. Robinson, a university mathematics lecturer won a quiz programme on mathematical problems.
6. A company sold its business for R3,000,000 in a lock stock and barrel sale. No amounts were included in the
sale as regards the amounts paid for each item. SARS indicated that R600,000 would be allocated to trading
stock, R2,000,000 to sale of an office building, and R400,000 to goodwill. R100,000 allowances were claimed
on the building in previous and current tax returns.
7. Interest of R1,000 was received by Humperdink.
8. Engelbert bought 15 kruger rands 5 years ago as a hedge against inflation
9. Dinglebert bought 7 kruger rands 25 years ago as he thought he would make a lot of money on them.
10. Gambling winnings by a professional gambler
11. Mr A regularly gambles and makes a profit spending 20 hours a week gambling.
12. Stakes winnings upon your horse winning the Durban July horse race
13. Trading stock sold on closure of a business
14. Purchase of 100 acres of farmlands and subsequent sale of 40 acres not needed.
15. Sale of land held for 50 years. Split the land into 60 plots
16. Sale of land held for 50 years. Split the land into 60 plots and supplied electricity and sewerage to each plot.
17. Asset acquired by Dilbert at a discount and sold at a substantial profit 1 week later. Dilbert never intended to
hold the asset for long
18. Goodwill not paid for but paid out of profits in the future

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SUGGESTED SOLUTION

1. Revenue. Compensation hole being filled is a scheme of profit making

2. Capital. Compensation hole being filled is for a capital item
3. Revenue for the stock. Compensation hole being filled is a scheme of profit making. Capital for the
warehouse. Compensation hole being filled is for a capital item.
4. Capital. Fortuitous gains are capital
5. Revenue. Mrs. Robinson’s livelihood is mathematics and as such will be revenue in nature.
6. For such sales, SARS will indicate how the purchase price is to be apportioned. The amount relating to trading
stock will be revenue. The amount allocated to goodwill will be capital and the amount allocated to the office
building will be part revenue (R100,000) and part capital (R1,900,000) (Niko case)
7. Revenue. Interest is revenue in nature
8. Capital. Kruger rands are capital in nature when bought as a hedge against inflation (CIR v Nel)
9. Revenue. Kruger rands only realize their value through resale. Intention was a scheme of profit making.
10. Revenue. Gamblers involved in a scheme of profit making when gambling
11. Revenue. Systematic gambling indicates revenue intent (Morrison case)
12. Revenue. Owner involved in a scheme of profit making.
13. Revenue. Trading stock retains its revenue identity.
14. Capital. CIR v Paul case deemed to be capital.
15. Capital. Realising asset to best advantage. Did not cross the Rubicon (Stott case, Berea West case)
16. Revenue. Laying of sewerage and electricity supply meant that company had crossed the Rubicon and had
changed intention from capital (land owner) to revenue (land developer) intention (Natal Estates case)
17. Revenue. Intention for quick resale is revenue (CIR v Wyner)
18. Revenue. Payment linked to profits (Deary case)

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4. SPECIFIC TYPES OF TRANSACTIONS

4.1 DAMAGES AND COMPENSATION

If the compensation is paid for trading profits lost, then the amount will be included in gross income

If the compensation is paid to replace a lost capital asset, then the amount will be capital in nature

ILLUSTRATION – DAMAGES AND COMPENSATION

For each of the following, state whether an amount will be included in gross income or not
1. Compensation is paid out for a loss of profits during the Eskom load shedding
2. A person lost his hand in an accident and was paid out for the loss of his hand.
3. The insurance company paid out for a machine that was lost in a fire.

SUGGESTED SOLUTION

1. The amount will be gross income

2. The amount will be capital in nature
3. The amount will be capital in nature. However in the gross income special inclusions, despite the fact that this
is capital in nature, a recoupment may be added to income.

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4.2 GAMBLING, LOTTERIES AND PRIZES

Amounts received because of luck, and not a business operation will be capital in nature.

However amounts received because of a business operation (something closely related to his income earning
operations) will be included in gross income.

ILLUSTRATION – DAMAGES AND COMPENSATION

For each of the following, state whether an amount will be included in gross income or not
1. A journalist received a prize for his literary contribution
2. A high school student won a prize for English literature by submitting the best grade 12 essay in South Africa
3. An English professor at University won a prize for English literature by submitting the best essay on the
similarities between Julius Caesar and Jacob Zuma.
4. A person won the lottery
5. A person who is a professional gambler won R20,000 gambling
6. A person who is not a professional gambler won R50,000 gambling

SUGGESTED SOLUTION

1. The amount is gross income

2. The amount is capital in nature
3. The amount is gross income
4. The amount is capital in nature
5. The amount is gross income
6. The amount is capital in nature

4.3 SHARES DEEMED TO BE CAPITAL IN TERMS OF SECTION 9C

Normal gross income rules will apply as to whether shares are held in a scheme of profitmaking or not. Consider
when someone regularly buys and sells shares,
 does this show a scheme of profitmaking, or
 is the person merely protecting the portfolio by diversifying the portfolio
 Does section 9C apply and make the proceeds capital after 3 years has elapsed.

Refer to the discussion of the revenue and capital nature within the gross income definition.

If an amount is not included in gross income, the amount received will be treated as proceeds for capital gains.

4.3.1 SHARES HELD FOR LESS THAN 3 YEARS

ILLUSTRATION – SHARES HELD FOR LESS THAN 3 YEARS

Mr Buyer purchased the following shares in year 1

 2,000 shares in X Ltd for R10,000. These shares were bought with speculative intent to make a profit in the
short term
 3,000 shares in Z Ltd for R8,000. These shares were bought with capital intent
 Four months later the shares were sold. The shares in X Ltd were sold for R9,500 and the shares in Z Ltd were
sold for R13,000. The shares were sold as the company needed to settle a fine issued by the government.

Calculate the taxable income

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SUGGESTED SOLUTION
CGT Income
Purchase of X Ltd shares (10,000)
Purchase of Z Ltd shares
Sale of shares in X Ltd 9,500
Sale of shares in Z Ltd 13,000
Base cost Z Ltd shares (8,000)

4.3.2 SHARES HELD FOR 3 OR MORE YEARS – SECTION 9C

CONSIDER THE FOLLOWING EXAMPLE

A person holds a share for 5 years and sells the share at a loss. The taxpayer states that this share was held for
revenue intention and claims a tax loss as a share dealer.

The same person sells a share held for 2 years at a huge profit. In submitting his tax return, he states that this
share was held with capital intention and is not included into gross income.

SARS has realized that taxpayers often call profits capital and losses as revenue to minimize taxes. Section 9C was
introduced to address this situation.

SECTION 9C

Section 9C deems the disposal of a share to be capital in nature if it has been held by the taxpayer for 3 years or
more, no matter what the intention was as regards holding the share..

The application of this section is not optional. Any share held for 3 years or more will automatically become
capital. For a share purchased and held for speculative reasons, the disposal of the share will be treated as capital
in nature by application of this section if held for 3 or more years.

ILLUSTRATION – SECTION 9C APPLICATION

Mr A bought shares 4 years ago for R30,000 as part of a scheme of profitmaking. His intention as regards those
shares had not changed when he sold the shares for R200,000 in the current year. What are the taxation
implications?

SUGGESTED SOLUTION

Normally the proceeds on disposal of the shares of R200,000 would be included in gross income as the shares
were sold in a scheme of profitmaking, but section 9C overrides this.

As the shares were held for 3 years or more, this will be treated as a capital receipt and be subject to capital gains
tax.

For a share dealer, shares are treated as trading stock. Section 9C is activated on disposal of trading shares. Shares
continue to be treated as speculative until actual disposal takes place. At disposal, any deductions claimed on
these ‘speculative” shares are added back to income. The disposal will then be treated as a disposal for capital
gains purposes and the base cost of the share will be determined using the deductions that have now been
reversed.

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ILLUSTRATION – BASIC EXAMPLE OF SECTION 9C

10,000 shares in Speculative Ltd are bought for R10,000 on 1 January of year 1 by Sharedealer Ltd who have a 31
December year end.. These shares are held in a scheme of profitmaking.

At the end of year 1, the shares are worth R20,000

In year 2, 4,000 shares are sold for R11,000 and at year end the remaining 6,000 shares are worth R21,000
At the end of year 3, the shares are worth R23,000.
At the end of year 4, the shares are worth R29,000.
In year 5, the remaining 6,000 shares were sold for R32,500.

What are the tax implications for each of the 5 years?

SUGGESTED SOLUTION

Year 1
Trading stock purchases deduction (10,000)
Closing stock added to income 10,000

Year 2
Opening stock deduction (10,000)
Gross income on sale of shares 11,000
Closing stock 6,000

Year 3
Opening stock deduction (6,000)
Closing stock 6,000

Year 4
Opening stock deduction (6,000)
Closing stock 6,000

Year 5
Opening stock deduction (6,000)
Add back opening stock deduction 6,000
No gross income but a capital gain of R32,500 – R6,000 = R26,500

Note

Even though the share disposal will become capital in nature at the end of year 3, the shares are still treated as
trading stock up and until the disposal date. At that date, the share deductions claimed are then added back to
income.

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5. SPECIAL INCLUSIONS
When the gross income definition does not include an amount into gross income, that amount may still be
included in gross income if an amount is specifically included in gross income.

Each special inclusion will be discussed hereafter

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5.1 ANNUITIES
Annuities are capital in nature and as such do not form part of the gross income definition.

Annuities are included into gross income per paragraph (a) of the gross income special inclusions.

An annuity is characterised by the following:

 it provides for a fixed annual payment
o If the fixed annual payment is in instalments over the year, this will still be a fixed annual
payment
o If the fixed annual payment changes year on year because of a fixed escalation say 10% per
annum, this will still be a fixed annual payment.
 the payment is repetitive;
o the payment must not be a once off but must be repetitive for a period of time.
 it is chargeable against some person
 there must be an obligation to pay the annuity.
o The annuity payment cannot be voluntary as if it is voluntary, there is no obligation to pay.

Annuities can also come in the form of:

 Living annuities (Individuals retire and get a monthly annuity from their pension, provident or retirement
annuity fund assets) and
 Purchased annuities

Note also that annuities can come from annuities purchased from life assurance companies.

ILLUSTRATION – DEBT OR ANNUITY?

A Ltd make a monthly payment of R1,000 to Mr Y, a former employee who has fallen on hard times. They have
made the payment monthly for the last 3 years. They have no obligation to pay the amount.

Will Mr Y include the amount received from A Ltd into his gross income?

SUGGESTED SOLUTION

The amount is not an annuity as it is not chargeable upon A Ltd.

The amount will thus not be included into gross income as the amount does not constitute gross income and there
is no special inclusion that will include the amount into gross income.

ILLUSTRATION – DEBT OR ANNUITY?

In return for getting a house worth R2,000,000 from his father, Mr A undertakes to pay his sister an amount of
R20,000 per month for 10 years. The first payment is on 1 January 20X5.

What are the taxation implications for the 20X5 and 20X6 tax years.

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SUGGESTED SOLUTION

This is not the payment for a debt as there was no amount agreed to pay his father for the house. The following
would be an annuity as:
 There is a fixed annual payment,
 The payment is repetitive
 The amount is chargeable on Mr A.

For the 20X5 tax year, R2,000 X 2 months = R4,000 would be included in the gross income of Mr A’s sister. In the
20X6 tax year, R2,000 X 12 months = R24,000 would be included in the gross income of Mr A’s sister.

Note that if a debt to be repaid conforms to the above definition of an annuity, it will not be an annuity as defined.
Repayment of debt is never considered to be an annuity.

ILLUSTRATION – DEBT OR ANNUITY?

Mr A buys a house from his father. He agrees to a selling price of R600,000 for the house and undertakes to pay
his father R5,000 a month for 10 years.

Will this amount be considered to be an annuity?

SUGGESTED SOLUTION

As this is the repayment of a debt, there will be no annuity.

The monthly repayments will not be included in the gross income of Mr A’s father.

ILLUSTRATION – DEBT OR ANNUITY

Mr A sells his business for R100 000. The payments are to be made in 10 instalments of R10,000 each over a
period of 10 years. What will the tax effects be?

SUGGESTED SOLUTION

Even though the sale of a business is a capital receipt, the capital nature may be overridden if there is an annuity.
The above is merely a repayment of a debt as the R10 000 payment for 10 years is payment of the debt of R100
000. The contract is one of sale; it is not an annuity contract.

ILLUSTRATION – DEBT OR ANNUITY

Mr A sells his business to Mr B who undertakes to pay Mr A 10 instalments of R10 000 each over a period of 10
years. What will the tax effects be?

SUGGESTED SOLUTION

Even though the sale of a business is a capital receipt, the capital nature may be overridden if there is an annuity.
No set fee was fixed for the business in this example and as such there is no debt owed by Mr B to Mr A. There is
merely an obligation to pay. The R10 000 payment falls into the definition of an annuity and as such will
constitute gross income.

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5.2 SERVICES RENDERED

Paragraph (c) of the gross income definition includes any amount, including any voluntary award, received or
accrued in respect of services rendered or to be rendered in respect of services rendered or to be rendered or
amount received in respect of or by virtue of any employment or holding of office

The special inclusion excludes amounts received by a taxpayer not for the benefit of the recipient. Examples of
amounts falling into para (c) are bonuses paid by employers to employees and tips received by waiters and
waitresses.

ILLUSTRATION – SERVICE RENDERED BY VIRTUE OF EMPLOYMENT

An employee wins a competition in the office for attracting the most new clients to the business. The first prize is a
cheque for R10,000. Will the amount be included into gross income?

SUGGESTED SOLUTION

This will be included in gross income due to the fact that the prize it is obtained by virtue of employment.
R10,000 will be included into gross income.

ILLUSTRATION - BRIBERY

Mr A was caught speeding and gave the police officer R50 to cancel the fine. Should the police officer include the
R50 in his gross income?

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SUGGESTED SOLUTION

Paragraph (c) does not require an employer-employee relationship to exist. The police officer has received an
amount of R50 by virtue of his employment and as such should include the R50 in his gross income.

If services are rendered by a taxpayer, and a third party is paid rather than the taxpayer rendering services, the
taxpayer that rendered the services includes the amount into gross income.

ILLUSTRATION – PAYING A THIRD PARTY

A Ltd rendered services to Bluto Ltd for a fixed fee of R14,000. Bluto Ltd paid Cyst Ltd, a creditor of A Ltd instead
of A Ltd.

What are the tax implications?

SUGGESTED SOLUTION

A Ltd will include the R14,000 into his gross income.

5.3 RESTRAINT OF TRADE PAYMENTS

Restraints of trade are included in gross income even though they are usually capital in nature.

Paragraph (cA) of the gross income definition includes “any amount received by or accrued to any person who—
(i) is a natural person;
(ii) is or was a labour broker as defined in the Fourth Schedule (other than a labour broker
in respect of which a certificate of exemption has been issued in terms of that Schedule);
(iii) is or was a personal service company as defined in the Fourth Schedule; or
(iv) is or was a personal service trust as defined in the Fourth Schedule,
as compensation for any restraint of trade imposed on such person”

ILLUSTRATION – RESTRAINT OF TRADE

Mr A was given a restraint of trade payment by his employer of R10,000.

Will the amount be included into the gross income of Mr A?

SUGGESTED SOLUTION

The amount must be included in Mr A’s gross income.

5.4 LEASE PREMIUMS

Paragraph (g) of the gross income definition includes” any amount received or accrued from another person, as
premium or like consideration for the right of use of land, buildings, machinery, patents, designs, trademarks,
copyright, movie, disks for TV use or music use and like assets. This includes all lease premiums paid by a lessee in
the income of a lessor.

An example of a lease premium is a lump sum paid at the beginning of a lease agreement to secure a lease.

The full amount of the lease premium is included in gross income in the year in which it accrues/is received.

This is discussed in more detail in the chapter on the taxation of lessors and lessees.

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ILLUSTRATION

Stress Limited enters into a lease with a property fund to rent out an office building. The terms of the agreement
were that Stress Limited paid R1,200,000 up front and then would pay rent of R23,000 a month for the next 5
years.

What amount would be included in gross income of the property fund for the R1,200,000 lease premium?

SUGGESTED SOLUTION

The lease premium of R1,200,000 will be included in gross income

5.5 KNOW-HOW PAYMENTS

Paragraph (gA) of the gross income definition includes “any amount received or accrued from another person as
consideration (or payment of like nature) for the imparting of or the undertaking to impart any scientific, technical,
industrial or commercial knowledge or information, or for the rendering of or the undertaking to render any
assistance or service in connection with the application or utilization of such knowledge or information”

ILLUSTRATION – ROYALTIES AND KNOW HOW PAYMENTS

A Ltd, a non-resident, invented a machine. Four years after the company invented the machine, the business
started to be effectively managed in South Africa and was thus a SA resident. The company received the following
amounts in relation to the machine:
 R10,000 from a local SA based company that uses the machine
 R150,000 from overseas companies that use the machine, and
 R60,000 for technical advice imparted to overseas companies that use the machine. Such services were
rendered during an overseas trip to the factories that manufacture overseas.

Which of the amounts received will be included into gross income?

SUGGESTED SOLUTION

As A Ltd is a SA resident, all three of the above amounts will be included in his gross income.

5.6 LEASEHOLD IMPROVEMENTS

Paragraph (h) of the gross income definition includes any amounts received in respect of leasehold improvements.

The amounts to be expended on the leasehold improvements as per the contract are included into gross income
or a fair amount representing the fair amounts for improvement is included in gross income if no amount is
stipulated.

If the lessee spends more than the amount stipulated in the contract, only the contracted amount will be included
in income unless the lessee could not have effected the improvements more cheaply.

The amount of income is subject to discounting per s11(h). See the chapter on the taxation of lessors and lessees
for a discussion of this deduction.

It is departmental practice to include the amount of leasehold improvements in the lessor’s gross income in the
year in which the improvements are completed. According to a strict reading of the Act, leasehold improvements
should be included in gross income in the year in which the lease agreement is concluded.

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ILLUSTRATION – LEASEHOLD IMPROVEMENT WITH NO AMOUNT SPECIFIED IN THE CONTRACT

A Ltd and B Ltd enter into a lease agreement whereby A Ltd agrees to effect leasehold improvements to the land
by building a factory there-on. No amount is stipulated in the agreement for the amount of the improvements.
The factory is built at a cost of R5,000,000.

What are the tax implications?

SUGGESTED SOLUTION

As no amount is stipulated in the contract, the amount spent of R5,000,000 will be included in the gross income of
the lessor.

ILLUSTRATION – VOLUNTARY IMPROVEMENT

A lessee voluntarily made improvements of R300,000 to leased property. What are the tax implications for the
lessor?

SUGGESTED SOLUTION

No amount is added to the gross income of the lessor as there was no contractual obligation to the lessee to effect
improvements.

ILLUSTRATION – WORDING OF LEASEHOLD AGREEMENT CONTRACT

C Ltd and D Ltd entered into a leasehold contract stipulating that at least 4,000,000 leasehold improvements be
done by D Ltd.

D Ltd actually spent R7,000,000.

What are the gross income implications for C Ltd, the lessor

SUGGESTED SOLUTION

The contract did not limit spending but stated at least R4,000,000. Thus R7,000,000 will be included in gross
income.

ILLUSTRATION – WORDING OF LEASEHOLD AGREEMENT CONTRACT

C Ltd and D Ltd entered into a leasehold contract stipulating that a 1,200 square meter factory needs to be erected
at a cost of R1,000.

D Ltd actually spent R7,000,000.

What are the gross income implications for C Ltd, the lessor

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SUGGESTED SOLUTION

R7,000,000 will be included in gross income, as the contract was drafted with a clearly misleading clause to avoid
tax as the building could not be built for R1,000.

5.7 MANUFACTURED OR ASSEMBLED TRADING STOCK USED AS A FIXED ASSET

Paragraph (jA) of the gross income special inclusions includes the subsequent sale of manufactured or assembled
trading stock in gross income

If a company uses manufactured trading stock as a fixed asset, the sale of the fixed asset is part of gross income,
not the sale of a fixed asset.

ILLUSTRATION – MANUFACTURED STOCK USED AS A FIXED ASSET

Manufactured trading stock costing R200,000 was used as a fixed asset seven years ago. The fixed asset has been
fully written off for accounting purposes and is sold for R600,000 this year.

SUGGESTED SOLUTION

The full amount of R600,000 is included in gross income. This fixed asset has been treated as trading stock for tax
purposes for the past 7 years.

5.8 DIVIDENDS
Local dividends and foreign dividends are included in gross income.

For nonresidents, only local dividends will be included in their gross income.

Note the dividend exemption per s10(1)(k). This will be discussed in further detail in the chapter on exempt
income.

5.9 KEY-MAN POLICIES

This includes in gross income amounts paid to companies in respect of key-man policies or amounts received on
loans against such key-man policies.

If a company has claimed a section 11(w) allowance against the premiums of a policy that now falls due, the
proceeds of the policy must be included in gross income.

A key-man policy has the following characteristics :

 The life being insured must be a key member of staff;
 The employer must be the beneficiary of the policy,

Any amount drawn from such a policy is gross income, even if a loan is granted. However once an amount is taxed
once, it may not be taxed again.

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ILLUSTRATION – KEY MAN POLICIES

A policy was taken out on a key man employee in 2001. The company involved, A Ltd, claims a section 11(w)
deduction on all contributions.

Discuss the tax implications of the following:

 A loan was taken on the policy of R120,000 in 2004
 The loan was repaid in 2005.
 The key man died and R3,000,000 was paid out to the company in the current year

What would happen if no deduction were claimed on the policy?

SUGGESTED SOLUTION

2004
The R120,000 is included in gross income
2005
There is no tax impact when the loan is repaid
Current year
R3,000,000 – R120,000 already taxed = R2,880,000 gross income for A Ltd

If no deductions were claimed on the policy, no amounts would be included in gross income. But there may be a
capital gain.

5.10 RECOUPMENTS AND OTHER INCLUSIONS

Recoupments are discussed in the chapter on recoupments. Recoupments are specifically included in gross
income.

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6. EXEMPT INCOME

Section 1 of the Act defines “income” as gross income less exempt income.

Exempt income is gross income which is NOT subject to normal tax.

Just as there are types of income which are not gross income but which are included in gross income as special
inclusions, so are there types of income that meet the definition of gross income but which the Act specifically
exempts from normal tax.

Exempt income is discussed in section 10 of the Income Tax Act.

If an income is exempt, (i.e. not forming part of income), then no deduction may be claimed in terms of the
general deduction formula in s11 (a).

It is very important that students first include the amount in gross income before applying the exemption. This
shows an understanding that the amount must first be included in gross income before it can be exempt and
marks will be allocated accordingly.

Let’s take one of the most common exemptions: local dividends.

ILLUSTRATION
Mr A, a resident of South Africa, received R50, 000 dividends from the Edcon group.

Show the tax implications.

SUGGESTED SOLUTION
Dividend received 50,000
Less: dividend exemption (50,000)
Income Nil

6.1 LOCAL DIVIDENDS

Local dividends are exempt from income, for the most part.

The following local dividends will not be exempt:

 Any dividends distributed by a fixed property company on shares included in a property portfolio.
(dividends from a property unit trust)
 Some dividends out of interest paid by a unit portfolio constituting a company, where the interest was
exempt from tax in the hands of the unit portfolio. (interest paid by a unit trust)
 Dividends distributed by a mutual building society if it was a fixed period paid-up share and the
investment was made before 1 March 1990. (Dividends from fixed period paid up shares in a mutual
building society are treated as interest)

Unit trust dividends come in the form of interest and dividends.

Only the dividend portion of the unit trust income will be exempt.

Property unit trust dividends also come in the form of interest and dividends. However the entire dividend is
taxable.

There is no dividend exemption for dividends received from a property unit trust by a resident.

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The local dividend exemption will not be applicable to dividends which are distributed by way of an annuity.

Income distributed by way of an annuity retains its identity, so dividends will still be dividends, but the Act clearly
indicates (s10 (2) (b)) that dividends received as an annuity will not be exempt.

ILLUSTRATION

The following dividends are received by X Ltd, an SA resident.

 R1, 000 from A Ltd, a company registered in SA.
 R2, 000 from B PLC, a company registered in the UK but controlled in SA.
 R3, 000 dividend received from C unit trust of which R1, 200 was interest and R1, 800 was a dividend.
 R4, 000 dividend received from D property unit trust of which R1, 500 was interest and R2, 500 was a
dividend.

Calculate the taxable income of X Ltd from the above assuming that he has already used up the full interest
exemption.

SUGGESTED SOLUTION

Dividend A Ltd R1, 000

Less: Exempt local dividend (R1, 000)
Dividend B PLC R2, 000
Less: Exempt local dividend (R2, 000)
Dividend – C unit trust R3, 000
Less: Exempt local dividend (R1, 800)
Dividend – D property unit trust R4, 000
Less: Exempt local dividend R Nil
Taxable income R5, 200

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7. FOREIGN DIVIDENDS
7.1 APPLICATION FOR RESIDENTS
Residents of South Africa are taxed on worldwide income. SA resident taxpayers include foreign dividends into
their gross income.

7.2 FOREIGN DIVIDEND DEFINITION

The term foreign dividend is defined in section 1 of the Income Tax Act.

It includes any amount paid or payable by a foreign company where such amount is treated as a dividend or
similar payment in the country that the foreign company is effectively managed.

It will not include any amount that is allowed as a deduction from income in the country.

ILLUSTRATION – FOREIGN DIVIDEND DEFINITION

Mr A owns shares in a foreign company. The company pays a dividend of R100,000. Will it be a foreign dividend as
defined if:
a) The foreign company is effectively managed offshore and does not get a deduction for the dividend payment
in its own country
b) The foreign company is effectively managed offshore and does get a deduction for the dividend payment in its
own country
c) The foreign company is effectively managed in South Africa and does not get a deduction for the dividend
payment in its own country.

SUGGESTED SOLUTION

Part a

This is a foreign dividend as defined. Exemptions for foreign dividends can be claimed in South Africa.

Part b

This is not a foreign dividend as defined as the foreign company treats the amount paid as a deduction.

The amount received will still be treated as gross income, but none of the foreign dividend exemptions can be
claimed.

Part c

This is a local dividend as the foreign entity is effectively managed in South Africa. This is not a foreign dividend.

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7.3 DIVIDEND EXEMPTIONS

The following table should be understood when determining whether foreign dividends are exempt or not.

WHAT ABSOLUTE EXEMPTIONS ARE AVAILABLE? IF THERE ARE NO ABSOLUTE EXEMPTIONS,

1. Where the taxpayer or connected person owns at least WHAT PARTIAL EXEMPTIONS MAY BE
10% of the foreign company. CLAIMED?
2. Where the taxpayer receiving the dividend receives a
dividend from a company incorporated in the same If a dividend is not exempt in total
country as the recipient. 1. 25/45 X foreign dividend will be exempt
3. In certain circumstances, where the taxpayer receives a if received by a natural person, deceased
dividend from a company taxed in terms of section 9D. estate, insolvent estate or trust.
4. Where a taxpayer receives a dividend from a foreign 2. 13/28 X foreign dividend if received by
company that is listed on Johannesburg Stock any other taxpayer such as a company.
Exchange(JSE). (Up till 1 March 2014, dividends in specie These exemptions are in terms of section
were not exempt) 10B(3).

Section 23(q) disallows any deductions for expenditure incurred in relation to foreign dividends

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FOREIGN DIVIDEND TEACHING EXAMPLE (INCORPORATING GROSS INCOME AND EXEMPT INCOME TAX
IMPLICATIONS)

Mr Gatta is a South African resident that owns shares in various foreign companies.

He received the following dividends:

 R10,000 from A Ltd, a company registered in Georgia(European country), but controlled and operated from
inside SA. He owned 5% of the shares in this company.
 R20,000 from B Ltd, a company registered in South Africa, but controlled and managed in England. He owned
2% of the company.
 R30,000 from C Ltd, a company registered in the Ukraine, and controlled from the Ukraine. He owned 8% of
the shares in this company.
 R40,000 from D Ltd, a company registered and controlled in France. He owned 10% of the shares in the
company.
 R80,000 from H Ltd, a company registered and controlled in France. He owned 1% of the shares in the
company. The company is not a controlled foreign company as per section 9D of the Act. The company is
listed on the French stock exchange
 R90,000from I Ltd, a company registered and controlled in Canada. He owned 0,3% of the shares in the
company. The company is not a controlled foreign company as per section 9D of the Act. The company is
listed on the Canadian stock exchange as well as the JSE.
 Trading stock worth R100,000 received from J Ltd as a dividend in specie. J Ltd is a company registered and
controlled in Canada. He owned 0,3% of the shares in the company. The company is not a controlled foreign
company as per section 9D of the Act. The company is listed on the Canadian stock exchange as well as the
JSE.
 R110,000 from K Ltd, a company registered and controlled in Iceland. This amount was allowed as a deduction
for K Ltd. He owns 20% of the company. The company is not a controlled foreign company as per section 9D.
 R130,000 from L Ltd, a company listed in Romania. L Ltd owns 60% of a SA listed company. R30,000 of the
R130,000 dividend relates to the dividend received from the SA listed company. L Ltd is not a controlled
foreign company as defined by section 9D.

In addition, Mr Gatta owns 100% of the shares in Gatta Ltd, a company that he owns. Gatta Ltd is incorporated in
Italy, yet is managed and controlled in South Africa.

It received the following dividends:

 R100,000 from Z Ltd, a company registered and controlled in Italy in which 4% of the shares were owned by
Gatta Ltd.
 R110,000 from Y Ltd, a company registered and controlled in Belgium in which 5% of the share capital is held.

Calculate the effects on taxable income for both Mr Gatta and Gatta Ltd.

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SUGGESTED SOLUTION

Gatta Ltd

Dividend – Z Ltd 100,000

Dividend exemption As the taxpayer and the company that they hold an
investment in are registered in the same country, the
dividend is exempt (100,000)
Dividend received – Y Ltd 110,000
Dividend exemption 13/28 X 110,000 section 10B dividend exemption (51,071)

Mr Gatta

Dividend received A Ltd 10,000

Less: Dividend exemption This is treated as a local dividend as the company is (10,000)
controlled from within SA.
Dividend received B Ltd 20,000
Less: Dividend exemption As the company is registered in South Africa, the
dividend paid will be a local dividend. Local dividends
are exempt. (20,000)
Dividend received C Ltd 30,000
Dividend exemption 25/45 X R30,000 (16,666)
Dividend received D Ltd 40,000
Dividend exemption All exempt as 10% or more of the shares in C Ltd are (40,000)
held by the taxpayer
Dividend received H Ltd 80,000
Dividend exemption For an amount to get the absolute exemption, the
company needs to be dual listed on the JSE and
another foreign stock exchange
25/45 X R80,000 (44,444)
Dividend received I Ltd 90,000
Dividend exemption Dividends from foreign companies listed on the JSE are
exempt (90,000)
Dividend received I Ltd 100,000
Dividend exemption Dividends from foreign companies listed on the JSE are
exempt except when received as a dividend in specie
0
Amount received K Ltd The amount is not treated as a foreign dividend as the 110,000
company paying the amount got a deduction for the
payment. As it is not a foreign dividend as defined,
there is no foreign dividend exemptions
Dividend received L Ltd 130,000
Dividend exemption Listed company dividend (30,000)
Dividend exemption 25/45 X (130,000 – 30,000) (55,555)

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CHAPTER 4
GENERAL DEDUCTION FORMULA SUMMARY

Table of Contents
1. APPROACH TO DEDUCTIONS............................................................................. 2
2. COMPONENTS OF THE GENERAL DEDUCTION FORMULA ............................. 2
3. DISCUSSION OF INDIVIDUAL COMPONENTS ................................................... 2
3.1 CARRYING ON A TRADE ................................................................................ 3
3.2 EXPENDITURE AND LOSSES ........................................................................ 3
3.3 DURING THE YEAR OF ASSESSMENT ......................................................... 4
3.4 IN THE PRODUCTION OF INCOME ................................................................ 4
3.5 NOT OF A CAPITAL NATURE ......................................................................... 5
3.6 TO THE EXTENT THE EXPENDITURE HAS BEEN INCURRED FOR THE
PURPOSES OF TRADE ......................................................................................... 6
4. EXPENDITURE THAT CANNOT BE DEDUCTED IN TERMS OF THE GENERAL
DEDUCTION FORMULA ........................................................................................... 7
5. DISCUSSION OF WHETHER CERTAIN EXPENDITURE IS SPECIFICALLY
DEDUCTIBLE IN TERMS OF THE GENERAL DEDUCTION FORMULA.................. 9

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1. APPROACH TO DEDUCTIONS
There are two types of deductions, namely special deductions (deductions where a specific section relates to
the deduction) and general deductions (deductions where one section is used for multiple types of expenses)

An example of a special deduction is legal expenses. Section 11(c) relates to the deduction of legal expenses,
and no other type of deduction.

An example of a general deduction is the salaries expense. There is no specific section that relates to salaries
and as such the general deduction formula is used.

Which section should be used first, special deductions or general deductions? The following approach to
determining whether an amount is deductible in terms of the Income Tax Act
1. First we have to determine whether there is a section that deals specifically with the item of
expenditure. If this is the case, apply that section. (Special deduction 1st )
2. If there is no specific section, apply the provisions of the general deduction formula. If all the
conditions of the general deduction formula apply, the amount will be deductible. (General deduction
2nd )
3. Section 23B disallows double deductions. Thus an item of expenditure cannot be claimed under the
specific section as well as the general deduction formula.

General deductions are covered in this chapter. Special deductions are covered in chapter 6-3.

2. COMPONENTS OF THE GENERAL DEDUCTION

FORMULA
The general deduction formula comprises two parts:
 There is a positive test that is contained in section 11(a) of the Act. This section sets out what may be
deducted
 There are negative tests contained in section 23 which stipulates what may not be deducted

The general deduction formula can be broken down into components. There will be allowed as a deduction if
all of the following apply
 expenditure and losses – section 11(a)
 actually incurred – section 11(a)
 from the carrying on a trade – section 11(a)
 during the year of assessment – section 11(a)
 in the production of income – section 11(a)
 not of a capital nature – section 11(a)
 to the extent it has been laid out for the purposes of carrying on that trade - section 23 (g)

Each of these components will be examined in detail.

3. DISCUSSION OF INDIVIDUAL COMPONENTS

Each individual component is discussed hereafter.

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3.1 CARRYING ON A TRADE

Requirement of general Discussion of the general deduction formula requirement
deduction formula
Carrying on a trade The definition of trade is very wide and includes many things.

What is not a trade?

It is easier to remember what is not a trade.

Where a person owns shares for investment purposes (and not speculative
purposes) is not carrying on a trade.

Where a person lends money, and the taxpayer is not a moneylender, this is not
carrying on a trade.

Similarly getting a pension is not part of a trade.

Note that SARS practice is to allow the interest incurred by a taxpayer when giving
a loan to a third party as a deduction limited to interest received.

What is a trade?

Earning a salary, or rental, or running a business is a trade. Any income earning

operation would constitute a trade.

Burgess v CIR

The definition of “trade” in sec 1 of the Income Tax Act should be given a wide
interpretation and the definition is not necessarily exhaustive.

3.2 EXPENDITURE AND LOSSES

Requirement of general Discussion of the general deduction formula requirement

deduction formula
Expenditure and losses This includes both expenditure and losses into the definition of a deduction

Actually incurred This requirement means that there must be an unconditional legal liability to pay
Caltex case

The court held that it is only at the end of a year of assessment that it is possible to
determine
the amounts received or accrued on the one hand and the expenditure actually
incurred on the other during the year of assessment.

Thus, expenditure incurred during the year of assessment must be quantified and
brought to account at the end of that year of assessment or at the date of the
discharge of the liability during that year of assessment. (See application example)

Edgars Stores Ltd v CIR

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Requirement of general Discussion of the general deduction formula requirement

deduction formula

Expenditure is actually incurred in a year of assessment only if there is an

unconditional legal obligation to incur the expenditure in that year.

Nasionale Pers Beperk v KBI

If the liability is conditional in any way (resolutive or suspensive), or contingent

rather than actual, there was no expenditure actually incurred.

CIR v Labat

The issue of shares to pay for something is not expenditure actually incurred

CIR v Golden Dumps (Pty) Ltd

If the outcome of a legal dispute is unresolved at year-end, it cannot be said that a

liability has been actually incurred.

It should be noted that if a claim is frivolously challenged, a legal liability may still
exist.

3.3 DURING THE YEAR OF ASSESSMENT

Requirement of general Discussion of the general deduction formula requirement
deduction formula
During the year of Concentra case
assessment
Expenditure is only deductible in the year incurred. Thus if not deducted in that
year, a deduction not allowed.

3.4 IN THE PRODUCTION OF INCOME

Requirement of general Discussion of the general deduction formula requirement
deduction formula
In the production of The income tax action that gave rise to the expenditure should be closely
income connected to the income earning activities (thus secretarial fees, JSE listing fees
and audit fees, even though they do not produce income directly, will be
deductible as they are closely connected to income earning activities)

Sub Nigel v CIR

In order for the expenditure to have been incurred “in the production of income”,
it is not required that the expenditure must have produced income in the same
year that the expenditure was incurred – as long as the expenditure has been laid
out for the purpose of producing income.

PE Electric Tramway case

Established the so-called “close connection” test.

The test is twofold, namely an enquiry to:

• whether the purpose of the expenditure is to produce income (regardless of
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Requirement of general Discussion of the general deduction formula requirement

deduction formula
whether such expenses are necessary for the performance of the business
operation or attached to it by chance or are bona fide incurred for the more
efficient performance of such operation) and, if
so;
• whether the expenditure is so closely connected with the income earned that it
may be regarded as part of the cost of performing it.

Joffe case

In this case the “close connection” test was referred to as the “inevitable
concomitant” test. The court held that the expenditure in question had not been
incurred for the purpose of earning profits and it had not been established
that negligent construction was a necessary concomitant of the trading operations
of a reinforced concrete engineer.

Drakensberg Gardens v COT

The principle established in DRAKENSBERG GARDEN HOTEL is that interest paid on

money borrowed to acquire shares is deductible for tax purposes, if the taxpayer’s
purpose with the acquisition of the shares is to ensure the continuance of its
trade/business income and in doing so, to secure an increased income.

3.5 NOT OF A CAPITAL NATURE

Requirement of general Discussion of the general deduction formula requirement
deduction formula
Such expenditure and There are a number of tests that can be applied. No test can be considered to be
losses are not of a more important than any other test. Usually all of the tests would be considered.
capital nature These tests include

Whether the expenditure or loss is more closely related to the income earning
operations than to the income earning structure or
Whether the expenditure was once and for all expenditure or
The expenditure forms part of floating capital of the taxpayer and not part of the
fixed capital (for tangible assets) or
The expenditure does not give rise to an enduring benefit (for intangible assets)

New State Areas case

Several tests were used by the court in determining whether the expenditure was
capital or revenue in nature. The main test used in this decision was
 to enquire whether the expenditure is to be regarded as part of the cost
of performing the income-earning operations or as part of the cost of
establishing or improving or adding to the income- earning structure, the
so-called “operations v structure” test.

The other tests used for assistance in deciding the matter were:
 the “fixed vs floating capital” test
 the test to establish whether there was any enduring benefit or
permanent asset created by the expenditure and
 the purpose (intention) of the taxpayer in incurring the expenditure
There is usually no “one test” that will cover all circumstances. A combination of all
the tests will usually lead to a correct decision.

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Requirement of general Discussion of the general deduction formula requirement

deduction formula

BPSA (Pty) Ltd v CSARS

BPSA paid royalties to operate under the BP name in South Africa. The expenditure
created no new asset.

When no new asset has been created for the enduring benefit of the taxpayer, the
expenditure naturally tends to assume more of a revenue character.

Thus royalties paid are revenue in nature.

Rand Mines v CIR

The “operations v structure” test as well as the “enduring benefit” test was
applied.

The court found that in each case close attention has to be given to its particular
facts.

It was held that the expenditure incurred in acquiring a contract to manage a mine
was capital in nature, because it was a cost expended to acquire an income-
earning right or structure.

3.6 TO THE EXTENT THE EXPENDITURE HAS BEEN

INCURRED FOR THE PURPOSES OF TRADE
Requirement of general Discussion of the general deduction formula requirement
deduction formula
To the extent the Only the extent applied for trade can be claimed as a deduction. Thus if a person
expenditure has been runs a business and uses his private car 40% for business purposes, 40% of the
incurred for the expenditure relating to the car can be claimed for taxation purposes in terms of the
purposes of trade general deduction formula.

Warner Lambert SA v CSARS

The issue was whether social responsibility expenditure, which a taxpayer was by
United States legislation obliged to incur in South Africa (compliance with the
Sullivan code), was expenditure laid out for the purposes of trade and, if so,
whether it was of a capital or a revenue nature.

It was held that Sullivan Code expenses were bona fide incurred for the
performance of the taxpayer’s income producing operation and formed part of the
cost of performing it and, therefore, the social responsibility expenditure had been
incurred for the purpose of trade.
Further, the social responsibility expenses incurred by the taxpayer were not of a
capital nature in that there was no question here of the creation or improvement
of a capital asset in the taxpayer’s hands and the taxpayer’s income
earning structure had been erected long ago.

Nemojim v CIR

Established the principle of apportionment in the case where expenditure was

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incurred for a dual purpose (i.e. partly for the purpose of producing “income” as
defined and partly for producing exempt income).

4. EXPENDITURE THAT CANNOT BE DEDUCTED IN

TERMS OF THE GENERAL DEDUCTION FORMULA
Section of the Act Discussion of the section
23(a) and 23(b) disallow If a person puts their child in a crèche so that they can go to work, this expenditure,
deductions for private will a deduction be allowed
or domestic expenditure
incurred by the There is no problem with the general deduction formula as there is a carrying on of
taxpayer. trade where expenditure is incurred to produce income that is not capital in
nature.

However this will be disallowed as it is a private/domestic expense.

23(c) disallows If a debtor goes bad and owes the company R300,000, of which an insurance
deductions for losses company pays the company R220,000 in terms of a bad debts insurance policy,
that are insured against. only R80,000 may be claimed as a bad debt as section 23(c) disallows losses on
which there are insurance claims against.

23(d) disallows If a company pays taxes on income, one could argue that in the carrying on of a
deductions for tax paid, trade, an expenses was actually incurred on the production of income that is not of
penalties paid or a capital nature.
interest on tax paid.
However section 23(d) prohibits a deduction for tax paid, or any interest or
penalties on tax.

23(e) disallows If a company transfers an amount from distributable reserves to non distributable
deductions for reserve reserves, section 23(e) prevents a deduction from being claimed in this regard.
transfers
23(f) disallows A company buys shares in a company for investment purposes, and takes out a
deductions for loan to buy the shares, incurring R100,000 interest on the loan.
expenditure that
produces exempt Dividends of R70,000 are received on the shares. This is included in gross income,
income but is exempt from taxation.

As the income received from the shares is used to produce exempt income, the
deduction for the R100,000 interest may not be claimed.

23(g) only allows An individual taxpayer not registered for vat uses his car 40% for business and 60%
deduction to the extent for private use. The cost R200,000 including vat last year and cars are written off
something was incurred over 5 years. A deduction of R200,000 X 1/5 X 40% can be claimed.
for the purposes of
trade
23(h) disallows A person states that he did not invest money in a bank as he did not trust them. He
deductions for notional would like to claim a deduction for the R12,000 interest he did not earn from the
interest bank.

This section prevents a deduction from being claimed.

23(i) disallows When a person retired, he received a lump sum of R800,000 of which R5,000 was
deductions claimed deducted off the amount when determining taxation paid.

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Section of the Act Discussion of the section

against any lump sum
payment on withdrawal That R5,000 cannot be claimed in the tax return as well. It can only be deducted
and retirement once.

23(k) limits deductions No deduction shall in any case, be made in respect of any expenses incurred by a
for personal service personal service company, as defined, except however in respect of the following
providers expenses:
 any expense which constitutes an amount paid or payable to any
employee of such company for services rendered by such employee,
which is or will be taken into account in the determination of the taxable
income of such employee.
 any expense, deduction or contribution contemplated in sections 11(c)
legal costs, 11 (i) bad debts, 11 (l) contributions to funds, 11 (nA) (nB)
certain fringe benefits paid to retired employees and
 expenses in respect of premises, finance charges, insurance, repairs, fuel
and maintenance in respect of assets if such assets are used wholly or
exclusively for trade.

A ‘personal service provider’ as defined in the Fourth Schedule to the Income Tax
Act is a provider
 where the owner renders services on behalf of the enterprise personally and
the person would have been regarded as an employee of employer if such
services were rendered by him directly to the employer
or
 more than 80% of its income consists of amounts earned from one client
and
 the enterprise does not employ more than three full-time employees that are
not members or connected persons in relation to the enterprise

23(l) prohibits A Ltd pay an employee R120,000 for a 6 month restraint. The deduction cannot be
deductions for restraint claimed under the general deduction formula, but in terms of section 11 (cA)
of trade other than where R40,000 a year for the next 3 years is written off.
those in terms of section
11 (cA)
23(o) prevents A bribe is not tax deductible.
deductions if companies
break the law or are Similarly if a truck is overloaded to earn more income and a fine is given to the
involved in a corrupt truck, this fine is not deductible as a deduction is not given when the enterprise
activity. incurs expenditure when producing more income.

23(p) disallows a If a company has claimed a key man deduction on a policy and the policy falls due,
deduction for various if the company pays the proceeds to the employee, the company will not get a
key man policy payouts deduction for the amount paid.
to employees
Thus if a company collect R1,000,000 in terms of a key man policy, the amount is
included in gross income.

If the amount is paid out to the employee or his/her family, no deduction can be
claimed as this is prohibited in terms of section 23(p)

23(q) disallows If a key man policy is ceded to an employee and is treated as exempt in the hands
deductions for ceded of the employee, no deduction can be claimed for the cession by the company
key man policies ceding the policy.

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5. DISCUSSION OF WHETHER CERTAIN

EXPENDITURE IS SPECIFICALLY DEDUCTIBLE IN
TERMS OF THE GENERAL DEDUCTION FORMULA
Specific expenditure Application

Advertising Deductible provided spent in the production of income and no enduring benefit
created. If an enduring benefit is created (such as the erection of a billboard that
will stand for 3 years), the amount is not deductible.

Employment costs Deductible if in production of income. For gratuities, they will be deductible if paid
in terms of a service contract or if paid in terms of an established policy (as an
incentive to staff thus producing income)

Compensation for loss of office is deductible if paid in terms of a service contract.

Educational costs If the knowledge is being gained for the first time, it is “capital” as it will form part
of your “knowledge structure” giving an enduring benefit.

Update seminars are deductible.

Excessive expenditure This is not deductible. Thus if a person pays his wife R30,000 for a job that should
have cost R4,000, the R26,000 excess costs cannot be deducted as it is excessive
expenditure.

Goodwill Purchases of goodwill will usually be capital unless:

 the business is bought with the intention for resale and as such will form
part of the taxpayers trading stock, or
 the taxpayer is buying the right to do something for a short time and the
original rights will revert to the original owner shortly.

Money lending losses Only deductible for moneylenders

Membership fees Entrance fees are capital.

Annual fees are deductible.

Moving costs For inventories and similar assets deductible.

For capital assets, these costs are not deductible and included into the cost of the
asset.

Theft Theft by junior staff deductible as this is an inevitable concomitant of doing

business.

Theft by management is not deductible as not an inevitable concomitant of doing

business.

Damages and All the requirements of the general deduction formula need to be complied.
compensation Particular attention should be paid to whether:
o the compensation or damages were paid in the course of carrying on of a
trade and
o the compensation and damages were paid in the production of income i.e.
as long as the damages arose as an inevitable concomitant of doing the
business, the damages and compensation would be tax deductible
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Specific expenditure Application

provided the other general deduction formula requirements are met.

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CHAPTER 5
SPECIAL DEDUCTIONS - SECTION 11 DEDUCTIONS

TABLE OF CONTENTS
1. INTEREST ......................................................................................................................................................................................... 2
2. LEGAL COSTS (section 11(c)) ........................................................................................................................................................... 3
3. RESTRAINT OF TRADE DEDUCTION (section 11(cA)) ....................................................................................................................... 5
4. REPAIR DEDUCTION (section 11(d)) ................................................................................................................................................ 6
5. BAD DEBTS DEDUCTIONS [section 11 (i) )] ................................................................................................................................... 13
6. PROVISION FOR DOUBTFUL DEBTS [section 1(j)] .......................................................................................................................... 16
7. AMOUNTS PAID TO EMPLOYEES ................................................................................................................................................... 18
7.1 SALARIES AND FRINGE BENEFITS ............................................................................................................................................ 18
7.2 Fringe benefits ........................................................................................................................................................................ 18
7.3 Section 7B Variable remuneration .......................................................................................................................................... 19
7.4 GOVERNMENT TAXES .............................................................................................................................................................. 19
7.5 AMOUNTS PAID TO PENSION, PROVIDENT AND MEDICAL AID FUNDS .................................................................................. 20
7.6 ANNUITIES PAID TO FORMER EMPLOYEES AND DEPENDANTS OF FORMER EMPLOYEES ...................................................... 20
7.7 GRATUITIES ............................................................................................................................................................................. 22
7.8 Broad based shares given to employees [section 11(lA)] ....................................................................................................... 23
7.9 Policies covering life, disability and dread disease for staff .................................................................................................... 23
7.8.1 Life and disability policy taken out to protect a company against losses in the course of employment ........................ 24
7.8.2 RISK AND INVESTMENT POLICIES [section 11(w)(i)] ........................................................................................................ 24
7.8.3 Risk policies ...................................................................................................................................................................... 26
7.8.4 Loans on policies .............................................................................................................................................................. 27
8. POST-RETIREMENT MEDICAL BENEFITS ........................................................................................................................................ 28
9.PRE TRADE EXPENDITURE (section 11A) ........................................................................................................................................ 29
9.1 WHEN CAN PRE TRADE EXPENSES BE CLAIMED? .................................................................................................................... 29
10.DEDUCTIBILITY OF PRE PAID EXPENDITURE................................................................................................................................. 31
11. LEARNERSHIPS ............................................................................................................................................................................ 35
12. SECTION 24 ALLOWANCES .......................................................................................................................................................... 38
13. SECTION 24 C – FUTURE EXPENDITURE ON CONTRACTS ............................................................................................................ 39
14. DONATIONS DEDUCTION [section 18A] ...................................................................................................................................... 39

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1. INTEREST
Interest deductions are a function of the general deduction formula and also section 24J

INTEREST PAID
Interest must be split between pre trade interest
and other interest. Each is governed by a different
section.

INTEREST OTHER INTEREST

INCURRED PRIOR Interest is deductible in terms of section 24J and the general deduction
TO TRADE formula.
If the interest is actually incurred in the production of income, not of a
Such interest capital nature, it will generally be deductible.
may be Examples of deductible interest include:
claimed, in  Interest incurred to buy a machine
various  Bank overdraft interest to fund operations
circumstances,
 Interest incurred to buy a supplier of raw materials
in terms of
section 11A,
Examples of non-deductible interest include:
pre trade
 Interest on a loan used to buy shares that earn dividends
expenses.
(dividends are exempt from income thus not in production of
Refer to the
income)
notes on
 Interest on a loan taken to pay dividends (not used to produce
section pre
income)
trade expenses
 Interest on a loan taken to pay tax (not used to produce income)
later in this
chapter.  Interest incurred on an asset, prior to the asset being brought into
use.

Further discussions of section 24J

For taxpayers other than companies, section 24J applies to loan transactions that cover more than 1 year or are issued or
redeemed at a premium or discount.

Companies are required to calculate all interest in terms of section 24J.

Interest is calculated on a day’s basis using the effective interest rate in terms of section 24J effective interest basis

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ILLUSTRATION – DEBENTURE MULTI YEAR PAYMENTS

On 1 May of year 1, a company buys a 2 year debenture on issue that pays interest of 7,5% every 6 months(15% per annum) on
a capital amount of R1,000,000 every 6 months. The debenture was issued at a price of R1,020,000 and is redeemable in 2 years’
time for R990,000. The company has a 31 December year end

The amortisation table is as follows

Capital Interest at 6,68743% Payment Closing balance end of year

1 (May-Oct) 1,020,000 68,212 -75,000 1,013,212
2 (Nov – Apr) 1,013,212 67,758 -75,000 1,005,970
3(May – Oct) 1,005,970 67,274 -75,000 998,243
4(Oct – Apr) 998,243 66,757 -75,000 990,000 (which is redeemed)

What amounts will be taxed in year 1, year 2 and year 3. Assume 365 day year for year 1 and a 366 day year for year 2.

SUGGESTED SOLUTION

The interest would be

 Year 1 – 68,212 +[67,758 X 61/181]
 Year 2 – [67,758 X 120/181] + 67,274 + [66,757 X 61/182]
 Year 3 – [66,757 X 121/182]

2. LEGAL COSTS (section 11(c))

To be deductible, legal costs must be prescribed legal expenditure which is:
1. actually incurred by the taxpayer during the year of assessment; and
2. in respect of any claim, dispute or action of law; and
3. arising in the course of, or by reason of, ordinary operations in carrying on trade; and
4. not of a capital nature; and
5. the income or expenditure linked to the legal expenditure must be:
o included in income or
o allowed as a deduction.

Prescribed legal expenditure includes:

 Fees for legal practitioners;
 Expenses incurred in order to procure evidence or expert advice;
 Court fees;
 Taxing fees, witness fees and expenses;
 The costs of sheriffs and messengers of the court; and
 Any other similar costs.

INTERACTIVE ILLUSTRATION
Mr E, a sole practitioner accountant, incurred legal fees of R3, 000 in respect of litigation in getting his lawyers to make an
insurance company pay R20, 000 in terms of a loss of profits policy, which should have been paid out because E was hospitalised
for 4 weeks. Would the amount of legal expenses be tax deductible in terms of section 11(c) of the Act?

SUGGESTED SOLUTION

In determining whether this expense is claimable under section 11(c), the following should be considered:
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 Actually incurred ( expenditure of R3, 000 was incurred)

 In respect of an action, claim, dispute or action at law ( action of law/litigation)
 it must be prescribed legal expenditure (practitioners fees are included in the prescribed legal fees);
 it must be incurred in the course, or by reason of, ordinary operations in carrying on trade (it is incurred in the ordinary
operations as it is reasonable for a sole practitioner to insure himself for incapacity to work);
 any income generated would be included in income (income from the loss of profits policy is included in income).
 it must not be capital in nature (it is not as it does not result in an enduring benefit);
A full deduction would thus be allowed for legal expenses under section 11(c).

The provisions of section 11(c) are broader than the general deduction formula. Some legal expenses would not be allowed
under s11(a) but are deductible under s11(c).
Examples of these include legal expenses:
- incurred in the protection of income
- to prevent a diminution of income
- to prevent an increase in deductible expenditure
- avoid a loss or resist a claim for compensation

This is due to the fact that the general deduction formula requires “in the production of income”, whilst section 11(c) requires
an amount “arising in the course of, or by reason of, ordinary operations in carrying on trade”.

ILLUSTRATION – VARIOUS LEGAL COST EXAMPLES

For each of the following situations, discuss whether a deduction may be claimed.
1. A Ltd incurred legal expenses on the collection of a debtor.
2. B Ltd, a food distributor, incurred legal expenditure of R1,000 and damages of R2,000 when settling out of court in respect
of damages to a customer who was poisoned with food bought from B Ltd. This poisoning was as a result of negligence on
the part of B Ltd.
3. C Ltd, a study institution, incurred R3,000 attorney legal expenses and R500 in court fees to force Mr D to give a series of
lectures that he had agreed to do per a contract signed between Mr D and C Ltd. C Ltd made R10,000 from these lectures.
4. D Ltd is a soft drinks company and sells a drink called blue cow. A competitor has made a similar drink and is selling it under
the name blue sheep. They took the rival company to court for infringing on their name and advertising and the judge ruled
that the competitor should change its name. This led to the competitor closing down. Legal costs incurred were R50,000.
5. Mr E, an accountant, was taken to court on a fraud charge. Fraud was not proved and Mr E incurred R100,000 legal costs in
proving his innocence.
6. F Ltd incurred a legal expense of R4,000 relating to the drawing up of a lease agreement for the renting their offices for a 5
year period.

Determine whether any deductions are allowable for the above legal expenses in terms of the Income Tax Act.

SUGGESTED SOLUTION

1. Debt collection expenses are deductible.

2. It cannot be said that it is an inevitable concomitant of being a food vendor that poisoned food will be sold. Thus no
deduction for damages can be claimed under section 11(a). As no deduction may be claimed under section 11(a) for
the damages, no deduction may be claimed under section 11(c) for legal expenses.
3. In assessing whether the amount is deductible under section 11(c), the following must be proved:
 it must be prescribed legal expenditure (it is as both attorney and court fees are prescribed legal fees);
 it must not be capital in nature (it is not as it does not create an enduring benefit);
 it must be incurred in the course, or by reason of, ordinary operations in carrying on trade (it is incurred in the ordinary
operations);
 any income generated would be included in income or expense would have been deductible (income from giving the
course is included into income);
A full deduction would thus be allowed for legal expenses under section 11(c).

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4. No deduction may be claimed. The elimination of competition is capital in nature and as such not deductible in terms of
section 11(c).
5. A deduction may be claimed for legal fees. It could be argued that the dominant reason that legal fees were incurred
was to prevent the accountant from going to jail. The amount would thus be deductible as it will be viewed as relating
to the income earning operations of the company and not to the capital structure of the company. As the expense is
deductible, the legal fees will be deductible.
6. No deduction will be allowed in terms of section 11(c) as this transaction is capital in nature.

3. RESTRAINT OF TRADE DEDUCTION (section 11(cA))

Companies generally invest resources to improve the skills of their employees in an effort to remain profitable and competitive.

When a key employee leaves a company, the company may take steps to restrain the employee from sharing trade secrets that
the employee would have been privy to whilst in the employ of the company.

One way to restrain the employee would be by paying a restraint of trade whereby the employee cannot trade payment for a
certain period of time.

A restraint of trade deduction is allowed if:

 actually incurred by the taxpayer during the year of assessment; and
 in the course of the carrying on of his trade; and
 as compensation in respect of any restraint of trade imposed on any natural person; and
 to the extent that the amount constitutes or will constitute income of the person to whom it is paid.

The restraint of trade is written over the greater of 3 years or the period of the restraint.

INTERACTIVE ILLUSTRATION

A Ltd paid Mr A a restraint of trade payment of R12, 000 in respect of:

a) a 2 year restraint, or
b) a 4 year restraint.

What will be deductible for tax purposes?

SUGGESTED SOLUTION TO ILLUSTRATION

a) Even though the restraint is only for 2 years, the minimum deductible period is 3 years and an amount of R4, 000 will be
deductible over the next 3 years.

b) The restraint will be written off over 4 years at R3, 000 per year.

The deduction may only be claimed to the extent that the restraint payment is included in the taxable income of the recipient.

Restraint of trade payments are specifically included in the gross income of individuals, trusts and personal service providers
that receive the payments. (Refer to the notes on special inclusions to gross income)

INTERACTIVE ILLUSTRATION

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A Ltd paid Mr A a restraint of trade payment of R12, 000 in respect of a 2 year restraint. Mr A included R9 000 into his taxable
income.

What will be deductible for tax purposes?

SUGGESTED SOLUTION TO ILLUSTRATION

Even though the restraint is only for 2 years, the minimum deductible period is 3 years. However only R9 000 will be deductible
over the three years. Therefore an amount of R3, 000 will be deductible over the next 3 years.

Restraint of trade deductions may be claimed if paid to:

 natural persons,
 trusts and
 personal service providers in terms of section 11(cA).

INTERACTIVE ILLUSTRATION

A Ltd pay a restraint of trade payment to B Ltd of R200, 000. This restraint payment covers a 5 year restraint period.

What deduction is available to A Ltd. B Ltd is not a personal service provider.

SUGGESTED SOLUTION

No deduction is allowed as the amount is paid to a company that is not a personal service provider.

A restraint deduction is not apportioned for periods of less than 1 year. Thus even if the restraint is paid 1 month before year
end, a full deduction for the year will be claimed.

Practice Questions

For each of the following situations, determine whether any deductions are allowable in terms of the Income Tax Act:
1. To Mr P, an amount of R100, 000 on 1 September 2012. The period of the restraint was 5 years. All R100, 000 was
included in Mr P’s income
2. To Mr Q, an amount of R500, 000 on 1 February 2011. The period of the restraint was 2 years. Only R300, 000 was
included in Mr Q’s income.
3. To company Z, an amount of R400, 000 on 1 May 2012. The period of the restraint was 10 years. Company Z is not a
personal service provider.

SUGGESTED SOLUTION

1. Restraint – Mr P The lesser of R100 000/3 or R100 000/5 20 000

2. Restraint – Mr Q The lesser of R300 000/2 or R300 000/3 100 000
3. Restraint – Company Z Not deductible Nil

4. REPAIR DEDUCTION (section 11(d))

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A repair deduction is allowed in terms of section 11(d) of the Act.

The following case should be understood before looking at the summary.

CIR v African Products Company Manufacturing Ltd
The court held
 A repair is restoration by renewal or replacement of subsidiary parts of the whole.
 In the case of repairs effected by renewal, it is not necessary that the materials used should be identical with the
materials replaced.
 The test for distinguishing repairs from improvements is
o Has a new asset been created resulting in an increase in the income earning capacity, or does the work
undertaken merely represent the cost of restoring the asset to a state in which it will earn income as before?

Fleming v KBI
The court concluded that repair involves the process of renewing, renovating, or restoring decayed or damaged parts. A repair
can only take place where the original structure is in need of repair

EXPENDITURE INCURRED

REPAIRS SECTION IMPROVEMENT TO

ASSETS
Section 11(d) of the Act allows as a deduction: Improvements are
 expenditure actually incurred capitalised into the
 during the current year of assessment cost of the asset.
 on the repair of property occupied for the purposes of trade, or in
respect of which income is receivable, or These improvements
 for the repair of machinery, implements, utensils and other articles are written off as a
used by the taxpayer for the purposes of his trade, or for beetle capital allowance if a
treatment of the timber property mentioned above. capital allowance is
available for the
It is important to note that the term ‘repairs’ is not defined in the Act. asset so improved.

Looking at the requirements for the deduction above, the following should be If a car has a 1.6 litre
noted: engine and the
 If an asset is not damaged, no repair deduction can be claimed. engine is replaced
with a new 3 litre
 A repair is a restoration or replacement of a subsidiary part of the whole. If
engine, the new
the whole asset has be rebuilt after it has been destroyed, the amount will
engine this will
not constitute a repair but will constitute a whole new asset. Capital
constitute an
allowances, if applicable, will be claimed on the new asset.
improvement.
 A repair need not be with the same material as before. Thus a tin roof
could be replaced with a tile roof and this would still constitute a repair.
The improvement
 If an asset is used for business and private purposes, the repair deduction
will be capitalised
can be apportioned.
and written off in
 Where an asset cannot be repaired with original parts due to improvement
terms of the wear
in technology, the repair deduction can be claimed notwithstanding the
and tear section
fact that the asset may be improved.
applicable to motor
 Repairs on an asset prior to earning income on that asset are not vehicles.
deductible.

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There is a need to distinguish the difference between a repair and an improvement as the tax treatment is different.

ILLUSTRATION – TREATMENT OF REPAIRS VS IMPROVEMENTS FOR TAX PURPOSES

A computer is bought on 1 January of the current year for R9,000 and is written off over 36 months at R250 per month. On 1
July, because the hard drive has crashed, a new hard drive is put into the computer costing R3,000.

Discuss the treatment for tax if:

a. The new hard drive is considered to be an improvement as the company put in a much better hard drive than before and
the old hard drive was available if the company wanted to put the hard drive into the computer.
b. The new hard drive is considered to be a repair

SUGGESTED SOLUTION

Part a

If the amount is an improvement, the new tax value will be R7,500 (R9,000 – 6/36 X R9,000) + R3,000 = R10,500. The computer
will be written over the remaining 30 months at R350 (R10,500/30 months) a month.

Part b

If the replacement of the hard drive is a repair, the full R3,000 will be claimed as an expense when incurred and the computer
will continue to be written off at R250 a month.

The distinction between a repair and an improvement needs to be made before the tax treatment can be applied

ILLUSTRATION – DETERMINING WHETHER SOMETHING IS A REPAIR OR AN IMPROVEMENT

For each of the following, determine whether such expenditure is a repair or an improvement
1. A new shopping mall was erected outside your Johannesburg shop. This resulted in more passing trade past your shop. The
existing shop front consisting of a plaster wall with a small door and a small 400X 100 cm window was in a state of disrepair
and needed to be re-plastered and the cracked glass needed to be replaced. The wall was re-plastered and the window was
replaced at a cost of R10,000.
2. A new shopping mall was erected outside your Durban shop. This resulted in more passing trade past your shop. The
existing shop front consisting of a plaster wall with a small door and a small 400X 100 cm window was in a state of disrepair
and needed to be re-plastered and the cracked glass needed to be replaced. Instead of doing this, the frontage of the shop
was knocked down and a 20 000 X 1800 cm shop front was installed that allowed passers-by to look at the goods that were
available in the shop. This cost R35,000.
3. The old signage in front of the Durban shop was taken down and replaced with new signage at a cost of R10,000.

SUGGESTED SOLUTION

1. This is a repair as the asset has been restored to the same condition as before.
2. This is an improvement. The work has been done to create a better asset that will lead to greater income as passing trade
will be able to better see the goods of the company.
3. This is neither a repair nor an improvement to an asset. This is a new asset that has been acquired.

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All the requirements of the repair deduction need to be present before a deduction is allowed.

The definition of a repair as per the African Products case need to be understood when determining whether a repair has taken
place or not. These are:
 A repair is restoration by renewal or replacement of subsidiary parts of the whole.
 In the case of repairs effected by renewal, it is not necessary that the materials used should be identical with the
materials replaced.
 The test for distinguishing repairs from improvements is
o Has a new asset been created resulting in an increase in the income earning capacity, or does the work
undertaken merely represent the cost of restoring the asset to a state in which it will earn income as before?

ILLUSTRATION – DISCUSSION OF THE REPAIR DEDUCTION

A Ltd’s factory roof is hit during a lightning strike and the roof is damaged. The roof is repaired at a cost of R50,000 by using new
tiles to replace the old tiles. This was done as the original tiles on the roof were no longer available, and the different make of
tile was used.

Will the amount be allowed as a repair deduction?

SUGGESTED SOLUTION

This is a repair as:

 The roof is damaged
 The amount is a repair as the roof fixing was a replacement of a subsidiary part of the whole. (The roof is only part of a
factory building i.e. it is the subsidiary part of the whole).
 It does not make a difference that a different material was used.
 No new asset has been created that increases the income earning capacity. This is not an improvement.

This is a repair.

The amount will be allowed as a repair deduction as:

 Expenditure was actually incurred
 During the year of assessment
 On the repair of property occupied for the purposes of trade

No repair can be claimed when an asset is not damaged.

There is no obligation to effect the cheapest repair on an asset. Consider a car that needs a new clutch. The company can get a
temporary fix at a cost of R2,000 which will allow the car to operate for 2 months or replace the clutch at a cost of R9,000. Both
would be repairs.

ILLUSTRATION – CLASSIFICATION AS A REPAIR DEDUCTION

A person wishes to fix up his house. He has an old roof on the building that is in good working order, but wishes to
replace the roof with another roof that will look better on the house.

He has another house with a roof that is breaking and is in a bad state. It will cost him R1,000 to fix the roof or
R5,000 to put a new roof on the house.

What may be claimed as a repair deduction?

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SUGGESTED SOLUTION

The replacement of the roof that was in good order would not constitute as a repair as the roof was not damaged when it was
replaced.

The replacement of the damaged roof would constitute a deductible repair as even though it could have been fixed cheaper. The
roof is a subsidiary part of a bigger asset (the house) and the replacement of a damaged roof would constitute a repair.

The African Products case held that the repair need not be made with the same material as before.

The taxpayer’s intention in this regard is very important. If the taxpayer intends to create a better asset, an asset that will
increase income earning capacity.

ILLUSTRATION – REPAIRS NEED NOT BE WITH THE SAME MATERIAL AS USED BEFORE

There are currently carpets that have been damaged on a floor. They need to be replaced and it will cost R5,000 to replace the
carpets. The company decides that it would rather tile the floor. It will cost R6,000 to tile the floor.

SUGGESTED SOLUTION

A repair deduction of R6,000 can be claimed as the floor covering is being repaired.

The taxpayer need not use the same materials as before to effect a repair.

There is no discernible increase in the income earning capacity and this is a repair.

ILLUSTRATION - REPAIRS NEED NOT BE WITH THE SAME MATERIAL AS USED BEFORE BUT CANNOT CREATE AN IMPROVEMENT

Shop fittings are in a general state of disrepair. The current fittings that are 1,5M high and made out of melamine are replaced
with metal shelves that are 2,1 M high. 40% more goods can now be displayed.

The company wanted extra shelves, and as such increased the height of the shelves by 600mm. In addition, the company knows
that the metal shelves have a 25 year life as compared to the melamine 10 year life.

The new shelves cost R25,000.

Is this a repair?

SUGGESTED SOLUTION

This is a replacement of a subsidiary part of the whole shop.

This is not a repair. As more products can be displayed, this is an improvement to the income earning structure.

The R25,000 may be treated as a new asset

If the whole asset is destroyed and then replaced, this will not constitute a repair.

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ILLUSTRATION – WHOLE ASSET DESTROYED AND REPLACED

A fire set by commuters burns down substantially the whole of a train station. Would the repairs made to the train
station constitute a deduction?

SUGGESTED SOLUTION

It would depend on the extent of the damage to the train station.

However it would seem that the repairs would seem to be a reconstruction of the entirety of the train station and as such no
deduction for repairs can be claimed. The whole station would be the whole, not a subsidiary part of the whole asset.

The repair deduction can be apportioned between a business and non-business portion.

ILLUSTRATION – APPORTIONMENT OF REPAIR DEDUCTION

A doctor runs a general practitioners practice from his private home. 20% of the private home has been converted into doctors
rooms.

He incurs the following expenditure during the tax year:

 R10,000 to fix the damaged roof on the house.
 R1,200 to paint only his doctors rooms
 R3,000 to repair faulty electricity plug points in the house, not in the doctors practice.

What amounts are deductible for tax purposes?

SUGGESTED SOLUTION

Repairs should be apportioned when the property being repaired is not used completely for business purposes.20% of the
amount to fix the damaged roof is deductible for tax purposes. Thus R2,000 will be claimed as a repair deduction. The full R1,200
to paint the doctors rooms will be deductible as a repair. The amount incurred to repair faulty plug points will not be deductible
as the plugs repaired did not form part of the doctors practice.

Repairs effected prior to bringing an asset into use are not deductible as the asset is not being used in the production of income.

ILLUSTRATION – REPAIRS PRIOR TO BRINGING AN ASSET INTO USE ARE NOT DEDUCTIBLE

Mr H bought house 1 for R1,200,000. The house was not in a lettable condition, and he spent R60,000 getting it into a lettable
condition. He then let the house out.

Mr H bought house 2 for R1,000,000. The house was in a lettable condition and he immediately advertised for prospective
tenants. As no tenants were obtained for January, he spent R30,000 on repainting the house. He then let the house out in
February.

Can the amounts be claimed as a deduction?

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SUGGESTED SOLUTION

The amount incurred on house 1 cannot be deducted as the repairs were not incurred for the purposes of trade. The owner had
yet to try let out the property.

The amount on house 2 can be claimed as a deduction as the taxpayer was trying to let the property when incurring the repair
cost.

Where an asset can only be repaired using material that improves the asset, as the old material was technologically obsolete,
the amount may still constitute a repair.

ILLUSTRATION – REPAIR DEDUCTION VS IMPROVEMENT WITH TECHNOLOGICAL OBSOLESCENCE

A company has a burglar alarm system. One of the infrared motion detectors breaks.

The motion detector is replaced by a new detector that has double the range. The old motion detector is not available as the
technology is obsolete. Can a deduction be claimed for the repair?

SUGGESTED SOLUTION

This is a replacement of a subsidiary part of the whole burglar alarm system.

If a subsidiary part of an asset is broken, and a new part is put into the asset that is better than the old part due to the fact that
the old part is not available due to technological obsolescence, a deduction will be allowed in terms of section 11(d)
notwithstanding the fact that there is an improvement.

A deduction can be claimed for the repair as it was

 Expenditure was actually incurred
 During the year of assessment
 On the repair of property used for the purposes of trade

Maintenance is considered to be a repair.

ILLUSTRATION – MAINTENANCE

A car undergoes its 40,000 km service which costs R3,000. Is this amount paid deductible?

SUGGESTED SOLUTION

Maintenance is considered to be a repairs deduction under section 11(d).

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5. BAD DEBTS DEDUCTIONS [section 11 (i) )]

Debtors arise when a taxpayer when a taxpayer is owed money either through selling goods on credit or by granting credit to a
third party.

If a debtor fails to pay the tax payer, the debt becomes bad.

Section 11(i) allows bad debts to be deducted if they:

1. are due to the taxpayer; and
2. are or were included in the taxpayer’s income for the current or any previous year of assessment; and
3. are proved to the Commissioner’s satisfaction to be bad; and
4. have during the year of assessment become bad.

All the above requirements have to be met otherwise no deduction can be claimed.

INTERACTIVE ILLUSTRATION

A Ltd sell trading stock for R2, 000,000. During the current year, R250, 000 of the debt has become a bad debt. Will a deduction
be allowed in terms of section 11(i)?

SUGGESTED SOLUTION

Applying the 4 rules

1. The amount (R250 000) is due to the taxpayer
2. The amount (R250 000) was included in the taxpayer’s gross income when the sale was made.
3. The amount (R250 000) is a proven bad debt.
4. The debt became bad during the current year of assessment.

The debt may be claimed in terms of section 11(i) as a deduction.

A capital loss will occur when a bad debt cannot be claimed.

INTERACTIVE ILLUSTRATION

A Ltd sell their office building for R2, 000,000. During the current year, R250, 000 of the debt became a bad debt. Will a
deduction be allowed in terms of section 11(i)?

SUGGESTED SOLUTION

Applying the 4 rules

1. The amount (R250 000) is due to the taxpayer
2. The amount (R250 000) was not included in the taxpayer’s gross income (was capital in nature)
3. The amount (R250 000) is a proven bad debt.
4. The debt became bad during the current year of assessment.

The debt may not be claimed as a deduction in terms of section 11(i) as it was in respect of a capital transaction that was never
included into gross income. (Requirement 2 not met).

As a bad debt cannot be claimed, a capital loss will be claimed.

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Therefore, proceeds will be nil. Base cost will be R250, 000. A capital loss of R250, 000 will be claimed.

Staff loans are not included in the income of a taxpayer and as such a bad debt deduction cannot be claimed. In such cases a
capital loss can be claimed.

INTERACTIVE ILLUSTRATION

A Ltd gave a staff loan to an employee. The capital portion of the loan is R10, 000 and interest of R2, 000 was charged on the
loan. The employee disappeared and the company decided to write off the loan in the year of assessment. Can a deduction be
claimed in terms of section 11(i) when the staff loan is written off by the employer?

SUGGESTED SOLUTION

No deduction can be claimed in terms of section 11(i) for the capital portion of the loan as the amount was never included in
gross income.

The interest portion of the loan is deductible as it was included in the gross income of the company. Thus R2, 000 will be
deductible in terms of section 11(i) of the Act.

A capital loss of R10, 000 may be claimed.

When a compromise is reached between a debtor and the person whom money is owed to, this will not constitute a bad debt as
the debt should actually have gone bad.

However, in practice the Commissioner permits a taxpayer to write-off such losses incurred.

INTERACTIVE ILLUSTRATION

L Ltd is approached by B Ltd who owes R10, 000 to L Ltd. L Ltd agrees that in order to retain B Ltd as a client, B Ltd need only pay
R7, 000 to L Ltd. What are the tax implications?

SUGGESTED SOLUTION

This R3, 000 compromise will not be allowed as a deduction in terms of section 11(i).

If a debtor is insured, and the insurance company pays out an amount to lessen the bad debt, this amount is taken into account
when determining the amount of a bad debt. The result of the insurance pay-out is that only the amount not covered by
insurance is included as a deduction.

INTERACTIVE ILLUSTRATION

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A Ltd insured their debtors book. A debtor recorded at R30, 000 went bad. The insurance company paid out R27, 000 in respect
of the bad debt. What are the taxation implications?

SUGGESTED SOLUTION

Only the amount not recoverable from the insurance company are not recoverable. Thus R3, 000 (R30, 000 – R27, 000) will be
deductible as a bad debt.

The bad debt deduction is only claimable only when the debt actually goes bad in the year of assessment.

INTERACTIVE ILLUSTRATION

A Ltd forgot to claim debts that actually went bad in the previous year of assessment. Can the company claim the allowances in
the current year of assessment?

SUGGESTED SOLUTION

The bad debt deduction is only claimable only when the debt actually goes bad in the year of assessment.

A debt taken over on the purchase of a business, or through inheritance that goes bad is not allowable as a deduction since the
amount is not included in gross income.
Similarly, when a debt is sold by a company, the selling company will not be able to claim a deduction as the debt is not due to
the company at year end.

INTERACTIVE ILLUSTRATION

A Ltd bought the debtors book of Mr D. They could not collect R2, 000 worth of debts from his debtor’s book. Can the company
claim a deduction for the bad debts?

SUGGESTED SOLUTION

A debt taken over on the purchase of a business that goes bad is not allowable as a deduction since the amount is not included
in gross income. Therefore, no deduction will be claimed.

When a bad debts which was claimed as a deduction is recovered, it forms part of gross income in the year of assessment.

INTERACTIVE ILLUSTRATION

Due to a turn in fortune of one of its clients, A Ltd managed to collect R10 000 which was previous deducted as a bad debt. What
are the tax implications of the transaction?

SUGGESTED SOLUTION

When a bad debts which was claimed as a deduction is recovered, it forms part of gross income in the year of assessment.
Therefore, the amount will be included into gross income.
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ILLUSTRATION – SUNDRY BAD DEBT EXAMPLES

A Ltd has the following bad debt write-offs for year ended 30 June 2010.

1. B Ltd owed A Ltd R1,000. B Ltd went insolvent on 2 February 2009. On 18 April 2009, the liquidator said that there was no
prospect of any money being received from B Ltd. A Ltd did not claim for the amount in year 1 due to a mistake. A Ltd
wants to deduct the amount for the year ended 30 June 2010.
2. Mr C owed R1,500. He bought goods on 30 May 2009. The company tried to trace him unsuccessfully and on 1 August
2009, gave up hope of recovering the debt.
3. Mr D owed R10,000. Due to an earthquake, his business was liquidated. His liquidator paid 20c on the rand, and CIG
insurance brokers paid n amount of R6,400 in terms of a debtors insurance policy taken out by A Ltd on Mr D.
4. Mr E, an employee, defaulted on an employee loan of R500.
5. F Ltd owes R5,000. F Ltd is still trading, but A Ltd believe he is probably going to go insolvent in the near future. To this
extent, they have stopped supplying F Ltd.
6. A Ltd bought the debtors book of Mr D. They could not collect R2,000 worth of debts from his debtors book.
7. A Ltd lent money to G Ltd, a supplier of theirs. They knew that G Ltd was in financial difficulty, but needed to ensure they
continued to receive goods. G Ltd went insolvent during the year and R2,000 was still owing to A Ltd. There is no prospect
of recovery.

Discuss the tax effects of the above 7 situations. Ignore CGT

SUGGESTED SOLUTION

1. No amount may be claimed as a bad debt in 2010 as the amount must be claimed in the year that the debt went bad.
2. The full amount is claimable as the debtor went bad in the current year (even though the goods were purchased in the
previous year), and the sale was previously included in income.
3. The net loss is included in bad debts i.e. R10,000 - R2,000 - R6,400 = R1,600.
4. No amount claimable as there was no sale including the amount into income.
5. No bad debt may be claimed as the debt is not yet bad. The amount must be included on A Ltd’s doubtful debts list.
6. No bad debt write-off is allowed as A Ltd never included those sales into their gross income.
7. No deduction is allowed in terms of section 11(i) as it was never included in income, but the bad debt may be claimed in
terms of section 11(a) as it was incurred in the production of income.

6. PROVISION FOR DOUBTFUL DEBTS [section 1(j)]

Debtors arise when a taxpayer when a taxpayer is owed money either through selling goods on credit or by granting credit to a
third party.
A doubtful debts arise when the debtor fails to pay the debt in good time. This is different from a bad debt in that a bad debt is a
debt that would have become uncollectible.
A taxpayer can claim for doubtful debts based on a list of outstanding debtors that are doubtful.
SARS practice is that 25% of the doubtful debts list is allowed as a taxable deduction in terms of this section.
The deduction allowed in the prior year is added back in the current year as income.

INTERACTIVE ILLUSTRATION

M Ltd believes that C Ltd, who owes M Ltd R10, 000, will go bad in the near future. In year 1, they include C Ltd on their
doubtful debtors list.

In year 2, the debt finally goes bad as C Ltd is liquidated. There is no prospect of a liquidation dividend. What are the tax
implications of the above if the Commissioner has indicated that an appropriate percentage under s11(j) would be 25%?
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SUGGESTED SOLUTION

Year 1,
25% of R10,000 will be claimed as a
deduction in terms of section 11(j). (R2 500.)

Year 2,
The debt has actually gone bad therefore full
deduction in terms of section 11(i). (10 000)
There are no doubtful debts therefore no s11(j) deduction (0)

However, the R2,500 previously claimed in terms of

section 11(j) in year 1 will be added back to income
in year 2. 7 500

The doubtful debts allowance can only be claimed on debts that can qualify for the section 11(i) bad debts deduction.

INTERACTIVE ILLUSTRATION

N Ltd was allowed a doubtful debts allowance of R2, 000 in the previous year. In the current year, they have compiled a
doubtful debts list which includes 2 names. The details are as follows:

Debtor Details Amount

B Ltd for trading stock purchased R15,000

Employee A staff loan R 5,000

What are the tax implications for A Ltd if an appropriate percentage on which to claim the provision for doubtful debts is
considered to be 25%?

SUGGESTED SOLUTION

The R2, 000 allowance from last year must be included in the current year’s income.
A doubtful debts allowance of 25% of R15, 000 i.e. R3, 750 will be allowed as a deduction from income in the current period.
As the staff loan is not deductible (as it was never included in income per section 11(i)), this amount is not added to the list of
doubtful debtors.

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7. AMOUNTS PAID TO EMPLOYEES

There are a number of expenses that may be claimed when amounts are paid in respect of employees.

7.1 SALARIES AND FRINGE BENEFITS

Salaries paid are deductible in terms of the general deduction formula.

INTERACTIVE ILLUSTRATION

Master Pot CC is a small business corporation that manufactures and distributes kitchen appliances. The company paid
R2 000 000 for salaries.
How much will be included as a deduction?

SUGGESTED SOLUTION

The full R2 000 000 will be deducted in terms of section 11(a).

Excessive portions of salaries paid are disallowed as a deduction.

INTERACTIVE ILLUSTRATION

Master Pot CC is a small business corporation that manufactures and distributes kitchen appliances. The company paid
R2 000 000 for salaries.
SARS considered R500 000 of this amount to be excessive. How much will be included as a deduction?

SUGGESTED SOLUTION

Only R1 500 000 will be deducted in terms of section 11(a). The excessive portion will be prohibited. However, the employees
will be taxed in full.

7.2 FRINGE BENEFITS

The cost of providing a fringe benefit will also be deductible, subject to the general deduction formula or capital allowance.

 If an employer pays for a Cape Town holiday for an employee and this is included as a fringe benefit, this will be
deducted in terms of the general deduction formula.

 If an employer buys a car and gives it to an employee as a company car fringe benefit, this amount is not deductible in
terms of the general deduction formula, but will be deductible in terms of the wear and tear allowance.

ILLUSTRATIVE EXAMPLE

A Ltd paid a travel allowance of R2 000 to an employee in the year of assessment. What is the impact on taxable income?
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SUGGESTED SOLUTION

The company will deduct R2 000 in terms of section 11(a).

7.3 SECTION 7B VARIABLE REMUNERATION

This section applies to overtime, bonuses, commission, advance payments for reimbursable expenditure and leave pay.

Each of the above types of remuneration is variable.

These are only deductible when actually paid to an employee.

ILLUSTRATION – LEAVE PAY PROVISION DEDUCTION

A Ltd have a provision for leave pay of R600,000 at the end of the 20X4 year. They have a R700,000 provision for leave pay at the
end of the 20X5 tax year.

The profit before taxation in the annual financial statements of the company is R10,000,000.

During the year, the company credited the provision with R1,200,000 as this was the leave pay actually accruing to employees
for accounting purposes. R900,000 in leave pay was taken by employees and R200,000 was actually paid out.

What are the taxation implications of the above?

SUGGESTED SOLUTION

To understand the tax treatment, one must look at the accounting journal entries:
Dr Expense 1,200,000
Cr Provision for leave pay 1,200,000

Leave pay expense incurred as people work within the organisation

Dr Provision for leave pay 900,000

Cr Expense 900,000

Leave pay provision written off as the staff take leave.

Dr Provision for leave pay 200,000

Cr Bank 200,000

Staff paid out for leave pay

The tax treatment in a tax return would be as follows:

o Add back the movement in the expense as the leave pay expense has not been incurred of R300,000
o Claim the R200,000 actually paid as a deduction in terms of section 11(a)

7.4 GOVERNMENT TAXES

Government taxes paid by an employer on behalf of an employee such as UIF and skills levy are deductible.
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INTERACTIVE ILLUSTRATION

A Ltd paid R15 000 for UIF and R20 000 as skills development levy. What is the impact on taxable income?

SUGGESTED SOLUTION

The R15 000 and R20 000 will be deductible from taxable income.

7.5 AMOUNTS PAID TO PENSION, PROVIDENT AND MEDICAL AID FUNDS

Section 11 (l) states that a taxpayer can deduct 100% of the employer’s contributions to provident and pension funds. Medical
aid contributions are deducted as a general deduction.

Contributions to retirement annuity funds are deductible in full

ILLUSTRATION – CALCULATION OF DEDUCTION

A company set of financial statements has the following extracts:

Salaries paid to staff R8, 000,000
Contributions to pension funds on behalf of employees R 500,000
Contributions to retirement annuity funds on behalf of employees R 600,000
Contributions to medical aid funds on behalf of employees R 450,000

What may be deductible and in terms of which section of the Act?

SUGGESTED SOLUTION

The R8, 000, 000 salaries are deductible in terms of section 11(a).
The R600, 000 contributions to a retirement annuity fund is deductible in terms of section 11(a).
The R500, 000 contributions to the pension fund are deductible in terms of section 11(l).
The R450, 000 medical aid contributions are deductible in terms of section 11(a).

7.6 ANNUITIES PAID TO FORMER EMPLOYEES AND DEPENDANTS OF FORMER EMPLOYEES

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Annuities are deductible in terms of section 11(m).

Annuities are fixed annual amounts that are payable by a taxpayer that are repetitive based on an agreement. Thus if a company
agrees to pay an employee an amount of R1, 000 per month for 5 years, this will be an annuity.

ILLUSTRATION – ANNUITY DEDUCTION

P Ltd pays an amount of R200 a month to an ex-employee Mr E, due to Mr E’s precarious financial position. They have no
obligation to pay this amount, but the directors feel obliged to as Mr E gave P Ltd 30 years of service. What are the tax
implications for P Ltd in making this payment?

SUGGESTED SOLUTION

An annuity has three characteristics:

1. it provides for a fixed annual payment (even if it is in installments over the year);
2. the payment is repetitive;
3. it is chargeable against some person i.e. there is an obligation to pay.

No deduction may be claimed as this is not an annuity payment as there is no obligation to pay the R200 a month.

However, there may be a deduction in terms of section 11(a) if P Ltd could argue that the payment was in the production of
income.

Annuities to former employees and their dependants that have been paid due to:
 retiring from superannuation,
 ill health,
 old age are deductible in full, or
 death of an employee.

Amounts paid to former partners are only deductible if that partner was a partner for at least 5 years.

In all other cases, the amount is not deductible.

ILLUSTRATION – DEDUCTIBLE ANNUITY

Q Ltd pays an amount of R5, 000 per month to Mr R in terms of an annuity as defined. Mr R retired due to old age. What are the
tax implications of this transaction?

SUGGESTED SOLUTION

Q Ltd will claim a deduction of R60, 000 this year as annuities paid to former employees that have retired due to old age are
deductible in full.

ILLUSTRATION – NON DEDUCTIBLE ANNUITY

Mr C, 37 years old, inherits R5, 000,000 and leaves the employ of D Ltd. D Limited have undertaken to pay him an annuity of R3,
000 per year for the next 8 years. What are the tax implications of this transaction?

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SUGGESTED SOLUTION

This is an annuity. No deduction may be claimed in terms of section 11(m) for the taxpayer as he did not retire on the basis of
old age, ill health or infirmity.

ILLUSTRATION – SUNDRY EXAMPLES

1. Mr A is given an annuity of R2,000 a month by the company. The annuity was given to him on retirement.
2. Mr B , a former employee who retired, is given an amount of R1,000. There is no obligation to give him this amount, but
has had this amount conferred to him by A Ltd for the past 3 years.
3. Mr C’s two children were paid an amount of R1,500 each. The annuity was conferred on them when the machine their
father was working on exploded, killing him at work.
4. Mr D was given a gratuity of R10,000 on retiring.

For A Ltd, discuss whether any of these amounts are deductible in terms of section 11(m).

SUGGESTED SOLUTION

1. All R24,000 may be deductible in terms of section 11(m).

2. The amount is not deductible in terms of section 11(m) as there is no obligation to pay and as such does not fall into the
annuity definition.
3. A full deduction may be claimed.
4. No deduction under section 11(m) as there is no annuity. Note that a deduction may still be claimed under section 11(a) for
those items not allowed under section 11(m). This question merely discusses whether they could be deducted under
section 11(m).

7.7 GRATUITIES
Gratuities are lump sums paid to employees. This lump sum may be paid on retirement, or on any other occasion.

Gratuities are only deductible if the general deduction formula allows a deduction. Thus gratuities are deductible if they are paid
in order to produce income.

 An amount paid to incentivise a staff member to work hard will be deductible as such amount is likely to produces
income.

 A gratuity paid in respect of a service contract is also deductible as the staff member would work to produce income in
terms of the service contract.

 However if a person is paid in recognition of past services, such amounts are not deductible as the payment is not in the
production of income.

ILLUSTRATION - GRATUITIES

For each of the following, state whether the gratuity paid is deductible or not
1. 13th cheque paid to an employee

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2. Amount paid on retirement. This payment is made in terms of established policy by the company to persons who are
retiring and have contributed to the company
3. Amount paid on retirement. There is no established policy for such payment but this particular employee gave 20 years of
excellent service to the company
4. R50,000 was paid to the best salesman for the calendar year.
5. Gratuity paid in terms of a service contract

SUGGESTED SOLUTION

1. Deductible
2. Deductible
3. Not deductible
4. Deductible
5. Deductible

7.8 BROAD BASED SHARES GIVEN TO EMPLOYEES [section 11(lA)]

Section 8B allows taxpayers to receive R50,000 in value in terms of a broad based share scheme tax free under certain
circumstances.

The company issuing such shares may also claim a deduction for such shares given to employees in terms of a broad based share
scheme in terms of section 11(lA).

If an employer provides an employee with shares in a broad based share employee scheme, a deduction of R10,000 per annum
per employee may be claimed. Any amount not claimed may be carried forward to the next tax year.

ILLUSTRATION – BROADBASED SHARE SCHEME DEDUCTION

A Ltd gives 20 employees shares worth R28,100 each as part of broad based share employee scheme. The employees
paid R100 for their shares.

What are the taxation implications?

SUGGESTED SOLUTION

Shares to the value of R28,100 – R100 = R28,000 are given to each employee in terms of a broad based share
scheme. Deductions are as follows:
 In year 1, R10,000 will be claimed as a deduction for each employee i.e. 20 X R10,000= R200,000. (R18,000
carried forward per employee)
 In year 2, R10,000 will be claimed as a deduction for each employee i.e. 20 X R10,000= R200,000. (R8,000 carried
forward per employee)
 In year 3, R8,000 will be claimed as a deduction for each employee i.e. 20 X R8,000= R160,000.

7.9 POLICIES COVERING LIFE, DISABILITY AND DREAD DISEASE FOR STAFF
There are a number of life policies that may be taken out by an enterprise. These include:
 Life policies taken out to protect a company against losses in the course of employment.
 Pure risk policies taken out on the life of a key employee
 Policies containing risk and investment elements on staff members
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Each will be discussed individually. Only the rules for policies taken out after 2012 are discussed hereafter.

7.8.1 LIFE AND DISABILITY POLICY TAKEN OUT TO PROTECT A COMPANY AGAINST LOSSES IN
THE COURSE OF EMPLOYMENT

Instances of such policies include:

 A policy taken out by a mine to cover instances where there are mining disasters that may kill staff.
 A policy taken out on the life of staff members that may get injured or killed whilst out of town on business.

These policies are not treated as fringe benefits.

These policies are deductible if the terms of the general deduction formula are complied with.

Usually the deduction will be allowed as :

 The enterprise is carrying on a trade
 The payment made is expenditure actually incurred
 In the production of income
 Not of a capital nature

Should the policy be paid out to the company, this would be treated as income.

Subsequent payments to any disabled employees will be in terms of normal rules:

 Annuities treated under section 11(m)
 Gratuities as discussed previously

ILLUSTRATION – GENERAL LIFE POLICY

A mining company takes out a general policy that pays out R750,000 for each miner killed underground.

During the year, the following is relevant:

 Premiums paid are R2,300,000
 4 miners died and R3,000,000 is received
 Annuities paid to the dependants of deceased miners are 600,000 for the year
 Gratuities of R100,000 were paid to each of the families of the deceased miners. (R400,000 in total). These payments were
made in line with an established policy of the company.

What are the tax implications?

SUGGESTED SOLUTION

The R2,300,000 premium paid is deductible in terms of the general deduction formula
The R3,000,000 collected is included in gross income.
The R600,000 is allowed as a deduction in terms of section 11(m)
The R400,000 is allowed as a deduction in terms of the general deduction formula as this is an established policy for staff
compensation.

7.8.2 RISK AND INVESTMENT POLICIES [SECTION 11(W)(I)]

This policy is earmarked to be paid to the family of a deceased employee.

This policy has a risk pay out upon the death, disability or severe illness of an employee and also has an investment value if
traded in before death. Deductions may be claimed if:
 The policy is for an employee or director
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 The employer owns the policy

 There is a pay out on death or disability or severe illness of the employee or director
 The premiums payable by the employee are taxed as a fringe benefit in the hands of the employee or director.

The proceeds could be paid out to the employee/director or to the company who will then pay out such proceeds to the
employee/director or their dependants.

As the policy is in the hands of the enterprise paying the premiums, the policy is usually ceded to an employee or director when
the employee leaves the company.

Section 23(p) prevents a deduction for the employer.

The value of the policy will form part of gross income (para (d) of gross income special inclusions). The amount is exempt in
terms of section 10(1)(gG) if all the premiums ever paid on the policy have been included as a fringe benefit in the employees’
pay slips.

Many policies were started prior to 1 March 2012, and these will not get the exemption as there was no requirement to treat
such policies as fringe benefits prior to this date.

ILLUSTRATION – RISK AND INVESTMENT POLICIES

The company pays R3,000 a month in respect of a risk and investment policy for Mr E, a senior employee. This amount is
included as a fringe benefit to Mr E.

Upon Mr E’s death, an amount of R4,000,000 is paid to his family.

Mr E died 4 months into the year

What are the taxation implications?

SUGGESTED SOLUTION

R3,000 X 4 months = R12,000 is allowed as a deduction.

The company has no tax effect with the amount paid to the family.

If the company acted as an intermediary, the R4,000,000 would be included in gross income and then R4,000,000 as a deduction
in terms of the general deduction formula when paid to the family.

It should be noted that the amount is exempt from income in the hands of the employee/family in terms of 10(1)(gG)

ILLUSTRATION – RISK AND INVESTMENT POLICIES

The company pays R5,000 a month in respect of a risk and investment policy for Mr T, a senior employee. This amount is
included as a fringe benefit to Mr E.

Mr T retires 3 months into the year and the policy is ceded to him when it had an investment value of R200,000.

What are the taxation implications?

SUGGESTED SOLUTION

R5,000 X 3 months = R15,000 is allowed as a deduction.

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No deduction may be claimed by the company when the policy is ceded in terms of section 23(p).

The amount will not be gross income in the hands of the employee (Note the employee has already had a fringe benefit included
previously)

7.8.3 RISK POLICIES

Risk policies have the following characteristics

 The employer is the policyholder when premiums are paid
 There is a pay out on death or disability or severe illness of the employee or director
 There is no cash value attached to the policy if it is surrendered/cashed in.
 The enterprise elects to claim the deduction

If the employer does not elect to claim the deduction, the amount will be included in gross income but will be exempt from
income in terms of section 10(1)(gH).

If the employee claims a deduction, the amount is included into gross income in terms of paragraph m of the gross income
definition.

If the employer cedes the policy to an employee, section 23(p) prevents a deduction for the employer.

The employee will not include an amount into gross income as a risk policy has no investment value.

ILLUSTRATION – RISK POLICY ON WHICH A DEDUCTION IS CLAIMED

A company paid R30,000 during the year for a risk policy (with no investment value) on a director.

Deductions were claimed in terms of section 11(w)

The director died and R1,000,000 was paid out.

What are the taxation implications?

SUGGESTED SOLUTION

The R30,000 is treated as a deduction.

The R1,000,000 is treated as gross income.

ILLUSTRATION – RISK POLICY ON WHICH NO DEDUCTION IS CLAIMED

A company paid R30,000 during the year for a risk policy (with no investment value) on a director.

No deductions were claimed in terms of section 11(w)

The director died and R1,000,000 was paid out.

What are the taxation implications?

SUGGESTED SOLUTION

The R30,000 is not treated as a deduction.

The R1,000,000 is treated as gross income. However the full amount received is exempt in terms of section 10(1)(gH)
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7.8.4 LOANS ON POLICIES

If a loan is taken out on a policy, such amount is included in gross income per paragraph m of the gross income special
inclusions.

If the loan is repaid, there is no tax effect.

Such loan repaid cannot be taxed twice.

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ILLUSTRATION – LOAN REPAID

A life policy is taken out with an investment component.

The company takes out a R200,000 loan against the policy which is repaid two years later.

The policy pays out R3,000,000 on death of the key employee.

What are the tax implications?

SUGGESTED SOLUTION

The loan amount of R200,000 will be included in gross income when taken.

There is no tax effect when the loan is repaid.

When the policy is paid out the R3,000,000, only R2,800,000 (R3,000,000 – R200,000) will be included in gross income.

8. POST-RETIREMENT MEDICAL BENEFITS

Certain taxpayers pay for medical aid for employees after they stop working for the taxpayer. This is called postretirement
medical benefits paid for by the employer.

If a taxpayer pays a lump sum amount for post-retirement medical benefits directly to the past employee, the amount paid to
the ex-employee in this regard will be allowed as a deduction in terms of section 12M.

In addition, if the taxpayer pays a lump sum to an insurance company that takes all risk for medical benefits for the ex-
employee, such amount is also deductible.

If an amount is paid partly for post-retirement medical benefits and partly for something else, only the post-retirement medical
fund portion may be deducted.

ILLUSTRATION – POSTRETIREMENT MEDICAL BENEFITS

Mr B retired from A Ltd. A Ltd agree to pay Mr B’s medical aid until he dies. To mitigate the risk, A Ltd purchase a policy from an
insurance company whereby the insurance company undertake to pay for Mr B’s medical aid until his date of death. The policy
cost A Ltd R300,000.

What are the tax implications of the above?

SUGGESTED SOLUTION

The R300,000 will be deductible in terms of section 12M.

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9.PRE TRADE EXPENDITURE (section 11A)

There is usually a requirement that a deduction cannot be claimed unless an organisation has started trading and started
producing income.

Taxpayers may incur expenses prior to trading. Section 11A has been introduced to allow an enterprise to claim a deduction for
such pre trade expenses.

9.1 WHEN CAN PRE TRADE EXPENSES BE CLAIMED?

If a taxpayer commences a new trade, this section (s11A) should be considered.

There are two possibilities:

 If a person has never traded before, and incurs costs before trade commences, such expenses incurred may be
deductible as pre trade expenditure if they would have been deductible under normal conditions.
 If there is a person who is already trading, who starts a whole new line of business different from the existing
business, such expenses incurred on the new line of business may be deductible as pre trade expenditure.

ILLUSTRATION – IS THIS A PRE TRADE BUSINESS

For the following state whether a new business subject to pre trade expenditure section 11A has been created.
1. New business opened by a company that has never traded before
2. Hardware supplier opens a new shop in another city
3. Manufacturing business opens up a cell phone shop

SUGGESTED SOLUTION

1. Pre trade claimable as new trade

2. Same trade. No pre trade expenses claimable
3. Pre trade claimable as new trade

Such pre-trade expenses may however only be set off against income from that specific trade once such trade commences.

9.2 HOW IS THE CALCULATION FOR PRE TRADE EXPENSES DONE?

Any amounts not claimed are carried forward to the next tax year. Thus in an existing business that has R5,000,000 profit from
previous trade, and R200,000 from the new trade, if pre trade expenditure is R270,000, R200,000 pre trade expenditure will be
claimed as a deduction and the R70,000 will be carried forward to be set off against the new trades income in the next year.
If a new trade is abandoned, such pre trade expenses will never be deductible as they may only be set off against income from
the new trade .
Note the following
No pre trade expenses can be claimed on donated assets.

Pre production interest will be claimed in terms of this section

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ILLUSTRATION – BASIC PRE TRADE EXPENDITURE EXAMPLE

A Ltd starts a business in the current tax year. Prior to commencing trade, he incurred R15,000 of expenditure that would have
been deductible in terms of section 11 of the Act.

He traded and made R100,000 taxable income after commencing trade (the trade the pre trade expenditure related to), taking
into account all deductions other than the pre trade expenditure.

Will the R15,000 pre trade expenditure be deductible?

SUGGESTED SOLUTION

The amount of R15,000 is deductible as:

 the taxable income earned was from a trade that the pre trade expenditure related to,
 the amount was incurred by the taxpayer prior to the trade commencing,
 the amount was deductible in terms of section 11 had the business been trading at the time of incurral, and
 the amounts were not incurred in a prior year of assessment.

ILLUSTRATION – PRE TRADE EXPENDITURE OVER A NUMBER OF YEARS

A Ltd had the following information:

Last tax year
The company carried on a successful factory and earned R10,000,000 taxable income. The company commenced a new retail
operation and incurred
 R80,000 of pre trade expenses that would have been deductible in terms of the general deduction formula had the business
been trading,
 R20,000 pre trade expenses on signing agreements that would have been capital in nature under the general deduction
formula and
 Earned R30,000 from the new retail trade.
Current year
There was a R2,000,000 profit from the factory and R24,000 profit from the retail trade.

What are the taxation implications for the current year?

SUGGESTED SOLUTION

In the previous year, R80,000 would have been deductible under section 11 and as such would be deductible in terms of section
11A pre trade expenditure limited to profit from the new business.

The R20,000 was capital in nature and as such would not have been deductible in terms of section 11 and as such will not qualify
as deductible pre trade expenditure.

Trade profit from the retail trade of R30,000 will be set off against the R80,000 pre trade expenditure and R50,000 pre trade
expenditure will be carried forward to the next tax year where it can be set off against further income from the retail trade. The
R10,000,000 profit from the factory will be taxed as normal with no loss being set off against such amount.
R24,000 further income is made from the retail trade in the next tax year. R24,000 of the pre trade expenditure is set off against
the taxable income from the retail trade. R26,000 pre trade expenditure is carried forward to the next tax year to be set off
against any further income from the retail trade.

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10.DEDUCTIBILITY OF PRE PAID EXPENDITURE

Prepayments arise when a taxpayer incurs expenditure in the year of assessment which will only be delivered or the benefits
thereon enjoyed in the next year of assessment.

According to s23H, prepaid expenditure is not deductible in the year it is incurred if:
 the amount is prepaid forward more than 6 months (first requirement); and
 the prepayment exceeds R100,000 (second requirement)

Therefore, prepaid expenditure is deductible if one of the requirements are not present.

This section relates to prepayments for:

 general deduction formula
 legal expenses
 repair expenses
 key man policies

The requirements for prepayments should be applied in the order listed above.

First requirement

The first requirement is applied to each individual item.

The period looked at is the 6 months after year end.

ILLUSTRATIVE EXAMPLE

A Ltd purchased and paid for specialised trading stock on the 26th of February 2017 for R80 000. Due to the nature of the stock,
delivery was only expected on the 30th of June 2017. Year end 28 February 2018.

What are the taxable income implications?

Suggested solution

The prepayment is for 4 months, which is less than 6 months. Therefore, the prepayment will be deducted in full in the year of
assessment.

When the first requirement is not met, the second requirement has to be considered.

ILLUSTRATIVE EXAMPLE

A Ltd purchased and paid for specialised trading stock on the 26th of February 2017 for R80 000. Due to the nature of the stock,
delivery was only expected on the 30th of November 2017. Year end 28 February 2017.

What are the taxable income implications?

Suggested solution

The prepayment is for 9 months, which is less more 6 months. Therefore, the expenditure will not be deductible until the second
consideration is considered.

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The second requirement

The second requirement is applied to all prepayments made by an enterprise that have 6 or more months outstanding in total at
year end.

Therefore, the sum of all these 6 months or longer prepayments exceeds R100, 000.

ILLUSTRATIVE EXAMPLE 1

A Ltd purchased and paid for specialised trading stock on the 26th of February 2017 for R80 000. Due to the nature of the stock,
delivery was only expected on the 30th of November 2017. The company did not make any other prepayments. Year end 28
February 2017.

What are the taxable income implications?

Suggested solution

The prepayment is for 9 months, which is less more 6 months. Therefore, the expenditure will not be deductible until the second
consideration is considered.

The total of prepayments is R80 000. The amount is less than R100 000 and therefore the expenditure is deductible.

ILLUSTRATIVE EXAMPLE 2

A Ltd purchased specialised trading stock on the 26th of February 2015 for R80 000. Due to the nature of the stock, delivery was
only expected on the 30th of November 2015. The company made other prepayments which exceed six months which amount to
R70 000. Year end 28 February 2017.

What are the taxable income implications?

Suggested solution

The prepayment is for 9 months, which is less more 6 months. Therefore, the expenditure will not be deductible until the second
consideration is considered.

The total of prepayments is R80 000 + R70 000 = R150 000. The amount is more than R100 000 and therefore the expenditure
(R150 000) is NOT deductible.

Portion of expenditure relating to the year of assessment

Depending on when the prepayment is made, it may be possible that a portion of the expenditure relates to the year of
assessment.

In such cases, the portion relating to the year of assessment will be deductible according to the relevant section applicable.

ILLUSTRATIVE EXAMPLE

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A Ltd paid R60 000 for business insurance on 1 January 2017. The period covered by this payment is from 1 January 2014 to 31
December 2017. Year end 28 February 2017. The company made no other prepayments.

What are the taxable income implications?

Suggested solution

S11 (a)
The period between 1 January and 28 February 2017 relates to the year of assessment. Therefore, a section 11 (a) R10 000
(60 000/12 x 2) deduction will be claimed.

Requirement 1

The prepayment is for 10 months (March to December), this period is greater than 6 months, and therefore requirement 2 has
to be considered.

Requirement 2

The prepayment amount is R60 000 which is less than R100 000. Therefore, the amount will be deductible in terms of section
12H.

Application of prepaid expenses

A company has a 31 December 2017 year end and made the following prepayments during the year:
 12 months prepaid insurance of R36,000 made for the period 1 October 2017 to 30 September 2018 and
 5 months prepaid advertising of R100,000 for the period 1 November 2017 till 31 March 2018 and
 12 months prepaid garden maintenance services of R48,000 from 1 September 2017 till 31 August 2018

What amounts will be deducted for taxation purposes.

SUGGESTED SOLUTION

Insurance

For the insurance, 3 months’ insurance have already occurred and 3/12 X R36, 000 = R9, 000 will be deductible in the 2017 tax
year.

There is a 9-month prepayment for insurance at year end totalling 9/12 X R36, 000 = R27, 000.

Advertising

For the advertising, 2 months has already occurred and 2/5 X R100,000 = R40,000 will be deductible in the 2011 tax year.

There is a 3-month prepayment for advertising at year end totalling 3/5 X R100,000 = R60,000. This is deductible in terms of test
1 as it is less than 6 months. Test 2 need not be done.

Maintenance

For the maintenance, 4 months has already occurred and 4/12 X R48,000 = R16,000 will be deductible in the 2011 tax year.

There is an 8-month prepayment for maintenance at year end totalling 8/12 X R48,000 = R32,000.

Applying requirement 2

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Total prepayments 6 months and over total R27,000 + R32,000 = 59,000 which does not exceed R100,000.

All amounts prepaid are deductible, both the R27,000 and the R32,000.

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11. LEARNERSHIPS

Deductions applicable to learnerships

Deduction whilst a
learnership is running
For able bodied people, Deduction upon completion of a
a deduction is allowed of learnership
R40,000 X no months of
learnership during the
year divided by 12 if in Learnership more than 2 years
Learnership less than
NQF Level 1 – 6 2 years
The amount is reduced A deduction of R40,000 if in Level 1 – 6 and R20 000 if in
A deduction of level 7 and above.
to R20 000 for NQF level
R40,000 if in Level 1 – For disabled people R60,000 if in Level 1 – 6 and R50 000
7 and above.
6 and R20 000 if in if in level 7 and above.
level 7 and above. Multiplied by the number of years of the learnership
For disabled people, a
For disabled people The person need not have been employed by the
deduction is allowed of R60,000 if in Level 1 –
R60,000 X no months of employer for the whole period of the learnership.
6 and R50 000 if in
learnership during the level 7 and above.
year divided by12 if in This deduction is granted to the employer that employs
Can be claimed upon the employee at the end of the learnership.
NQF level 1 - 6. The
the successfull
amount is reduced to
completion of the
R40 000 if in NQF level 7
learnership.
and above.

Section 12H is a section that aims to incentives employers to skill employees through learnership training programmes.
Over and above section 11(a) deductions such as for salaries and other deductions such as for variable leave pay payments
available to tax payers, the following deductions are available for learnership agreements:

Entering a learnership agreement

For able bodied people, a deduction is allowed of R40,000 X no months of learnership during the year divided by 12 if in NQF
Level 1 – 6. The amount is reduced to R20 000 for NQF level 7 and above.

For disabled people, a deduction is allowed of R60,000 X no months of learnership during the year divided by12 if in NQF level 1
- 6. The amount is reduced to R40 000 if in NQF level 7 and above.

Illustrative example
A Ltd entered into a 12 month learnership agreement with two employees on 1 January 2017 at an NQF level 3. One of the
employees was disabled. The year end of the company is 31 December 2017. R300 000 was paid as a salary to the employees in
the current year of assessment.
Suggested solution
Section 11(a) deduction salary payment = R300 000
Disabled employee deduction = R60 000
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Other employee deduction = R40 000

Where the learnership agreement is valid for a portion of the current period of assessment, the allowance is apportioned to the
number of full months the learnership agreement is valid.

Illustrative example
A Ltd entered into a 12 month learnership agreement with two employees on 1 February 2017 at an NQF level 8. One of the
employees was disabled. The year end of the company is 31 December 2017. R300 000 was paid as a salary to the employees in
the current year of assessment.
Suggested solution
Section 11(a) deduction salary payment = R300 000
Disabled employee deduction (50 000 x 11/12) = R45 833
Other employee deduction (20 000 x 11/12) = R18 333

The deduction is available each consecutive year the contract is running.

Illustrative example
A Ltd entered into a 36 month learnership agreement with two employees on 1 February 2017 at an NQF level 8. One of the
employees was disabled. The year end of the company is 31 December 2018. R300 000 was paid as a salary to the employees in
the current year of assessment.
Suggested solution
2017 year of assessment
Section 11(a) deduction salary payment = R300 000
Disabled employee deduction (50 000 x 11/12) = R45 833
Other employee deduction (20 000 x 11/12) = R18 333
2018 year of assessment
Section 11(a) deduction salary payment = R300 000
Disabled employee deduction = R50 000
Other employee deduction = R20 000

Deduction upon completion of a learnership agreement

The taxpayer is allowed a deduction upon the completion of a learnership agreement as follows

For Learnerships less than 2 years

A deduction of R40,000 if in Level 1 – 6 and R20 000 if in level 7 and above.

For disabled people R60,000 if in Level 1 – 6 and R50 000 if in level 7 and above.

This is amount is not apportioned if the period is less than one year.

ILLUSTRATIVE EXAMPLE

A Ltd entered into a 12 month learnership agreement with two employees on 1 February of the previous year of assessment at
an NQF level 4. One of the employees was disabled. The year end of the company is 31 December. R40 000 was paid as a salary
to the employees in the current year of assessment.
What is the impact of the transaction on taxable income?
Suggested solution
Section 11(a) deduction salary payment = R40 000
Deductions for entering the contract
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Disabled employee deduction (60 000 x 1/12) = R5 000

Other employee deduction (20 000 x 1/12) = R1 666
Deductions for completing the contract
Disabled employee deduction (amount is not apportioned) = R60 000
Other employee deduction (amount is not apportioned) = R20 000

For Learnerships more than 2 years

A deduction of R40,000 if in Level 1 – 6 and R20 000 if in level 7 and above.
For disabled people R60,000 if in Level 1 – 6 and R50 000 if in level 7 and above.
Multiplied by the number of years of the learnership
The person need not have been employed by the employer for the whole period of the learnership.

ILLUSTRATIVE EXAMPLE

A Ltd entered into a 24 month learnership agreement with two employees on 1 February two previous years of assessment ago
at an NQF level 4. One of the employees was disabled. The year end of the company is 31 December. R40 000 was paid as a
salary to the employees in the current year of assessment.
What is the impact of the transaction on taxable income?

Suggested solution
Section 11(a) deduction salary payment = R40 000
Deductions for entering the contract
Disabled employee deduction (60 000 x 1/12) = R5 000
Other employee deduction (20 000 x 1/12) = R1 666
Deductions for completing the contract
Disabled employee deduction (2 x 60 000) = R120 000
Other employee deduction (2 x 20 000) = R40 000
Two completed years of assessment

The person need not have been employed by the employer for the whole period of the learnership. This deduction is granted to
the employer that employs the employee at the end of the learnership.

ILLUSTRATIVE EXAMPLE

A Ltd employed two people who are on a 24 month learnership agreement. The two employees entered into the contract on 1
February two previous years of assessment ago. One of the employees was disabled. The year end of the company is 31
December. R40 000 was paid as a salary to the employees in the current year of assessment.
What is the impact of the transaction on taxable income?

Suggested solution
Section 11(a) deduction salary payment = R40 000
Deductions for entering the contract
Disabled employee deduction (60 000 x 1/12) = R5 000
Other employee deduction (20 000 x 1/12) = R1 666
Deductions for completing the contract
Disabled employee deduction (2 x 60 000) = R120 000
Other employee deduction (2 x 20 000) = R40 000
Two completed years of assessment

If a contract is terminated and not completed no completion allowance may be claimed.

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12. SECTION 24 ALLOWANCES

In certain circumstances, sales are made where the collection of cash happens far later. The taxpayer is expected to pay taxes
when no cash has been collected from the debtor.

The debtors allowance can only be claimed when more than 25% of the purchase price is paid more than 12 months after the
sale takes place.

SARS allows amounts to be claimed as a debtors allowance provided that the amount claimed as a deduction in the current year
is added back to income in the next year.

The debtors allowance is equal to gross profit percentage X balance outstanding excluding vat and finance charges.

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EXAMPLE OF DEBTORS ALLOWANCES

An asset with a cost of R300,000 is sold for R500,000 plus Vat on 1 January 2018. Interest at 10% per annum
is charged. R328,428.50 is paid back on 31 December 2018 and 31 December 2019 in full and final
settlement of the debt.
This is the amortisation table
Balance Vat Interest at 10% Repayment
500,000 70,000 57,000 -328,428.5
298,572 29,857 -328,428.5
0
The tax effect will be as follows:

2018 tax year

Gross profit percentage is 200,000/500,000 = 40%
R500,000 is gross income.
R57,000 will be treated as interest income
Debtors allowance deduction is 40% X 298,572 x 100/115 = 103,851

2019 tax year

Interest received is 29,857
Debtors allowance added back to income is R103,851.

13. SECTION 24 C – FUTURE EXPENDITURE ON CONTRACTS

An allowance can be granted by SARS for future expenditure on a contract. Such amounts will be provided in a question. The
allowance is claimed in the current year and is added back to income in the next tax year.
The allowance claimed is the future expenditure expected on a contract where the proceeds have already been recorded as
gross income. The amount will be provided in exam.

14. DONATIONS DEDUCTION [section 18A]

Section 18A allows a deduction to be made by a taxpayer of the sum of any bona fide donations (in cash or property in
kind) during the year of assessment.

The deduction is only available to certain beneficiaries such as Public Benefit Organisations.

The amount that may be deducted is limited to 10% of taxable income after all other deductions have been made.

To claim a donations deduction, the donation must be to a registered public benefit organisation that issues a prescribed section
18A certificate as proof of the donation.

INTERACTIVE ILLUSTRATION
A company with a taxable income before the donations deduction of R100, 000 contributes R17, 000 to an approved
public benefit organisation and obtains the prescribed certificate per section 18A.
What deduction may be claimed?

SUGGESTED SOLUTION

A deduction of R17, 000 limited to 10% X R100, 000 = R10, 000 will be granted to the individual.
Thus R10, 000 may be claimed as a section 18A deduction.

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If an amount is not deducted in one year, the unused amount is carried forward to the next year of assessment.

ILLUSTRATIVE EXAMPLE

Z Ltd donated R100 000 to an approved public benefit organisation (PBO) on 1 June 2014. The company donated another
R50 000 on 1 April 2015 (all with a S18A certificate).
The company had a taxable income of R850 000 for the 2015 year of assessment and R950 000 for the 2016 year of assessment.
Calculate the S18A deduction available for the 2015 and 2016 year of assessment.

Suggested solution

2015 year of assessment

Donation 100 000 but limited to
850 000 x10% (85 000)
Amount carried forward to next year R15 000.

2016 year of assessment

Donation 50 000 + 15 000 but limited to
950 000 x10% (65 000)

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 CHAPTER 5-2
FOREIGN EXCHANGE (SECTIONS 25D AND 24I)

Contents
1. INTRODUCTION ................................................................................................................................... 2
2. Section 25D ......................................................................................................................................... 2
3. SECTION 24I FOREIGN EXCHANGE TRANSACTIONS ............................................................................ 5
3.1 Exchange items ............................................................................................................................. 5
3.2 Assess whether section 24I applies for a particular taxpayer ...................................................... 6
3.3 When are foreign exchange gains and losses calculated? ............................................................ 7
4. Forward exchange contracts ............................................................................................................. 10
5. ASSET NOT BROUGHT INTO USE BY YEAR END ................................................................................. 13
6. Special rules for transactions with connected persons (section 24i(10a) ........................................ 16

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1. INTRODUCTION

This chapter covers the following areas

 Section 25D which deals with determining at what rate foreign transactions are converted into rands
 Section 24I which deals with foreign exchange gains and losses
 Various CGT paragraphs relating to capital gains and losses on foreign owned assets and liabilities

2. SECTION 25D

An enterprise buys trading stock for $30,000 from Canada. How is the $30,000 converted from Canadian
dollars to South African rands.

Section 25 D deals with determining at what rate foreign transactions are converted into rands.

Companies and trading trusts

Transactions entered into by companies and trading trusts are translated into rands using the spot rate ruling
on the date the transaction was received or accrued, or when the expenditure was incurred.

Illustrative example

A Ltd received foreign rent of $20,000 when the spot rate was $1 = R12

Suggested solution

The average rate cannot be used for a company. Use the spot rate ruling on the date of the transaction of $1 =
R12 and include $20,000 X 12 = R240,000 into gross income.

Individuals and non-trading trusts

Transactions entered into individuals and non-trading trusts are translated to Rands using either:

 The spot rate ruling on the date the transaction was received or accrued, or when the expenditure was
incurred or

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 The average rate ruling for the year of assessment

This selection may be made on a year by year basis and all transactions for a particular year have to be done
using the basis selected.

Illustrative example

Mr A received $10,000 as foreign rent when the spot rate was $1 = R10.80. He also received $8,000 rent when
the spot rate was $1 = R11.01. Assume the average exchange rate was $1 = R11.

Suggested solution

Natural persons can use average rate or the spot rate. Once this selection is made, it is applied to all
transactions during the year. The person should choose the rate that will result in less taxation being payable.

Using spot rates, R108,000 ($10,000 X R10,80) plus R88,080 (8,000 X 11.01) will be included into gross income.
This totals R196,080.

If the average rate is used, R198,000 ($18,000 X 11) is included. Mr A should use spot rates as he will have less
income if he uses spot rates(R196,080 vs R198,000).

Permanent business establishment located overseas

A permanent business establishment is a fixed place of business that is run overseas, An example of this would
be the London branch of a South African company.

To translate the profit or loss of a permanent business establishment into South African Rands,

1. Calculate the profit or loss of the branch in the foreign currency of operations (in this case pounds because
it is a London branch); and then
2. Convert the foreign amount (pounds) to South African rand using the average exchange rate for the year

Headquarter company rules included in section 25D are not dealt with in this chapter.

Illustrative example

A Ltd’s foreign branch made $120,000 for the year. Assume the average exchange rate was $1 = R11.

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Suggested solution

The average rate is used for a permanent business establishment overseas. $120,000 X 11 = R1, 320,000 will
be included in the taxable income of A Ltd.

ILLUSTRATION – INTEGRATING A COMPANY WITH FOREIGN EXCHANGE TRANSACTIONS AND A FOREIGN

BRANCH

A South African company has the following information

 SA gross income of R8,000,000

 SA expenses of R5,800,000
 Sales from SA to the USA of $400,000. $300,000 was sold when the exchange rate was $1 =10, and
$100,000 was sold when the exchange rate was $1 = R11.
 Foreign branch run in the USA which made $500,000 profit.

The monthly average exchange rate is $1 = R10.60 and the daily average exchange rate is $1 = R10.40.

Calculate the taxable income of the company

SUGGESTED SOLUTION

The sales from SA to the USA are recorded at spot for the company.

The profit of the foreign branch is recorded at average. As there is a profit, use the lower average exchange
rate of $1 = R10.40 as you want to pay less tax.

Taxable income calculation

SA gross income 8,000,000

SA expenses (5,800,000)

Sales to USA - $300,000 X 10 3,000,000

Sales to USA - $100,000 X 11 1,100,000

Foreign branch - $500,000 X 10.40 5,200,000

12,500,000

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3. SECTION 24I FOREIGN EXCHANGE TRANSACTIONS

Foreign exchange gains and losses in terms of section 24I are only calculated for exchange items

To determine the gain or loss of an exchange item the transaction date, translation date and realisation date
have to be determined.

Once the above have been determined the foreign exchange gains or losses on realisation or at year end can
then be determined.

3.1 EXCHANGE ITEMS

Taxpayers record transaction initially in accordance with section 25D. For companies this is at a spot rate.

Consider stock that is bought for $100,000 when the exchange rate is $1 = R10.

Both the stock and the overseas creditor are captured at R1, 000,000.

The underlying asset or revenue

The amount captured for the underlying asset or revenue (in this case R1, 000,000 for trading stock) will not
change once captured.

The underlying asset will therefore not be affected by forex fluctuations subsequently.

The taxable implications of the underlying asset will be based on the type of asset:

 For example stock – When purchased the company claims a S11 (a) deduction of R1, 000, 000, when
included in closing stock subsequently the entity will recoup the R1,000, 000 into income if not sold,
and if the asset is sold the amount received will be included in gross income.
 For example a manufacturing asset – The Company can claim a capital allowance on the cost of the
asset at transaction date.

Underlying exchange item

However the underlying creditor which is an exchange item can change. Section 24I is used to calculate gains
and losses when the exchange rate changes.

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If the exchange rate were to move to $1 = R11, the creditor owing would be R1, 100,000 ($100,000 X 11). A
loss of R100, 000 would have occurred.

Exchange items such as the creditor will be revalued causing foreign exchange gains and losses from time to
time. These foreign exchange profits and losses are calculated separately for each exchange item.

An exchange item is therefore an amount in a foreign currency:

 Owing by a person in respect of a loan, debt incurred by the person;

 Owing to a person in respect of a loan payable by a person to another person;
 Owing by or to a person in respect of a foreign exchange contract; and
 In respect of which the person has the right to buy or sell in terms of a foreign currency option
contract.

3.2 ASSESS WHETHER SECTION 24I APPLIES FOR A PARTICULAR

TAXPAYER

Section 24I applies to all transactions for

 Companies and close corporations

 Any trust that trades
 Natural persons who hold foreign currency and foreign debt or debt as trading stock
 Natural persons who have foreign exchange contracts and foreign currency options
 Non-trading trusts who have foreign exchange contracts and foreign currency options
 Controlled foreign companies taxed under section 9D

ILLUSTRATION - TAXPAYERS

A $100,000 loan is taken out by an enterprise in a foreign currency. Will section 24I apply to the exchange
gains or losses on the loan if:

(a) the enterprise is a company,

(b) the enterprise is a trading trust,
(c) the enterprise is a non-trading trust
(d) the enterprise is a trading individual.

SUGGESTED SOLUTION

The first question to ask is whether the loan is an exchange item or not.

As the loan is an exchange item, section 24I may apply. Section 24I will apply if the enterprise is a company or
trading trust.

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If the enterprise is a non-trading trust or an individual, section 24I will not apply. In these cases, one might look
to the 8th schedule for the calculation of gains or losses.

3.3 WHEN ARE FOREIGN EXCHANGE GAINS AND LOSSES

CALCULATED?

Exchange items are revalued for taxation purposes when

1. they are paid (the realisation date);and/or

2. at the year end of the enterprise (the translation date).
The starting point is to determine the transaction date;

What is the transaction date?

The transaction date has a different definition based on the type of transaction.

We will not define all types of transaction dates. However, the concept of transaction date is the
determination of when the transaction took place.

For example, when as asset is purchased, the transaction date is when risk and rewards of owning the asset
pass.

The transaction date is very important as it determines when the transaction is recorded in the accounting
records and hence the starting point for determining fluctuations in foreign exchange differences.

ILLUSTRATION – IDENTIFICATION OF TRANSACTION DATE, YEAR END DATE AND REALISATION DATE

A Ltd buys trading stock on 1 April for $1,000. The company’s year end if 30 June. The amount is paid on 15
July. Indicate when the transaction date, the translation date and realisation date are.

SUGGESTED SOLUTION

The transaction date is 1 April. The translation date is 30 June. The realisation date is 15 July.

ILLUSTRATION – TRANSACTION DATE AND REALISATION DATE ARE ON THE SAME DAY

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A Ltd sell stock to an overseas supplier on 1 June 20X3 for $100,000 and the overseas supplier pays for the
stock on the same day. Are there any exchange differences that occur?

SUGGESTED SOLUTION

There is an exchange item for a company as there was a foreign creditor when the goods were acquired. As
such section 24I will apply. There are no exchange differences as the item was bought and settled on the same
date.

Based on the above revaluation rules, foreign exchange gains and losses can be calculated in the following
instances:

1. Movement in the value of the exchange item from transaction date to realisation date;

ILLUSTRATION – TRANSACTION DATE AND REALISATION DATE IN THE SAME YEAR

A Ltd sell stock to an overseas supplier on 1 June 20X3 for $100,000 and the overseas supplier pays for the
stock on 30 June 20X3. A Ltd has a 31 October year end. Are there any exchange differences that occur?

The rates applicable are:

1 June $1 = R7.00 30 June $1 = R7.40

31 October $1 = R7.25 Average rate for the year $1 = R7.20.

SUGGESTED SOLUTION

When the goods are sold, a foreign debtor comes into existence that is denominated in a foreign currency. The
foreign debtor is an exchange item for a company and as such section 24I will apply. There are exchange
differences as the item was bought and settled on a later date.

The sale will be recorded at the spot rate in terms of section 25D. Thus the sale will be recorded at $100,000 X
R7.00 = R700,000.

The exchange difference will be calculated from the transaction date to the date of settlement as the amount
was sold and settled within one year. The exchange difference recorded into income will be calculated as
follows:

Amount sold at transaction date $100,000 X 7 R700,000

Amount received at realisation date $100,000 X 7.40 R740,000

Foreign exchange gain to be included in income R 40,000

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As the foreign debtor has been settled as at the tax year end, there is no need to calculate any exchange gain
or loss at year end as the exchange item no longer exists as at year end.

2. Movement in the value of the exchange item from transaction date to year end date;

3. Movement in the value of the exchange item from year end date to the following year end date; or

4. Movement in the value of the exchange item from year end date to realisation date

ILLUSTRATION – TRANSACTION AND REALISATION DATE NOT IN THE SAME YEAR

A Ltd sell stock to an overseas supplier on 1 June 20X3 for $100,000 and the overseas supplier pays for the
stock on 31 December 20X4. A Ltd has a 31 October year end.

Are there any exchange differences that occur?

The rates applicable are:

1 June 20X3 $1 = R7.00

30 June 20X3 $1 = R7.40

31 October 20X3 $1 = R7.25

31 October 20X4 $1 = R8.20

31 December 20X4 $1 = R8.00

Average exchange rate for the 20X3 year is $1 = R7.20.

Average exchange rate for the 20X4 year is $1 = R7.80.

Suggested solution

When the goods are sold, a foreign debtor comes into existence that is denominated in a foreign currency. The
foreign debtor is an exchange item for a company and as such section 24I will apply. There are exchange
differences as the item was bought and settled on a later date.

The sale will be recorded at the spot rate in terms of section 25D. Thus the sale will be recorded at $100,000 X
R7.00 = R700,000.

The next question to be asked is whether any amount is paid for before the year end of the company. No
amount is paid for prior to the year end of the company as such the foreign exchange difference will be

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calculated by comparing the rate ruling on the transaction date to the rate ruling at the year-end date. The
exchange difference recorded into income will be calculated as follows:

Amount sold at transaction date $100,000 X 7 R700,000

Amount owing at translation date $100,000 X 7.25 R725,000

Foreign exchange gain to be included in income R 25,000

No amount was paid for in the 20X4 year of assessment. Thus the next exchange difference will be from the
one year end date to the next year end date. The exchange difference recorded into income will be calculated
as follows:

Amount owing at previous year end $100,000 X 7.25 R725,000

Amount owing at the next year end date $100,000 X 8.20 R820,000

Foreign exchange gain to be included in income R 95,000

In the 20X5 year of assessment the amount was settled. The exchange difference recorded into income will be
calculated as follows:

Amount owing at previous year end $100,000 X 8.20 R820,000

Amount owing when debt was settled $100,000 X 8.00 R800,000

Foreign exchange loss to be included in income R 20,000

As the foreign debtor has been settled as at the tax year end, there is no need to calculate any exchange gain

or loss at year end as the exchange item no longer exists as at year end.

4. FORWARD EXCHANGE CONTRACTS

If an FEC is settled in the year of the transaction, an exchange gain or loss will be the difference in the amount
at transaction date and realisation date.

If not settled at year end , an exchange gain or loss is calculated at year end by comparing the spot rate
recorded and the spot rate for a similar FEC contract with a similar termination date.

On realisation, the difference between the last spot rate recorded and the settlement spot rate is used to
calculate a gain or loss.

ILLUSTRATION

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Stock was sold on 1 April 20X7 for $100,000 when the exchange rate was $1 = R7,80 by a company An FEC was
taken out to cover the transaction. The amount was due to be paid on 30 September. The year end is 30 June.
On 1 April, a $100,000 6 month FEC contract was taken out at a rate of $1=8. At 30 June, the following FEC
contracts were available:

2 month contract $1=8.10

3 month contract $1=8.20

4 month contract $1=8.30

6 month contract $1=8.50

The year-end rate was $1=8.05. The rate ruling when the amount outstanding was paid was $1 = 8.50. The
average rate for the year is $1 = R7.97.

(a) What journal entry will be passed in the accounting records for the above transaction?
(b) Calculate the exchange gain/loss in respect of the receivable outstanding for the 20X7 year.
(c) Calculate the exchange gain/loss in respect of the forward exchange contract for the 20X7 year.
(d) Calculate the exchange gain/loss in respect of the receivable outstanding for the 20X8 year.
(e) Calculate the exchange gain/loss in respect of the forward exchange contract for the 20X8 year.

SUGGESTED SOLUTION

Part a

The journal entry to record the transaction in the accounting records was:

Dr Receivables R780,000

Cr Sales R780,000

Part b

Section 24I applies to this transaction. For tax purposes, the sales are recorded at $100,000 X 7.80 = R780,000.

For the purposes of section 24I, two exchange items can be identified namely the foreign debtor and the FEC.

The next step is to identify the dates which are used to calculate foreign exchange gains and losses. The
transaction date is 1 April. The next date is the translation date which is 30 June. The realisation date is 30
September.

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In respect of the debtor

The first exchange difference will be the difference between the transaction date rate of $1=7.80 and the
translation date rate of $1 = R8.05.

The R0.25 gain is multiplied by $100,000 and there will be a gain of R25,000.

Otherwise the gain can be calculated as follows:

Debtor at transaction date $100,000 X 7.80 R780,000

Debtor at translation date $100,000 X 8.05 R805,000

Foreign exchange gain for the year R 25,000

Part c

In respect of the FEC

At year end, there are 3 months left on the FEC. Thus the 3 month rate FEC will be used.

The rate at the transaction date was $1=8.00. The rate at the translation date was $1=8.20.

A loss of R0.20 X $100,000 = R20,000 will be made on the FEC.

Otherwise the gain can be calculated as follows:

FEC at transaction date $100,000 X 8.00 R800,000

FEC at translation date $100,000 X 8.20 R820,000

Foreign exchange loss for the year R 20,000

Part d

For the debtor, the rate recorded at year end was $1 = 8.05. The rate the receivable was settled at was $1 =
R8.50. There would be a gain of R0.45 X $100,000 = R45,000.

Part e

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For the FEC, the rate recorded at year end was $1 = 8.20. The rate the FEC was settled at was $1 = R8.50. There
would be a loss of R0.3 X $100,000 = R30,000.

5. ASSET NOT BROUGHT INTO USE BY YEAR END

If a good is acquired from overseas, and not brought into use at year end, the foreign exchange gain or loss
cannot be recorded until the asset is brought into use.

The amount will be deferred until the year the asset is brought into use.

ILLUSTRATION – ASSET NOT BROUGHT INTO USE IN THE CURRENT YEAR

H Ltd has a December year end. They bought a new machine on 1 November 20X5 for $250,000 from the USA.
On 15 December 20X5, $100,000 of the creditor was paid.

The machine was installed at a cost of R100,000 and brought into use on 18 January 20X6. The creditor was
paid in full on 8 February 20X6.

Exchange rates were as follows:

1 November 20X5 $1 = R8

15 December 20X5 $1 = R8.15

31 December 20X5 $1 = R8.50

18 January 20X6 $1 = R8.40

8 February 20X6 $1 = R8.30

What are the taxation implications?

SUGGESTED SOLUTION

20X5 year

The cost of the machine is $250,000 X 8 = R2,000,000.

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A loss of $100,000 X (8.15 – 8) = R15,000 is made on payment of the $100,000

Note that the other $150,000 is not revalued at this date as may be done in financial accounting. The tax act
does not allow this.

A loss of $150,000 X (8.5 – 8) = R75,000 is made when the creditor is revalued at year end.

Neither the R15,000 loss nor the R75,000 loss is deductible in the 20X5 year as the machine has not been
brought into use.

20X6 year

A gain of $150,000 X (8.50 – 8.30) = R30,000 is made on payment of the $150,000

A capital allowance of (R2,000,000 + R100,000) X 40% = R840,000 is allowed on the machine

Last year’s losses of R15,000 and R75,000 are allowed in the 20X6 year as the machine has been brought into
use.

In the event of an asset never being brought into use, once it has been determined that the asset will definitely
not be brought into use, the amount can be realised

ILLUSTRATION – ASSET NEVER BEING BROUGHT INTO USE

A machine was bought from the USA for $300,000. The exchange rate at the time the asset was acquired was
$1 = R10.

The machine was placed on a ship by the company to go to South Africa, and a freight and insurance cost of
R20,000 were incurred.

At year end, the exchange rate was $1 = R10.20.

The ship unfortunately sunk after year end and the insurance company paid out R2,900,000.

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The machine was paid for at a rate of $1 = R10.50

What are the taxation implications?

SUGGESTED SOLUTION

Year 1

The machine is recorded at a cost of ($300,000 X 10) + 20,000 = 3,020,000.

There is an exchange loss as follows

Value at transaction date ($300,000 X 10) 3,000,000

Value at year end as the transaction is not realised ($300,000 X 10.2) 3,060,000

Loss 60,000

However the loss is deferred until the machine is brought into use.

Year 2

As the machine will never be brought into use, the R60,000 loss from last year is brought into the tax
calculation.

There is also a loss on realisation of the debt.

Value at year end as the transaction is not realised ($300,000 X 10.2) 3,060,000

Value at transaction date ($300,000 X 10) 3,150,000

Loss 90,000

There is capital gain on the disposal of the machine as it was never brought into use.

Proceeds 2,900,000

Less: Base cost (3,020,000)

Capital loss 120,000

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6. SPECIAL RULES FOR TRANSACTIONS WITH CONNECTED
PERSONS (SECTION 24I(10A)

This transaction applies to loans between parties that are:

 Part of the same group of companies, or

 Parties that are connected persons to one another
 AND
 There is no forward exchange contract or foreign currency option contract entered to serve as a
hedge
 AND
 The amount owing between the parties is not treated as a current asset or current liability in terms of
IFRS

If all of the above apply, transactions with connected persons will only have foreign exchange gains and losses
recognised when these transactions are settled.

The amounts outstanding are not revalued on an annual basis like other exchange items.

There is a 2 step process to calculate the exchange gain or loss.

1. Recognise the gain or loss that has been deferred

 from the end of the last tax year before the one in which the loan was settled and
 the loan at transaction date
2. Calculate the current years gain or loss.

ILLUSTRATION – CONNECTED PERSON LOANS

A long term loan was taken out between a SA company and its overseas holding when the holding company
lent $500,000 when the exchange rate was $1 = R7 on 12 March 2012.

The loan was repaid on 17 September 2016 when the exchange rate was $1 = R12.

The company has a June year end and the exchange rate at 30 June 2016 was $1 = R11.

What are the taxation implications?

SUGGESTED SOLUTION

The deferred exchange gain is realised.

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Value at transaction date ($500,000 X 7) 3,500,000

Value at last year end before settling ($500,000 X 11) 5,500,000

Deferred loss now recognised 2,000,000

The current year gain or loss is also recognised

Value at last year 5,500,000

Amount repaid ($500,000 X 12) 6,000,000

Current year loss recognised 500,000

There used to be a section 24I(10) that applied to connected person transactions before years ends
commencing on 1 January 2013.

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 1

CHAPTER 5-3
TRADING STOCK

TABLE OF CONTENTS
1. introduction.................................................................................................................................................... 2
1.1 Valuation of trading stock......................................................................................................................... 2
1.2 Basic trading stock rules ........................................................................................................................... 3
1.3 Deductions relating to trading stock ........................................................................................................ 4
1.4 Trading stock treated as income............................................................................................................... 6
1.5 SPECIAL RULES FOR MANUFACTURERS OR ASSEMBLERS OF GOODS .................................................... 10
2. Trading stock anti avoidance ............................................................................................................................ 11
3. Trading stock used for business purposes ........................................................................................................ 13
4. DETAILED EXAMPLE .......................................................................................................................................... 14

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1. INTRODUCTION

Trading stock is dealt with in section 22 of the Income Tax Act.

Trading stock comprises

 Raw materials
 Work in progress
 Finished goods
 Packing materials
 Consumable stores (such as fuel held on a mine located in the middle of a desert or stationery held by
a company that has not been issued to staff)
 Spare parts and
 Purchased goods for resale

1.1 Valuation of trading stock

Trading stock is valued in accordance with the accounting statement on inventories i.e. inventory is measured
at the lower of cost or market value.

Cost includes costs of acquisition, moving and production. Selling costs are not included in the cost of trading
stock.

There are special rules for shares held as trading stock. This is done in the chapter dealing with share dealers.

ILLUSTRATION – VALUATION OF THE COST OF TRADING STOCK

A Ltd imports stock from overseas Free On Board and incurs the following costs:
 cost of stock = R10,000
 shipping costs to Durban harbour = R1,000
 insurance = R300
 import duties = R200
 exchange differences on payment = R100
 transport to Johannesburg = R200

What is the value of the trading stock?

SUGGESTED SOLUTION

Valuation of trading stock

Stock purchased deducted per section R10, 000

Shipping costs deducted per section R 1,000
Insurance deducted per section R 300
Import duties deducted per section R 200
Exchange differences per section 24I R 0
Transport to Johannesburg R 200
Total value R11, 700

Note that all costs, excluding exchange differences, are included in the value of the stock. The gain or loss of
the difference is included separately into gross income.

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1.2 Basic trading stock rules

There is no “cost of sales” in the Income Tax Act. However, the following are the basic rules for all items of
stock other than spare parts which are discussed separately.

When trading stock is purchased or produced as finished goods, such production or purchase costs may be
claimed in terms of the general deduction formula as a deduction.

ILLUSTRATIVE EXAMPLE

A Ltd purchased trading stock of R40, 000 in the current year of assessment.

Calculate the taxable income

SUGGESTED SOLUTION

Purchases section 11(a) deduction (R40,000)

The amount received from the sale of trading stock is treated as gross income.

ILLUSTRATIVE EXAMPLE

A Ltd made sales totalling to R70, 000 during the year of assessment.

SUGGESTED SOLUTION

Gross income (sales) R70, 000

Any stock held at year end (closing stock) is treated as income (section 22(1) income)

ILLUSTRATIVE EXAMPLE

A Ltd had closing stock amounting to R20, 000 at the end of the year of assessment.

SUGGESTED SOLUTION

Add: closing stock s22 (1) addition into gross income R20, 000

Opening stock is a treated as a deduction (section 22(2) deduction)

ILLUSTRATIVE EXAMPLE

A Ltd had closing stock amounting to R10, 000 during the prior year of assessment.

SUGGESTED SOLUTION

Opening stock s22 (2) deduction R10, 000

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ILLUSTRATION – COMBINED

The following are the transactions of A Ltd, a retailer for the current tax year:
o Trading stock of R40, 000 is purchased during the year.
o Opening stock amounted to R10,000 and
o Closing stock amounted to R20, 000.
o Sales totalled R70, 000.

Calculate the taxable income from the above information.

SUGGESTED SOLUTION

Gross income (sales) R70, 000

Less: opening stock s22 (2) deduction (R10, 000)
Less: purchases section 11(a) deduction (R40, 000)
Add: closing stock s22 (1) addition R20, 000
-------------
Taxable income R40, 000

1.3 Deductions relating to trading stock

The following are treated as deductions:

If stock is received via donation or inheritance, the market value of the stock that is donated is treated as a
purchases deduction.

ILLUSTRATIVE EXAMPLE

Mr. C decides to start an Art Gallery which will also sell paintings to the public. His aunt, after finding about
him opening the gallery, donated three paintings to Art Gallery with a value of R5, 000. These paintings had
cost her R1, 000. What will be the Art Gallery’s deductions in the year of assessment?

SUGGESTED SOLUTION

Stock deduction (R5 000)

The market value of the paintings will be allowed as a deduction in accordance with section 22(4) as this is a
donation of trading stock to an existing business. This stock is treated as a purchases deduction at market
value.

If an asset is held for personal reasons and is then used as trading stock, the taxpayer is deemed to have sold
the asset to the business at market value, and a deduction can be claimed on the market value of trading stock
acquired.

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ILLUSTRATIVE EXAMPLE

Mr. C decides to start an Art gallery which will also sell paintings to the public. He brought 10 paintings which
he bought for private purposes at cost of R20, 000. They are currently worth R50, 000 when he brought them
into the business.

SUGGESTED SOLUTION

Stock deduction (R50 000)

R50, 000 may be deducted as an opening stock deduction. The cost is used in accordance with section 22(3)
which deems that when a fixed asset becomes trading stock, the opening stock deduction per section 22(2) (b)
will be equal to market value.

ILLUSTRATION – COMBINED

Mr. C decides to start an art gallery which will also sell paintings to the public. He brings the following into the
business:
a) 10 paintings which he bought for private purposes which cost R20, 000. They are currently worth R50, 000
when he brought them into the business.
b) He inherited paintings from his uncle. The paintings were worth R10, 000. He chose to include these
paintings into his trading stock.
c) His aunt, after finding about him opening the gallery, donated three more paintings to him with a value of
R5, 000. These paintings had cost her R1, 000. What will be his deductions in respect of the three items
above?

SUGGESTED SOLUTION

a) R50, 000 may be deducted as an opening stock deduction. The cost is used in accordance with section
22(3) which deems that when a fixed asset becomes trading stock, the opening stock deduction per
section 22(2)(b) will be equal to market value. There is a capital gain of R30, 000 but this is disregarded as
the paintings were a personal use asset to him.
b) R10, 000 may be deducted as an opening stock deduction.
c) The market value of the paintings will be allowed as a deduction in accordance with section 22(4) as this is
a donation of trading stock to an existing business. A deduction of R5 000 will be claimed.

If a fixed asset was not trading stock in the previous year, but the intention as regards the asset has changed to
be trading stock, the fixed asset is deemed to be sold for market value (recoupment and CGT done) and the
market value at the date the intention changed is allowed as a deduction (as if trading stock has been
acquired)

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ILLUSTRATION

A company owns land that cost R1 000 000 that has a current market value of R4, 000,000 at the time that
they decide to develop the land. Previously the land had been held by the company for 12 years with the
intention of using the land for a factory complex for the organisation.

The company starts to develop the land as a land dealer and the land becomes part of the company’s trading
stock. A township is declared and electrical and sanitation services are provided to the 100 plots that exist
within the township.

The cost of providing such amenities is R6, 000,000.

Assume that the base cost of the land is R1, 000,000.

What are the taxation implications if 25 of the plots are sold for R200, 000 each in the current tax year?

Assume these are the only transactions of the company during the tax year.

SUGGESTED SOLUTION

The company has changed intention from holding the land for capital purposes to holding the land for revenue
purposes.

Trading stock deduction @ market value (4 000 000)

Taxable Capital gain (3 000 000 x 80%) 2 400 000

The company is deemed to have sold and reacquired the land at its market value at that date that the
intention changed. The land is deemed to be disposed of for R4, 000,000. The base cost given is R1, 000,000. A
capital gain of R3, 000,000 results. The tax cost of the land is R4, 000,000 after the capital gain is realized. This
will be treated as an opening stock deduction for tax purposes.

Disposal of stock – gross income 5 000 000

The plots of land is sold for R200, 000 X 25 = R5, 000,000. This amount will be treated as gross income.

Production cost – deduction (6 000 000)

The R6, 000,000 incurred on the land will also be treated as a deduction for the purposes of section 11(a).

Closing stock – recoupment 7 500 000

The closing stock of the land will be 75/100 X (R4, 000,000 + R6, 000,000) = R7, 000,000.

1.4 Trading stock treated as income

The following are treated as income in the following circumstances:

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If trading stock is not sold but used for business purposes, it is deemed to be recouped into income at market
value. An example is when trading stock is distributed for marketing purposes.

The enterprise may then claim a deduction based on market value so recouped into income as a marketing
expenditure.

ILLUSTRATION

A dress designer gives a dress with a cost of R5, 000 and a market value of R14, 000 to Miss SA to wear to
promote the dress brand. She wears this dress at the Miss Universe ceremony promoting your brand.

What are the taxation implications?

SUGGESTED SOLUTION

Trading stock is deemed recouped at market value and R14, 000 is included into gross income.

A deduction of R14, 000 is claimed for the advertising expense at market value.

If stock is given to a sole proprietor by his business (i.e. not a company but to an individual who owns the
business), it is deemed to be sold at lower of cost or market value.

ILLUSTRATION

Mr A sells vacuum cleaners in his shop. The shop is a sole proprietorship. The vacuum cleaners cost R1000 and
are sold for R1500.

What are the taxation implications if Mr A takes a vacuum cleaner home? Ignore VAT

SUGGESTED SOLUTION

A recoupment of R1, 000 (lower of cost or market value) would be included in Mr A’s income.

If trading stock is given to the shareholders as a dividend, it is deemed to be sold by the taxpayer at market
value on the date the trading stock was given as a dividend.

ILLUSTRATION

A Ltd distributed trading stock with a cost of R3, 000 and a market value of R5, 700 (incl vat) as a dividend in
specie to the sole shareholder. What are the tax implications?

SUGGESTED SOLUTION

The trading stock will be recouped into income in terms of section 22(8). An amount of R5, 000 will be added
to income. STC will also be payable. (Note disposal to a connected person may attract output vat).

If stock is given to an employee (including a shareholder) as a fringe benefit, it is deemed to be sold at the
lower of cost or open market value.

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ILLUSTRATION

Mr A owns 100% of A Ltd. He is also employed by A Ltd. A Ltd gave Mr A trading stock with a cost of R12,000
and a market value of R16,000 to take home as a fringe benefit. What are the taxation implications?

SUGGESTED SOLUTION

R12, 000 is included in gross income.

If stock is donated to a public benefit organisation, and a section 18A prescribed certificate is obtained, the
stock is deemed to be sold at lower of cost or market value.

ILLUSTRATIVE EXAMPLE

B Ltd donated R10,000 worth of trading stock that cost R7,000 to an orphanage that was registered as a public
benefit organisation. The section 18A prescribed certificate was received.

SUGGESTED SOLUTION

Recoupment R7 000

R7, 000 is deemed to be recouped in terms of section 22(8) as the prescribed certificate is received from the
public benefit organisation.

If stock is given/donated to a 3rd party at no cost, the stock is deemed to be sold at market value.

ILLUSTRATIVE EXAMPLE
B Ltd allowed a movie star to keep their clothes that had been manufactured in terms of their clothing label as
long as he wore such clothes to a gala award evening. The clothes cost R1,000 and are normally sold for
R8,000.

SUGGESTED SOLUTION

Stock recoupment R8 000

The clothes are recouped in terms of section 22(8) for R8,000. However a deduction of R8,000 can be claimed
in terms of section 11(a) as the clothes were given away for advertising purposes.

If trading stock is sold for an amount below market value in a transaction that is not arm’s length in nature, the
difference between the market value of the trading stock and the amount that the trading stock is sold for is
treated as gross income.

ILLUSTRATIVE EXAMPLE
B Ltd allowed a movie star to keep their clothes that had been manufactured in terms of their clothing label as
long as he wore such clothes to a gala award evening. The movie star paid R500 on collection of the clothes.
The clothes cost R1, 000 and are normally sold for R8, 000.

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SUGGESTED SOLUTION

Gross income – sales R500

Stock recoupment R7 500

The clothes are recouped in terms of section 22(8) for R8,000. However a deduction of R8,000 can be claimed
in terms of section 11(a) as the clothes were given away for advertising purposes less amount paid by the
employee (8000 – 500 = 7 500).

If trading stock (that is not manufactured or assembled by the taxpayer) is converted into a fixed asset, the
trading stock is deemed to be sold at market value.

ILLUSTRATIVE EXAMPLE

B Ltd changed intention from property dealer to property owner when they decided to keep a factory that
they bought for speculative purposes. They bought the factory for R100, 000 and when it was worth R210,
000, changed intention and started to use the factory in a process of manufacture. The factory was erected in
1994.

SUGGESTED SOLUTION

Gross income R210 000

Opening stock (100 000)

The factory is deemed to be sold for R210, 000 in terms of section 22(8). An amount of R210, 000 will be
included in gross income and opening stock of R100, 000 would be allowed as a deduction.

R210, 000 X 5% = R10, 500 will be allowed as a building allowance in the current tax year.

Spare parts are included in the definition of trading stock. However, the sale of spare parts is treated like the
sale of fixed assets (CGT and recoupment).

ILLUSTRATION – COMBINED

Trading stock with a market value of R15,000 is sold for R11,000 to a third party. What are the taxation
implications if:
a) The sale was in the ordinary course of trade to a non-connected person, and
b) The sale was not in the ordinary course of trade and the sale was to his son who he wanted to give the
asset to cheaply..

SUGGESTED SOLUTION

Part a
Gross income R11 000
The R11,000 will be included in gross income.

Part b

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Gross income R11 000

Recoupment R4 000
The R11,000 will be included into gross income. The R4,000 difference between market value and the amount
the goods were sold for will be added to income in terms of section 22(8).

1.5 SPECIAL RULES FOR MANUFACTURERS OR ASSEMBLERS OF GOODS

If stock that is not manufactured or assembled by the taxpayer becomes a fixed asset, it is deemed to be sold
at market value. The fixed asset is then depreciated using the market value.

Goods that are manufactured or assembled by the taxpayer remain classified as trading stock for tax purposes
(and are not treated as fixed assets) even if the taxpayer uses them as fixed assets. This is per section jA of the
gross income definition.

ILLUSTRATION – PARAGRAPH jA TO GROSS INCOME

A company imports computer parts and assembles such parts in order to sell desk top computers to the
market. The parts and completed computers constitute trading stock.

In the current year, the following result

 R5,000,000 worth of trading stock is assembled (R4,600,000 of parts and R400,000 of labour to assemble
the computers)
 Of this, R300,000 is used as computers internally by the company. (These computers could normally be
sold for R500,000)
 The remaining R4,700,000 of stock is sold for R7,000,000

After a period of two years the computers used internally are sold for R200,000.
What are the taxation implications of the above?

SUGGESTED SOLUTION

These computers are assembled and as such paragraph jA will apply.

Year 1

Gross income 7,000,000

Purchases (4,600,000)
Salaries (400,000)
Closing stock 300,000

Year 2

Opening stock (300,000)

Closing stock 300,000

Year 3

Opening stock (300,000)

Gross income 200,000

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2. TRADING STOCK ANTI AVOIDANCE

Anti-avoidance Anti-avoidance Anti-avoidance

Section 23F(1) adds back to income any Section 23F(2) disallows any losses on Section 23F(3) creates a deemed
amount of stock claimed as a deduction sale if the final selling price remains recoupment where a taxpayer disposes
if the stock is neither included in closing unquantified. The loss is carried of his right to stock which has the effect
stock, not part of gross income. forward to later years and set off that his remaining right to trading stock
against future income. does not form part of trading stock.

ILLUSTRATION TAX AVOIDANCE – 23F(1)

A Ltd bought R100,000 worth of stock. The goods had not yet been delivered at year end and were placed on a
ship FOB on 28 December 20X5.

The company has a 31 December year end. The goods were only received by A Ltd on 3 February 20X6. A Ltd
paid for the goods on 28 December 20X5.

A Ltd claimed the purchase of the goods but did not include the goods in closing stock at year end.

What are the taxation implications?

SUGGESTED SOLUTION

No deduction will be allowed for the purchase of stock per section 11(a) in 20X5. The amount of stock in
transit will also not form part of the closing stock at the end of 20X5.

The deduction denied will be claimed forward in terms of section 23F(1) and in 20X6, the deduction for the
purchase of trading stock per section 11(a) will be allowed.

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ILLUSTRATION – TAX AVOIDANCE 23F(2)

A Ltd sell trading stock. The amounts of the proceeds are dependent on future events. The amounts that are to
be paid will be received in the current and 2 future years of assessment.

The following amounts become quantifiable:

 current year = R100,000
 year 2 = R30,000
 year 3 = R50,000

The trading stock had a cost of R125,000 and was included in opening stock.

You are required:

a) to calculate the tax implications for the three tax years.
b) How would the taxation implications change if the trading stock cost R220,000.

SUGGESTED SOLUTION

Part a

In the current year, R100,000 would be included into gross income. A section 22(2) opening stock deduction of
R125,000 would be claimed. However per section 23F(2), an amount of R25,000 would be added back to gross
income as the proceeds on the sale of the trading stock would be unquantified.

This would result in a nil tax effect.

In the next year, R30,000 would be included in gross income. The R25,000 carried forward per section 23F(2)
would be allowed as a deduction. There would thus be a net taxable income of R5,000.

The R50,000 that is quantified in year 3 would be gross income in that year.

Part b

If the cost of the trading stock was R220,000, in the current year, R100,000 would be included into gross
income. A section 22(2) opening stock deduction of R220,000 would be claimed. However per section 23F(2),
an amount of R120,000 would be added back to gross income as the proceeds on the sale of the trading stock
would be unquantified.

This would result in a nil tax effect.

In the next year, R30,000 would be included in gross income. Out of the R120,000 carried forward per section
23F(2), only R30,000 would be allowed as a deduction in year 2 as per section 23F(2)(A). R90,000 would be
carried forward to the next year.

In the next tax year, R50,000 would be included in gross income. Out of the R90,000 carried forward per
section 23F(2), only R50,000 would be allowed as a deduction as per section 23F(2A). As all amounts have now
been quantified, the remaining R40,000 would be deducted in terms of section 23F(2B).

Summary

Total deduction available R220,000

Less: Amount realised year 1 (R100,000)
Less: Amount realised year 2 (R 30,000)
Less: Amount realised year 3 – through quantification (R 50,000)
Balance recognised year 3 as transaction completed R 40,000

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3. TRADING STOCK USED FOR BUSINESS PURPOSES

If trading stock is not sold and used for business purposes, it is deemed to be recouped into income at market
value.

The enterprise may then claim a deduction based on market value so recouped into income.

ILLUSTRATION

A dress designer gives a dress with a cost of R5,000 and a market value of R14,000 to Miss SA to wear to
promote the dress brand. She wears this dress at the Miss Universe ceremony promoting your brand.

What are the taxation implications?

SUGGESTED SOLUTION

Trading stock is deemed recouped at market value and R14,000 is included into gross income.

A deduction of R14,000 is claimed for the advertising expense at market value.

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4. DETAILED EXAMPLE
A Ltd has a 31 December 2015 year end.

The following relates to trading stock:

 Opening stock had a cost of R1,000,000 and a market value of R1,100,000.

 Land costing 300,000 was acquired in 2008 to build a factory on. During the year, when the market
value of the land was R400,000, the company decided to become a property dealer as regards the
land. The company built a commercial development at a cost of R3,000,000. 60% of the development
was sold for 2,600,000 and the remaining 40% was in closing stock at year end.
 Other closing stock was valued as follows:
o Raw materials had a cost of R200,000 and a market value of R220,000.
o Fuel used by their remote depot had a cost of R140,000 and a market value of R130,000
o Spare parts had a cost of R160,000 and a market value of R210,000.
o Packing materials had a cost and market value of R200,000.
o Finished goods had a cost of R400,000 and a market value of R590,000.
o Work in progress had a cost of R320,000 and a realisable value of R350,000.
o Included in closing stock was sales department costs of R50,000.
 Purchases of trading stock during the year was R9,000,000
 Purchases of spare parts for machinery during the year was R305,000.
 Spare parts costing R50,000 were sold by the company for R70,000.
 The company received stock that was donated from a 3rd party. The stock cost the 3rd party R300,000
but was worth R200,000 upon giving the stock to the company.
 Stock with a cost of R500,000 and a market value of R700,000 was given to shareholders as a dividend
in specie.
 Stock with a cost of R10,000, but with a market value of R13,000 was given to a staff member (who is
also a shareholder) during the year as a present.
 Stock with a cost of R100,000 and a market value of R120,000 was donated to a public benefit
organisation. The certificate as prescribed by section 18A was received in this regard.
 The company owns a range of dress shops and gave a dress with a cost of R3,000 to Miss South Africa
to wear at a function on condition that she told the media who the dress came from. The dress would
usually be sold for R9,000.
 The company sold trading stock that cost R3,000 and had a market value of R4,000 to a connected
person for R500.
 Furniture held as trading stock with a cost of R10,000 and a market value of R12,000 was used as a
fixed asset as from 1 October 2012. Furniture is written off in terms of interpretation note 47 over 6
years. The furniture was purchased from a 3rd party.
 The company manufactures cash registers. On 1 July 2010, the company took 20 cash registers with a
cost of R4,000 each and a selling price of R6,000 each and used them in their stores at till points. On 1
July 2012, these cash registers were sold for R3,000 each. Depreciation of R18,000 has been included
for these cash register in the net profit figure.

Cost of sales has been calculated properly with the exception of the following:

 Goods costing R100,000 have been claimed as a deduction already, but they were located on a ship
travelling to South Africa. As a result of this they were not included in the closing stock of the
company.
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 Goods costing R200,000 were sold to a supplier for R50,000 + 70% of the final selling price received
by the supplier. This supplier had not yet sold the goods at year end. No entries have been processed
in this regard including for the purchase of the R200,000 goods.
 In the previous year goods costing R300,000 were sold to a supplier for R60,000 + 60% of the final
selling price received by the supplier. This supplier had not yet sold the goods at the prior year end.
In the current year, the supplier sold the goods for R450,000.

In addition, the company had operated a joint venture with B Ltd until there was a disagreement this year. B
Ltd owned 50% of the joint venture. The company sold their claim to stock that had cost R400,000 (and had a
market value of R500,000) for R180,000 on condition that the legal claim was settled between the parties. The
R400,000 had not been included in the opening stock figure previously.

Calculate the taxable income from the above.

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SUGGESTED SOLUTION

CGT Deduction Income

Net profit 10,000,000
Reverse cost of
goods sold 6,000,000
Opening stock last Treated as a deduction
year (1,000,000)
Opening stock Deemed to be sold to taxpayer at
Fixed asset market value on the date the intention
converted to changed Treated as a deduction
trading stock
Proceeds 400,000
Base cost (300,000)
Production cost (400,000)

Sale of 60% of
development Sale of trading stock is treated as gross (3,000,000)
income
Closing stock (400,000 + 3,000,000) X 40% 2,600,000
Closing stock treated as income 1,360,000
Closing stock
Raw materials 200,000

Consumables Fuel is a consumable store which is

treated as trading stock 130,000

Spare parts Spare parts is treated as trading stock

160,000
Packing materials is treated as trading
Packing materials stock
200,000

Finished goods 400,000

Work in progress 320,000

Sales department Selling costs are not allowed to be

costs included in the cost of trading stock (50,000)

Purchases trading Purchases are treated as a deduction in

stock terms of general deduction formula
(9,000,000)

Purchases of spare Treated as a repair deduction in terms

parts of section 11(d) (305,000)

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CGT Deduction Income

Sale of spare parts Recoupment of deduction claimed,
limited to cost 50,000

Proceeds (70,000 – 50,000) 20,000

Base cost (50,000 – 50,000) Nil

Donation of stock Stock donated to taxpayer allowed to

be deducted using market value on the
date of the donation (200,000)

Dividend in specie Deemed to be sold to the shareholders

at market value 700,000

Trading stock given Fringe benefit treated as recoupment at

to employee the lower of cost or market value
10,000

Trading stock given Treated as income at cost as it was

as a donation donated to a public benefit
organisation 100,000

Trading stock Miss SA is not a public benefit

donated/given to organisation. Treated as income at
Miss SA market value 9,000

Deduction Dress given to Miss SA for advertising

purposes (9,000)

Sale of stock 500

Deemed sale Trading stock deemed income of

R4,000 – R500 3,500

Conversion of Deemed to be sold at market value to

trading stock to the enterprise on the day the intention
fixed asset changes. 12,000

Wear and tear 12,000 X 1/6 X 3/12 (500)

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CGT Deduction Income

Reverse Cash registers treated as trading stock
depreciation for taxation purposes as manufactured
by the taxpayer 18,000

Opening stock Cash register are treated as trading

deduction stock thus opening stock deduction at
cost 80,000

Sale of cash Sale of cash registers treated as income

registers as cash registers are treated for tax
purposes as trading stock 60,000

Goods in transit Add back to income section 23F(1).

Goods not in closing stock nor in
income 100,000

Purchase goods
given to supplier Deduction section 11(a) 200,000

Income received Supplier paid R50,000 included in gross

income 50,000

Incomplete sale 23F(2) disallows loss 150,000

Last year’s Goods worth R300,000 sold to supplier

incomplete sale for 60,000 + 60% final sale. Section
23F(2) loss of R300,000 – R60,000
disallowed last year. This loss is now
allowed as a deduction 240,000

Income from 60% X 450,000 received from supplier

completed sale 270,000

Opening stock joint

venture (400,000)

Sale of stock joint

venture 180,000

Recoupment Section 23F(3) giving up of right leads

to deemed recoupment 220,000

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 CHAPTER 6
CAPITAL ASSETS

Contents
1. INTRODUCTION TO CAPITAL ALLOWANCES ..............................................................................................................3
2. MOVABLE ASSETS ......................................................................................................................................................3
3.1 SECTION 12C - MACHINERY USED IN A PROCESS OF MANUFACTURE.................................................................3
3.1.1 Qualifying assets ...........................................................................................................................................3
3.1.2 Write-off period ............................................................................................................................................4
3.1.3 Other considerations ....................................................................................................................................5
3.2 SECTION 12E – SMALL BUSINESS CORPORATION ..............................................................................................10
3.2.1 Qualifying assets .........................................................................................................................................10
3.2.2 Write-off period ..........................................................................................................................................10
3.2.3 Other considerations ..................................................................................................................................12
3.3 SECTION 11(e) – MACHINERY NOT USED IN A PROCESS OF MANUFACTURE....................................................13
3.3.1 Qualifying assets .........................................................................................................................................13
3.3.2 Write-off period ..........................................................................................................................................13
3.3.3 Other considerations ..................................................................................................................................14
3.4 IN SUMMARY .....................................................................................................................................................16
4. BUILDING ALLOWANCES ..........................................................................................................................................17
4.1 BUILDINGS USED IN A PROCESS OF MANUFACTURE – s13 (1) ..........................................................................17
4.1.1 Qualifying assets .........................................................................................................................................17
4.1.2 Disposal of manufacturing buildings ..........................................................................................................21
4.1.3 Summary .....................................................................................................................................................22
4.2 COMMERCIAL BUILDINGS – s13quin .................................................................................................................23
4.2.1 Qualifying assets .........................................................................................................................................24
4.2.2 Write-off period ..........................................................................................................................................24
4.2.3 Other considerations ..................................................................................................................................26
4.2.4 Summary .....................................................................................................................................................28
4.3 RESIDENTIAL UNITS – s13sex .............................................................................................................................29
4.3.1 Qualifying assets .........................................................................................................................................29
4.3.2 Write-off period ..........................................................................................................................................29
4.3.3 Low cost housing ........................................................................................................................................31
4.3.4 Sale of low cost housing on loan ................................................................................................................31
4.3.5 Summary .....................................................................................................................................................36
4.4 URBAN DEVELOPMENT ZONES – s13 quat ........................................................................................................37
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 4.4.1 Qualifying assets .........................................................................................................................................37
4.4.2 Write-off period ..........................................................................................................................................37
4.4.3 Summary .....................................................................................................................................................42
5. Intangible assets ......................................................................................................................................................43
5.1 Registration – s11 (gB). ......................................................................................................................................43
5.2 Acquisition of intangible assets s11 (gC) ...........................................................................................................43
5.3 Research and development S11D ......................................................................................................................44
5.4 Summary ............................................................................................................................................................47
6. DISPOSAL OF ASSETS ...............................................................................................................................................48
6.1 SCRAPPING ALLOWANCE – s11 (o) ....................................................................................................................48
6.1.1 Qualifying allowances .................................................................................................................................48
6.1.2 Loss events..................................................................................................................................................49
6.1.3 Determining the allowance ........................................................................................................................49
6.1.4 Other considerations ..................................................................................................................................51
6.1.5 Summary .....................................................................................................................................................52
6.2 RECOUPMENTS – s8 (4) (a) ................................................................................................................................53
6.2.1 Qualifying allowances .................................................................................................................................53
6.2.2 Determining the recoupment .....................................................................................................................53
6.2.3 Other considerations ..................................................................................................................................54
6.2.4 Deferral of recoupment ..............................................................................................................................55
6.2.4 Summary ................................................................................................................................................62
7. LEASED ASSETS – LESSEE CONSIDERATIONS ............................................................................................................63
7.1 RENTAL PAYMENTS ............................................................................................................................................63
7.2 LEASE PREMIUMS ..............................................................................................................................................64
7.3 LEASE IMPROVEMENTS .....................................................................................................................................65
7.4 EXCESS AMOUNTS SPENT ..................................................................................................................................66
7.5 VAT Considerations............................................................................................................................................67
8. LEASED ASSETS – LESSOR CONSIDERATIONS ...........................................................................................................68
8.1 RENT RECEIVED ..................................................................................................................................................68
8.2 LEASE PREMIUM ................................................................................................................................................68
8.3 LEASEHOLD IMPROVEMENTS ............................................................................................................................69
8.4 RELIEF FOR LESSOR ............................................................................................................................................71
8.5 Summary ............................................................................................................................................................74

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1. INTRODUCTION TO CAPITAL ALLOWANCES
When expenditure is incurred, an enterprise determines whether the expenditure is capital in nature or not.

In the event that the expenditure is capital in nature, an entity identifies whether a specific section in the Income
Tax Act allows for the deduction of the expenditure.

In the event that the expenditure is not capital in nature, the general deduction formula is applied to account for
the deduction of the expenditure.

This section will explore capital allowances allowed to be deducted for capital expenditure.

The determination of whether an item is capital in nature or not is dealt with in the general deduction section.

2. MOVABLE ASSETS

In accounting, the cost of assets is reduced over time through depreciation over its useful life to reflect usage.

In tax, the expenditure of capital assets is not allowed as a deduction when the expenditure occurs.

However, similar to accounting, the cost of an asset can be deducted over time as a special depreciation allowance
called “wear and tear”.

Capital expenditure can be classified as follows:

 Movable assets;
 Buildings; and
 Other assets

This section will deal with moveable capital assets.

3.1 SECTION 12C - MACHINERY USED IN A PROCESS OF MANUFACTURE

The income Tax Act contains a special deduction that can be claimed by where the value of a capital asset
diminishes over time in section 12C.

3.1.1 Qualifying assets

This section is applicable to:

 The cost of movable assets which are;
 new or used plant and machinery used in the process of manufacturing or a similar process.

These assets should be:

 owned by the taxpayer or

 acquired in terms of an instalment sale agreement (finance lease)
 and brought into use for the first time by the taxpayer.

No s12C allowance is claimable if the asset qualifies for s12E allowance.

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3.1.2 Write-off period

New or unused

New assets are written off over 4 years using the following rates:

40%, 20%, 20%, 20%

Except:

 Banking
 Financial services
 Insurance: or
 Rental businesses

ILLUSTRATION

A Ltd buys a new machine on 1 March 2018 for R400, 000. The machine is used in a process of manufacture.

What tax deduction can be claimed for the February 2019 year end?

SUGGESTED SOLUTION

The deduction that can be claimed is 400 000 X 40% = R160, 000.

These rates are not apportioned even if asset is bought part way through the year; and the machines are written
down to a nil value.

ILLUSTRATION

A Ltd buys a new machine on 20 February 2019 for R400 000. The machine is used in a process of manufacture.

What tax deduction can be claimed for the February 2019-year end?

SUGGESTED SOLUTION

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The deduction that can be claimed is 400,000 X 40% = R160, 000.

There is no apportionment even though the machine was used for a few days in this tax year.

Used/second hand

5 years

20%, 20%, 20%, 20%, 20%

Including assets excluded above.

ILLUSTRATION

A Ltd has a 31 December year end.

A second hand machine was purchased on 1 March 2018 for R400 000.

What write-off can be claimed in the 2019 tax year?

SUGGESTED SOLUTION

The deduction that can be claimed is 456,000 X 20% = R80, 000.

There is no apportionment even though the machine was used for a few days in this tax year.

3.1.3 Other considerations

Cost

The cost of the asset is the lesser of:

 actual cost to acquire the asset; or

 The market value of the asset at the time of acquisition.

The actual cost of an asset includes:

 Cost to acquire the asset;

 Customs and excise duty;
 Installation and erection costs;
 Costs to install a supporting structure; and
 All other costs incurred to bring the asset it its present condition and location.
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Actual costs exclude VAT and finance charges.

ILLUSTRATION

A Ltd has a 28 February year end. A Ltd purchased a new foreign machine for R100, 000 on 1 March 2018. Freight
costs incurred were R10, 000. Insurance, customs duty and import charges incurred were R15, 000.

The machinery was installed and ready for use on I February 2019 and was used in the process of manufacture.

What is the cost of the machinery?

What write-off can be claimed in the 2019 tax year?

SUGGESTED SOLUTION

The cost of the asset is R100, 000 + R10, 000 + R15, 000 = R 125, 000

The machine would have been written-off in 2019 at a rate of 40% X R125, 000 = R50, 000.

Moving costs are deducted over the remaining life of the asset.

ILLUSTRATION

A Ltd has a 31 December year end. A Ltd purchased a foreign machine for R100, 000 on 1 January 2018. Freight
costs incurred were R10, 000. Insurance, customs duty and import charges incurred were R15, 000.

The machinery was installed and ready for use on 1 February 2019 and was used in the process of manufacture. In
January 2020, A Ltd decided to move their operations to another city. The move cost the enterprise R20, 000.

What write-off can be claimed in the December 2020 tax year?

SUGGESTED SOLUTION

The allowance for 2020 will be: 125, 000 * 20% = R25, 000.

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Moving costs 20 000 * 0.25 = 5 000 (written off over the remaining period which is four years.)

If a fully depreciated asset is moved, moving costs are immediately written off.

ILLUSTRATION

A Ltd has a 31 December year end. A Ltd purchased a foreign machine for R100, 000 on 1 January 2009. Freight
costs incurred were R10, 000. Insurance, customs duty and import charges incurred were R15, 000.

The machinery was installed and ready for use on 1 February 2009 and was used in the process of manufacture. In
January 2019, A Ltd decided to move their operations to another city. The move cost the enterprise R25, 000.

What write-off can be claimed in the December 2019 tax year?

SUGGESTED SOLUTION

The asset if fully depreciated therefore, no wear and tear allowances.

Moving costs of R25 000 will be immediately written off as an expense.

A section 12C deduction is allowed only if there is an actual cost incurred on the asset. If asset is acquired for no
consideration then no allowances are deductible.

ILLUSTRATION

B Ltd received a machine that is used in a process of manufacture with a market value of R200, 000 through a
donation from a shareholder. Can a section 12C allowance be claimed?

SUGGESTED SOLUTION

No deduction can be claimed in terms of s12C as the machine has no cost. The machine does, however, have a
value and therefore a wear and tear allowance may be claimed under s11 (e).

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Permanent structures

S12C allowances can be claimed on permanent machinery i.e. mounted on a permanent foundation.

ILLUSTRATION

A Ltd bought a new machine on 1 March 2018 for R456, 000 including VAT. The machine is used in a process of
manufacture. To secure the machine, the company installed a permanent structure to house the asset at a cost of
R100 000.

What tax deduction can be claimed for the February 2019-year end?

SUGGESTED SOLUTION

The deduction that can be claimed is (456 000 X 100/115 + 100 000) x 40% = R198, 609.

Process of manufacture

For a process to be manufacturing the following need to be met:

 The process must be a complete process i.e. must be continuous.

 There must be an essential change from the material introduced to the end product.
 The process need not produce the end product as long as it contributes to the finished product.

ILLUSTRATION

An enterprise is in the motor industry.

The enterprise purchased;

A machine which manufactures motor vehicles.
A machine that diagnosis faults on vehicles after they are sold to the public.
A building in which the motor vehicle machine is used exclusively.

Which asset is a qualifying asset?

SUGGESTED SOLUTION

The machine used to manufacture vehicles is a qualifying asset.

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The machine used to diagnose faults is not a qualifying asset.

The building is not a qualifying asset as it is not used directly in the process of manufacture.

Finance lease

Finance leases used in the process of manufacture qualify for a section 12C allowance

ILLUSTRATION

A Ltd buys a new machine on 1 March 2018 for R400, 000 through a finance lease. The finance charges amount to
R42 000. The machine is used in a process of manufacture.

What tax deduction can be claimed for the February 2019-year end?

SUGGESTED SOLUTION

The deduction that can be claimed is 400 000 X 40% = R160, 000.

Cost excludes finance charges.

Brought into use for the first time

The taxpayer can only qualify for this allowance if they bring the asset into use for the first time whether new or
second hand.

ILLUSTRATION

A Ltd entered into a four-year finance lease for a new machine on 1 March 2010 for R400, 000. The finance charges
amount to R42 000 over the period of the lease. At the end of the contract the company obtains ownership of the
asset. The market value on this date is R250 000. The machine is used in a process of manufacture.

What tax deduction can be claimed for the February 2019-year end?

SUGGESTED SOLUTION

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The company cannot qualify for a Section 12C deduction as the asset is not brought into use for the first time. The
company will qualify for a section 11(e) deduction.

S12C is not limited to industrial machinery or plant, but also applies to:

 Agricultural co-operatives;
 Hotelkeepers;
 Aircraft;
 Ships; and
 Machinery or plant used for research and development depreciated at a rate of 50%, 30% and 20%.

3.2 SECTION 12E – SMALL BUSINESS CORPORATION

The income Tax Act contains a special deduction that can be claimed by where the value of a capital asset
diminishes over time in section 12C.

3.2.1 Qualifying assets

This section is applicable to:

 The cost of movable assets which are;

 new or used plant and machinery used in the process of manufacturing or a similar process and
 are used by a Small Business Corporation (SBC).

Refer to SBC definition in unit 1.

These assets should be:

 owned by the taxpayer or

 acquired in terms of an instalment sale agreement (finance lease)
 and brought into use for the first time by the taxpayer.

3.2.2 Write-off period

New and used manufacturing plant and machinery qualify for a 100% deduction.
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This allowance is not apportioned for part of a year.

ILLUSTRATION

A Ltd is owned 100% by Adam and is a small business corporation as defined.

A Ltd purchased a brick moulding machine considered to the used in the process of manufacture for R100, 000.

What allowance is allowable?

SUGGESTED SOLUTION

100% of R100, 000 will be claimed as a deduction

Other types of assets qualify for a 50%, 30%, 20% allowance.

This allowance is not apportioned for part of a year.

ILLUSTRATION

A Ltd is owned 100% by Adam and is a small business corporation as defined.

A Ltd purchased a water tank for R12, 000.

What allowance is allowable?

SUGGESTED SOLUTION

50% of the water tank: R6, 000 in the first year of assessment.

30% of the water tank: R3 600 in the second year of assessment.

20% of the water tank: R2 400 in the second year of assessment.

If a small business corporation buys an asset other than a manufacturing asset with a cost less than R 7 000, the
asset may be written down to R1 in the period in which it is purchased using s11 (e) or using the normal rates of
50; 30; 20.

ILLUSTRATION

A Ltd is owned 100% by Adam and is a small business corporation as defined.

A Ltd purchased a computer for R4, 000.

What allowance is allowable?

SUGGESTED SOLUTION

A choice of either:

50% of the computer: R2, 000 or

Write-off to R1 the computer using the s11 (e) deduction.

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The taxpayer will therefore write off R3 999.

3.2.3 Other considerations

A Section 12E deduction is allowed only if there is an actual cost incurred on the asset. If asset is acquired for no
consideration then no allowances are deductible.

ILLUSTRATION

B Ltd received a machine that is used in a process of manufacture with a market value of R200, 000 through a
donation from a shareholder. B Ltd is a Small Business Corporation as defined. Can a section 12C allowance be
claimed?

SUGGESTED SOLUTION

No deduction can be claimed in terms of s12E as the machine has no cost. The machine does, however, have a
value and therefore a wear and tear allowance may be claimed under s11 (e).

Moving costs are deducted over the remaining life of the asset.

ILLUSTRATION

A Ltd which is a Small Business Corporation has a 31 December year end. A Ltd purchased a heavy duty printer
which is not a manufacturing asset for R100 000 on 1 January 2019.

The machinery was installed and ready for use on 1 February 2019 and was used in the process of manufacture. In
January 2020, A Ltd decided to move their operations to another city. The move cost the enterprise R25, 000.

What write-off can be claimed in the December 2020 tax year?

SUGGESTED SOLUTION

The allowance for 2020 will be: 100 000 * 30% = R30, 000.

Moving costs 20 000 * 0.5 = 12 500 (written off over the remaining period which is two years.)

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If a fully depreciated asset is moved, moving costs are immediately written off.

ILLUSTRATION

A Ltd which is a Small Business Corporation has a 31 December year end. A Ltd purchased a heavy duty printer
which is not a manufacturing asset for R100 000 on 1 January 2012.

The machinery was installed and ready for use on 1 February 2012 and was used in the process of manufacture. In
January 2020, A Ltd decided to move their operations to another city. The move cost the enterprise R25, 000.

What write-off can be claimed in the December 2020 tax year?

SUGGESTED SOLUTION

The asset if fully depreciated therefore, no wear and tear allowances.

Moving costs of R25 000 will be immediately written off as an expense.

3.3 SECTION 11(e) – MACHINERY NOT USED IN A PROCESS OF

MANUFACTURE

3.3.1 Qualifying assets

All movable assets other than those that qualify for special depreciation allowances such as s12C and 12E
allowances.

3.3.2 Write-off period

The rates are determined by the Commissioner in Interpretation Note 47 and Binding General Ruling Number 7.

These rates will be provided in the exam.

The write-off is apportioned if the asset is brought into use during the assessment period.

The assets are written down to a residual of R1.

ILLUSTRATION

A Ltd purchased a computer for R9, 000 on the 1st of January 20x1. The period of assessment is 30 June 20x1.
Calculate the wear and tear of the asset. According to Interpretation Note 47 SARS allows a write-off period of 3
years.

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SUGGESTED SOLUTION

The computer has to be written off over 3 years. However, as it was purchased during the year it has to be
apportioned for 6 months. Therefore the wear and tear amount will be R1 500 (6 000/3 x ½).

Over the coming 2 and a half periods of assessment, the tax payer will write of the asset over the period down to a
residual of R1.

3.3.3 Other considerations

Wear and tear is based on value and not cost.

If there is no cost, use market values.

ILLUSTRATION

A Ltd receives a donation of a computer. The market value of the computer is R5, 000.

Can a wear and tear allowance be claimed for the computer?

SUGGESTED SOLUTION

Yes, wear and tear can be claimed for the computer.

The deemed cost for purposes of the deduction is R5, 000.

Moving costs are included in the cost of the asset.

Where the asset is used for only part of the year, the allowance is apportioned.

Small items that cost less than R7 000 per asset may be written off in full in the year of acquisition.

ILLUSTRATION

A Ltd purchased a computer for R6, 000 on the 1st of January 20x1. The period of assessment is 30 June 20x1.
Calculate the wear and tear of the asset. According to Interpretation Note 47 SARS allows a writeoff period of 3
years.

SUGGESTED SOLUTION

The computer has to be written off over 3 years. However, as it was purchased for less than R7 000 the asset will
be written down to R1, i.e. the wear and tear allowance will be R5 999.

Permanent Structures

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Section 11(e) is not applicable to permanent structures.

A permanent structure is a structure which is affixed to the ground.

If it is the intention of the taxpayer for the structure not to be removed then it is permanent in nature.

An allowance is allowed on the foundations or supporting structures of an asset qualifying for the wear and tear
allowance.

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 3.4 IN SUMMARY

Machinery

Machinery used in a process of manufacture Machinery not used in a process of manufacture

Capital allowances are claimed in accordance with section Capital allowances will be calculated in terms of section
12C. The following rules apply: 11(e). This is the section on wear and tear.

 If purchased new, write off at 40:20:20:20 (40%

year 1, 20% year 2, 20% year 3 and 20% year 4) Machinery used in a process of manufacture by a small
 If purchased second hand, write off at 20% business corporation
straight line
 The capital allowances are not apportioned. Thus
if an asset is purchased 2 days before year end, Instead of the asset being written off at 40:20:20:20 (new
the full 40% can be claimed if the asset is new. asset) or 20% straight line (2nd hand asset), all machines
Similarly in the year the asset is sold, the full 20% acquired, both new and 2nd hand are written off 100% in the
can be claimed despite the fact that the asset has
year of acquisition.
not been used for the whole year.
 When calculating cost, remember that cost is the
sum of cost plus installation costs plus moving
costs (Thus for a foreign machine, freight,
insurance, customs duty and import charges
could be included in cost. Vat will not be included General considerations
in cost as input vat can be claimed on machines
by a vendor)
 If a new asset is moved after it has been acquired, It should be noted that for a machine to be written of in
the moving cost is written off over the remaining terms of section 12C (40/20/20/20 or 20% straight line) or
life. Thus if R20,000 is incurred moving the
section 12E (100% small business corporation), the machine
machine in year 3, the R20,000 is written off over
needs to have a cost.
2 years, R10,000 in year 3 and R10,000 in year 4.
(20% left in year 3 and 20% left in year 4, thus
20/40 X R20,000 in year 3 and 20/40 X R20,000 in
year 4) The amount written off is the lower of cost or market value
 The machines are written down to a nil value. at the date of acquisition.

Thus if a machine is donated, it cannot be written off in

terms of section 12C or 12E.

Thus a machine that is donated is written off in terms of

section 11(e) wear and tear even if used in a process of

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4. BUILDING ALLOWANCES

Consider the following:

An enterprise:

Purchased a machine used to bake bread i.e. convert dough to bread.

Received a donation of a new building which houses the baking machine.

Constructed a building which is used partly by the administration staff also used to house the staff (30% for
administration and 70% accommodation purposes).

Purchased land and buildings in an urban development zone for R10 million.

How should the expenditure be treated?

Building allowances can be classified as follows:

 Buildings used in a process of manufacture;

 Commercial buildings;
 Residential buildings; and
 Urban developments.

4.1 BUILDINGS USED IN A PROCESS OF MANUFACTURE – s13 (1)

Manufacturing buildings do not qualify for s12C allowances but section 13 is used for the deduction of building
allowances used in a process of manufacture.

4.1.1 Qualifying assets

Section 13 is applicable to;

 The cost of manufacturing buildings i.e. used for housing a process of manufacture.

 Constructed by the company;

 Used wholly or mainly for carrying on in them, a process of manufacture or similar process. Wholly or
mainly = more than 50% of the floor area.

Section 13 allows for a 5% annual allowance unless:

 Erected between 26/3/1959 – 31/12/1988 - 2%

 Erected between 1/7/1996 and 30/0/1999 and brought into use before 31/3/2000 – 10%
 Erected before 25 March 1959 – none even if purchased after this date.
 Purchased buildings – claim the rate used by the seller.

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ILLUSTRATION

A Ltd, constructed 2 buildings on 1 January 2018. The company’s year-end is 28 February 2019.

Building A that has 60% of its space as a factory and 40% of its space as a canteen. The cost of the building was R2,
100,000. The canteen was run on a subsidised basis to staff.

Building B that has 45% of its space as a factory and 55% of its space as a warehouse. The cost of the building was
R3, 000,000.

What building allowances can be claimed?

SUGGESTED SOLUTION

An allowance of 5% X R2, 100,000 = R105, 000 can be claimed for building A. It is used mainly in the process of
manufacture. (More than 50%)

No allowance will be granted for building B. (used less than 50% for manufacture) No allowance can also be
claimed in terms of the administration building status of this building (see later in the chapter for a discussion on
this.)

The cost of a building includes transfer duties and vat, if such amounts cannot be claimed back as a vat input. In
addition, legal costs such as conveyancing will be included in the cost of a building.

The allowance is not apportioned if brought into use in the middle of the year.

Buildings are written down to a nil book value.

ILLUSTRATION

A Ltd, constructed a building on 1 July 2018. The company’s year-end is 28 February 2019.

Building A that has 60% of its space as a factory and 40% of its space as a canteen. The cost of the building was R2,
280,000. The canteen was run on a subsidised basis to staff. Conveyancing costs of R100, 000 (excl. VAT) were also
incurred.

What building allowances can be claimed?

SUGGESTED SOLUTION
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An allowance of 5% X (R2, 280,000 x100/115 + 100,000) = R104, 130 can be claimed for building A. It is used mainly
in the process of manufacture. (More than 50%).

The allowance is not apportioned for part of the year.

The buildings should have a cost. If there is no cost, no allowance can be claimed.

ILLUSTRATION

A Ltd, received a donation from the shareholder on 1 July 2018 of a building. The company’s year-end is 28
February 2019.

Building A that has 60% of its space as a factory and 40% of its space as a canteen. The value of the building was
R2, 000,000.

What building allowances can be claimed?

SUGGESTED SOLUTION

An allowance of 5% X R2, 000,000 = R100, 000 can be claimed for building A. It is used mainly in the process of
manufacture. (More than 50%).

The allowance is not apportioned for part of the year.

Buildings used wholly or mainly for research or development on or after 1 October 2012 also qualify for a section
13 allowance.

Section 13 allowances are also available to purchased buildings if:

 purchased from enterprises which were entitled to the allowance; or

 purchased new for a process of manufacture.

For purchased assets, the allowance is claimed on the cost of the asset to the purchaser and not to original cost.

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ILLUSTRATION

A Ltd, bought a building a new building used for a process of manufacture on 1 January 2018. The company’s year-
end is 28 February 2019.

Building A that has 60% of its space as a factory and 40% of its space as a canteen. The cost of the building was R2,
100,000 including vat. The canteen was run on a subsidised basis to staff.

What building allowances can be claimed?

SUGGESTED SOLUTION

An allowance of 5% X R2, 100,000 = R105, 000 can be claimed for building A. It is used mainly in the process of
manufacture. (More than 50%)

An improvement is treated as a separate asset i.e. if a new wing is added, such new wing is treated as a new
building. (Old building could be at 2% and new wing at 5%)

ILLUSTRATION

A Ltd erected a new wing to its existing factory.

The original cost of the factory was R1, 000,000 in 1982. A Ltd erected the factory in 1982.

The new wing cost R500, 000 was brought into use in the current year. What capital allowances can be claimed for
the factory?

SUGGESTED SOLUTION TO ILLUSTRATION

Old factory = 2% X R1, 000,000 = R20, 000

New wing = 5% X R500, 000 = R25, 000

Section 13 allowances are claimed only on the building and not the land. Therefore, land is not depreciable.

ILLUSTRATION

A Ltd purchased a new manufacturing building ZZ for R10 000 000 on 1 April 2018 and brought it into use on the
same date. The cost was made up as follows:

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Land R1 000 000

Building R9 000 000

Total R10 000 000

SUGGESTED SOLUTION

Land (no allowance claimable) Nil

4.1.2 Disposal of manufacturing buildings

If the manufacturing building is sold at a profit, the recoupment determined in the same manner as all other
assets.

Where the disposed building is replaced with another manufacturing building, the recoupment determined may be
set off against the cost of a new building, or against the lease improvement for the replacement building.

The recoupment is not deferred in terms of Par 65 of the Eighth Schedule when a building is sold, but the
recoupment is set off against the cost of the replacement building if so chosen by the taxpayer according to
section 13(3).

In order to elect s13(3):

 the taxpayer has to purchase or erect the replacement building within 12 months or any longer period
that the Commissioner may allow from the date on which the event giving rise to the recoupment
occurred, AND
 the replacement building must qualify for the s13(1) building allowance

ILLUSTRATION

Manufacturing building AA was sold on 1 January 2018 for R5 000 000 by A Ltd. A recoupment of R800 000 was
determined. The company purchased a new manufacturing building ZZ for R10 000 000 on 1 April 2018 and
brought it into use on the same date. The cost was made up as follows:

Land R1 000 000

Building R9 000 000

Total R10 000 000

What is the implication on taxable income?

SUGGESTED SOLUTION

Land (no allowance claimable) Nil

Manufacturing building ZZ
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Cost 9 000 000

Less: recoupment on previous building (s13 (3)) (800 000)

Cost on which allowance is based 8 200 000

S13 (1) building allowance (R8 200 000 x 5%) (410 000)

Where the building is sold at a loss no scrapping allowances is claimable. The building will only be able to claim a
capital loss.

ILLUSTRATION

A factory was sold in the current year for R2, 000,000. The building was acquired at a cost of R5, 000,000 and had a
tax value of R3, 000,000.

Can a scrapping allowance be claimed on sale of the building?

SUGGESTED SOLUTION TO ILLUSTRATION

No scrapping allowance can be claimed on buildings. The building will qualify for a capital loss.

4.1.3 Summary

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 Factory buildings

FACTORY BUILDINGS

Land Donated Erection of Erection of Erection of Exception

buildings factory building factory factory
before building building
Land is 25/3/1959 from from 1989 If a factory building
not If a building is 26/3/1959 till current was erected by the
written donated to a to day taxpayer claiming
off. taxpayer, If a factory was 31/12/1988 the allowance
such building erected pre between 1/7/1996
cannot be 1959, no These and 30/9/1999
Buildings written off in building These factories (and brought into
are terms of the allowance is factories are are written use before
written off Tax Act as claimed even if written off off at 5% 31/3/2000), the
in terms they have no acquired after at 2% per per annum building is written
of the Act cost. this date annum off at 10% per
annum

4.2 COMMERCIAL BUILDINGS – s13quin

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4.2.1 Qualifying assets

Section 13quin applies to:

 The cost of commercial buildings

 Used wholly or mainly for the purposes of producing income. Wholly or mainly = more than 50% of the
floor area

 Constructed or purchased by the taxpayer.

 Used in own trade or let.

The allowance is claimable from on or after 1 April 2007.

The allowances are only claimed on the building and not the land.

4.2.2 Write-off period

New or unused buildings

The allowance to constructed buildings is 5% per annum.

The allowances are not apportioned for part of a year.

Allowance is limited to the cost and written off to nil

Allowance based on the lesser of cost or market value of the building.

ILLUSTRATIVE EXAMPLE

A Ltd acquired the following assets:

Office building J erected on 1 January 2003 at a cost of R230, 000.

Office building K erected on 1 July 2007 at a cost of R400, 000.

Suggested solution

Office building J

Pre 1 April 2007 thus not written off

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Office building K

400,000 X 5% (20 000)

Acquired Buildings

The allowance can also be claimed on the purchase of new and unused buildings.

The allowance claimable on the purchase of part of a building is 55% of the 5% building allowance.

ILLUSTRATIVE EXAMPLE

A Ltd acquired the following assets:

Office building M acquired for R2, 000,000. The building was unused since it was improved.

40% of office building Z bought new by the company for R450, 000 in the current tax year.

Suggested solution

Building M: 2 000 000 x 0.05 = (100 000)

Did not buy whole building.

Thus claim R450,000 X 5% X 55% (12 375)

Acquired improvements

The allowance can also be claimed on the purchase of new improvements.

The allowance claimable is 30% of the 5% building allowance.

ILLUSTRATIVE EXAMPLE

Office building N was acquired for R2, 400,000. The previous owner had acquired the building in 1991. The building
had been substantially renovated and was bought unused since it was improved.

Suggested solution

30% X 2,400,000 X 5%
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(Improvements done by 3rd party thus 30% X 5%) (36 000)

4.2.3 Other considerations

No allowance on second hand buildings acquired.

Improvements treated as a separate asset for capital allowances.

ILLUSTRATIVE EXAMPLE

Office building M acquired second hand on 1 December 2009 for R1, 200,000. An amount of R1, 300,000 was spent
improving the building.

What are the tax implications?

Suggested solution

On acquisition – no write-off as not acquired new or unused

1,300,000 X 5%
(Improvements done by company thus full deduction) (R65 000)

No scrapping allowances can be claimed on these buildings

ILLUSTRATIVE EXAMPLE

Office building J erected on 1 January 2003 at a cost of R230, 000.

Office building K erected on 1 July 2007 at a cost of R400, 000.

40% of office building Z bought new by the company for R450, 000 in the current tax year.

Office building L erected on 1 February 2009 and bought new by the company on 1 April 2009 for R1, 100,000.

Office building M acquired second hand on 1 December 2009 for R1, 200,000. An amount of R1, 300,000 was spent
improving the building.

Office building N was acquired for R2, 400,000. The previous owner had acquired the building in 1991. The building
had been substantially renovated and was bought unused since it was improved.

SUGGESTED SOLUTION

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Office J Pre 1 April 2007 thus not written off 0
Office K 400,000 X 5% (20,000)
Office Z Did not buy whole building. Thus claim R450,000 X 5% X 55%
(12,375)
Office L 1,100,000 X 5% (55,000)
Office M On acquisition – no writeoff as not acquired new or unused
0
Office M improvements 1,300,000 X 5% (improvements done by company thus full
deduction) (65,000)
Office N 30% X 2,400,000 X 5% (improvements done by 3rd party thus
30% X 5%) (36,000)

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4.2.4 Summary

Commercial Building

Land Building erected 2nd hand building New or unused building

pre 1/4/2007 acquired post either erected or
1/4/2007 purchased by the
Land on which commercial taxpayer post 1/4/2007
building is placed is not No capital
written off. allowance is No capital allowance
claimed on these is claimed on these Capital allowances are

Purchase 100% of the new or Purchase part of a new Purchase an improvement

unused building or erect the building part of a building
building

(55% X 5% X cost) capital (30% X 5% X cost) capital

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4.3 RESIDENTIAL UNITS – s13sex

4.3.1 Qualifying assets

Section 13sex is applicable to;

 The cost of new or unused residential units in South Africa;

 Used in own trade or let;

 Claimable from on or after 21 April 2008; and

 Tax payer must own more than 5 units.

Residential units are buildings or self-contained apartments solely used for residential accommodation.

Assets are written down to nil

Allowance not apportionment

Allowance claimed only on the building and not the land

Allowance can only be claimed if there is a cost which is

 the lesser of cost or

 market value of the building.

4.3.2 Write-off period

New or unused buildings

Section 13sex allows 5% annual allowance on the erection of new buildings;

Section 13sex also allows 5% annual allowance on the purchase of a whole building.

ILLUSTRATIVE EXAMPLE

Part A

Two standalone residential units were bought in the year of assessment at a cost of R400, 000 each. They were let
out at R5, 500 per month.

What are the tax implications?

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Part B

Ten standalone residential units were bought in the year of assessment at a cost of R400, 000 each. They were let
out at R5, 500 per month.

What are the tax implications?

Suggested solution

Part A

No write-off as the company owns less than 5 units

Part B

Deduction of:

400 000 x10 x 5% (200 000)

Purchased part building and improvements

Section 13sex allows 55% of the annual allowance of 5% on the purchase of part of a building.

Section 13sex allows 30% of annual allowance of 5% on the purchase of improvements of part of a building.

ILLUSTRATIVE EXAMPLE

Ten residential units were bought in the year of assessment in The Birches complex at a cost of R400, 000 each.
They were let out at R3, 500 per month. The complex has 50 units.

What are the tax implications?

Deduction of:

400 000 x10 x 5% x 55% (110 000)

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Disposal of residential buildings

Where a taxpayer disposes of an asset, the recoupment is calculated in the same manner as all other assets.

However, residential assets do not qualify for a scrapping allowance.

4.3.3 Low cost housing

A low cost building is a building where it is a stand-alone unit with a cost of less than or equal to R300, 000, or an
apartment with a cost of less than and equal to R350, 000: and

Rental charged of less than or equal to 1% of the cost of the unit

Low cost housing qualify for an additional 5% allowance to the residential accommodation allowance of 5%.
(Therefore 10% in total)

ILLUSTRATIVE EXAMPLE

Eight new residential units were bought on 1 November 2009 in The Willows complex at a total cost of R1,
500,000. They were let out at R1, 800 a month. The Willows complex has 120 units.

Suggested solution

Cost per unit 1,500,000 / 8 = 187,500

and rent of 1,800 is less than 1%

Therefore, the units are low cost units and qualify for an additional 5% allowance.

1,500,000 X 55% X 10% (82 500)

4.3.4 Sale of low cost housing on loan

Section 13sept allows for a deduction where a tax payer sells a low cost residential unit to an employee.

The deduction is calculated as:

 10% of any amount owing to the taxpayer.

The deduction is not allowed:

 In the 11th year onwards.

 If the loan accrues interest
 If the unit costs more than the cost to the employer
 If disposal is subject to any condition other than an obligation on the employee to sell the unit back to the
employer on termination of employment.

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ILLUSTRATIVE EXAMPLE

A Ltd has a 31 August 2019 year end. The company had a 5 unit complex that was erected at a cost of R500, 000
and brought into use on 1 November 2012.

Each unit cost R100, 000 and was sold to 5 separate employees at a cost of R100, 000, financed by an interest free
loan given by the company to the employee.

A deduction of R10, 000 was claimed on each of the 5 units in terms of section 13 sept in the last financial year.
Annual repayments on the loan account are determined in accordance with the grade of an employee. One
employee repaid R5, 000. One employee repaid R15, 000 and another repaid R20, 000. The other 2 employees did
not repay any amounts.

Suggested solution

Employee 1 and 2 – no repayment

The outstanding amount = 100,000

Loan deduction is 100 000 X 2 X 10% (20 000)

Employee 3 repaid 5,000

Outstanding amount = 100 000 – 5 000 = 95,000

95 000 X 10% (9 500)

Employee 4 repaid R15, 000

The outstanding amount = 100,000 – 15 000 = 85 000

Loan deduction is 85 000 X 10% (8 500)

Employee 5 repaid R20, 000

The outstanding amount = 100,000 – 20 000 = 80 000

Loan deduction is 80 000 X 10% (8 000)

Recoupment

Section 13sept requires a recoupment where a tax payer receives payment on the low cost housing debt, where
the taxpayer claimed an allowance on such a debt.

The deduction claimed on the low cost loan is recouped when the loan is repaid (partly or in total) as the lower of:
32© FOR USE BY EDGE STUDENTS ONLY
  The amount of the repayment: or
 The amount deducted under this section in the current or previous year of assessment.

ILLUSTRATIVE EXAMPLE

A Ltd has a 31 August 2019 year end. The company had a 5 unit complex that was erected at a cost of R500, 000
and brought into use on 1 November 2019.

Each unit cost R100, 000 and was sold to 5 separate employees at a cost of R100, 000, financed by an interest free
loan given by the company to the employee.

A deduction of R10, 000 was claimed on each of the 5 units in terms of section 13 sept in the last financial year.
Annual repayments on the loan account are determined in accordance with the grade of an employee.

One employee repaid R5, 000. One employee repaid R15, 000 and another repaid R20, 000. The other 2 employees
did not repay any amounts.

Suggested solution

Employee 1 and 2 – no repayment

Therefore no recoupment

Employee 3 repaid 5,000

Recoupment is the lower of:

- The amount of the repayment (R5 000): or

- The amount deducted under this section in the current or previous year of assessment.

(R100 000 x 10% =R10 000 prior year plus R9 500 current year = 19 500)

Therefore recoupment R5 000

Employee 4 repaid R15, 000

The outstanding amount = 100,000 – 15 000 = 85 000

Recoupment is the lower of:

- The amount of the repayment (R15 000): or

- The amount deducted under this section in the current or previous year of assessment.

(R100 000 x 10% =R10 000 prior year plus R8 500 current year = 18 500)

Therefore recoupment R15 000

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Employee 5 repaid R20, 000

The outstanding amount = 100,000 – 20 000 = 80 000

Recoupment is the lower of:

- The amount of the repayment (R15 000): or

- The amount deducted under this section in the current or previous year of assessment.

(R100 000 x 10% =R10 000 prior year plus R8 000 current year = 18 000)

Therefore recoupment R18 000

Treatment of rental income

The income collected from residential property is included in to gross income of the tax payer.

ILLUSTRATIVE EXAMPLE

Ten residential units were bought in the year of assessment in The Birches complex at a cost of R400, 000 each.
They were let out at R3, 500 per month. The complex has 50 units.

Suggested solution

Rental income (10 x 3 500) 35 000

ILLUSTRATIVE EXAMPLES

The following buildings were all rented out by the taxpayer

Two residential units were bought on 1 September 2009 in The Birches complex at a cost of R400, 000 each. They
were let out at R3, 500 per month.

Eight new residential units were bought on 1 November 2009 in The Willows complex at a total cost of R1,
500,000. They were let out at R1, 800 a month. The Willows complex has 120 units.

The company erected a block of flats on 1 March 2010 at a cost of R2, 600,000. There were 20 units in the block of
flats and each flat was rented out for R1, 500 per month.

Bought 10 units in townhouse complex (The Palms) 2nd hand for R3, 000,000. Improved the units at a cost of R600,
000.

Bought 7 units in a 20 unit complex (The Oaks) for R1, 400,000. The units were 8 years old and had been
substantially renovated and improved. The units were unused since the renovation took place. They were rented
out for R3, 000 a month.

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SUGGESTED SOLUTIONS

2 residential units No write-off as own less than 5 units in the complex

0
8 units The Willows Cost 1,500,000 / 8 = 187,500 and rent of 1,800 is less than 1%
of cost per month thus low cost housing 1,500,000 X 55% X
10% (82,500)
20 units in block of Cost 2,600,000 / 20 = 130,000 and rent of 1,500 is more than 1%
flats of cost per month thus not low cost housing 2,600,000 X 5%
(130,000)
10 units townhouse 0
bought second hand

Not new or unused thus not deductible

Improve 10 units in Not low cost (30,000)
The Palms 600,000 X 5%
(21,000)
7 units in the Oaks 1,400,000 X 30% X 5%

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 4.3.5 Summary

RESIDENTIAL BUILDINGS

NEW OR UNUSED RESIDENTIAL BUILDINGS NEW OR UNUSED LOW COST RESIDENTIAL

BUILDINGS

New or unused residential buildings are written off as

follows: A low cost building is a building where it is a
stand alone unit with a cost of less than or equal
 5% X cost for residential buildings erected by to R200,000, or an apartment with a cost of less
the taxpayer
than and equal to R250,000
 5% X cost for residential buildings if the whole
building was acquired and
 55% X 5% X cost if part of a residential
building was acquired. Rental charged of less than or equal to 1% of the
 30% X 5% X cost if an improvement part of a cost of the unit
residential building was acquired.

Low cost buildings are written off in a similar

manner to residential buildings, but 10% may be
written off per annum, not the 5%.

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4.4 URBAN DEVELOPMENT ZONES – s13 quat

4.4.1 Qualifying assets

Section 13 quat applies to:

 The cost of commercial or residential buildings;

 Constructed or purchased new by the taxpayer (owned by the tax payer);and

 Used in own trade or let in urban development zones.

The allowance is claimable from on or after 21 October 2008.

The allowance is only claimed on the building and not the land.

The allowance is not apportioned

4.4.2 Write-off period

Constructed buildings

New buildings and extension of existing buildings qualify for the following allowances:

 20% of the cost of the erection in the first year and

 8% of the cost in each of the following 10 year assessment or
 5% of the cost in each of the following 16 years of assessment

ILLUSTRATIVE EXAMPLE

A Ltd erected building A in an urban development area at a cost of R2, 000,000.

What is the taxable income implications?

Erected Building AA urban development

2,000,000 X 20% = (400 000) First year

2,000,000 X 8% = (160 000) Second year till 11th year

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Refurbishment of existing buildings owned by the taxpayer qualifies for 20% allowances over 5 years.

ILLUSTRATIVE EXAMPLE

A Ltd refurbished building A in an urban development area at a cost of R 500,000.

What is the taxable income implications?

Erected Building AA urban development

500,000 X 20% = (100 000)

Purchased buildings

The purchase of a new buildings or part of the building qualifies for a 55% of purchase price on the allowance.

ILLUSTRATIVE EXAMPLE

A Ltd bought new building DD in 2008 tax year for R2, 000,000. The building is in an urban development area.

Suggested solution

New building R2 000 000 x 20% x 55% = R220 000

The purchase of a second hand buildings does not qualify for an allowance.

ILLUSTRATIVE EXAMPLE

A Ltd Bought building BB in urban development area 2nd hand for R1, 000,000 in January 2005. The company spent
R1, 300,000 improving the building in the current year.

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Suggested solution

Purchase building BB urban development

No write off as not purchased new

Improvement/refurbishment of building BB

20% X 1,300,000

The purchase of improvements qualifies for a 30% of the purchase price on the allowance.

ILLUSTRATIVE EXAMPLE

A Ltd bought new improvements to building DD in current tax year for R 200,000. The building is in an urban
development area. The deduction claimable is?

Suggested solution

New building R200 000 x 20% x 30% = R12 000

Low cost housing

Where a company refurbishes an existing low cost housing building it will qualify for a 25% per annum allowance.

ILLUSTRATIVE EXAMPLE

A Ltd refurbished existing building DD in current tax year for R 100,000. The building is in an urban development
area. The building is a low cost house. The deduction claimable is?

Suggested solution

New building R100 000 x 25% = R25 000

Where a company constructs a new low cost housing building it will qualify for a 25% allowance in the first year
and 13% per annum in year two to six, and 10% in year seven.

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ILLUSTRATIVE EXAMPLE

A Ltd constructed building DD in current tax year for R 100,000. The building is in an urban development area. The
building is a low cost house. The deduction claimable is?

Suggested solution

New building R100 000 x 25% = R25 000 year 1

New building R100 000 x 13% = R13 000 year 2 to year 6

New building R100 000 x 10% = R10 000 year 7

Where a company purchases a new building which is a low cost house it will qualify for 55% of the allowance.

ILLUSTRATIVE EXAMPLE

A Ltd purchased a new building DD in current tax year for R 100,000. The building is in an urban development area.
The building is a low cost house. The deduction claimable is?

Suggested solution

New building R100 000 x 25% x 55% = R13 750 year 1

New building R100 000 x 13% x 55% = R7 150 year 2 to year 6

New building R100 000 x 10% x 55% = R5 500 year 7

Where a company purchases new refurbishments to a low cost house, it will qualify for 30% of the allowance.

ILLUSTRATIVE EXAMPLE

A Ltd purchased new refurbishments to existing building DD in current tax year for R 100,000. The building is in an
urban development area. The building is a low cost house. The deduction claimable is?

Suggested solution

New building R100 000 x 25% x 30% = R7 500

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ILLUSTRATIVE EXAMPLE

A company:

Erected building AA in an urban development area at a cost of R2, 000,000.

Bought building BB in urban development area 2nd hand for R1, 000,000 in January 2005. Spent R1, 300,000
improving the building in the current year.

Bought building CC in urban development area 2nd hand for R1, 000,000 in January 2005. Spent R600, 000
improving the building in the previous financial year.

Bought new building DD in 2008 tax year for R2, 000,000. The building is in an urban development area.

What are the tax implications?

SUGGESTED SOLUTION

Erected Building AA
urban development
2,000,000 X 20% (400,000)
Purchase building BB
urban development
No write off as not purchased new 0
Improvement building
BB 20% X 1,300,000 (260,000)
Purchase building CC
urban development
No write off as not purchased new 0
Improvement building
CC 20% X 600,000 (120,000)

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4.4.3 Summary

URBAN DEVELOPMENT BUILDINGS

Not low cost Low cost

Erect new Improve existing building Erect a new building Improve existing building
building

Claim only on improvements Claim 25% in year 1, Claim only on

Claim 20% in year 13% in years 2 to 5 improvements
Claim 20% per annum straight
1 and 8% in years and 10% in year 6
line Claim 25% per annum
2-11
straight line

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5. Intangible assets

5.1 Registration – s11 (gB).

The following costs are deductible in full for intangible assets (i.e. patents, copyrights, designs and even
trademarks):

 Registration;
 Renewal;
 extension; or
 Restoration.

INTERACTIVE ILLUSTRATION

Management decided that the company’s brand needed to be protected, and as a result, the company’s
trademark registration was renewed on 1 February 2019, at a cost of R7 700.

How should this expenditure be treated?

Suggested solution

Trademark renewal 100% deduction (7 700)

5.2 Acquisition of intangible assets s11 (gC)

The following allowances are granted for the purchase of intangible assets used in the production of income:

 5% annual allowance on the purchase of patents and copyrights

 10% annual allowance on the purchase of designs
 100% deduction on the purchase of patents, copyrights and designs purchased for less than R5 000.
 No allowance on the purchase of trademarks

INTERACTIVE ILLUSTRATION

These costs were incurred during the year of assessment;

- The company purchased Patent A1 for R60 000;

- The company purchased Patent A 2 for R3 000;

- The company purchased Design A2 for R100 000;

- The company purchased from its competitor Trademark B2 for R200 000.
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What is the implication of the above mentioned transactions on taxable income?

SUGGESTED SOLUTION

Patent A1 60 000 x 5% (5 000)

[next]

Patent A2 3 000 x 100% (3 000)

[next]

Design A2 100 000 x 10% (10 000)

[next]

Trademark B2 200 000 x 0% (0)

5.3 Research and development S11D

Under section 11D a taxpayer gets a 100% deduction of revenue costs.

An additional 50% deduction is granted for revenue expenditure only if

 Approved by the Minister of Science and Technology,

 expenditure is incurred after the approval is received, and
 the expenditure meets the definition of research and development.

INTERACTIVE ILLUSTRATION

Easy Drive CC is an enterprise which manufacture motorcar spare parts. During the year of assessment the
company spent R100 000 in order to design and develop their own patent, “Park Assist System”. The design was
approved by the Minister of Science and Technology before the expenditure.

SUGGESTED SOLUTION

The expenditure is development as defined and therefore the expenditure qualifies for 150% deduction i.e. (100
000 x150% = 150 000).

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The additional deduction is also claimable if research is done by a third party on behalf of the tax payer as long
as the third party does not claim the allowance.

Non qualifying expenditure under s11D include:

 Market research or sales promotion,

 Administration costs,
 Quality control processes such as testing,
 Development of internal business processes,
 Social science research,
 Exploration of oil and gas,
 The creation of financial instruments,
 The creation or enhancement of trademarks or goodwill.

Some of the costs noted above may qualify for a section 11(a) deduction.

INTERACTIVE ILLUSTRATION

B Ltd incurred costs of R50 000 to develop a trade mark (Trade mark 1A).

SUGGESTED SOLUTION

Development of a trademark does not qualify for a section 11D deduction. Therefore no deduction.

Capital allowances of 50/30/20 are granted to a taxpayer for assets that are purchased and used directly in
research.

Research buildings qualify for a 5% allowance.

INTERACTIVE ILLUSTRATION

Gigabyte Systems (Pty) Ltd is a small business corporation. It researches, develops and manufactures electronic
tracking systems. The company researched and developed a completely new tracking device invention. A
microscope purchased for this research amounted to R68 000. The research was approved by the Minister of
Science and Technology. The company also purchased a research lab for R1 000 000.

SUGGESTED SOLUTION

Approved capital expenditure qualifies for a 50/30/20 allowance. The deduction will be:

Microscope 68 000 x50% = 34 000.

Lab 1 000 000 x 5% = 50 000

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Where research and development is government funded the taxpayer will not qualify for the additional 50%
deduction.

Section 11D is aimed at promoting self-funded research and development. Therefore when government funds
the project the additional deduction is not allowed.

INTERACTIVE ILLUSTRATION

A company researched and developed a completely new tracking device invention. The research project was
approved by the Department of Science and Technology on 1 June 2012, after which Digital Systems (Pty) Ltd
starting incurring research costs. Qualifying research costs amounted to R2 120 000 and administration related
costs of R160 000 were also incurred. The project was funded by means of a government grant of R2 million.

Suggested solution

Research costs

(R2 000 000 x 100%)

Funded portion does not qualify for s11D (2 000 000)

Amount incurred in excess of grant (unfunded)

(R120 000 x 150%) qualifies for s11D deduction (180 000)

Admin costs – deductible, section 11(a)

Does not qualify for S11D deduction (160 000)

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 5.4 Summary

INTANGIBLE ASSETS

INTANGIBLES INTERNALLY DEVELOPED

(RESEARCH AND DEVELOPMENT)

PURCHASED s11D
INTANGIBLES

Revenue expenses

OWN RESEARCH RESEARCH FOR 3RD

Intangibles Intangibles
PARTY
(other than (patents,
trademarks) inventions, design,
Revenue expenses such as research salaries
costing copyright, technical
and research consumables, and any The amount paid to
R5,000 or knowledge) bought
prototypes created not for sale are deducted the company by
less are for greater than
at 150% of cost if the 3rd party is
written off in R5,000
included in gross
 The expenditure is incurred in the
income.
production of income
Purchased  The expenditure is incurred in
Purchased Purchased trademarks carrying on a trade
patents, designs are are not  The research is approved by the a Revenue expenses
inventions, written off allowed to person authorized by the minister of such as research
copyrights at 10% be written science and technology salaries and
are written
off  Expenditure must be incurred after research
off at 5% this approval. consumables are
deducted at 100%
of cost
These allowances are not apportioned for
periods of less than 1 year. Capital expenses
Renewal costs (even for trademarks) are 50:30:20 no apportionment for research plant and equipment
deductible in full.
Building allowance (2% or 5%) applicable for buildings

Research includes discovering non-obvious scientific or technical knowledge, creating an invention(that can be registered as a
patent), design (that can be registered), computer program (which can be copyrighted), or knowledge how to use the patent,
design or computer program. Any improvement to the function, performance , reliability and quality will also be research.

Research does not include routine testing, analysis and collection of information in the normal course of business, development
of internal processes, market research, market testing, sales promotion, social science research, oil and gas or mineral

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6. DISPOSAL OF ASSETS

Consider the following

An enterprise purchased a two movable machine used in the process of manufacture in the 2018 year of
assessment.

In the 2019 year of assessment a fire destroyed one of the assets.

The other asset was sold by the enterprise at a profit.

What are the implications of the events?

6.1 SCRAPPING ALLOWANCE – s11 (o)

6.1.1 Qualifying allowances

Scrapping allowances can be claimed as a section 11(o) deduction when there is a loss event upon the disposal of:

 all manufacturing machinery per section 12C,

 small business corporation assets per section 12E;and
 all movable assets with a useful life of 10 years or less per section 11(e) wear and tear.

Scrapping losses are not applicable to land and buildings as there do not qualify for the allowances noted above.

ILLUSTRATION

A current client of yours asks whether a scrapping allowance can be claimed on the following assets:

A machine depreciated in terms of section 12C

A machine depreciated in terms of section 11(e)

Ship depreciated in terms of section 12C

Land

Office building

A factory building

Trademarks

Patents

Motor vehicles written off over 5 years

Trucks written off over 4 years

Computers written off over 3 years

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Research & Development

Safe written off in terms of section 11(e) over 25 years

Answer each part with either a yes or no.

SUGGESTED SOLUTION

Yes

Yes

Yes

No scrapping allowance on building

No scrapping allowance on building

No scrapping allowance on building

No, intangibles are written off in terms of section 11(gA)

No, intangibles are written off in terms of section 11(gA))

Yes

Yes

Yes

No, research and development claimed in terms of 11D therefore no scrapping allowance

No as written off over 25 years therefore no scrapping allowance.

6.1.2 Loss events

Losses on disposal of assets may occur when there is

 Sale of an asset, or
 Abandonment of an asset or
 Simply ceasing to use an asset.

6.1.3 Determining the allowance

Scrapping allowances are determined as follows:

1. Determine whether the asset involved is a qualifying asset for which a scrapping allowance can be
claimed.
2. Determine the cost of the asset.
3. Determine the amount of capital allowances allowed on the asset up to the date of disposal.
4. Determine the tax value ( 2 – 3)
5. Determine the proceeds that the asset was sold for.
6. The scrapping allowance will be the tax value less the proceeds on disposal (4-5)

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This may be displayed as follows:

Cost of the asset for tax purposes XXXX

Less: Capital allowances (xxxx)

Tax value XXXX

Less: Selling price on disposal (xxxx)

Scrapping allowance claimable XXXX

ILLUSTRATION – SCRAPPING ALLOWANCE

A Ltd bought a second hand machine for R10, 000 which is written off over 5 years, no apportionment on 1 January
20X1. A Ltd has a 31 March year end. The asset was sold on 1 January 20X3 for 3,000.

Calculate the loss that may be claimed on the sale of the machine.

Suggested solution

The tax value is calculated as follows:

Cost R10, 000

Less: Write off 31 March 20X1 year-end (R 2,000)

Less: Write off 31 March 20X2 year end (R 2,000)

Less: Write off 31 March 20X3 year end (R 2,000)

Tax value on the date of sale R 4,000

Less: Proceeds on disposal (R 3,000)

Loss on disposal of assets R 1,000

Scrapping losses are not applicable to land and buildings as there do not qualify for the allowances noted above.

ILLUSTRATIVE EXAMPLE

A factory building bought new for R1, 800,000 on 17 November 2010 was sold on 12 January 2020 for R1, 125,000.

Suggested solution

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Cost 1,800,000

Less: Dep 2010 – 2019

5% X 1,800,000 X 5 (450,000)

Less: Dep 2020

5% X 1,800,000 (90,000)

1,260,000

Selling price 1,125,000

Loss 135,000

Scrapping allowance cannot be claimed for buildings, therefore capital loss will be claimed.

Proceeds 1,125,000

Less: Base cost (1,260,000)

Capital loss 135,000

6.1.4 Other considerations

Scrapping allowances cannot be claimed if the transaction with a connected person.

Moving costs are included in scrapping allowances

ILLUSTRATION – SCRAPPING ALLOWANCE WITH MOVING COSTS

A Ltd bought a second hand machine for R10, 000 which is written off over 5 years. In the middle of year 2, the
machine was sold for R6, 400. However at the beginning of year 2, the machine was moved at a cost of R4, 000.
Machines are written off over 5 years, no apportionment, for tax purposes.

What are the tax implications?

Suggested solution

Cost R10, 000

Less: Depreciation year 1 (R 2,000)

Tax value a the end of year 1 R 8,000

Add: Movement cost capitalised R 4,000

Capitalised amount to be written off over 4 years R12, 000

Less: Depreciation year 2 (R 3,000)

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Tax value at the date of sale R 9,000

Less: Proceeds (R 6,400)

Loss on sale claimable for tax purposes R 2,600

6.1.5 Summary

SCRAPPING ALLOWANCES

SECTION 11(o)

Scrapping allowances can be claimed on all machinery per

section 12C, small business corporation assets per section
12E and all movable assets with a useful life of 10 years or
less per section 11(e) wear and tear

Losses on disposal of assets may occur when there is

1. Sale of an asset, or
2. Abandonment of an asset or
3. Simply ceasing to use an asset.

Scrapping allowances are determined as follows:

1. Determine whether the asset involved is a qualifying

asset for which a scrapping allowance can be claimed.
2. Determine the cost of the asset.
3. Determine the amount of capital allowances allowed on
the asset up to the date of disposal.
4. Determine the tax value ( 2 – 3)
5. Determine the proceeds that the asset was sold for.
6. The scrapping allowance will be the tax value less the
proceeds on disposal (4-5)

This may be displayed as follows:

Cost of the asset for tax

purposes
XXXX

Less: Capital allowances

= Tax value

Less: Proceeds on disposal

= Scrapping allowance claimable

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6.2 RECOUPMENTS – s8 (4) (a)

6.2.1 Qualifying allowances

Tax allowances that have been claimed by a taxpayer are recouped in terms of this section upon the disposal of
such assets.

6.2.2 Determining the recoupment

A recoupment arises when a depreciable asset is sold for more than tax value.

The recoupment calculated is included into gross income as a special inclusion.

A recoupment is determined as follows:

1. Determine the cost of the asset.

2. Determine the amount of capital allowances allowed on the asset up to the date of disposal.
3. Determine the tax value ( 1 – 2)
4. Determine the selling price that the asset was sold for (limited to cost).
5. The recoupment will be the proceeds less the tax value (4-3)

This may be displayed as follows:

Cost of the asset for tax purposes XXXX

Less: Capital allowances (xxxx)

Tax value XXXX

Less: Selling price on disposal (xxxx)

Recoupment XXXX

ILLUSTRATION

Thus if a machine costs R100 and has been written off by 60, and the machine is sold for R110, the recoupment
cannot be larger than 60.

What are the tax implications?

Suggested solution

The recoupment is calculated as follows:

Selling price limited to cost 100

Cost 100

Less: Allowances ( 60)

Tax value on disposal 40 (40)

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Recoupment – limited to 60

The other 10 profit will be subject to capital gains provisions.

6.2.3 Other considerations

ILLUSTRATION – ASSET SOLD BELOW COST

A Ltd buy a machine for R100, 000 second hand on 15 April 20X2. The machine is sold for R90, 000 on 1 April 20X3.
The company has a November year end. Assume the machine is written off at 20% per annum over 5 years no
apportionment.

What are the taxation implications on the sale of the machine? Ignore capital gains taxation

SUGGESTED SOLUTION

Initial cost of the machine R100, 000

Less: Section 12C allowance for the 20X2 tax year (R 20,000)

Less: Section 12C allowance for the 20X3 tax year (R 20,000)

Tax value on the date of sale R 60,000

The recoupment is based on the lower of cost or selling price

Tax value R 60,000

Lower of cost or selling price R 90,000

Recoupment R 30,000

The R30,000 profit above cost is capital in nature and subject to capital gains taxation.

ILLUSTRATION – ASSET SOLD FOR ABOVE COST

A car was originally bought for R30, 000. Over the past three and a half years, the company has claimed wear and
tear allowances of R21, 000. The current tax value is thus R9, 000. The car is sold for:

a) R20,000, or
b) R32,000
What are the tax consequences of the two sale amounts? Ignore capital gains tax implications.

SUGGESTED SOLUTION
Part a

If the car is sold for R20, 000, there will be a recoupment of R20, 000 - R9, 000 = R11, 000.

Part b
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The car is sold for greater than its original cost. The recoupment is limited to the lesser of R30, 000 (original cost)
or R32, 000 selling price. Thus R30, 000 will be used.

The recoupment is R30, 000 – R9, 000 = R21, 000.

There will be a capital gain. (See unit 7 for a calculation of this capital gain)

ILLUSTRATION – RECOUPMENT FROM AN INSURANCE CLAIM

A fire destroyed A Ltd’s machine that had a cost of R400, 000 and a tax value of R80, 000. The insurance company
paid R228, 000 to A Ltd in terms of A Ltd’s insurance policy. What are the tax implications? A Ltd is a vat vendor.

Suggested solution

The machine is deemed to be sold for R228, 000 including VAT to the insurance company for vat purposes.

The net selling price after VAT is R228, 000 X 100/115 = R198, 261.

The machine has a tax value of R80, 000 at the date of sale.

An amount of R120,000 (R200,000 proceeds – R80,000 tax value) will be recouped in terms of section 8(4)(a) of the
tax act.

ILLUSTRATION – RECOUPMENTS SECTION DOES NOT ONLY APPLY TO SALE OF ASSETS

A Ltd sells goods on credit to 3rd parties. Last year, a bad debt of R10, 000 was claimed in terms of section 11(i) of
the Act.

In the current year, the R10, 000 was paid by the creditor back to A Ltd.

What are the tax implications?

SUGGESTED SOLUTION

The R10, 000 allowed as a deduction in the past will be included in gross income as a recoupment for the current
year in terms of section 8(4)(a).

Any amount allowed as a deduction that is recovered can be recouped.

6.2.4 Deferral of recoupment

A recoupment is included in full in gross income and increases taxable income in the year of disposal.

Recoupments under specific conditions may be deferred and taxed over a certain number of years.

This section will explore when a deferral will be made and when it will not be made.

No deferral

If an asset is sold at a profit and not replaced, the recoupment and/or capital gain is reflected in the taxable
income and not deferred.

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ILLUSTRATIVE SOLUTION

Machine A bought new for R100, 000 on 1 February 2019 and sold on 31 August 2020 for R86, 000.

Cost 100,000

Less: Dep 2019 (40,000)

Less: Dep 2020 (20,000)

Tax value 40,000

Sold for 86,000

Recoupment 46,000

No capital gain as sold for less than cost and no deferral of recoupment.

If an asset is sold at a profit and replaced with asset/s where the receipts on disposal of the old assets are more
than the amount spent on the replacement assets, the recoupment and/or capital gain is reflected in the taxable
income and not deferred.

ILLUSTRATIVE EXAMPLE

Machine B bought 2nd hand for R300, 000 on 1 February 2020 was sold on 30 November 2020 for R340, 000.
Machine B was replaced by Machine Z, another 2nd hand machine which cost R250, 000 (total amount paid) from a
non-vendor.

Suggested solution

Cost 300,000

Less: Dep 2020 (60,000)

Tax value 240,000

Lesser of cost/SP 300,000

Less: Tax value (240,000)

Recoupment 60,000

Selling price 340,000

Less: Recoupment (60,000)

Proceeds 280,000

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Cost 300,000

Less: Allowances (60,000)

Base cost 240,000

Capital gain 40,000

There is no deferral as the replacement asset cost less than the receipt on disposal of the machine.

Machine Z

20% X 250,000 X 100/115 = 43,478

A factory building replaced with another factory building is dealt with in section 13 unless destroyed or
expropriated.

ILLUSTRATIVE EXAMPLE

An office building that was erected in 2002 at a cost of R4, 000,000 was sold for R5, 000,000 on 12 February 2020.
The building was replaced with another office building that the company erected at a cost of R6, 000,000.

Suggested solution

There is no write-off of the office building as it was erected prior to 1 April 2010. There is thus no recoupment

Proceeds on sale 5,000,000

Less: Base cost (4,000,000)

Capital gain 1,000,000

This gain is not deferred as the building was sold. Deferrals can only be done when a section 11(e), 12B, 12C, 12E
asset is replaced by a section 11(e), 12B, 12C, 12E asset.

Buildings are section 13 assets.

Recoupments and capital gains on buildings can only be deferred when the building is destroyed or expropriated

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New office

6,000,000 X 5% = (300,000)

ILLUSTRATIVE EXAMPLE

A new machine that cost R1, 000,000 on 1 October 2019 was bought to replace the computer mainframe that had
been sold. In the prior year, the recoupment of R250, 000 and capital gain of R150, 000 on the mainframe had
been deferred. This machine was sold in the current year for R780, 000 and there was no replacement asset. The
company has 28 February 2020 year end.

Suggested solution

Cost 1,000,000

Less: Dep 2019 (400,000)

Less: Dep 2020 (200,000)

Tax value 400,000

Sold for 780,000

Recoupment 380,000

Deferral recognized

Current year 250,000 X 20% 50,000

Remainder not yet recognized 250,000 X 40% 100,000

Capital gain recognized 150,000 X 20% 30 000

Remainder not yet recognized 150,000 X 40% 60 000

Deferral

Sold assets

If an asset is sold and:

1. Contract for replacement asset concluded within 12 months, and asset replaced within 3 years;
2. Replacement asset costs more than receipts on sale of old asset;

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 3. 11(e) wear and tear asset, 12B asset, 12C Machine, 12E Small bus corp asset to be replaced with an 11(e)
12B, 12C, 12E asset;
4. Proceeds on disposal to exceed or equal base cost of asset sold

Then the recoupment and capital gain on old asset is deferred and recognized as the new asset is written off.

The asset replacement need not be the same.

ILLUSTRATIVE EXAMPLE

Truck that cost R125, 000 on 1 October 2019 sold for R175, 000 on 1 July 2020. The receipt was used to buy a new
machine X at a cost of R200, 000. Trucks are written off over 4 years in terms of interpretation note 47.

Suggested solution

Cost 125,000

Dep 2019

3/12 X 125,000 X ¼ ( 7,813)

Dep 2020

6/12 X 125,000 X ¼ (15,625)

Tax value 101,562

Lesser of cost/SP 125,000

Less: Tax value (101,562)

Recoupment 23,438

Recoupment deferred

Capital gain

Selling price 175,000

Less: Recoupment (23,438)

Proceeds 151,562

Base cost 101,562

Capital gain 50,000

Capital gain deferred

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The asset was sold and asset replaced within 3 years; the replacement asset costs more (R200 000) than receipts
on sale of old asset (R175 000). Truck a section 11(e) wear and tear asset was replaced with a section12C asset.
Proceeds (175 000) on disposal exceed or equal base cost (101 562) of asset sold.

Note that a truck can be replaced with a machine. The assets need not be the same.

Machine X wear and tear 40% X 200,000 = (80 000)

Recoupment recognized 40% X 23,438 = 9 375

Capital recognized 40% X 50,000 = 200 000

Destroyed assets

The recoupment and capital gain on the disposal of any asset (excluding financial instruments) that is replaced
with any asset (excluding financial assets) when the asset was stolen, destroyed or expropriated may be deferred
if:

1. Contract for replacement asset concluded within 12 months, and asset replaced within 3 years.
2. Replacement asset costs more than receipts on sale of old asset.
3. Proceeds on disposal to exceed or equal base cost of asset sold.

ILLUSTRATIVE EXAMPLE

A machine was destroyed in the 2019 year. Insurance paid out R1, 800,000 for the machine. A recoupment of R1,
200,000 and capital gain of R400, 000 was deferred. SARS was told that the machine would be replaced with a
residential complex that would cost no less than R2, 000,000. The residential complex consisting of 10 units was
erected and brought into use in the current year at a cost of R2, 100,000 including vat. The units were given to
employees to use free of charge.

Calculate the income, deductions and capital gains of A Ltd.

Residential building 2,100,000 X 10% (210,000)

Recoupment recognized 1,200,000 X 10% 120,000

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Capital gain recognized 400,000 X 10% 40,000

The recoupment and capital gain are deferred until the new asset is brought into use.

Section 13 applies to the disposal of factory buildings unless when they are destroyed or expropriated. If a building
is destroyed then the recoupment provisions of this section will be applicable.

ILLUSTRATIVE EXAMPLE

A factory building was erected in 2018 at a cost of R2, 000,000. The factory was destroyed in the current year and
insurance paid out R2, 200,000. This money was used to buy a 2nd hand machine that cost R3, 000,000 in the
current year.

Suggested solution

Cost 2,000,000

Dep 2018,2019 (200,000)

Dep 2020 (100,000)

Tax value 1,700,000

Lower cost/SP 2,000,000

Less: Tax value (1,700,000)

Recoupment 300,000

Recoupment deferred paragraph 65

Selling Price 2,200,000

Less: Recoupment (300,000)

Proceeds 1,900,000

Base cost 1,700,000

Capital gain 200,000

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Capital gain deferred paragraph 65

Note the building need not be replaced by the same asset. Any asset can be replaced by any asset provided the
asset is not a financial instrument.

Replacement asset 3,000,000 X 20% = (600 000)

Deferral recoupment 300,000 X 20% = 60 000

Capital gain deferral 200,000 X 20% = 40 000

6.2.4 Summary
RECOUPMENTS

SECTION 8(4)(a)

Tax allowances that have been allowed are recouped in terms of this section.

The section does not apply only to fixed assets but any allowances that may have been granted such as capital allowances, or
bad debts or other deductions.

When a tax depreciable asset is sold for more than tax value, a recoupment occurs.

Recoupments are limited to the allowances that were previously granted on the asset being disposed of.

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7. LEASED ASSETS – LESSEE CONSIDERATIONS

An asset leased in terms of an operating lease bears the following characteristics:

 The asset is owned by the lessor.

 At the end of lease, asset is taken back by the lessor.

The following considerations need to be taken into account for operating leases:

7.1 RENTAL PAYMENTS

Rent paid is deductible if the property is used in the production of income according to section 11(a).

ILLUSTRATIVE EXAMPLE

A Ltd rented a machine as an operating lease. A monthly rental amount of R3 800 was also payable from 1 January
2019. The lease contract granted the use of the machine to A Ltd for a period of 5 years from 1 January 2019.
Year end is 31 March 2019.

Suggested solution

The amount included as a rental deduction is 11 400 (3 800 x 3)

If a plot of vacant land is rented subject to an improvement being placed thereon, the rent will not be deductible
until the improvement is brought into use.

ILLUSTRATIVE EXAMPLE

A Ltd wanted to rent a piece of vacant land adjacent to build an additional factory. The owner of the land actually
wanted to sell the property and granted the use of the land on a lease to A Ltd only after A Ltd had agreed to pay a
lease premium on 1 January 2018. A monthly rental amount of R3 800 was also payable from 1 January 2018. The
lease contract granted the use of the land to A Ltd for a period of 5 years from 1 January 2019. The new factory
construction was completed and brought into use on 1 January 2019. Year end is 31 March 2019.

Suggested solution

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The amount included as a rental deduction is 11 400 (3 800 x 3)

Deduction only from the date brought into use.

If a factory is leased subject to an improvement being added to the factory, rent can be deducted immediately
provided the existing factory is used immediately.

7.2 LEASE PREMIUMS

Lease premiums are lump sum amounts paid at the inception of the lease.

These lease premium lump sum amounts can be written off over the probable duration of the lease whilst the
asset is used in the production of income in accordance to section 11(g).

Formula

Lease premium amount paid

1/probable duration of lease (max 25 years) – original lease period plus extension period

no months used/12 (in the year of assessment)

ILLUSTRATIVE EXAMPLE

A Ltd wanted to rent a piece of vacant land adjacent to the factory for storage, parking and loading space. The
owner of the land actually wanted to sell the property and granted the use of the land on a lease to A Ltd only
after A Ltd had agreed to pay a lease premium of R150 000 on 1 January 2019. The lease contract granted the use
of the land to A Ltd for a period of 5 years from 1 January 2019. Year end is 31 March 2019.

Suggested solution

Lease premium amount paid (150 000)

1/probable duration of lease (max 25 years) – original lease period plus extension period – 1/(5 x 12) = 60

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 X

no months used (in the year of assessment) - 3

The deduction is therefore R7 500.

7.3 LEASE IMPROVEMENTS

When a lease is entered into, a term of the lease may be that improvements are effected to the leased property.

These improvements effected may be deducted from when the improvements on the property are finished till the
end of the lease.

Formula

Lower of amount spent and amount per contract

1/probable duration of the lease (max 25 years) - original lease period less period to completion date plus
extension period

No months used / 12 (in the year of assessment)

ILLUSTRATIVE EXAMPLE

F Ltd decided to lease a commercial building from which to sell some of its own manufactured stock and concluded
a lease agreement with P Ltd. The lease period commenced on 1 August 2018 for a 10-year period, with an
optional extension period of another five years.

In terms of this agreement F Ltd had to effect improvements on the premises to the value of R285 000. The
commercial building was brought into use by F Ltd on 1 August 2018. The building improvements commenced on
1 September 2018 and were completed and brought into use on 1 February 2019. The total cost of the
improvements was R305 000. The financial year end is 31 March 2019.

Suggested solution

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Improvements deduction

Improvements effected may be deducted from when the improvements on the property are finished till the end of
the lease.

Formula

Lower of amount spent and amount per contract (285 000) X

1/probable duration of the lease (max 25 years) - original lease period less period to completion date plus
extension period 1/ ((10 x 12) + (5 x 12) – 6) = 174 X

No months used (in the year of assessment) 2

Therefore, deduction should be R 3 276

Excess payments

If a lessee spent more on improvements than the contracted amount, such amounts may be claimed as an asset
allowance depending on the type of asset it is.

Excess portion = 305 000 – 285 000 = 20 000

Deduction = 20 000 x 0.05 = 1 000

Total deduction = 1 000 + 3 276 = R4 276

7.4 EXCESS AMOUNTS SPENT

If a lessee spent more on improvements than the contracted amount, such amounts may be claimed as an asset
allowance depending on the type of asset it is.

Thus if an extra R200, 000 is spent on a factory improvement, 200,000 X 5% (asset allowance granted for factories)
can be claimed on the excess.

ILLUSTRATIVE EXAMPLE

F Ltd decided to lease a commercial building from which to sell some of its own manufactured stock and concluded
a lease agreement with P Ltd. The lease period commenced on 1 August 2018 for a 10-year period, with an
optional extension period of another five years.

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In terms of this agreement F Ltd had to effect improvements on the premises to the value of R285 000. The
commercial building was brought into use by F Ltd on 1 August 2018. The building improvements commenced on
1 September 2018 and were completed and brought into use on 1 February 2019. The total cost of the
improvements was R305 000. The financial year end is 31 March 2019.

Suggested solution

Improvements deduction

Improvements effected may be deducted from when the improvements on the property are finished till the end of
the lease.

Formula

Lower of amount spent and amount per contract (285 000) X

1/probable duration of the lease (max 25 years) - original lease period less period to completion date plus
extension period 1/ ((10 x 12) + (5 x 12) – 6) = 174 X

No months used (in the year of assessment) 2

Therefore, deduction should be R 3 276

Excess payments

If a lessee spent more on improvements than the contracted amount, such amounts may be claimed as an asset
allowance depending on the type of asset it is.

Excess portion = 305 000 – 285 000 = 20 000

Deduction = 20 000 x 0.05 = 1 000

Total deduction = 1 000 + 3 276 = R4 276

7.5 VAT Considerations

Operating lease payments for a motor car will be deductible inclusive of vat as vat cannot be claimed on a motor
car.

An asset leased in terms of an operating lease bears the following characteristics:

 The asset is owned by the lessor. At end of lease, asset usually transferred to lessee

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  Operating lease payments are deductible in the hands of the taxpayer.

For finance leases, vat is claimed up front on the asset.

INSTALMENT CREDIT AGREEMENTS/ SUSPENSIVE SALES/HP AGREEMENTS

Instalment credit agreements are not considered to be leased assets.

These agreements place ownership of the asset into the user’s hands with a clause stating that in the event of non-
payment, the asset is returned to the seller.

Thus the user will claim depreciation/wear and tear and interest and not the lease payments as a deduction.

8. LEASED ASSETS – LESSOR CONSIDERATIONS

8.1 RENT RECEIVED

Rent received by the lessor is included in gross income.

Illustrative example

A Ltd decided to lease a commercial building from which to sell some of its own manufactured stock and
concluded a lease agreement with Property (Pty) Ltd. The lease period commenced on 1 August 2018 for a 10-year
period, with an optional extension period of another five years.

In terms of this agreement A Ltd had to pay a monthly rental amounting to R10 000 from 1 August 2018. The
financial year end is 31 March 2019.

Suggested solution

The amount included as a deduction is 80 000 (10 000 x 8 = 80 000).

8.2 LEASE PREMIUM

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Paragraph (g) of the gross income definition includes” any amount received or accrued from another person, as
premium or like consideration for the right of use of land, buildings, machinery, patents, designs, trademarks,
copyright, movie, disks for TV use or music use and like assets. This includes all lease premiums paid by a lessee in
the income of a lessor.

An example of a lease premium is a lump sum paid at the beginning of a lease agreement to secure a lease.

The full amount of the lease premium is included in gross income in the year in which it accrues/is received.

ILLUSTRATION

Stress Limited enters into a lease with a property fund to rent out an office building. The terms of the agreement
were that Stress Limited paid R1, 200,000 up front and then would pay rent of R23, 000 a month for the next 5
years.

What amount would be included in gross income of the property fund for the R1, 200,000 lease premium?

SUGGESTED SOLUTION

The lease premium of R1, 200,000 will be included in gross income

8.3 LEASEHOLD IMPROVEMENTS

Paragraph (h) of the gross income definition includes any amounts received in respect of leasehold improvements.

The amounts to be expended on the leasehold improvements as per the contract are included into gross income or
a fair amount representing the fair amounts for improvement is included in gross income if no amount is
stipulated.

If the lessee spends more than the amount stipulated in the contract, only the contracted amount will be included
in income unless the lessee could not have effected the improvements more cheaply.

The amount of income is subject to discounting per s11(h).

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It is departmental practice to include the amount of leasehold improvements in the lessor’s gross income in the
year in which the improvements are completed. According to a strict reading of the Act, leasehold improvements
should be included in gross income in the year in which the lease agreement is concluded.

Where the leasehold improvement is done and no amount is stipulated in the contract, the amount spent is
included in gross income.

ILLUSTRATION – LEASEHOLD IMPROVEMENT WITH NO AMOUNT SPECIFIED IN THE CONTRACT

A Ltd and B Ltd enter into a lease agreement whereby A Ltd agrees to effect leasehold improvements to the land
by building a factory there-on. No amount is stipulated in the agreement for the amount of the improvements. The
factory is built at a cost of R5, 000,000.

What are the tax implications?

SUGGESTED SOLUTION

As no amount is stipulated in the contract, the amount spent of R5, 000,000 will be included in the gross income of
the lessor.

ILLUSTRATION – VOLUNTARY IMPROVEMENT

A lessee voluntarily made improvements of R300, 000 to leased property. What are the tax implications for the
lessor?

SUGGESTED SOLUTION

No amount is added to the gross income of the lessor as there was no contractual obligation to the lessee to effect
improvements.

ILLUSTRATION – WORDING OF LEASEHOLD AGREEMENT CONTRACT

C Ltd and D Ltd entered into a leasehold contract stipulating that at least 4,000,000 leasehold improvements be
done by D Ltd.

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D Ltd actually spent R7, 000,000.

What are the gross income implications for C Ltd, the lessor?

SUGGESTED SOLUTION

The contract did not limit spending but stated at least R4, 000,000. Thus R7, 000,000 will be included in gross
income.

ILLUSTRATION – WORDING OF LEASEHOLD AGREEMENT CONTRACT

C Ltd and D Ltd entered into a leasehold contract stipulating that a 1,200 square meter factory needs to be erected
at a cost of R1, 000.

D Ltd actually spent R7, 000,000.

What are the gross income implications for C Ltd, the lessor?

SUGGESTED SOLUTION

R7, 000,000 will be included in gross income, as the contract was drafted with a clearly misleading clause to avoid
tax as the building could not be built for R1, 000.

8.4 RELIEF FOR LESSOR

Section 11(h) provides some relief for the lessor in certain circumstances.

As the lessor only gets the use of the property back in many years’ time, the Act allows a section 11(h) deduction
of the difference between

 the current value of the improvements and

 the discounted present value of the improvements in a few years’ time when the lessor gets the use of the
property back.

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The Commissioner usually allows the amount of the leasehold improvements to be discounted at a rate of 6% per
annum over the life of the initial lease agreement. Lease renewal periods are ignored. The period of discounting
begins on the day the improvements are completed.

ILLUSTRATION – INTEGRATED EXAMPLE

Company A (the lessor) enters into a lease agreement with Company B (the lessee).

The lease agreement, signed on 1 January, provides for

 improvements of R80,000,
 a rental of R1,000 per month and
 a lease premium of R10,000 to be paid up front.

The lease has an initial time period of 5 years, but may be renewed at the option of Company B for a further 15
years at a nominal rental. The Commissioner considers that the probable duration of the lease will be 20 years.
While the agreement was signed on 1 January, the improvements were only completed on 31 March. What will
the tax effects of Company A be for the year ended 31 December?

SUGGESTED SOLUTION

Rental income for the year ended 31 December R1, 000 X 12 R12, 000

Lease premium R10, 000

Leasehold improvements R80, 000

Less: Section 11(h) relief (R19, 342)

-----------

Income R82, 658

======

Section 11(h) relief

In order to calculate the relief, one needs to discount R80, 000 by 6% for 4 years and nine months (from date of
completion of improvements).

Using the financial calculator:

FV = R80, 000

n = 4.75 years

i = 6%

Compute PV
72© FOR USE BY EDGE STUDENTS ONLY
The answer you get is R60,658. The section 11(h) relief is thus R80,000 - R60,658 = R19,342.

Note that no allowance will be granted if the lessor and lessee are interested in more than 50% of the shares of
each other, or any third party holds more than 50% of the shares of both companies.

This makes sense as the group does not have to wait until some future date to get a benefit from the leasehold
improvement.

ILLUSTRATION – NO RELIEF FOR CONNECTED PERSONS

Mr A owns 60% of A Ltd and 70% of B Ltd. A Ltd enters into a lease with B Ltd. In terms of the agreement, B Ltd
must effect improvements of R100, 000. Will A Ltd obtain section 11(h) relief?

SUGGESTED SOLUTION

No, as the companies are owned more than 50% by Mr A.

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 8.5 Summary

LEASED ASSETS NOT A LEASED ASSET

ASSET LEASED IN TERMS OF AN ASSET LEASED IN TERMS OF A INSTALMENT CREDIT

OPERATING LEASE FINANCE LEASE AGREEMENTS/ SUSPENSIVE
SALES/HP AGREEMENTS

The asset is owned by the lessor. At The asset is owned by the lessor. At
the end of lease, asset is taken back end of lease, asset usually transferred These agreements place
by the lessor. to lessee ownership of the asset into the
user’s hands with a clause
stating that in the event of non
Operating lease payments are Finance lease payments are deductible payment, the asset is returned
deductible in the hands of the in the hands of the taxpayer. to the seller. Thus the user will
taxpayer. claim depreciation/wear and
tear and interest and not the
lease payments as a deduction
Note that for a finance lease, vat is
Note the nature of the asset for claimed up front on the asset. See the
vat. Operating lease payments for a capital allowances example to see how
motor car will be deductible vat is removed from lease payments
inclusive of vat as vat cannot be for assets where vat was claimed

LEASED ASSET WITH LEASE PREMIUMS AND IMPROVEMENTS

RENT LEASE PREMIUMS LEASE IMPROVEMENTS EXCESS

AMOUNTS
Rent is deductible if the SPENT
property is used in the
Lease premiums are lump When a lease is entered into, a
production of income.
sum amounts paid at the term of the lease may be that
inception of the lease. improvements are effected to the If a lessee spent
leased property. more on
Thus if a plot of vacant land improvements
is rented subject to an than the
These lease premium lump
improvement being placed contracted
sum amounts can be written These improvements effected
thereon, the rent will not be amount, such
off over the probable may be deducted from when the
deductible until the amounts may be
duration of the lease whilst improvements on the property
improvement is brought into claimed as an
the asset is used in the are finished till the end of the
use. asset allowance.
production of income. lease.

If a factory is leased subject Thus if an extra

Formula Formula
to an improvement being R200,000 is
added to the factory, rent Lease premium amount spent on a
can be deducted factory
immediately provided the X Lower of amount spent and
improvement,
existing factory is used amount per contract
1/probable duration of lease 200,000 X 5%
immediately.
74© FOR USE BY EDGE STUDENTS ONLY
 CHAPTER 7
CAPITAL GAINS TAX CLASS NOTES

Contents
1. INTRODUCTION TO CAPITAL GAINS TAX............................................................................................................. 2
1.1 Outline of the taxable income calculation .................................................................................................... 2
1.2 Outline of capital gains tax ........................................................................................................................... 3
1.2.1 Illustrative example............................................................................................................................... 4
2. PRINCIPLES ON THE DISPOSAL OF ASSETS .......................................................................................................... 5
2.1 When is CGT levied? ..................................................................................................................................... 5
2.2 Disposal......................................................................................................................................................... 5
2.3 Basic steps for calculating capital gains ........................................................................................................ 5
3. CALCULATION OF PROCEEDS .............................................................................................................................. 7
3.1 Non-depreciable capital assets ..................................................................................................................... 7
3.2 Depreciable assets ........................................................................................................................................ 7
4. CALCULATION OF BASE COST ............................................................................................................................. 8
4.1 Base cost of an asset after 2001 ................................................................................................................... 8
4.1.1 Depreciable asset ................................................................................................................................ 10
4.1.1 Non-depreciable assets....................................................................................................................... 11
4.2 Base cost of an asset before 2001 .............................................................................................................. 12
4.2.1 Asset 1 – Proceeds exceed expenditure – Paragraph 26 .................................................................... 14
4.2.2 Asset 2 – Proceeds exceed expenditure but less than MV – Paragraph 26 ........................................ 15
4.2.3 Asset 3 – Expenditure exceeds market value and proceeds ............................................................... 15
4.2.4 Asset 4 – Expenditure exceeds proceeds but less than market value ................................................ 16
5. ILLUSTRATIVE EXAMPLE ............................................................................................................................ 23
6. ASSESSMENT QUESTIONS ............................................................................................................................ 26

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1. INTRODUCTION TO CAPITAL GAINS TAX

1.1 Outline of the taxable income calculation

Income
=

Gross income less exempt income

Less

Deductions
=

General + specific + prohibited deductions

Equals

Taxable income before capital gains

Plus

Taxable capital gains

Equals

Taxable Income

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1.2 Outline of capital gains tax

AMOUNT RECEIVED BY A TAXPAYER

GROSS INCOME CGT

Amount received is treated as If an amount received is not gross income, the proceeds so received may
gross income if it complies be subject to taxes on capital gains.
with:

 The gross income

definition or
 Is specially included as
gross income in terms CGT FOR RESIDENTS CGT FOR NON RESIDENTS
of the Act
This is discussed in the chapter Non residents are taxed only on the
on gross income disposal of immoveable property or
SA residents are taxed on
interests in immoveable property
the disposal of worldwide
located in SA and on assets of a
assets for CGT purposes
permanent business establishment
located in SA

BASIC STEPS IN THE CGT PROCESS

1. For each asset that is disposed of

 Calculate the proceeds on disposal of the asset
 Calculate the base cost of the asset
 Deduct any amounts that are excluded, deferred or limited
 Profit/loss on asset = proceeds – base cost - exclusions
2. Add up the profits and/or losses determined in step 1
3. Deduct any assessed capital losses brought forward
4. Multiply the answer by 80% (if taxpayer is a company or trust)
5. Add the answer to taxable income.

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1.2.1 Illustrative example

ILLUSTRATION – GROSS INCOME VS CAPITAL GAINS

A Ltd sells a 15 metre long boat for R1, 200,000. What are the taxation implications if:
a) The directors use the boat for recreational purposes on the weekend, and
b) A Ltd runs a business which buys and sells boats and the boat was part of A Ltd’s stock in trade.

SUGGESTED SOLUTION

Part a

The sale of the boat will be capital in nature and such proceeds from the sale of the boat may form part of a
capital gains tax calculation.

Part b

The proceeds on the sale of the boat will form part of A Ltd’s gross income.

ILLUSTRATION – RESIDENT VS NON RESIDENT APPLICATION OF CGT

A taxpayer disposes of the following assets during the year:

1. Shares from a company registered in SA
2. Shares from an offshore company that has never traded in SA
3. A business in Cape Town that he has run from 1 January 1985 situated in Milnerton
4. A rolex watch that he used as his watch for 7 years. The asset was sold in Cape Town.
5. A house in Cape Town sold by the taxpayer.

Which items will form part of the CGT calculation if:

a) The taxpayer was a SA resident
b) The taxpayer is not a SA resident.

SUGGESTED SOLUTION

Part a

All the above items may form part of the CGT calculation as residents include all disposals of assets into their
capital gains tax calculations.

Part b

For a non-resident, Items 3 and 5 will be included in a CGT calculation as these are the only assets disposed of
that the CGT legislation would be applicable to.

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2. PRINCIPLES ON THE DISPOSAL OF ASSETS

2.1 When is CGT levied?

CGT is levied on the disposal of assets.

2.2 Disposal
Assets could be disposed of via sale, donation, expropriation, cession, redemption, scrapping or many other
similar disposals.

Assets can be disposed of through actual disposals or through deemed disposals.

Deemed disposals arise when a person actually does not dispose of an asset, but is deemed to dispose of the
asset for tax purposes.

The most common instance of deemed disposals are:

 Death: a taxpayer is deemed to have disposed of all assets on the date of death at market value.
 Emigration: a taxpayer is deemed to have disposed of all assets on the date of emigration at market
value.

It should be noted that currency is not considered to be an asset. Thus the disposal of currency is not subject
to capital gains.

2.3 Basic steps for calculating capital gains

Capital gains are determined as the proceeds less the base cost of an asset.

1. For each asset that is disposed of

 Calculate the proceeds on disposal of the asset (usually will be the selling price of the goods)
 Calculate the base cost of the asset (Usually the cost of the asset)
 Gain/loss on asset = proceeds – base cost - exclusions

2. Add up the gains and/or losses determined in step 1

3. Deduct any assessed capital losses brought forward

4. Multiply the answer by 80% if taxpayer is a company or trust

5. Add the answer to taxable income.

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ILLUSTRATIVE EXAMPLE

A taxpayer had a taxable income before capital gains of R300, 000. The taxpayer sold 2 assets during the year
and all three sales were subject to CGT.

Asset 1 cost R100, 000 and was sold for R625, 000.

Asset 2 was acquired for R105, 000 and sold for R60, 000.

The taxpayer had an assessed capital loss carried forward from the previous year of assessment of R20, 000.

Calculate the taxable income of the taxpayer after the inclusion of the capital gain if:

a) the taxpayer is a company

All assets of the taxpayers were acquired after 1 October 2001.

SUGGESTED SOLUTION

Step 1 – Determine the capital gain or loss on the disposal for each individual disposal

Asset 1 Asset 2

Proceeds R625, 000 R60, 000

Less: Base cost (R100, 000) (R105, 000)
R525, 000 (R 45,000)

Step 2 – Calculate the aggregate capital gain or loss for the year

Asset 1 capital gain R 525, 000

Asset 2 capital loss (R 45,000)
R480, 000

Step 3 – Deduct the assessed capital loss brought forward from the previous year

R480, 000
Less: Aggregate capital loss carried forward from the previous year (R 20,000)
Net capital gain R460, 000

Step 4 – Apply the inclusion rate

Net capital gain R460, 000

Inclusion rate X 80%
Capital gain included in taxable income R368, 000
Taxable income before capital gain R300, 000
Taxable income after the inclusion of the capital gain R668, 000
Tax payable (R 327 390 x 28%) R 187 040

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3. CALCULATION OF PROCEEDS
To calculate proceeds an entity has to distinguish between a depreciable and non-depreciable asset as the
assets have different implications on the calculation.

Depreciable assets are assets which qualify for capital allowances.

3.1 Non-depreciable capital assets

Proceeds for non-depreciable assets equals the selling price on the disposal of the asset before any selling
expenses are taken into account.

ILLUSTRATIVE EXAMPLE

Banana (Pty) Limited is a manufacturer of soccer balls and its year-end is 31 March 2014.

On 1 April 2012, Banana (Pty) Ltd bought land and a factory building at a cost of R1 370 000. According to the
contract the original purchase price was made up as follows:

Cost of land R450 000

Factory building R920 000

Owing to a cash flow problem, the company was forced to sell the land and factory building on 30 October
2013. The selling price was R3 825 000 and was arrived at as follows:

Land R1 175 000

Factory building R2 650 000

The total capital allowances claimed on the factory building was R92 000.

Which of the above mentioned assets is non-depreciable? And what are the proceeds?

Suggested solution

The land is non-depreciable

Proceeds on the land = R 1 175 000 (selling price on disposal of the asset)

3.2 Depreciable assets

Proceeds for depreciable assets equal the selling price less any income included in gross income.

The amount included gross income (recoupment) is determined as follows:

i. For a depreciable asset, this will be the lesser of selling price or cost less tax value known as
recoupment;
 For example a capital asset with a cost of R500, 000, a tax value of R400, 000 is sold for
R550, 000. Gross income/recoupment would be (Selling price) R500,000 – (tax value)
R400,000 = R100,000
 Therefore Proceeds = (Selling price)R550,000 – (Recoupment)R100,000 = R450,000
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ILLUSTRATIVE EXAMPLE

Banana (Pty) Limited is a manufacturer of soccer balls and its year-end is 31 March 2014.

On 1 April 2012, Banana (Pty) Ltd bought land and a factory building at a cost of R1 370 000. According to the
contract the original purchase price was made up as follows:

Cost of land R450 000

Factory building R920 000

Owing to a cash flow problem, the company was forced to sell the land and factory building on 30 October
2013. The selling price was R3 825 000 and was arrived at as follows:

Land R1 175 000

Factory building R2 650 000

The total capital allowances claimed on the factory building was R92 000.

Which of the above mentioned assets is depreciable? And what are the proceeds?

Suggested solution

The factory building is a depreciable asset

Proceeds = Selling price less recoupment

Recoupment: = Selling price (limited to cost) less tax value (cost less allowances)

= Selling price is 2 650 000 limited to cost of 920 000) – (Tax value: 920 000 – 92 000)

= 920 000 – 828 000

= 92 000

Proceeds = 2 650 000 – 92 000

= 2 558 000

4. CALCULATION OF BASE COST

For the calculation of base cost, one should distinguish between an asset purchased before 1 October 2001
and an asset purchased after 1 October 2001 and whether the asset is depreciable or non-depreciable.

4.1 Base cost of an asset after 2001

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Base cost represents the actual cost incurred by the tax payer for the acquisition and disposal of the asset.

Actual amounts included in base cost include:

 Cost of acquisition or creation
 Valuation costs incurred on valuing the asset
 Remuneration of a surveyor, valuer, auctioneer, accountant, broker, agent, consultant or legal
advisor, for services rendered;
 Stamp duty, transfer duty or similar duty
 Transfer costs
 Advertising costs to find a buyer
 Selling expenses
 The cost of moving an asset from one place to another
 Installation costs.
 Donations tax payable
 Legal costs not deductible in terms of section 11(a) or 11(c)
 Cost of an option
 Interest if interest is incurred wholly for business purposes on the acquisition of asset, and the
interest was not deductible for tax
 Cost of an improvement provided the improvement is still there on disposal

Cost does not include repairs, interest and rates and taxes which have already been included as a deduction in
taxable income i.e. general deduction s11(a) or repairs deduction s11(d).

ILLUSTRATION – POST 2001 BASE COST

Mr Homeowner bought a home for R2, 000,000 on 1 January 2002. He wanted to rent out the property to
receive rental income. He has incurred the following costs

 He built a new entertainment area at a cost of R500,000

 He added a Jacuzzi at a cost of R13,000, but ripped it out and threw it away before he sold the house.
 To get a bond on the house, bank valuer had to come out and value the property. He paid R3,000 for this
service.
 He hired his lawyer to inspect the offer to purchase document before signing the offer. The lawyer
charged R1,000
 Transfer duty of R92,000 was paid acquiring the house
 He took out a bond on the house when he acquired the house and paid R302,000 in interest up till the
time the bond was repaid in full
 He took out a further bond upon running into financial difficulties and paid interest of R130,000 before
this bond was also repaid
 Repairs of R480,000 were incurred on the house whilst the house was owned by him

He decided to sell the property in the current year and incurred the following costs

 He advertised the property himself initially and incurred costs of R15,000 unsuccessfully trying to sell the
property
 He paid an agent R300,000 in commission when she sold the property.

What is the base cost of the asset?

SUGGESTED SOLUTION

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Base cost is

Original cost R2, 000,000

Improvement – Entertainment area R 500,000

Improvement – Jacuzzi – Not there on sale and not added to base cost R 0

Valuation cost R 3,000

Lawyer charge R 1,000

Transfer duty R 92,000

Bond 1 interest – Took out wholly for purposes of financing the asset for business R 0

Bond 2 interest – Not taken out on acquisition, thus not part of base cost R 0

Repairs R 0

Advertising costs to find a buyer R 15,000

Selling expense R 300,000

Total base cost R2, 911,000

4.1.1 Depreciable asset

For a depreciable asset purchased after 2001, base cost is equal to cost less allowances plus selling costs.

ILLUSTRATIVE EXAMPLE

Banana (Pty) Limited is a manufacturer of soccer balls and its year-end is 31 March 2014.

On 1 April 2012, Banana (Pty) Ltd bought land and a factory building at a cost of R1 370 000. According to the
contract the original purchase price was made up as follows:

Cost of land R450 000

Factory building R920 000

Owing to a cash flow problem, the company was forced to sell the land and factory building on 30 October
2013. The selling price was R3 825 000 and was arrived at as follows:

Land R1 175 000

Factory building R2 650 000

The total capital allowances claimed on the factory building was R92 000.

Are the assets pre-2001 or post 2001 asset?

What is the base cost of the assets?

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Suggested solution

The assets are post 2001 assets.

Depreciable asset: factory buildings

Base cost = Cost less allowances plus selling costs

= 920 000 – 92 000

= 828 000

4.1.1 Non-depreciable assets

For non-depreciable assets purchased after 2001, base cost is equal to cost plus selling cost.

ILLUSTRATIVE EXAMPLE

Banana (Pty) Limited is a manufacturer of soccer balls and its year-end is 31 March 2014.

On 1 April 2012, Banana (Pty) Ltd bought land and a factory building at a cost of R1 370 000. According to the
contract the original purchase price was made up as follows:

Cost of land R450 000

Factory building R920 000

Owing to a cash flow problem, the company was forced to sell the land and factory building on 30 October
2013. The selling price was R3 825 000 and was arrived at as follows:

Land R1 175 000

Factory building R2 650 000

The total capital allowances claimed on the factory building was R92 000.

Are the assets pre-2001 or post 2001 asset?

What is the base cost of the assets?

Suggested solution

The assets are post 2001 assets.

Non - depreciable asset: land

Base cost = Cost

= 450 000
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4.2 Base cost of an asset before 2001
For Pre-2001 assets base cost = Valuation date value + post 2001 cost

Capital gains tax was introduced on 1 October 2001. This means that assets can only be taxed on capital gains
that occurred after 1 October 2001. Any capital gain from before the date is not taxable.

Therefore, an entity needs to determine the base cost on 1 October. This value determined for/on this date is
the valuation date value (VDV).

Valuation date value can be determined as either:

 The market value at 1 October 2001 (provided in the exam); or

 For people that did not value their property at 1 October 2001, and who did not have any of the
original purchase documentation, SARS allows post 1 October 2001 base cost to be 20% X (Proceeds
less post 2001 cost). (You have to calculate in the exam).
 For people that could find their original documentation, but did not do a market valuation as at 1
October 2001, a time apportioned base cost was allowed by SARS. (Provided in the exam).

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The table hereafter discusses how pre-1 October 2001 base cost is determined.

PRE-2001 BASE COST TABLE

Asset bought before 1 October 2001

Paragraph 26 – Proceeds exceed expenditure Paragraph 27 Proceeds do not

exceed expenditure

Initial test If market value is used for base cost and

Proceeds > Expenditure Proceeds < Market value 1 October 2001

Use the greater of Use the proceeds less the expenditure

1. Market value on 1 October 2001 incurred on the asset after 1 October 2001

2. Time apportioned base cost

3. 20% rule

Expenditure before 1 October 2001 In all other cases

equals or exceeds the proceeds and

exceeds market value

Use greater of
Use lower of

1. Market value; 1. Market value

2. Proceeds – expenditure incurred on the asset after 1 October 2001 2. Time apportioned
base cost
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ILLUSTRATION – APPLYING THE PRE 2001 BASE COST TABLE

For the following assets that were all bought prior to 1 October 2001, determine the capital gain or loss using
the pre 2001 base cost table shown previously

Time
Cost pre Cost post Market value apportioned
Asset Proceeds 1/10/2001 1/10/2001 1/10/2001 base cost
Asset 1 1,000,000 400,000 200,000 900,000 700,000
Asset 2 1,000,000 400,000 200,000 1,200,000 700,000
Asset 3 1,000,000 1,500,000 50,000 1,400,000 1,300,000
Asset 4 1,000,000 1,500,000 50,000 1,600,000 1,300,000

SUGGESTED SOLUTION

4.2.1 Asset 1 – Proceeds exceed expenditure – Paragraph 26

Proceeds = 1, 000, 000

Expenditure pre 1 Oct 2001 and post 2001 is = R400, 000 + 200 000

= R600 000

Thus Proceeds > Expenditure – use paragraph 26

Proceeds > Market value

Valuation date value is the greater of:

Market value (at 1/10/2001) = 900,000 (given)

TIME APPORTIONED BASE COST = R700, 000 (given)

20% rule = (Proceeds less post 2001 cost) x 20%

= (1,000,000 – 200,000) X 20%

= R160, 000

Thus valuation date value is R900, 000.

Base cost = Valuation date value + Post 1/10/2001 base cost

= R900, 000 + R200, 000

= R1, 100,000.

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Capital gain/Loss = R1, 000,000 – R1, 100,000

= (R100, 000) loss

4.2.2 Asset 2 – Proceeds exceed expenditure but less than MV – Paragraph 26

Proceeds = 1, 000, 000

Expenditure (pre 1 Oct 2001 and post 2001) = R400, 000 + R200 000

= R600 000

MV at 1/10/2001 = 1,200,000

Thus Proceeds > Expenditure – use paragraph 26

However as MV > Proceeds Therefore use proceeds less expenditure after 2001

Valuation date value = 1,000, 000 – 200 000

= 800, 000

Base cost = VDV + post 2001 cost

= 800, 000 + 200, 000

= 1, 000, 000

Capital gain/Loss = R1, 000,000 – R1, 000,000

= R0

4.2.3 Asset 3 – Expenditure exceeds market value and proceeds

Proceeds = 1, 000, 000

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Expenditure ( pre 1 Oct 2001 and post 2001) = R1, 550,000

Thus Proceeds < Expenditure – use paragraph 27

Expenditure exceeds MV

Thus use greater of:

Market value = R1, 400,000; or

Proceeds – post 2001 expenditure = 1,000,000 – 150,000

= R850, 000

Thus Valuation date value is the greatest, which is R1, 400,000.

Base cost = Pre 1/10/2001 base cost + Post 1/10/2001 base cost

= R1, 400,000 + R150, 000

= R1, 550,000.

Capital gain/Loss = R1, 000,000 – R1, 550,000

= R550, 000 loss.

4.2.4 Asset 4 – Expenditure exceeds proceeds but less than market value

Proceeds = 1, 000, 000

Expenditure pre 1 Oct 2001 = R1, 550,000

thus Proceeds < Expenditure – use paragraph 27

As Market value exceeds expenditure use lesser of:

Market value = R1, 600,000: and

TIME APPORTIONED BASE COST = R1, 300,000

Thus VDV is the lower, which is R1, 300,000.

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Base cost = VDV + Post 1/10/2001 base cost

= R1, 300,000 + R150, 000

= R1, 450,000.

Capital gain/Loss = R1, 000,000 – R1, 450,000

= R450, 000 loss.

ILLUSTRATION – DEPRECIABLE ASSET BOUGHT POST 1 OCTOBER 2001

A machine was bought new on 1 November 2009 for R200, 000 and was sold on 12 January 2012 for R260,
000. The tax value on the date of sale was R40, 000. Calculate the amount of the capital gain on the sale of the
asset.

SUGGESTED SOLUTION

Step 1 – Calculate the tax value of the asset

R40, 000 given

Step 2 – Calculate the recoupment on sale

Recoupment on sale of the asset = R200, 000 – R40, 000 = R160, 000

Step 3 – Calculate proceeds

Proceeds = Selling price adjusted for tax effects

Proceeds = R260, 000 selling price – R160, 000 recoupment = R100, 000

Step 4 – Calculate base cost

Base cost = cost adjusted for tax effects

Base cost = cost – amounts written off the asset = 200,000 – 160,000 = R40, 000.
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Step 5 – Calculate capital gain

The capital gain = proceeds – base cost = R100, 000 – R40, 000 = R60, 000.

ILLUSTRATION – CGT WITH ASSET ACQUIRED PRE 1 OCTOBER 2001

A Ltd owned an asset which was used in a process of manufacture. The machine was bought on 1 October 1995
at a cost of R3 000 000 and brought into use on that date. The machine was sold on 30 September 2012 for
R3 700 000.

An assessed capital loss was brought forward from the previous year of assessment and amounted to R265 000.

Calculate A Ltd’s taxable capital gains or assessed capital loss for the year of assessment ended
31 December 2012. (All amounts exclude VAT)

The time apportioned base cost is R350, 000.

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SUGGESTED SOLUTION

Step 1 – Calculate tax value of the asset

Asset tax value is nil. Bought 1995 and written off over 5 years therefore fully written off.

Step 2 - Calculate the recoupment

Lower of cost or selling price R3, 000,000

Less: Tax value (R NIL)

Recoupment R3, 000,000

Step 3 – Calculate proceeds

Selling price R3, 700,000

Less: Recoupment (R3, 000,000)

Proceeds R 700,000

Step 4 – Calculate base cost

 Calculate post 2001 costs – There are none

 Calculate the valuation date value (as at 1 October 2001):

As the proceeds exceeds the expenditure, determine the following three items:

- Market value at 1/10/01, not given; or

- 20% x (proceeds after deducting expenditure incurred after the valuation date)

= 20% x (R700 000 - R0)

= R140 000

- Time apportionment base cost =R350, 000 (given)

 Calculate base cost:

Base cost = valuation date value + cost after 1/10/01

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Base cost = R350, 000 + R0

= R350, 000

Proceeds 700 000

Less: Base cost 350,000

Capital gain 350,000

Less: Assessed capital loss, brought forward from previous

Year of assessment 265,000

Net capital gain 85,000

Taxable capital gain (R85, 000 x 80%) 68, 000

ILLUSTRATION – CGT WITH PRE AND POST 2001 COSTS

A Ltd bought a new machine on 1 January 2000 for R2, 000,000.

At 1 October 2001, the machine was valued at 1,100,000 by an independent appraiser.

During the current year, a new finishing machine (that is capable of being used separately from the existing
machine) was added to the machine at a cost of R400, 000.

Both the machine and the finisher were sold for R3, 600,000 just before year end.

Time apportioned base cost is R1, 120,000.

Calculate the income tax and capital gains for the above asset for the year ended 28 February 2017.

SUGGESTED SOLUTION

Step 1 Determine the tax value of the assets on the date of sale

Asset bought before 1/10/2001

Tax value is nil. The asset is fully written off.

Cost R2, 000,000

Less: Allowances to date (R2, 000,000)

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 Nil

Asset bought after 1/10/2001

Cost R400, 000

Less: 40% allowance this year (R160, 000)

Tax value R240, 000

Step 2 – Calculate the tax recoupment on the sale of the goods

Selling price R3, 600,000

Less: Tax value on the date of sale (R 240,000)

3, 360 000

Limited to allowances granted in the past (see working below) R2, 160,000

Workings

Tax cost (R2, 000,000 + R400, 000) R2, 400,000

Tax value (RNil + R240, 000) (R 240,000)

Allowances granted in the past R2, 160,000

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Step 3 – Calculate proceeds

Proceeds = R3, 600,000 – R2, 160,000 = R1, 440,000

Step 4 – Calculate base cost

The base cost of the acquisition after 1/10/2001 is R400, 000 – 160,000 = R240, 000.

The base cost of the acquisition before 1/10/2001 needs to be calculated as the higher of:

 Market value R1,100,000

 Time apportioned base cost given of R1,120,000
 (Proceeds–exp post 1 Oct 2001) X 20% = (R1,440,000–240,000) X 20% = R240,000

Use the higher amount which is time apportioned base cost. This gives the value at 1 October 2001.

The total base cost = R240, 000 (post) + R1, 120,000 (pre) = R1, 360,000.

Step 5 Calculate capital gain

Proceeds R1, 440,000

Less: Base cost before 1/10/2001 (R1, 120,000)

Less: Base cost after 1/10/2001 (R 240,000)

Capital gain R 80,000

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5. ILLUSTRATIVE EXAMPLE
On 1 July 2001, Charlie’s Famous Chocolate Ltd acquired a factory where they produce theirworld famous
chocolate. The factory cost R1 500 000. The factory qualified for the section 13manufacturing building all
owance.

On 30 June 2006, additions to the factory were completed at a cost of R160 000. Charlie’sFamous Choc
olate Ltd decided to sell the factory because it was offered a good price for it. Itwas sold on 30 Septem
ber 2012 for R1 800 000. The time apportionment base cost for the factory was R671 084 and the market v
alue was R600 000 on 1 October 2001.

Original factory Additions to Total

factory
Cost R1 500 000 R160 000 R1 660 000
Allowances (R 900 000) (R 56 000) (R 956 000)
Tax values on 30 September 2012 R 600 000 R104 000 R 704 000

Note the following applicable values:

Charlie’s Famous Chocolate Ltd had a capital loss of R50 000 in the previous year.

Calculate the taxable capital gain for the year of assessment ended 31 December 2012

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Suggested solution

Calculation of recoupment for income tax purposes:

Selling price 1 800 000
Less: Tax value (704 000)
Potential recoupment 1 096 000

Limited to previous allowances claimed 956 000

Proceeds:
Selling price 1 800 000
Less: Recoupment (as calculated above) (956 000)
844 000
Determine the base cost to be used:
As the asset was purchased before 1 October 2001, the base cost con-
sists of the valuation date value plus any expenses after 1 October 2001.

Calculate the valuation date value as the greatest of:

(1) Market value

600 000
(2) Time apportionment based cost (TAB) is given as
671 084
(3) 20% rule
Proceeds
(adjusted proceeds – must agree to amount calculated above) 844 000

Less: Expenditure incurred after 1 October 2001 160 000

Less: allowances (56 000)

740 000
Valuation date value- 20% rule (R740 000 x 20%)
148 000

Paragraph 26 is applicable, because the proceeds (R844 000) > the

expenditure incurred before and after 1 October 2001 (R704 000).

Valuation date value is TAB since it is the greatest amount:

Valuation date value – as calculated above 671 084

Plus: Expenditure incurred after 1 October 2001 160 000
Less: allowances (56 000)
104 000
Base cost will therefore be 775 084
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Taxable capital gain is therefore calculated as follows:

Proceeds (adjusted) 844 000

Less: Base cost - as calculated above (775 084)
Capital gain 68 916
Less: Loss brought forward from previous year (50 000)
Net capital gain for the year 18 916

Inclusion rate of 80% 15 133

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6. ASSESSMENT QUESTIONS

Question 1

Rings and Things (Pty) Ltd manufactures jewellery. Its year of assessment ends on 31 March 2013. A
manufacturing machine of the company was destroyed in a fire on 31 January 2013. The machine was
originally purchased second hand on 31 May 2011 for R500 000 and was brought into use on the same date in
a process of manufacture. The destroyed machine was sold to a scrap dealer on 15 February 2013 for R15 000.
Rings and Things (Pty) Ltd paid advertising costs of R1 000 to advertise the scrap (destroyed machine) for sale
in several newspapers. An indemnity payment of R600 000 was received on 31 March 2013 from Rings and
Things (Pty) Ltd’s insurance company.

Required

Calculate the taxable capital gain/loss for the 2013 year of assessment.

Question 2

Go-Go (Pty) Ltd purchased an office building on 1 August 1982 at a cost price of R1 235 000. No capital
allowances were claimable on this building. Transfer duty and transfer costs amounted to R133 500.

During November 2006, extensive improvements were effected to the building amounting to R832 000. The
company sold the building on 15 December 2013 for R12 500 000. The time apportionment base cost is R5
539 026. Go-Go also paid agent’s commission to the amount of R67 500 when the building was sold.

Required:

Calculate the taxable capital gain or capital loss that Go-Go (Pty) Ltd realised in selling the building for the year
of assessment ended 31 March 2014, if the market value of the building on 1 October 2001 amounted to:

a) R12 000 000, or

b) R14 000 000.

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CHAPTER 8
DIVIDENDS TAX

Table of Contents
1. basic mechanics of Dividends tax AND THE TAXATION OF DIVIDENDS RECEIVED ................................................... 2
1.1 RATE OF DIVIDENDS TAX .................................................................................................................................... 2
1.2 income taxation of dividends and dividends tax aspects ................................................................................... 2
1.3. GENERAL PROCESSES AND EXEMPTIONS .......................................................................................................... 3
2. DIVIDEND DEFINITION .............................................................................................................................................. 5
2.1 GENERAL DISCUSSION OF CONTRIBUTED SHARE CAPITAL................................................................................. 7
3. WHO PAYS DIVIDENDS TAX....................................................................................................................................... 9
4. When is dividends tax payable ............................................................................................................................... 10
5.Dividends in specie .................................................................................................................................................. 11
6. Exemptions from dividends tax .............................................................................................................................. 12
7. refunds section 64l and section 64m ...................................................................................................................... 14

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1. BASIC MECHANICS OF DIVIDENDS TAX AND THE TAXATION

OF DIVIDENDS RECEIVED
Dividends tax was introduced from 1 April 2012.

This sections deals with the basics of dividends tax. These include:
 The rate of dividends tax
 Income tax and dividends tax implications
 General processes and exemptions

1.1 RATE OF DIVIDENDS TAX

Dividends tax is levied at a rate of 20% on the dividend that is declared by a company.

Dividends tax can be paid at a lower rate when there is a double tax agreement regulating the rate of dividends
tax.

ILLUSTRATION – RATE OF DIVIDENDS TAX

A Ltd has two shareholders, Mr D, a SA resident that owns 60% of the shares and Mr E, a non-resident that owns
40% of the company.

A Ltd declared a dividend of R10,000.

The country that Mr E is a resident of has a double tax agreement with SA and the amount of dividends tax
payable by such non-residents is at a rate of 8%.

Calculate the amount of dividends tax payable.

SUGGESTED SOLUTION

Mr D – 60% X R10,000 X 20% = R1 200

Mr E (non resident) – 40% X 10,000 X 8% = R320

1.2 INCOME TAXATION OF DIVIDENDS AND DIVIDENDS TAX ASPECTS

Dividends tax is not levied on the company paying the dividend.

Dividends tax is a tax levied on shareholders that receive dividends.

The company declaring the dividend is required to withhold tax on dividends paid, and pay such withholding tax
across to SARS on behalf of the shareholder. This is not a tax paid by companies.

The shareholder receives the net dividend after withholding tax has been taken off.

ILLUSTRATION – BASIC MECHANICS OF DIVIENDS TAX EXAMPLE 1

A company declares a dividend of R1,000 to Mr A, a shareholder.

Discuss what the process relating to dividends tax.

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SUGGESTED SOLUTION

Dividends tax is payable by Mr A. The dividends tax is 15% X R1,000 = R150.

The company withholds this R150 from Mr A and pays this across to SARS.

R850 is paid to Mr A by the company.

In most instances, as dividends tax has been withheld on the dividend paid, the dividend is exempt as per section
10(1)(k) of the Act.

ILLUSTRATION – BASIC MECHANICS OF DIVIENDS TAX EXAMPLE 2

A Ltd declares a dividend of R1,000 to Mr A, a SA resident shareholder.

Discuss what the taxation implications are?

SUGGESTED SOLUTION

Dividends tax is payable by Mr A. The dividends tax is 15% X R1,000 = R150.

The company withholds this R150 from Mr A and pays this across to SARS.

R850 is paid to Mr A by the company.

Mr A includes R1,000 as his dividend gross income.

The full R1,000 is exempt from taxation.

1.3. GENERAL PROCESSES AND EXEMPTIONS

Companies registered in South Africa do not pay dividends tax. There are some others that do not pay tax which
are discussed later in the chapter.

All other taxpayers are required to pay dividends tax.

Dividends tax is withheld by the company in all instances other than when:
 Paid to a SA company, or
 Paid to a registered intermediary who will pay the dividends tax over to SARS
o An example of this is a unit trust, who will receive the dividend, and will pay dividends tax across
to SARS for all shareholders other than companies that own units in the unit trust fund.

The company paying the dividend determines whether a shareholder is a SA company or not by getting
shareholders to fill out forms.

Dividends tax is separate from income tax. Income tax is levied at a rate of 28% of taxable income earned by
companies.

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ILLUSTRATION – BASIC MECHANICS OF DIVIDENDS TAX EXAMPLE 2

Mr A and Buster (Pty)Ltd are the only two shareholders of Custard (Pty) Ltd, a company registered and controlled
in South Africa.

Custard (Pty) Ltd sent out forms to these 2 shareholders.

Mr A declared that he was an individual, and Buster (Pty) Ltd declared that it was a SA company, exempt from the
payment of dividends tax.

In addition, Buster (Pty) Ltd also sent out forms to Mr A. Mr A declared that he was an individual, liable to pay
dividends tax.

During the current year, Custard (Pty) Ltd made R3,000,000 taxable income, and decided to pay R1,000,000 as a
dividend to shareholders.

Mr A owns 80% of Custard (Pty) Ltd and 100% of Buster (Pty) Ltd.

Buster Pty (Ltd) only owns 20% of Custard (Pty) Ltd, and has no other interests, income or expenses. B (Pty) Ltd
decides to declare a dividend of R200,000.

Calculate the tax payable in respect of the above two dividend payments.

SUGGESTED SOLUTION TO ILLUSTRATION

Custard (Pty) Ltd

Custard (Pty) Ltd pay income tax of R3,000,000 X 28% = R840,000 income tax.

Custard (Pty) Ltd declared a dividend of R1,000,000.

R200,000 of the dividend is paid to Buster (Pty) Ltd. There is no dividends tax payable as Buster (Pty) Ltd is a SA
resident company.

Mr A receives a dividend from Custard (Pty) Ltd of 80% X R1,000,000 = R800,000. Dividends tax of 15% X R800,000
= R120,000 will be withheld by Custard (Pty) Ltd and paid across to SARS.

Mr A will receive a net dividend of R800,000 – R120,000 = R680,000. As dividends tax has been paid on this local
dividend:
 Mr A will include R800,000 into his taxable income in his tax return
 All R800,000 will be exempt as local dividends are exempt (as there has been dividends tax already)

As regards Buster (Pty) Ltd,

 A dividend of R1,000,000 X 20% is declared to the company.
 The company will receive all R200,000. No dividends tax is withheld when paying such amount to a South
African company.
 The company will pay no tax on the R200,000 dividend declared.

Buster (Pty) Ltd

Buster (Pty) Ltd includes R200,000 into Gross income from the dividend received. The full R200,000 is exempt from
income and no income tax is payable by Buster (Pty) Ltd.

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As regards Mr A:
 Mr A will receive a dividend of R200,000 from Buster (Pty) Ltd
 As Mr A is not a South African company, withholding tax of 15% will be withheld on the dividend of R200,000
and R30,000 will be paid to SARS.
 Mr A will receive R170,000 in cash.
 Mr A will include R200,000 into his taxable income in his tax return
 All R200,000 will be exempt as local dividends are exempt.

2. DIVIDEND DEFINITION
Dividends are
 Any amount transferred or applied by a resident company for the benefit of any person that owns shares in
the company
 In respect of a share held by that shareholder
o By way of a distribution (such as when cash or an asset is distributed by the company to a
shareholder)
o By way of consideration for the share (such as when an amount is paid to the shareholder the
company when there is a share buyback)
 But will not include
o Return of contributed tax capital (such as share capital or share premium being returned)
o An issue of shares by the company (thus capitalisation issues of preference shares and ordinary
shares will not be a dividend as defined)
o Amounts given to shareholder that relates to fees, services rendered or remuneration earned by
the shareholder.
o When a listed company repurchases its own shares in terms of JSE requirements.

On a simplistic level, there are a number of transactions that companies may encounter where shareholders are
paid an amount by the company. These include:
o Salaries, fringe benefits and fees given to employees / service providers of a company (that are also
shareholders) for the work performed on behalf of the company
o This is not treated as a dividend received but as remuneration or professional fees paid.
o Distribution of profits given to shareholders in the ordinary course of business to ordinary shareholders
and preference shareholders.
o This would normally be termed an ordinary dividend or a preference dividend and will be treated
as a dividend as defined
o Payment of interest on a shareholders loan given to the company.
o This is not a dividend as this is interest paid.
o Note that in certain circumstances such as section 31 transfer pricing that the interest can be
converted into a dividend if there is excessive interest paid.
o Buyback of share capital
o When share capital is bought back, the accounting share capital is reduced.
o The company will decide how much of its contributed share capital is returned.
o The portion that is not a return of contributed capital will be a dividend.
o Capitalisation issues
o These are not treated as dividends
o When these are added to share capital (the accounting entry is usually debit retained income
and credit share capital), these amounts do not constitute contributed capital.
o It is important to analyse share capital to split contributed capital from share capital created
when there is a capitalisation issue.
o Debts of the shareholder paid by the company
o If paid because shareholder is an employee, and is received in the capacity of an employee, this
is not a dividend
o If paid because the person is a shareholder, this is a dividend
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o Write-off of a shareholder loan where the shareholder owes the company money
o In the event of a loan being written off, this is a dividend as the shareholder has received a
benefit in his capacity as a shareholder.
o Dividends in specie (transfer of an asset rather than cash) to shareholders are a dividend as defined and
are valued at market value.

The following is a summary of the amounts received by shareholders in a company that are treated as a dividend.

DISTRIBUTIONS TO IF A COMPANY WRITES OFF A IF A COMPANY BUYS BACK ITS

SHAREHOLDERS OF ORDINARY LOAN OWING BY A SHARES, THE DIVIDEND WILL BE
SHARES IN THE ORDINARY COURSE SHAREHOLDER, THIS WILL BE A THE AMOUNT RECEIVED BY THE
OF BUSINESS WILL BE CLASSIFIED DIVIDEND SHAREHOLDER LESS THE AMOUNT
AS A DIVIDEND OF CONTRIBUTED TAX CAPITAL
ALLOCATED TO THE TRANSACTION

DISTRIBUTIONS TO
SHAREHOLDERS OF PREFERENCE LOCAL DIVIDENDS RECEIVED
IF A COMPANY PAYS THE DEBTS
SHARES IN THE ORDINARY COURSE OF THE SHAREHOLDER, THIS WILL
OF BUSINESS WILL BE CLASSIFIED BE A DIVIDEND AS LONG AS THIS
AS A DIVIDEND IS NOT TREATED AS
REMUNERATION.

ILLUSTRATION – APPLICATION OF THE DIVIDEND DEFINITION

For each of the following, determine whether a dividend has been received for ABC Limited. ABC Limited is a
company that is registered and controlled in SA. If the amount is a dividend received, determine how much the
dividend is?
1. Mr A owns 40% of Albert Limited, and is the major shareholder. He is employed by the company and receives
a bonus of R80,000 in his capacity as CEO of the company.
2. Management fees of R30,000 was received from a wholly owned subsidiary, F Pty(Ltd)
3. A distribution of R10,000 was made by D Ltd to the owners of ordinary shares in D Ltd
4. A preference dividend of R20,000 was received from E Ltd
5. Three Limited pays interest of R100,000 on a R1,000,000 loan to Two Limited, its holding company.
6. R50,000 was received from G Ltd when G Ltd bought back shares. Included in the R50,000 was R14,000
contributed tax capital (R4,000 share capital and R10,000 share premium.)
7. A bonus issue of ordinary shares was received from F Ltd that was worth R40,000
8. A company has a contributed capital of R100,000 when a 1:2 capitalisation issue debiting retained income
with R50,000 and crediting share capital with R50,000. After this capitalisation issue, share capital is stated as
R150,000. (This consists of R100,000 contributed share capital and R50,000 reserves converted into share
capital.) A distribution is made of R100,000 of which R40,000 is taken from contributed share capital and
R30,000 is removed from capitalisation issue reserves. (There is a share capital of R80,000 left (R60,000
contributed capital and R20,000 capitalised reserves.)
9. Zero Limited paid a R100,000 debt of it’s major shareholder. The shareholder does not work for the company.
10. Zero Limited paid a R100,000 debt of it’s major shareholder. The shareholder does work for the company and
the debt was paid in the capacity as an employee.
11. Star Limited write off a R100,000 loan owing by a shareholder to the company.
12. A company distributed trading stock with a cost of R500,000 and a market value of R800,000 to its holding
company as a dividend.
13. A listed company repurchases R300,000 of its own shares.

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SUGGESTED SOLUTION

1. Even though he is a shareholder and has received an amount from the company, he receives this amount is
his capacity as an employee and not as a shareholder. This is not a dividend.
2. This is not a dividend. Although this is an amount received from a company that ABC Limited has shares in,
this amount is paid for services rendered and not as a dividend.
3. R10,000 dividend is received
4. R20,000 dividend is received
5. This is an amount received by a shareholder from a subsidiary. However as this is a payment for interest on a
loan, this will not be treated as a dividend.
6. The amount that is not a bonus/capitalization issue, nor is a return of contributed capital is a dividend as
defined. R36,000 (R50,000 – R14,000 contributed share capital) will be a dividend as defined.
7. Bonus and capitalization shares are not treated as dividends, as defined.
8. Of the R100,000 distributed to shareholders, R40,000 comes from contributed share capital. The remaining
R60,000 is a dividend.
9. The amount will be treated as a dividend as the amount is paid on behalf of the shareholder in the capacity as
a shareholder.
10. The amount is not a dividend as it is paid for the person in his capacity as an employee and not as a
shareholder.
11. This will be treated as a R100,000 dividend.
12. R800,000 is treated as a dividend. (Dividends in specie are valued at market value.
13. When a listed company repurchases its own shares, such transaction are excluded from the dividend
definition.

2.1 GENERAL DISCUSSION OF CONTRIBUTED SHARE CAPITAL

If shares are issued by a company for R300,000, the balance of contributed tax capital will be R300,000.

When the company makes a profit, this is not contributed tax capital as it has not been contributed by the
shareholders.

When a company has a capitalisation issue converting R100,000 of reserves to share capital, this R100,000 is not
contributed tax capital as it has not been contributed by the shareholders.

For accounting purposes, the share capital will reflect a balance of R400,000. For tax purposes, contributed tax
capital is R300,000.

For accounting purposes, share capital can be increased when

 Shares are issued to investors (will add to contributed tax capital)
 there is a capitalisation issue (debit retained income credit share capital) (not contributed tax capital) and
 shares are issued to pay for assets or for services rendered. (will increase contributed tax capital)

For accounting purposes, share capital can be reduced by:

 Writing off share capital for no payment (will not affect contributed share capital)
 Share buybacks (may reduce contributed tax capital)

It should be noted that the company involved will state the amount of the contributed tax capital to be reduced in
the event of a share buyback.

ILLUSTRATION

B Ltd is a company which has 10 shareholders who each own 10% of the company. B Ltd is a company with a
contributed tax capital of R500,000 for the 500,000 shares it issued. The company buys back 100,000 shares
equally from all shareholders. The company pays R10 a share to its shareholders and state they are paying back
R450,000 contributed tax capital.
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Calculate the amount of the dividend

SUGGESTED SOLUTION

The total amount paid is R10 X 100,000 shares = R1,000,000.

The company has stated that R450,000 contributed tax capital was bought back.

The dividend is R1,000,000 – R450,000 = R550,000.

The balance of contributed tax capital is R500,000 – R450,000 = R50,000.

Note:
 The balance on the share capital account need not correspond with the contributed tax capital.
 It is up to the company to decide how much contributed tax capital is paid back with each transaction.
 However the contributed tax capital may never drop below R0

ILLUSTRATION – CONTRIBUTED TAX CAPITAL

The following relates to Astro (Pty) Limited

1. A company is created when shareholders contribute R150,000 subscribing for 100,000 shares of R1 each.
There is a share premium of R50,000.
2. There is a 3:1 share split where 300,000 R1 shares are issued to shareholders. In the accounting records, this is
taken from retained income R250,000 and share premium R50,000.
3. There is a dividend paid of R500,000 where the company declares it will be returning R50,000 contributed tax
capital to shareholders.
4. 30,000 shares are issued to Mr Z in return for professional services rendered to the company. The shares were
worth R210,000 on the date of issue. Mt Z gave an invoice of R210,000 to the company for services rendered.

Calculate the value of contributed tax capital after all 4 of the above transactions.

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SUGGESTED SOLUTION

1. The contributed tax capital is R150,000

2. The contributed is unchanged by the capitalisation issue. It is still R150,000.
3. The contributed tax capital will be reduced by R50,000 to R100,000.
4. The contributed tax capital will increase by R210,000 and will now be R310,000.

3. WHO PAYS DIVIDENDS TAX

Dividends that are paid by the following entities are subject to dividends tax:
 A SA resident company
 A foreign dividend to the extent that it is paid by a company listed on the JSE (Johannesburg Stock Exchange).
(This applies to all dividends other than a dividend in specie paid by the foreign company. A dividend in specie
is a dividend of something other than monetary amounts. An example is a company that has declared a
machine as a dividend.)

There is no dividends tax for non resident companies that are not listed on the JSE.

Dividends tax is paid on distributions by any:

 company that is registered and controlled in South Africa
 company that is registered in South Africa, but controlled outside of South Africa
 company that is registered in another country, but is managed and controlled in South Africa
 company that is registered in another country, but is listed on the Johannesburg Stock Exchange.

For cash distributions, the person liable for the tax is the recipient of the dividend. However the company paying
the dividend withholds the tax and pays it on behalf of the recipient.

For dividends in specie (asset declared as a dividend), the company paying the dividend is liable for dividends tax
that needs to be paid on the dividend.

Tax is withheld and paid across to SARS by

 the company paying the dividend or
 regulated intermediaries.

The definition of regulated intermediary is contained in section 64D. Regulated intermediaries are various
organisations that receive dividends on behalf of others. The dividend paid to the intermediary is the full dividend,
without any withholding tax having been withheld. The regulated intermediary will then determine whether
dividends tax needs to be withheld and paid across to SARS on behalf of the taxpayer. An example of a regulated
intermediary will be a unit trust.

The company and the regulated intermediary send out a form to all shareholders asking for
 the status of the shareholder (are you a company registered in SA, an individual, a trust, a regulated
intermediary, etc.)
 an undertaking from the shareholder that should their status change (such as when they are no longer
the beneficial owner), that the shareholder will notify them of any changes

The company declaring the dividend or the regulated intermediary will withhold or not withhold tax based on the
reply obtained.

If the shareholder does not reply, dividends tax is withheld irrespective of whether the shareholder is a SA
company or not.

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In certain circumstances, dividends tax is not withheld at the standard rate (currently 15%) if the shareholder
resides in a country where there is a double tax agreement that reduces the rate of dividends tax. (Example of this
is Mauritius where 5% dividends tax will be withheld)

ILLUSTRATION

A (Pty) Ltd has 3 shareholders.

 30% owned by Mr B
 25% owned by C Ltd, a South African company
 45% owned by D Equity Unit Trust, a regulated intermediary. D Equity unit trust is owned 90% by natural
persons and 10% by SA companies

A (Pty) Ltd pays a dividend of R1,000,000 to shareholders.

Determine the amount of dividends tax to be paid across to SARS by the company or regulated intermediaries.

SUGGESTED SOLUTION

R300,000 dividend is payable to Mr B. The company, A (Pty) Ltd will pay across 300,000 X 15% = R45,000 to SARS
on behalf of Mr B.

The R250,000 paid to C Ltd does not attract dividends tax as it is paid to a company registered and controlled in
SA.

R450,000 is paid to the unit trust. As the unit trust is a regulated intermediary, no dividends tax is withheld.

However the unit trust will have to withhold 90% X R450,000 X 15% = R60,750 before paying out amounts to
individuals and pay this amount across to SARS on behalf of its unit holders that are not companies. Nothing will
be withheld by the unit trust for unit holders that are SA companies.

4. WHEN IS DIVIDENDS TAX PAYABLE

Dividends tax is triggered
 For a listed company when the dividend is paid and
 For an unlisted company at the earlier of dividend payment date or the date the dividend becomes due
and payable.

The amount of dividends tax must be paid to SARS by the last day of the month following the month the dividend
was paid.

Thus if a dividend was paid on 5 March, the dividends tax needs to be paid by the last day of April. Similarly if a
dividend is paid on 29 September, dividends tax must be paid to SARS by the last day of October.

ILLUSTRATION

Naspers, a company,
 declares a dividend of 120 cents a share on 12 April
 to shareholders registered at the share registrars on 21 April,
 payable on 29 April.

Due to a problem with the share registers, shareholders were only paid on 5 May.

What are the taxation implications?

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SUGGESTED SOLUTION

If the company is listed, the dividend tax trigger is 5 May. Dividends tax need be paid across by the end of June.

If the company is unlisted, the dividends tax trigger is on the earlier of

 29 April (date the dividend becomes payable by the company) or
 5 May (date the dividend was actually paid.)

29 April is used and the dividends tax must be payable by the end of the following month. Thus dividends tax must
be paid across to SARS by 31 May.

5.DIVIDENDS IN SPECIE
A dividend in specie is when a company distributes an asset to a shareholder and not cash. Where a company
declares a dividend in specie:
 The dividends tax is based on the market value of the asset so distributed as a dividend in specie
 The date that the company uses as payment date will be the earlier of
o the date the asset is given to the shareholder, or
o the date the asset should be given to the shareholder

For a discussion on the vat treatment for dividends in specie, refer to the chapter on local SA dividends. The
illustration below deals with the vat treatment.

The company that is paying the dividend in specie is liable for the payment of dividends tax in respect of the
dividend in specie. (Section 64EA of the Act)

For cash distributions, the person liable for the tax is the recipient of the dividend. However the company paying
the dividend withholds the tax and pays it on behalf of the recipient.

ILLUSTRATION

B (Pty) Ltd, a company that retails furniture, is owned 100% by Mr A. On 15 March, Mr A is declared a dividend of
a motor car with a cost of R500,000, a tax value of R350,000 and a market value of R300,000, plus R400,000 in
cash. The dividend is payable on 7 April. However the company gives the cash and the motor car to Mr A on 29
March.

This is the only transaction during the current tax year between the parties. B (Pty) Ltd is a vat vendor. Mr A will
use the asset for private purposes.

You are required to discuss the taxation implications?

SUGGESTED SOLUTION TO ILLUSTRATION 6A

Note that for this transaction, there are no vat implications. As an input vat claim is denied on the acquisition of
motor car, there will thus be no output vat on disposal of the motor car by the company.

The dividends tax is payable on the earlier of

 7 April (date the dividend becomes payable by the company) or
 29 March (date the dividend was actually paid.)

29 March is used and the dividends tax must be payable by the end of the following month. Thus dividends tax
must be paid across to SARS by 30 April.

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 12

The amount of the dividends tax to be withheld by the company is R400,000 cash plus R300,000 (use market value
for a dividend in specie) X the rate of dividends tax.

Withholding tax of R700,000 X 15% = R105,000 will be withheld and paid to SARS by the company by 30 April.

However the shareholder is liable for 400,000 X 15% = R60,000 dividend tax as this is the cash distribution. This is
withheld by the company paying the dividend and net amount of R340,000 (R400,000 – R60,000) is received by Mr
A.

R340,000 (R400,000 – R60,000 tax) plus the motor car will be received by Mr A.

The company is liable for the remainder of the R45,000 dividends tax payable on the car.

The company will be deemed to have disposed of the motor car and will make a loss of R50,000 (R350,000 –
R300,000) on the disposal of the car being the amount that the market value is below tax value.

B (Pty) Ltd and Mr A are connected person in terms of the Act. (Mr A owns 100% of the company)

A scrapping allowance cannot be claimed on transactions between connected persons in terms of the Act. Thus
the R50,000 loss is not claimable in the tax return.

As no scrapping allowance can be claimed, a capital loss of R50,000 results, which is clogged. The amount of
R50,000 will not be used in the current year’s tax calculation and carried forward to a later year of assessment.

Note
 Capital losses on transactions between connected persons may only be set off against transactions between
the same 2 parties. If not used in the current year, the amount is carried forward to the next year.
 As the asset is used for private purposes, no capital allowances will be claimable by Mr A on the motor car
received.

6. EXEMPTIONS FROM DIVIDENDS TAX

Dividends are exempt from dividends tax if the beneficial owner is:
 a company which is a resident;
 the Government, a provincial administration or a municipality;
 a public benefit organisation approved by the Commissioner in terms of section 30 (3) of the Act
 a trust contemplated in section 37A (closure rehabilitation trust);
 an institution, board or body contemplated in section 10 (1) (cA) (institutions providing scientific knowledge,
institutions providing necessary or useful commodities to the State, institutions providing financial assistance
to promote commerce, industry or agriculture)
 a fund contemplated in section 10 (1) (d) (i) or (ii) (pension, provident, retirement annuity or benefit fund,
including pension provident or retirement annuity preservation funds)
 a person contemplated in section 10 (1) (t) (parastatals such as CSIR, SAIDC, SANRAL, ARMSCOR and its
subsidiaries, traditional councils, traditional communities, regional electricity or water distributors,
development bank of SA, compensation funds for the compensation for occupational disabilities Act)
 a shareholder in a registered micro business, to the extent that the aggregate amount of dividends paid by
that registered micro business to its shareholders during the year of assessment in which that dividend is paid
does not exceed the amount of R200 000;
 a person that is not a resident of SA and the dividend is paid by a non-resident listed company on the JSE and
the dividend is not a dividend in specie.

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 13

ILLUSTRATION

Part a

Below are some shareholders that have shares in BATTY Ltd, a foreign dual listed company on the JSE. State for
which shareholders dividends tax would be paid:
1. Mr A, a SA resident
2. Mr B, a US resident
3. C Ltd, a SA company
4. D Inc, a foreign company
5. E Inc, a foreign company receiving a dividend in specie
6. The F trust
7. A nominee company who owns shares on behalf of G Ltd, a SA company
8. A nominee company who owns shares on behalf of Mr H
9. A tax exempt public benefit organisation
10. Government

Part b

If the company was an unlisted SA company, would the solution change?

SUGGESTED SOLUTION TO ILLUSTRATION

Part a

1. Dividends tax paid

2. No dividends tax paid
3. No dividends tax paid
4. No dividends tax paid
5. Dividends tax paid
6. Dividends tax paid
7. Dividends tax paid
8. Dividends tax paid
9. No dividends tax paid
10. No dividends tax paid

Part b

1. Dividends tax paid

2. Dividends tax paid
3. No dividends tax paid
4. Dividends tax paid
5. Dividends tax paid
6. Dividends tax paid
7. Dividends tax paid
8. Dividends tax paid
9. No dividends tax paid
10. No dividends tax paid

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7. REFUNDS SECTION 64L AND SECTION 64M

In various circumstances, refunds of dividends tax can be made.

This is done where dividends tax has been withheld incorrectly by the company.

Consider the situation where R100,000 dividends tax has been withheld by a company on a dividend paid to S Ltd,
a SA company.
 Normally there is no dividends tax on a dividend to a SA company
 However S Ltd did not fill in the form as required to disclose their status to the company paying the
dividend.
 4 months later, the necessary form is completed and S Ltd requests that the R100,000 tax withheld by the
company be refunded to them.

The following is relevant

 The company and not SARS will make a refund
 If the refund is requested before the dividends tax is paid across to SARS, the amount is simply taken off
the dividends tax payable.
 If the refund is requested after SARS has received the funds, but within 3 years of the dividend payment,
the company will refund the tax to S Ltd and then claim a refund from SARS.
 This refund can be done in 2 ways:
o If a dividend is paid within 1 year of the declaration being received by S Ltd, the amount of the
refund may be set off against the dividends tax collected for the subsequent dividend
o If more than 1 year has passed, and an amount has still not been claimed back from SARS, the
company may claim back directly from SARS (as long as this is done within 4 years of the original
dividend)

Similar rules apply for regulated intermediaries, but the 4 year rule does not apply to these intermediaries.

DISCUSSION

B Ltd owns 50% of A Ltd.

A Ltd pays a dividend on 1 May 2012. A dividend of R85,000 is paid to B Ltd (R100,000 – R15,000 dividends tax).
Normally no dividends tax would be withheld, but B Ltd has not submitted the required documentation to A Ltd.

On 22 November 2012, B Ltd submit the required documentation to A Ltd, and A Ltd refund the R15,000 dividends
tax to B Ltd.

On 1 May 2013, the company declared another dividend. This time A Ltd receives R30,000 dividend without any
withholding tax being taken off as the required forms have been completed. The company withholds R3,000
dividend tax from other shareholders.

The company submits a return to SARS but indicates on the return that R3,000 was withheld but that a refund was
made in terms of section 64L, and no dividends tax is payable.

The company has to wait until 1 year after the revised declaration was given in by B Ltd. At this date, the company
is R12,000 out of pocket with the refund (R15,000 paid to B Ltd less the R3,000 not paid to SARS for subsequent
dividend payments)

On 23 November 2013, the company submits the required documentation to claim the R12,000 not yet repaid to
them. SARS refunds them as the claim was submitted within 4 years of the original dividend date.

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 PROVISIONAL TAX – COMPANIES 2017 TAX YEAR (WITH FEB YEAR END)
CALCULATION OF MINIMUM PAYMENTS TO AVOID INTEREST AND PENALTIES
10% late submission penalty
A 10% late submission 20% late payment penalty Interest is payable on
penalty is payable 20% underestimate penalty – amounts not paid by 30
Par20 of 4th Schedule September

31 August 2016 28 February 2016

1 March 2016
1st provisional tax payment 2nd provisional tax payment 31 August 2016 30 September 2016
2017 tax year starts
2017 tax year 2017 tax year 1st provisional tax payment 3rd provisional tax payment
2017 tax year 2017 tax year

Steps
2nd provisional tax payment
Steps 3rd provisional tax payment
Steps
Actual income including capital gains > 1,000,000 Actual income including capital gains < 1,000,000
1st provisional tax payment 1. Calculate the actual taxable income
1. Calculate the basic amount 2. Tax per tables on actual taxable income
1. Calculate the actual income for the year 1. Calculate basic amount
2. Calculate tax on basic amount 3. Less: 1st provisional tax payment
including capital gains 2. Calculate 90% X actual income excluding capital gains
3. X ½ (year) 4. Less: 2nd provisional tax payment
2. Multiply the amount in step 1 by 80% (par 20(a)) 3. Calculate tax based on the lesser of the amounts in
4. Less Employees tax March – August 5. Less: Employees tax March – February
3. Calculate tax based on the amount in step 2 step 1 and 2 (par 20(b))
5. Less rebates (6 quat) 6. Less: Rebates 6 quat
4. Less: 1st provisional tax payment 4. Less: 1st provisional tax payment
5. Less: Employees tax March – February 5. Less: Employees tax March - February
6. Less: Rebates 6 quat 6. Less: Rebates 6 quat

The following should be noted

1. The basic amount is the most recent assessed amount that has been received more than 14 days prior to the tax payment being due. If this is more than 1 year behind, 8% is added to the basic amount
from end of year used for basic amount to end of the current year of assessment.
2. Companies pay provisional tax. The 1st payment is 6 months into the tax year, the 2nd payment is at year end and the 3rd payment is 6 months after year end (7 months if a February year-end). Thus a
company with a March year end will have 1st provisional tax payment date of 30 September, a 2nd provisional tax payment of 31 March and a 3rd provisional tax payment date of 30 September of the
next year.
3. Companies can have employees tax withheld in certain circumstances. This amount would have to be provided. Employees taxation is withheld for companies at a rate of 28%.
4. There are two options for the 2nd provisional tax payment depending on the taxable income of the company.
 CHAPTER 9
Provisional tax
Contents
1. First provisional payment ................................................................................................................................... 3
1.1 Basic amount ................................................................................................................................................ 4
2 Second payment ................................................................................................................................................ 12
2.1 Estimated taxable income .......................................................................................................................... 13
2.2 Seriously calculated amount ....................................................................................................................... 14
2.2.1 Where actual taxable income is more than R1million ......................................................................... 15
2.2.2 Seriously calculated amount................................................................................................................ 15
3 Third provisional tax .......................................................................................................................................... 17
4 Penalties and interests ...................................................................................................................................... 19

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Provisional tax

What is provisional tax?

Provisional tax is a method of tax collection. Under this system, taxes are
collected in advance based on the estimates.
Provisional taxes are determined in the Fourth Schedule of the Tax Act.
Provisional tax payments made are deducted from the taxpayer’s normal tax
liability on assessment date.
ILLUSTRATIVE EXAMPLE
Sweets Are For Us (Pty) Ltd a company that manufactures sweets has a year of
assessment ending 30 April 2016. The undertaking is not a small business
corporation as defined in the Income Tax Act.
Taxable income calculated for the 2016 year is R520 000. Provisional tax
payments for the 2016 year of assessment amounted to R100 000.
Calculate the tax liability.

SUGGESTED SOLUTION
Taxable income multiplied by 28% less provisional tax payments = tax liability
(520 000 x 28%) – 100 000 = 45 600

Who pays provisional taxes?

Provisional tax is payable by all tax payers who are “provisional tax payers”.
Provisional taxpayers according to paragraph 1 of the fourth schedule are;
 All companies except public benefit organisations;

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  Any person notified by the Commissioner to be a provisional taxpayer;
and
 A person who derives other income which is not remuneration (tax on
remuneration is collected through employees tax).

1. First provisional payment

There are two compulsory provisional payments made each year.

The first provisional payment is made on or before the sixth month of the year
of assessment (4th Schedule para 23(a)).

ILLUSTRATIVE EXAMPLE
The year end of a company is 28 February. When should the first provisional
payment be made?
SUGGESTED SOLUTION
No later than 31 August.

The amount of provisional tax payable is calculated as follows:

1. Estimate the total expected income for the year – Basic amount usually
used i.e. R100

2. Calculate the tax payable on the amount (R100 x 28%) = R28

3. Divide the tax payable by two (28/2) = 14

4. Deduct other tax payments already made i.e. s6quat rebate, employees
tax or provisional taxes 14-0

5. Difference is the provisional tax payable 14

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ILLUSTRATIVE EXAMPLE
A company has a February year end and is in the 2017 year of assessment.
The most recent assessment available is the 2016 year of assessment which has
an amount of R 1 000 000. Assume the basic amount is R1 000 000.
What is the provisional tax payable?
SUGGESTED SOLUTION

Basic amount = 1 000 000

Tax payable (1 000 000 x 0.28) = 280 000
Divide by two (280 000/2) = 140 000
Less: No other taxes paid = nil
Provisional tax payable = 140 000

1.1 Basic amount

The estimate used for the first provisional payment is usually the basic amount.
The basic amount is:
 The taxable income reflected in the most recent assessment received
from SARS (Fourth Schedule Para 19(1)(d)).
 Which is received no less than 14 days before the date on which the
provisional payment is being made. (Fourth Schedule Para 19(1)(e)).
 Adjusted by 8% each year where:
o the basic amount is estimated ≥ 18 months from the recent
assessment; and
o ≥ 1 year of assessment from the most recent assessment; (Fourth
Schedule Para 19(1)(d)) and
 Which excludes capital gains (Fourth Schedule Para 19(1)(d)).

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ILLUSTRATIVE EXAMPLE – LATEST ASSESSMENT RELATES TO A PERIOD ONE
YEARS OLD

A company has a February year end and is in the 2017 year of assessment.
The most recent assessment available is the 2016 year of assessment which
has an amount of R 1 000 000 which was received on the 1st of May 2015.
What is the basic amount for the first provisional payment?

SUGGESTED SOLUTION
First payment due date = 31 August 2016

Latest assessment date = 1 May 2016 (More than 14

days from 1st payment date of 31
August 2016 123 days)

Latest assessment period = 2016

Period from recent assessment period

to current year of assessment = 1 (≤ a year) (Feb 2016 to Feb
2017)

Months from recent assessment period

to submission date = 6 months (≤ 18 months) (Feb 2016
to Aug 2016)
Therefore no adjustment required.
Basic amount = 1 000 000 (per the latest
assessment)
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ILLUSTRATIVE EXAMPLE – LATEST ASSESSMENT RELATES TO A PERIOD THREE
YEARS OLD
A company has a February year end and is in the 2017 year of assessment.
The most recent assessment available is the 2014 year of assessment which
has an amount of R 1 000 000 which was received on the 1st of May 2016.
What is the basic amount for the first provisional payment?

SUGGESTED SOLUTION
First payment due date = 31 August 2016

Latest assessment date = 1 May 2016 (More than 14

days from 1st payment date – 1
May 2016 to 31 Aug 2016)

Latest assessment period = 2014

Period from recent assessment period

to current year of assessment = 3 (≥ 1 year) (Feb 2014 to Feb
2017)

Months from recent assessment period

to submission date = 30 months (≥ 18
months)(Feb 2014 to Aug 2016)

Therefore an adjustment is required.

Basic amount = 1 000 000 (per the latest
assessment)
Plus 8% for three years
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(8% x 3 x 1 000 000) = 240 000
Adjusted basic amount = 1 240 000

ILLUSTRATIVE EXAMPLE – LATEST ASSESSMENT RELATES TO A PERIOD TWO

YEARS OLD

A company has a February year end and is in the 2017 year of assessment.
The most recent assessment available is the 2015 year of assessment which
has an amount of R 1 000 000 which was received on the 1st of May 2016.

What is the basic amount for the first provisional payment?

SUGGESTED SOLUTION
First payment due date = 31 August 2016

Latest assessment date = 1 May 2016 (More than 14

days from 1st payment date) 1 May
2016 – August 2016

Latest assessment period = 2015

Period from recent assessment period

to current year of assessment = 2 (≥ a year)

Months from recent assessment period

to submission date = 18 months (not more than
18 months)

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 28 Feb 2014 to 31 August 2016

Therefore no adjustment as the greater than 18 month’s criteria is not met.

Basic amount = 1 000 000 (per the latest

assessment)
ILLUSTRATIVE EXAMPLE – WITH CAPITAL GAINS
A company has a February year end and is in the 2017 year of assessment.
The most recent assessment available is the 2014 year of assessment which
has an amount of R 1 000 000 which was received on the 1st of May 2016.
The assessment included a capital gain of R200 000.
What is the basic amount for the first provisional payment?

SUGGESTED SOLUTION
First payment due date = 31 August 2016

Latest assessment date = 1 May 2016 (older than 14

days from 1st payment date)

Latest assessment period = 2014

Period from assessment period

to current year of assessment = 3 (Feb 2014 – Feb 2017)

Months from recent assessment period

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to submission date = 30 months (≥ 18 months)
(28 Feb 14 – 31 Aug 2017)
Adjustment required
Basic amount = 1 000 000
Less Capital gain = (200 000)
Subtotal = 800 000
Plus 8% for three years
(8% x 3 x 1 000 000) = 240 000
Adjusted basic amount = 1 040 000

ILLUSTRATIVE EXAMPLE – NOT OLDER THAN 14 DAYS

A company has a February year end and is in the 2017 year of assessment.
The most recent assessment available is the 2016 year of assessment which
has an amount of R 1 000 000 which was assessed on the 22nd of August 2016.
The previous assessment is the 2014 assessment with an amount of R 850 000
received on 1 December 2014.
What is the basic amount for the first provisional payment?

SUGGESTED SOLUTION
First payment due date = 31 August 2016

Latest assessment date = 22 August 2016

The 2016 assessment cannot be
used as it is not more than 14 days
from the 1st payment date i.e. 10
days from 22nd August to 31
August 2016. Therefore, use the

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 assessment received on the 1st of
December 2014.

Latest assessment period = 2014

Period from assessment period

to current year of assessment = 3 (Feb 2014 to Feb 2017)

Basic amount = 850 000

Plus 8% for three years
(8% x 3 x 850 000) = 136 000
Adjusted basic amount = 1 054 000
If a company makes an estimate, and the estimate is greater than the basic
amount, the estimate may be used. However, the taxpayer may use the basic
amount to calculate the provisional tax.

ILLUSTRATIVE EXAMPLE
A company has a February year end and is in the 2017 year of assessment.
The most recent assessment available is the 2016 year of assessment which
has an amount of R 1 000 000.
The company made an estimate of R1 250 000 for the year.
What is the basic amount for the first provisional payment?

SUGGESTED SOLUTION
Basic amount = 1 000 000 (also acceptable to use the higher amount.)

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If a company makes an estimate less than the basic amount, the basic amount
has to be used. An estimate can be used if less than the basic amount only with
the consent of SARS.

Where there is no previous assessment, basic amount is nil. However, at such

time the basic amount cannot be used as an estimate has to be made
(Interpretation Note 1 of 30 November 2001).

ILLUSTRATIVE EXAMPLE

A company has a February year end and is in the 2017 year of assessment.
The most recent assessment available is the 2016 year of assessment which
has an amount of R 1 000 000.
The company made an estimate of R950 000 for the year which they used in
their provisional tax calculation.
Is this appropriate?

SUGGESTED SOLUTION

No – If estimate is lower than Basic amount, the basic amount has to be used
unless SARS consent is obtained.

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2 Second payment

The second payment is made no later than the last day of the year of
assessment (Fourth Schedule Para 23(b)).

ILLUSTRATIVE EXAMPLE

The year end of a company is 28 February. When should the second provisional
payment be made?
SUGGESTED SOLUTION

No later than 28 February.

The amount of the second provisional tax payable is calculated as follows:

1. Estimate the total expected income for the year – i.e. R100

2. Calculate the tax payable on the amount (R100 x 28%) = R28

3. Less the amount paid in the first payment(28-14) = R14

4. Deducting tax payable with tax payments already made 14-0

5. Difference is Provisional tax payable R14

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2.1 Estimated taxable income

Where actual taxable income is less than R1million

The estimated taxable income is the lower of:

 Taxable income seriously calculated; or
 The basic amount

ILLUSTRATIVE EXAMPLE

A company has a February year end and is in the 2017 year of assessment.
The most recent assessment available is the 2016 year of assessment which
has an amount of R 950 000.
In February 2017, the company made a serious calculation of taxable income
and the amount is R900 000.
Actual taxable income was R920 000.
The first provisional payment made was R173 600
Calculate the second provisional tax payment.
SUGGESTED SOLUTION
Estimated taxable amount = 900 00
Which is the lower of taxable income seriously calculated and the basic
amount
Tax payable (900 000 x 0.28) = 252 000
Less: First provisional payment 173 600
Second Provisional tax payable 78 400

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2.2 Seriously calculated amount

The seriously calculated amount should be at least 90% of actual taxable

income excluding capital gains.
If the amount is less than 90% of actual SARS can levy up to 20% in interest
penalties.
The estimate made includes capital gains unless the estimate is the basic
amount.

ILLUSTRATIVE EXAMPLE

A Limited is a taxpayer with the following details;

Tax year Date of assessment Amount of assessment

2014 14 February 2014 R300, 000
2015 10 August 2015 R400, 000
2016 R500, 000*
* The R500,000 is the actual taxable income for the 2015 year end and includes
a taxable capital gain of R40,000. First provisional payment made was R13 120.
Calculate the minimum provisional tax payments that need to be made to
avoid any penalties and indicate the date by which payment must be made.

SUGGESTED SOLUTION
2nd payment which must be made by 28 February 2016
Basic amount Must use 2015 assessment 400,000
90% of actual (500,000 X 90%) 360 000
Use lower amount 360 000
Tax per tables 360 000 x 28% 100 800
Less 1st provisional tax payment (13 120)
2nd provisional tax payment 87 680
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2.2.1 Where actual taxable income is more than R1million

The estimated taxable income is the taxable income seriously calculated.

ILLUSTRATIVE EXAMPLE
A company has a February year end and is in the 2017 year of assessment.
The most recent assessment available is the 2016 year of assessment which
has an amount of R 1 030 000.
In February 2017, the company made a serious calculation of taxable income
and the amount is R1 050 000.
The first provisional payment made was R173 600
Calculate the second provisional tax payment.
SUGGESTED SOLUTION
Basic amount 1 000 000
Therefore use seriously calculated amount is R1 050 000.

Estimated taxable amount 1 050 00

Tax payable (1 050 000 x 0.28) 294 000
Less: First provisional payment 173 600
Second Provisional tax payable 120 400

2.2.2 Seriously calculated amount

The seriously calculated amount should be at least 80% of actual taxable

income excluding capital gains.
If the amount is less than 80% of actual SARS can levy up to 20% in interest
penalties.
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ILLUSTRATIVE EXAMPLE
A Limited is a taxpayer with the following details;

A Limited is a taxpayer with the following details;

Tax year Date of assessment Amount of assessment

2014 14 February 2014 R1,300, 000
2015 10 August 2015 R1,400, 000
2016 R1,500, 000*
* The R1,500,000 is the actual taxable income for the 2015 year end and
includes a taxable capital gain of R40,000. First provisional payment made was
R13 120.
Calculate the minimum provisional tax payments that need to be made to
avoid any penalties and indicate the date by which payment must be made.

SUGGESTED SOLUTION
2nd payment which must be made by 28 February 2016
80% of actual (1,500,000 X 80%) 1 200 000
Tax per tables 1 200 000 x 28% 336 000
Less 1st provisional tax payment (13 120)
2nd provisional tax payment 332 880

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3 Third provisional tax

The third provisional tax payment is made according to the requirements of

Section 89quat.
The third payment is a voluntary payment.
The third provisional tax amount is made before the last day of the seventh
month after year end for companies with a February year end.

ILLUSTRATIVE EXAMPLE

When should a company with a February year end submit their third
provisional payment?

Suggested solution

A company with a February year end has to submit the third provisional
payment before the end of the 30th of September.

The third provisional tax amount is made before the last day of the sixth month
after year end for companies with a yearend other than February.
ILLUSTRATIVE EXAMPLE

When should a company with a December year end submit their third
provisional payment?

Suggested solution

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A company with a December year end has to submit the third provisional
payment before the end of the 30th of June.
The third payment is based on the actual taxable income of the company.

The amount of the third provisional tax payable is calculated as follows:

1. Calculate the actual taxable income
2. Tax per tables on actual taxable income
3. Less: 1st provisional tax payment
4. Less: 2nd provisional tax payment
5. Less: Employees tax March – February
6. Less: Rebates 6 quat

ILLUSTRATIVE EXAMPLE

A Limited is a taxpayer with the following details;

Tax year Date of assessment Amount of assessment

2014 14 February 2014 R300, 000
2015 10 August 2015 R400, 000
2016 R500, 000*
* The R500,000 is the actual taxable income for the 2015 year end and includes
a taxable capital gain of R40,000. First provisional payment made was R13 120
and R63 126 for the second payment.
Calculate the minimum provisional tax payments that need to be made to
avoid any penalties and indicate the date by which payment must be made.

SUGGESTED SOLUTION
3rd payment which must be made by 30 September 2016
Actual 500 000
Tax per tables 500 000 x 28% 140 000

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Less 1st provisional tax payment (13 120)
Less 2nd provisional tax payment (63 126)
3rd provisional tax payment 63 754

4 Penalties and interests

First provisional payment

A late payment penalty of 10% on the first provisional payment amount is

levied for late payment of said amount. (Fourth Schedule para 27(1))

Second provisional payment

Late submission penalty
A late submission penalty of 20% on the excess of normal tax payable over the
first provisional tax payment.
The penalty is calculated as follows:
20% x (normal tax payable for the year – total provisional tax)

Understatement penalty
An understatement penalty is levied on 20% on the excess of the provisional
tax that was supposed to be paid over the sum of provisional tax payments
made.
The penalty is calculated as follows:
Lower of ;
1. Normal tax on 90% of actual taxable income
2. Normal tax on basic amount
Less Provisional tax payments

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Amount on which the penalty is based
The penalty is 20% of this amount

ILLUSTRATIVE EXAMPLE

A Limited is a taxpayer with the following details;

Tax year Date of assessment Amount of assessment

2014 14 February 2014 R300, 000
2015 10 August 2015 R400, 000
2016 R500, 000*
* The R500,000 is the actual taxable income for the 2015 year end and includes
a taxable capital gain of R40,000. First provisional payment made was R13 120
and R63 126 for the second payment.
Recalculate the second minimum provisional tax payments that need to be
made to avoid any penalties and indicate the date by which payment must be
made.

SUGGESTED SOLUTION
90% of Actual (500 000 x 0.9) 450 000
Basic amount 400 000
Use the lower 400 000
Tax per tables 400 000 x 28% 112 000
Less 1st provisional tax payment (13 120)
Less 2nd provisional tax payment (63 126)
Underestimate 35 754
Penalty (35 754 x 20% 7 151

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