CTA Level 1 and 2

Basic Company Taxable

income implications
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
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CHAPTER 12-1
OUTLINE OF DEDUCTIONS, CAPITAL ALLOWANCES
AND RECOUPMENTS
DEDUCTIONS
AND
RECOUPMENTS

CAPITAL EXPENDITURE NON CAPITAL EXPENDITURE

Various assets are acquired and written off over There are two types of deductions
the life of the asset. namely special deductions and general
deductions.

Special deductions are deductions

specific to a particular type of
expenditure. If there is a specific
deduction applicable, the special
CAPITAL CAPITAL UNQUANTIFIED
deduction section will be applied to the
ALLOWANCES RELATED AMOUNTS
expenditure involved.
BASICS EXPENSES
This chapter will
If there is no specific deduction, the
This chapter This chapter deal with
general deduction formula will be
will deal with will deal with amounts that
applied to the expenditure incurred.
basic capital capital are incurred
allowances related over a number
including expenses of years.
machines, such as
SPECIAL GENERAL
buildings, learnerships,
DEDUCTIONS DEDUCTION
wear and tear, royalty LESSORS FORMULA
intangibles, payments, See the
and other and other This chapter chapter on See the chapter on
capital assets similar discusses taxation specific the general
expenditure. of lessors
deductions deduction formula

RECOUPMENTS AND
PROHIBITION OF DOUBLE PROHIBITION OF DEDUCTING VAT
SCRAPPING ALLOWANCES
DEDUCTIONS THAT HAS BEEN CLAIMED FOR VAT
The chapter on
In terms of section 23B, multiple deductions In terms of section 23C, if vat has been
recoupments and could not be claimed for the same item of claimed, no deduction may be claimed for
scrapping allowances will expenditure (such as a bad debts deduction the vat so claimed as an input tax deduction.
deal with sales of capital being claimed twice, once in terms of the If no vat as been claimed as an input vat, the
bad debts deduction section and then again total amount including vat will be
assets and other
in terms of the general deduction formula. considered for deduction as an expense.
recoupments.
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CHAPTER 12-1-1 SPECIAL 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) )] ................................................................................................................................ 12
6. PROVISION FOR DOUBTFUL DEBTS [SECTION 1(J)] ....................................................................................................................... 14
7. AMOUNTS PAID TO EMPLOYEES ................................................................................................................................................... 17
7.1 SALARIES AND FRINGE BENEFITS ............................................................................................................................................ 17
7.2 FRINGE BENEFITS .................................................................................................................................................................... 17
7.3 SECTION 7B VARIABLE REMUNERATION ................................................................................................................................. 17
7.4 GOVERNMENT TAXES .............................................................................................................................................................. 18
7.5 AMOUNTS PAID TO PENSION, PROVIDENT AND MEDICAL AID FUNDS .................................................................................. 18
7.6 ANNUITIES PAID TO FORMER EMPLOYEES AND DEPENDANTS OF FORMER EMPLOYEES ...................................................... 18
7.7 GRATUITIES ............................................................................................................................................................................. 20
7.8 BROAD BASED SHARES GIVEN TO EMPLOYEES [SECTION 11(LA)] (NOT EXAMINABLE) .......................................................... 20
7.9 POLICIES COVERING LIFE, DISABILITY AND DREAD DISEASE FOR STAFF ................................................................................. 21
7.9.1 LIFE AND DISABILITY POLICY TAKEN OUT TO PROTECT A COMPANY AGAINST LOSSES IN THE COURSE OF EMPLOYMENT
.................................................................................................................................................................................................. 21
7.9.2 RISK AND INVESTMENT POLICIES [SECTION 11(W)(I)] ..................................................................................................... 22
7.9.3 RISK POLICIES ................................................................................................................................................................... 23
7.9.4 LOANS ON POLICIES ......................................................................................................................................................... 24
7.9.5 CESSION OF POLICIES ....................................................................................................................................................... 25
8. POST-RETIREMENT MEDICAL BENEFITS (SECTION 12M) (NOT EXAMINABLE) .............................................................................. 25
9.PRE TRADE EXPENDITURE (SECTION 11A) ..................................................................................................................................... 26
9.1 WHEN CAN PRE TRADE EXPENSES BE CLAIMED? .................................................................................................................... 26
9.2 HOW IS THE CALCULATION FOR PRE TRADE EXPENSES DONE? ............................................................................................. 26
10. DEDUCTIBILITY OF PRE PAID EXPENDITURE ................................................................................................................................ 28
11. LEARNERSHIPS ............................................................................................................................................................................ 31
12. SECTION 24 ALLOWANCES .......................................................................................................................................................... 32
13. SECTION 24 C – FUTURE EXPENDITURE ON CONTRACTS ............................................................................................................ 32
14. DONATIONS DEDUCTION [SECTION 18A] ................................................................................................................................... 33

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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.

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2. LEGAL COSTS (section 11(c))

To be deductible, legal costs must be
1. actually incurred by the taxpayer during the year of assessment
and
2. in respect of any claim, dispute or action at 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 included in income or allowed as a deduction.

The provisions of section 11(c) are broader than the general deduction formula. Some legal expenses would not be
disallowed 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 – APPLICATION OF THE LEGAL COSTS DEDUCTION

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:
 it must be prescribed legal expenditure (it is as litigation fees are included in the definition of prescribed legal fees);
 it must not be capital in nature (it is not as it does not result in 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 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).

A full deduction would thus be allowed for legal expenses under section 11(c).

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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).
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.

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3. RESTRAINT OF TRADE DEDUCTION (section 11(cA))

Restraint of trade deductions may be claimed if paid to natural persons, personal service trusts and personal service providers in
terms of section 11(cA).

The restraint of trade is written over the greater of 3 years or the period of the restraint.

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.

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, personal service trusts and personal
service providers.

ILLUSTRATION – RESTRAINT OF TRADE DEDUCTION

A Ltd, a company with a July year end, paid Mr A a restraint of trade payment of R12,000 on 1 February 20X1 in respect of:
a) a 2 year restraint, or
b) a 4 year restraint.

The amount was included by Mr A in his gross income per special inclusion paragraph cA of the gross income definition.

What will be deductible for tax purposes?

SUGGESTED SOLUTION

Part 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.

Part b

The restraint will be written off over 4 years at R3,000 per year.

Note
The deduction is not apportioned for a period of less than 1 year.

ILLUSTRATION – RESTRAINT OF TRADE PAID TO A COMPANY

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 company.

SUGGESTED SOLUTION

No deduction is allowed as the amount is paid to a company that is not a personal service provider.

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4. REPAIR DEDUCTION (section 11(d))

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) )]

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.

ILLUSTRATION – DEDUCTIBILITY OF BAD DEBTS

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 amounts is due to the taxpayer
2. The amount is included in the taxpayer’s gross income (was capital in nature)
3. This is a bad debt
4. The debt became bad during the current year

The debt may be claimed in terms of section 11(i).

A capital loss will occur when a bad debt cannot be claimed.

ILLUSTRATION – DEDUCTIBILITY OF BAD DEBTS

A Ltd sell their office building 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 amounts is due to the taxpayer
2. The amount is not included in the taxpayer’s gross income (was capital in nature)
3. This is a bad debt
4. The debt became bad during the current year

The debt may not be claimed 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)

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. A capital loss can
be claimed.

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ILLUSTRATION – DEDUCTIBILITY OF BAD DEBTS

A Ltd give a staff loan to an employee. The capital portion of the loan is R10,000 and interest of R2,000 has been charged on the
loan. The employee disappears and the company decides to write off the loan. 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 has been 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.

It should be noted that if a compromise is reached between a debtor and the person whom money is owed to, this will not
constitute a bad debt.

ILLUSTRATION – COMPROMISE WITH DEBTOR

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 accopunt
when determining the amount of a bad debt.

ILLUSTRATION – INSURANCE PAYOUTS ON BAD DEBTS

A Ltd insure their debtors book. A debtor recorded at R30,000 goes bad. The insurance company pay 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.

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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 11(j)]

A taxpayer can claim a doubtful debts allowances as noted below.

Amendments to s11j as from 1 January 2019 are as follows:

If a company does not apply IFRS 9, the allowance is calculated as follows:

 The sum of 40% of debtors in arears of 120 days or more: and
 25% of debtors in arears of 60 days or more (excluding debt to which IFRS 9 applies or that is already included in the
40%).

If a company applies IFRS 9, the allowance is calculated as follows:

 40% of the sum of the loss allowance relating to impairment measured at an amount equal to the lifetime expected
credit loss in respect of debt other than in respect of lease receivables, plus
 Bad debt written off and reported in the financial statements that was not allowed as a section 11(i) bad debt
deduction and that was included in the taxpayer’s income in the current or any previous year, plus
 25% of the loss allowance relating to impairment in respect of debt other than in respect of lease receivables or that is
already included in the 40% above.

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SARS practice is that 25% of the doubtful debts list is allowed as a taxable deduction in terms of this section for the period
before 1 January 2019.

The deduction allowed in the prior year is added back in the current year as income.

ILLUSTRATION – DOUBTFUL DEBTS AND BAD DEBTS

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

In year 1, 25% of R10,000 will be claimed as a deduction in terms of section 11(j).

In year 2, the full R10,000 will be claimed as a deduction in terms of section 11(i). However, the R2,500 previously claimed in
terms of section 11(j) in year 1 will be added back to income in year 2. There will be a net effect on income of R7,500.

The doubtful debts allowance can only be claimed on debts that are subject to the section 11(i) bad debts deduction.

ILLUSTRATION – DOUBTFUL DEBTS

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 TO ILLUSTRATION 6B

The R2,000 allowance from last year must be included in the current years income.

A doubtful debts allowance of 25% of R15,000 i.e. R3,750 will be allowed as a deduction from income.

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 are deductible in terms of the general deduction formula unless an excessive amount is paid to an employee.

Excessive portions of salaries are disallowed as a deduction

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.

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

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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 such as UIF and skills levy are deductible.

7.5 AMOUNTS PAID TO PENSION, PROVIDENT AND MEDICAL AID FUNDS

With the revision of the pension and retirement fund rules for individuals, the following applies
 All contributions to pension and RAF funds are deductible for the taxpayer under section 11(l).
 Benefit funds such as medical aid will only be deductible if they qualify for deduction in terms of the general deduction
formula. (section 11(a))

7.6 ANNUITIES PAID TO FORMER EMPLOYEES AND DEPENDANTS OF FORMER EMPLOYEES

Annuities are deductible in terms of section 11(m).

Annuities are fixed annual amounts that are payable by a taxpayer that are repetitive. Thus if a company agrees to pay an
employee an amount of R1,000 per month for 5 years, this will be an annuity.

Annuities to former employees and their dependants that have been paid due to retiring from superannuation, ill health or old
age are deductible in full.

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 – 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.

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ILLUSTRATION – ANNUITY DEDUCTION

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 – ANNUITY DEDUCTION

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?

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).

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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
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)] (not examinable)
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.

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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

Each will be discussed individually. Only the rules for policies taken out after 2012 are discussed hereafter.

In an exam, it will be stated if an amount is deductible or not.

7.9.1 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)
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 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.

7.9.2 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
 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.

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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.

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)

7.9.3 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).

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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)

7.9.4 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.

7.9.5 CESSION OF POLICIES

With effect from years of assessment commencing on/after 1 March 2015, section 11(w)(ii)(cc) has been amended to no longer
allow for a deduction of insurance policies, where the policy was ceded for an outstanding loan of the taxpayer’s employee or
director; in other words, a deduction of premiums under section 11(w) will only be allowed if the policy is the property of the
taxpayer at the time of the payment of the premiums.

8. POST-RETIREMENT MEDICAL BENEFITS (SECTION 12M) (NOT

EXAMINABLE)
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

Whenever research and development is done, consider whether this section will apply.

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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

Prepaid expenditure is governed by section 23H of the Act. Prepaid expenditure is not deductible in the year it is incurred if:
the prepayment exceeds R100,000 (first requirement)
and
the amount is prepaid forward more than 6 months (second requirement)

Thus if one of the requirements are not present, the prepaid expenditure will be deducted.

The first requirement is applied to each individual item. The period looked at is the 6 months after year end. Thus if the R45,000
is a 3 month prepayment at year end and the R42,000 is a 8 month prepayment at year end, the R45,000 prepayment will be
deductible in the year in which it is paid (it is under 6 months) and the R42,000 prepayment will not be deductible (it exceeds 6
months)until test 2 has been applied.

The second requirement is applied to all prepayments made by an enterprise that have 6 or more months outstanding in total at
year end. The important consideration is that the sum of all these 6 months or longer prepayments exceeds R100,000.

This section only applies to prepayments for:

 general deduction formula
 legal expenses
 repair expenses
 key man policies

It should however be noted that all prepayments to government institutions are deductible in full, notwithstanding this section.

In addition, this section does not relate to trading stock. Trading stock prepayments are dealt with under the notes for trading
stock.

In addition, prepaid interest is deductible under section 24J and this section will not apply to prepaid interest.

ILLUSTRATION – BASIC PREPAID EXPENDITURE

B Ltd has prepaid insurance for R40,000 just days before the current tax year end. The insurance will cover the organization for
the forthcoming financial year for a period of 12 months.

This is the only prepayment made by the organization. Is the amount deductible in terms of the general deduction formula?

SUGGESTED SOLUTION

Test 1 – The prepayment is more than 6 months forward

Test 2 - All R40,000 will be deductible as the total prepayment amount is less than R100,000. This is notwithstanding the fact
that the organization will obtain a benefit for longer than 6 months.

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ILLUSTRATION – MORE COMPLEX PREPAID EXPENSES

A company has a 31 December 2011 year end and made the following prepayments during the year:
 12 months prepaid insurance of R36,000 made for the period 1 October 2011 to 30 September 2012 and
 5 months prepaid advertising of R100,000 for the period 1 November 2011 till 31 March 2012 and
 12 months prepaid garden maintenance services of R48,000 from 1 September 2011 till 31 August 2012

What amounts will be deducted for taxation purposes.

SUGGESTED SOLUTION

For the insurance, 3 months insurance have already occurred and 3/12 X R36,000 = R9,000 will be deductible in the 2011 tax
year.

There is a 9 month prepayment for insurance at year end totalling 9/12 X R36,000 = R27,000.

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.

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 a 8 month prepayment for maintenance at year end totalling 8/12 X R48,000 = R32,000.

Applying test 2

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.

ILLUSTRATION – DETAILED EXAMPLE COVERING WHICH SECTIONS 23 H DOES NOT APPLY TO

A Ltd incurred the following prepayments at the end of the current tax year:
 Paid for stock of R1,000,000 of which only R600,000 has been delivered as at the year end of the company. The remaining
R400,000 will only be delivered 10 months after year end.
 Paid R300,000 for energy efficient transformers to be attached to plugs. 25% of the plugs had this attachment. It will take a
further 8 months to attach the transformer to all plugs within the organization. Assume that this cost is a revenue and not
capital cost.
 Paid R200,000 for insurance for the whole year 3 months ago.
 Paid R50,000 as a prepayment for next months rent.
 Paid R48,000 as a legal retainer for a 12 month period to ABC attorneys 4 months prior to year end.
 Paid R12,000 for a 3 year maintenance plan on a car at the beginning of the tax year. 2 years of the maintenance plan is still
outstanding at year end. The maintenance plan is for 60,000 kms and 30,000 kms have been traveled.
 Paid R100,000 for 12 months medical aid on behalf of employees 3 months before year end.
 Rates payable to the city council have been paid in advance. 11 months rates of R44,000 have been prepaid and R4,000
rates have been incurred to date.

What deductions may be claimed?

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SUGGESTED SOLUTION

The following deductions will be allowed for the current year of assessment:

All prepayments exceed R80,000 in total. Thus all that needs to be looked at is whether the amounts are prepaid for more than
6 months after year end.

Trading stock

 Trading stock is deductible in terms of section 11(a).

 A full deduction will be allowed for the trading stock under section 11(a) as section 23H does not relate to trading stock
 Note that section 23F may apply. See the notes on trading stock.

Transformers

 As this is a revenue cost, a deduction could possibly be claimed in terms of section 11(a). Section 23H applies to section
11(a).
 25% X R300,000 = R75,000 will be allowed as a deduction as the installation will only be finished more than 6 months after
year end.

Insurance

 Insurance can be claimed in terms of section 11(a).

 3/12 X R200,000 = R50,000 as the insurance is for a period of longer than 6 months after year end.
 There is R150,000 still left over that needs to be claimed next year. Section 23H will defer the deduction to the next tax
year.

Rent

 Rent is claimable in terms of section 11(a)

 R50,000 will be deductible for prepaid rent as the amount is incurred within 6 months of year end.

Retainer

 The retainer is a legal cost that is deductible in terms of section 11(c) of the Act. Section 23H applies to section 11(c).
 4/12 X R48,000 = R16,000 may be claimed as a deduction in terms of section 11(c).
 8 months/12 months X R48,000 = R32,000 will be the prepayment.
 No deduction may be claimed on the R32,000 in the current year in terms of section 23H.

Maintenance plan

 The maintenance plan is considered to be repairs that are deductible in terms of section 11(d). Section 23H applies to
section 11(d).
 Section 23H prohibits the deduction of the amount in full as the amount is prepaid more than 6 months and as discussed
earlier more than R50,000 has been prepaid 6 months or more.
 1/3 X R12,000 = R4,000 would be allowed as a deduction in terms of section 11(d) if time is used as a basis .
 30,000/60,000 X R12,000 = R6,000 would be allowed as a deduction if kms are used as the basis for apportioning the
maintenance cost.

Medical aid

 Medical aid contributions are deductible in terms of section 11(l). Section 23H does not apply to section 11(l).
 The full R100,000 will be deductible in the current year of assessment as section 23H does not apply.

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Rates

 Rates payable to the city council are deductible in terms of section 11(a). However section 23H will not apply as amounts
paid in respect of rates apply to an unconditional liability to pay an amount imposed by legislation.
 The R4,000 incurred will be deductible as well as the R44,000 prepayment due to the fact that section 23H does not apply to
amounts paid to government institutions and the amount will be deductible in terms of section 11(a).

ILLUSTRATION – SECTION DOES NOT APPLY TO INTEREST

A Ltd takes a loan of R100,000 and has to repay the loan in 3 years time. Interest of 15% for 3 years i.e. R45,000 is payable in
advance. Will section 23H apply?

SUGGESTED SOLUTION

Section 23H will not apply as section 24J of the Income Tax Act will apply.

11. LEARNERSHIPS
Deductions applicable to learnerships

Deduction whilst a learnership is Deduction upon completion of a

running learnership

If doing a NQF1-6 qualification

for able bodied people, a deduction
is allowed of R40,000 X no months Learnership less than 2 Learnership more than 2 years
of learnership during the year years
divided by12 For disabled people, an A deduction of R40,000 (R60,000 for disabled
additional deduction is allowed of A deduction of R40,000 persons) for each completed year can be claimed
R20,000 X no months of learnership (R60,000 for disabled upon the successful completion of the
during the year divided by12 persons) can be claimed learnership for NQF1-6. (R20,000 for able bodied
If doing a NQ7-10 qualification upon the successfull and R50,000 for disabled persons for NQF7-10)
for able bodied people, a deduction completion of the
is allowed of R20,000 X no months learnership for NQF 1-6 The person need not have been employed by the
of learnership during the year and R20,000 (R50,000 employer for the whole period of the
divided by12 For disabled people, an for disabled persons) learnership.
additional deduction is allowed of can be claimed upon the
R30,000 X no months of learnership successfull completion This deduction is granted to the employer that
during the year divided by12 of the learnership for employs the employee at the end of the
NQF 7-10 learnership.

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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.

EXAMPLE OF DEBTORS ALLOWANCES

An asset with a cost of R300,000 is sold for R500,000 plus Vat on 1 January 20X10. Interest at 10% per
annum is charged. R328,428.50 is paid back on 31 December 20X10 and 31 December 20X11 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:

20x10 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 100/114 = 104,762

20x11 tax year

Interest received is 29,857
Debtors allowance added back to income is R104,762.

13. SECTION 24 C – FUTURE EXPENDITURE ON CONTRACTS

When taxpayers receive large advance payments, there may be the potential that taxpayers are taxed in one year on income,
but have little income to set off against the future expenditure due to be expended on a contract in the future. The
Commissioner introduced section 24C of the Act which provides for an allowance in respect of future expenditure in certain
circumstances.

Future expenditure is defined as meaning, in relation to any year of assessment, an amount of expenditure which the
Commissioner is satisfied will be incurred after the end of a year:
a) in such a manner that it will be allowed as a deduction from income in a subsequent year,(An example of this would be
future salaries) or
b) in respect of an the acquisition of any asset in respect of which any deduction will be admissible under the provisions of the
Act.(An example of this would be the purchase of future materials)

The conditions of the section 24C allowance are that:

1. the income of the taxpayer in the relevant tax year must include or consist of an amount received by or accrued to him by in
terms of a contract; and
2. the Commissioner must be satisfied that the amount will be used by the taxpayer in whole or part to finance future
expenditure which the taxpayer will incur in performing his obligations under the contract.
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Where these conditions are present, the amount of the allowance is an amount equal to so much of the future expenditure(but
not exceeding the amount included in the taxpayers income) as the Commissioner considers relates to the amount included in
the taxpayers income. The allowance made in any year of assessment must be added back in the next year of assessment. (As
this calculation is subject to the Commissioners discretion, the original estimate of cost is usually used in the calculation.
However, if the Commissioner allows the revised cost to be used, then the taxpayer may calculate the section 24C allowance
based on the revised estimated total cost.)

The amount of the allowance is equal to:

_
Total expected costs at beg1 of contract Greater of : _ Total s11(a)
----------------------------------------------------- X Total cash received or expenses to date
_Total expected proceeds from contract Total income accrued

1
The revised costs of the contract may also be used if the Commissioner accepts the revised estimate.

Note that a section 24C allowance cannot be claimed for contingent expenditure.

ILLUSTRATION

A Ltd give a warranty when selling their goods. Can a section 24C allowance be claimed on the warranty.

SUGGESTED SOLUTION

They may not claim a section 24C allowance on future warranty expenditure.

Note that the section 24C allowance is not restricted to construction activities only.

Section 24C is an allowance for future expenditure on a contract. Thus whenever there is future expenditure on a contract, there
may be a section 24C allowance.

ILLUSTRATION - COMPANIES OTHER THAN CONSTRUCTION COMPANIES THAT MAY CLAIM A S24C

Mastercare subscribers pay an amount in advance in respect of repairs of their TV sets. The amount paid up front covers all
parts and maintenance for the year after the date of payment. At year end, an amount of R100,000 was paid in advance.
Mastercare estimate (and the Receiver agrees) that they only make a 25% profit on each repair contract. Can they claim a
section 24C allowance?

SUGGESTED SOLUTION

Yes, the provision for future expenditure is 75% X R100,000 = R75,000.

The allowance granted is deducted from income in the year it is received but added back in the next year.

14. DONATIONS DEDUCTION [section 18A]

The donations deduction is the last deduction that is calculated for a company.

The amount that may be deducted in respect of donations is limited to 10% of taxable income after every other
deduction for a company.

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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.

If an amount is not used in one year, the unused amount is carried forward to the next year (from 2015 years of assessment)

ILLUSTRATION – BASIC DONATIONS DEDUCTION

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.

Section 18A(3A) was added to the Act to determine the value when immoveable property is donated to the state for a period of
time (eg 99 years)

The deduction in respect of the donation of this type of immovable property transferred during years of assessment
commencing on or after 1 March 2014 is limited to:
A = B + (C x D)
Where:
 A is the amount to which the deduction of qualifying donations will be limited
 B represents the cost of the immovable property being donated
 C represents the amount of a capital gain (if any) that would have been determined in terms of the Eighth Schedule had
it been disposed of for an amount equal to the lesser of the market value or the municipal value (to prevent excessive
deductions as a result of artificial valuations) on the day of the donation
 D represents the percentage of the capital gain after deduction of the portion that would have been included in taxable
income as a taxable capital gain, thus 66.6% in the case of a natural person or special trust or 33.3% in all other
instances (s 18A(3A)).

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12-2 ASSESSED LOSSES
Contents
1. INTRODUCTION ................................................................................................................................... 2
2. APPLICATION ....................................................................................................................................... 4
3. SECTION 20 SUMMARY ........................................................................................................................ 4
3.1 SEQUESTRATION ............................................................................................................................ 5
3.2 – FOREIGN LOSSES.......................................................................................................................... 6
3.3 SUMMARY ..................................................................................................................................... 7
4. COMPANIES ......................................................................................................................................... 8
5. INDIVIDUALS ..................................................................................................................................... 10
5.1. INSOLVENCY OF THE TAXPAYER ................................................................................................... 10

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1. INTRODUCTION
The following is an introduction as to how the basic principles of assessed losses work.

“Assessed loss” means any amount by which the deductions exceed income in respect of which
they are admissible.

Illustration 1A

A Ltd starts trading an in year 1 gross income totals R1,000,000 and allowable deductions total
R1,250,000.

Calculate the amount of the assessed loss.

Suggested solution

Gross income R1,000,000

Less: Allowable deductions (R1,250,000)
Assessed loss (R 250,000)

The assessed loss can be carried forward to the next year and utilised in the next year by the
taxpayer that incurred the assessed loss.

Illustration 1A (continued)

In year 2, gross income totals R2,000,000 and allowable deductions total R1,900,000.

What are the taxation implications?

Suggested solution

Gross income R2,000,000

Less: Allowable deductions (R1,900,000)
Taxable income R 100,000
Less: Assessed loss carried forward (R 250,000)
Assessed loss carried forward to year 3 (R 150,000)

Assessed losses can only be used by the taxpayer that incurred it. The transfer of assessed losses
between companies is not allowed. The same taxpayer running different businesses in his own
name may set off the loss from one business off against the gain on another business.

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Illustration 1B

A taxpayer carries on three trades during the year of assessment, the result of trading being:
Business A - loss R1,000;
Business B - profit R2,000;
Business C - profit R500.
In addition, there is an assessed loss carried forward of R3,000 because of huge assessed losses
incurred by business A in the prior year.
(Note that these are businesses, not companies).

You are required to

(a) Discuss the taxation implications of the above profits and losses.
(b) Discuss how the taxation would change if these were separate companies and not businesses.

Suggested solution

Part a

As the taxpayer owns three businesses which are not incorporated, the businesses are all taxed in
the taxpayer’s name. The following is an illustration of the treatment of the above situation:

Income Business A (1,000)

Income Business B 2,000
Income Business C 500
Assessed loss brought forward (3,000)
----------
Assessed loss at end of year (1,500)
=====

Part b

If the businesses are incorporated, losses of one company cannot be set off against the loss of
another company.

Company A will have a R4,000 loss carried forward to next year.

Company B made a R2,000 profit and R600 taxation will be paid.

Company C made a R500 profit and R150 taxation will be paid.

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2. APPLICATION
The question arises as to what deductions may create an assessed loss.

All deductions and allowances from section 11 to section 37H are taken into account in determining
the amount of the assessed loss.

3. SECTION 20 SUMMARY
The provisions relating to assessed losses are contained in section 20 of the Income Tax Act.

It is important to understand what section 20 requires.

The first requirement that must be looked at is whether a taxpayer is carrying on a trade. An
assessed loss cannot be created unless a taxpayer is carrying on a trade.

The second thing that must be looked at is that the assessed loss that has been created must be
set off against income that has been generated from a trade.

Illustration 3A

A company had an assessed loss carried forward from last year of R40,000. Income of R10,000 is
made from a trade and R50,000 is made from non trade purposes.

What are the tax effects?

Suggested solution

The trade income of R10,000 will be set off against the assessed loss of R40,000. R30,000 will be
carried forward to the next tax year. Tax of 28% X R50,000 will be paid on the non trade income.

The following is the definition of trade included into the Act.

“Trade” includes every profession, trade, business, employment, calling, occupation or venture,
including the letting of any property and the use of or the grant of permission to use any patent as
defined in the Patents Act, 1978 (Act No. 57 of 1978), or any design as defined in the Designs Act,
1993 (Act No. 195 of 1993), or any trade mark as defined in the Trade Marks Act, 1993 (Act No.
194 of 1993), or any copyright as defined in the Copyright Act, 1978 (Act No. 98 of 1978), or any
other property which is of a similar nature;

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The definition of trade is very wide. In ITC 770, stated that trade was “obviously intended to
embrace every profitable activity.” As can be seen from the definition,
o rentals,
o royalties,
o salaries and
o ventures (where a person risks something for a profit)
are considered to be carrying on a trade.

It is perhaps easier to understand what trade is by discussing what would not be considered to be
carrying on of a trade.

The following would normally not constitute carrying on a trade namely:

o Interest earned,
o dividends received on investments,
o annuities and
o pensions are not included

Interest and dividends could be within the definition of trade if:

o the interest is earned by a moneylender; or
o the dividends are received by a sharedealer.

There thus may be a problem in determining whether a person is in fact carrying on a trade or not
for interest and dividends.

An example of this is when a person lends money to someone. Is the person a moneylender
carrying on a trade or is this an isolated transaction.

An approach that could be adopted to determine whether someone is carrying on a trade in this
instance is as follows:
1. is there a continuity of the activity generating the income (i.e. using our example how often
is money lent by you to third parties)
2. Is the long term objective of the activity being carried out to generate a profit (i.e. using our
example do we lend money to generate a profit.)

If the answer to the above two questions is yes, the taxpayer will be carrying on of a trade.

Certain things need to be considered

3.1 SEQUESTRATION
If you are sequestrated, you may not carry forward your assessed loss. If the sequestration is put
aside, the assessed loss may be retained.

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Illustration 3B

Mr A was put forward for sequestration in 20X4. He had an assessed loss of R300,000 at the
point he was put forward for sequestration. Discuss how much tax Mr A would pay if:
(a) Mr A was sequestrated and earned R30,000 income after the date of sequestration.
(b) Mr A’s sequestration was set aside and he earned R30,000 during the year of assessment.

Suggested solution

Part a

The assessed loss is forfeited on sequestration. Tax on R30,000 will be paid as per normal tax
rules.

Part b

As the sequestration was set aside, the assessed loss is not lost and the R30,000 is set off
against the R300,000 assessed loss. There will be an assessed loss of R270,000 carried forward
to the next year of assessment.

3.2 – FOREIGN LOSSES

In determining the taxable income of any person from the carrying on of any trade, there shall be
set off against such income -
 any assessed loss incurred by the taxpayer during the same year of assessment in
carrying on any other trade either alone or in partnership with others, otherwise than as a
member of a company the capital whereof is divided into shares:
 Provided that there shall not be set off against any amount—
(a) derived by any person from the carrying on within the Republic of any trade,
any—
(i) assessed loss incurred by such person during such year; or
(ii) any balance of assessed loss incurred in any previous year of
assessment,
in carrying on any trade outside the Republic.

With the introduction of the residence basis of taxation for years commencing 1 January 2001, it
became necessary to consider the impact of foreign losses on SA income.

There are two problems facing the SA government:

 They do not know the extent of foreign losses that could be claimed and as such erode the
SA tax base, thereby reducing tax collections
 There is a potential for abuse in that a division could be operated offshore whilst it is trading
at a loss, thereby reducing SA taxes paid and then be converted into a subsidiary when it
starts running at a profit. Thus the losses will be claimed in SA and the profits taxed
elsewhere.
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To protect the SA tax base, the legislation was drafted to state that foreign assessed losses may
not be set off against SA income.

Thus foreign losses incurred either in the current or previous years of assessment cannot be set off
against SA income. However foreign profits may be set off against foreign losses. In addition, SA
losses may be set off against foreign profits.

Illustration 3C

A Ltd has a foreign branch in the UK that traded at a loss of 20,000 pounds. It also had a foreign
branch in Germany that traded at a profit of 25,000 DM. The rate of pounds to rands at year end
was 15 to 1 and DM to rands was 8 to 1. The SA taxable income was R2,000,000 for the tax year.
A South African assessed loss of R1,100,000 was carried forward from the previous year.

(a) What will the taxation implications be for the current year?
(b) What will the taxation implications be for the next year if the British branch trades at a profit of
30,000 pounds and the German branch trades at a loss of 15,000 DM. Assume that the
exchange rates are 20 rands to the pound and 10 rand to the DM. The SA operation traded at a
loss of R70,000 for the year.

Suggested solution

Part a

The British loss equates to R300,000 and the German profit equates to R200,000. The South
African profit equates to R900,000 (after taking off the assessed loss of R1,100,000). The foreign
loss of R300,000 can be set off against the R200,000 foreign profit. The nett R100,000 loss cannot
be set off against the R900,000 SA profit as this is not allowed in terms of section 20 of the Act.

Taxation of R900,000 X 30% = R270,000 is paid in SA. The R100,000 foreign assessed loss is
carried forward to the next year.

Part b

The British profit is the equivalent of R600,000 and the German loss is R150,000. The nett foreign
profit is R350,000 after setting off the foreign assessed loss of R100,000 against the nett foreign
profit of R450,000 for the year. The SA assessed loss of R70,000 can be set off against the foreign
profit and the net taxable income for the year will be R280,000.

Taxation of 280,000 X 30% = R84,000 is paid in SA less any section 6 quat rebate.

3.3 SUMMARY
In summary, the taxpayer may deduct from the taxable income calculation:
o assessed losses brought forward from prior years and

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o losses from other businesses carried out.

Note that section 20A will limit the use of such assessed losses for natural persons taxpayers that
are taxed at the maximum marginal tax rate. In certain cases, losses are ringfenced and can only
be set off against income from a similar trade.

See the notes on section 20A in chapter 13B.

4. COMPANIES
Companies may utilise assessed losses.

The assessed loss may only be set off against its own trade income.

If a company does not trade during a particular year, the assessed loss is lost and the company
loses the right to carry forward the assessed loss to following years.

In SA Bazaars (Pty) Ltd v CIR (and later confirmed in the Robin Consolidated Industries case), it
was held that a company (note – it does not apply to individuals) cannot carry forward an assessed
loss from a previous year to the current year, if it has not traded during the current year.

As companies are incorporated, the assessed loss has to be used by the company that has
incurred it. An assessed loss of one company may not be utilised by any other company or
individual. This means that an assessed loss of a company cannot be set off against the taxable
income of its shareholders.

Illustration 4A

A Ltd owns 100% of the shares of B Ltd. B Ltd has an assessed loss of R10,000. Mr. A owns A
Ltd.
1. May A Ltd utilise B Ltd’s assessed loss?
2. May Mr. A utilise B Ltd’s assessed loss?
3. What will the situation be if B Ltd did not trade in the current year?

Suggested solution

1. A Ltd cannot utilise B Ltd’s assessed loss.

2. Mr. A cannot utilise B Ltd’s assessed loss.
3. If B Ltd did not trade this year, the assessed loss is lost and may never be utilised again.

Note that a company may not set off an assessed loss against non-trade income (eg interest
earned by a non money lender).

However SARS practice is to allow the set off of non trade income against the assessed loss if the
company trades during the year.

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If a company tries to trade in a particular year, but is unsuccessful (as in the case of a property
letting company who is not able to let its properties but tries to do so), the assessed loss will
probably not be lost due to the fact that no trade has been carried out. The attempt to trade is
sufficient.

Illustration 4B

B Ltd, a property owning company, had an assessed loss at the end of year 1 of R100,000. They
owned a property which was not let out in year 2 and a loss of R10,000 was made in year 2. In
year 3, R120,000 income was earned when the property was rented out.

Calculate the taxation for year 2 and 3 if:

(a) B Ltd attempted to rent out the property in year 2 but were unsuccessful
(b) B Ltd did not try to rent out the property in year 2.

Suggested solution

Part a

As they tried to rent out the property, the assessed loss is not foregone.

The R10,000 loss will be added to the assessed loss carried forward from the previous year and
R110,000 assessed loss will be carried forward to year 3.

Taxation of R10,000 X 30% = R3,000 will be paid in year 3 after setting off the R110,000 assessed
loss carried forward against the R120,000 profit made.

Part b

As there was no trade in year 2, and there was no attempt to trade, the assessed loss carried
forward from year 1 will be lost. The R10,000 loss incurred by B Ltd in year 2 will also be lost.

B Ltd will pay taxation of R36,000 in year 3 as a profit of R120,000 was made and no assessed
loss can be set off against the profit.

Note that the receipt of interest and dividends will not constitute the carrying on of a trade unless
the taxpayer is either a sharedealer or moneylender.

Illustration 4C

A Ltd has an assessed loss of R100,000 for year 1. In year 2, the company made no attempt to
trade other than by earning R40,000 interest from a bank account. A Ltd is not a moneylender.

What are the taxation implications?

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Suggested solution

The assessed loss cannot be set off against the R40,000 interest income and the assessed loss
will not be carried forward to the next year. Tax on the R40,000 interest income will be paid.

In the case of Robin Consolidated Industries v CIR, the principle established in this case is that the
realisation of stock or assets in the ordinary course of liquidation does not necessarily amount to
carrying on a trade as required for the purposes of section 20(1).

5. INDIVIDUALS
Individuals with assessed losses are treated differently to companies. Individuals may also utilise
assessed losses. The differences between individuals and companies are:
 Assessed losses may be set off against all their trade income and also against their non- trade
income (interest, etc.);
 An assessed loss can be created by losses from non trade income and
 If an individual does not trade, s/he will be able to keep his assessed loss

5.1. INSOLVENCY OF THE TAXPAYER

When a taxpayer’s estate is either voluntarily or compulsorily sequestrated, he will as from the date
of sequestration not be entitled to carry forward any assessed loss incurred prior to that date,
unless the order of sequestration is set aside.

(Note that this applies only to an order of sequestration made by the court, not due to a private
assignment).

In terms of section 25C, the insolvent estate prior to sequestration and the insolvent are the same
person for tax purposes and the assessed loss of the person can be used for the insolvent estate.

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CHAPTER 13-1
CAPITAL ASSETS ACQUIRED FOR USE IN THE BUSINESS

Table of Contents
1. CONNECTED PERSONS RULES ................................................................................................................... 2
2. MACHINERY USED IN A PROCESS OF MANUFACTURE .............................................................................. 3
3. FACTORY BUILDINGS ................................................................................................................................. 4
4. OFFICE, ADMINISTRATION OR COMMERCIAL BUILDINGS ........................................................................ 5
5. RESIDENTIAL BUILDINGS ........................................................................................................................... 6
6. LOANS ON LOW COST HOUSING ............................................................................................................... 7
7. WEAR AND TEAR ....................................................................................................................................... 8
8. LEASED ASSETS ......................................................................................................................................... 9
9. LESSEE RECOUPMENTS ........................................................................................................................... 10
10. INTANGIBLES ......................................................................................................................................... 12
11. BIO RENEWABLE ENERGY ASSETS (SECTION 12 B)................................................................................ 13
12. GOVERNMENT LEASEHOLD IMPROVEMENTS....................................................................................... 13
13. SHIPS AND AIRCRAFT ............................................................................................................................ 13
14. HOTELS .................................................................................................................................................. 15
15. SECTION 40CA EXCHANGE OF SHARES OR DEBT FOR ASSETS .............................................................. 15
16. VAT CONSIDERATIONS .......................................................................................................................... 15

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1. CONNECTED PERSONS RULES

The definition of a connected person is provided in s1 of the Act.

We note the connected person in relation to a natural person and to a company below.

A connected person to a natural person (par (a) of the definition is:

- any relative within the third degree of consanguinity
- a trust of which the natural person or the relative is a beneficiary

A connected person to a company (par(d)(i)-(vA) of definition) is:

- any other company in the same group of companies with a controlling company that has more
than 50% of the equity shares or voting rights in one company and directly or indirectly more
than 50% in other group companies
- any person who individually or jointly holds 20% or more of a company’s equity shares or voting
rights
- any company who holds 20% or more of a company’s equity shares or voting rights
- any other company that is managed or controlled by a connected person

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2. MACHINERY USED IN A PROCESS OF MANUFACTURE

Machinery

Machinery used in a process of manufacture Machinery not used in a process of manufacture

Capital allowances are claimed in accordance with Capital allowances will be calculated in terms of
section 12C. The following rules apply: section 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
 If purchased second hand, write off at 20%
small business corporation
straight line
 The capital allowances are not apportioned. Instead of the asset being written off at 40:20:20:20
Thus if an asset is purchased 2 days before (new asset) or 20% straight line (2nd hand asset), all
year end, the full 40% can be claimed if the machines acquired, both new and 2nd hand are written
asset is new. Similarly in the year the asset is off 100% in the year of acquisition.
sold, the full 20% can be claimed despite the
fact that the asset has not been used for the The rest of the rules are the same, such as no
whole year. apportionment, write down to nil, etc
 When calculating cost, remember that cost is
the sum of cost plus installation costs plus
moving costs (Thus for a foreign machine,
General considerations
freight, insurance, customs duty and import
charges could be included in cost. Vat will not
It should be noted that for a machine to be written off
be included in cost as input vat can be
in terms of section 12C (40/20/20/20 or 20% straight
claimed on machines by a vendor)
line) or section 12E (100% small business corporation),
 If a new asset is moved after it has been
the machine needs to have a cost.
acquired, the moving cost is written off over
the remaining life. Thus if R20,000 is incurred
The amount written off is the lower of cost or market
moving the machine in year 3, the R20,000 is
value at the date of acquisition.
written off over 2 years, R10,000 in year 3
and R10,000 in year 4. (20% left in year 3 and
Thus if a machine is donated, it cannot be written off
20% left in year 4, thus 20/40 X R20,000 in
in terms of section 12C or 12E.
year 3 and 20/40 X R20,000 in year 4)
 If a 2nd hand machine is acquired from a non
Thus a machine that is donated is written off in terms
vendor, the notional input vat can be claimed
of section 11(e) wear and tear even if used in a
if the purchaser is a vat vendor.
process of manufacture.
 The machines are written down to a nil value.
Wear and tear is based on value, not cost

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3. FACTORY BUILDINGS

FACTORY BUILDINGS

Land Donated Erection of Erection of Erection Exception

buildings factory factory of factory
Land is building building building If a factory
not If a building before from from building was
written is donated 25/3/1959 26/3/1959 1989 till erected by the
off. to a to current taxpayer claiming
taxpayer, If a factory 31/12/198 day the allowance
Buildings such was erected 8 between
are building pre 1959, no These 1/7/1996 and
written cannot be building These factories 30/9/1999 (and
off in written off allowance is factories are brought into use
terms of in terms of claimed even are written written before
the Act the Tax Act if acquired off at 2% off at 5% 31/3/2000), the
as they have after this date per annum per building is written
no cost. annum off at 10% per
annum

Students only need to know of the 5% deduction. In all other instances, the rate of the
allowance will be provided.

Other considerations

 If an asset is used 55% for factory and 45% for admin, as the building is being used mainly in a
process of manufacture, a full deduction can be claimed on the factory
 There is no apportionment of the building allowance. Thus a full amount is claimed even if the
building is not used for a full year.
 The buildings are written down to a nil book value.
 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%)
 There are no scrapping allowances claimable on disposal of factory buildings.
 If the building is sold at a profit ,para 65 of the 8 th schedule cannot be used to defer the profit as it
does not apply to buildings and the recoupment may be set off against the cost of a new building, or
against the lease improvement for the replacement building. (only if replaced within 12 months and
the replaced building qualifies for a building allowance.
 The cost of a building includes transfer duties4and vat, if such amounts cannot be claimed back as a
vat input. In addition, legal costs such as conveyancing CHAPTER 13-1
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4. OFFICE, ADMINISTRATION OR COMMERCIAL BUILDINGS

Commercial Building

Land Building 2nd hand building New or unused

erected pre acquired post building either erected
Land on which 1/4/2007 1/4/2007 or purchased by the
commercial building is taxpayer post
placed is not written off. No capital No capital 1/4/2007
allowance is allowance is
Buildings are written off claimed on claimed on these Capital allowances are
in terms of the Act these buildings buildings allowed to be claimed

Purchase 100% of the new or Purchase part of a new Purchase an improvement

unused building or erect the building of a building
building
(55% X 5% X cost) capital (30% X 5% X cost) capital
(5% X Cost) capital allowance allowance is claimable allowance is claimable
claimable

OTHER CONSIDERATIONS

 Any erection or improvement by the taxpayer post 1/4/2007 will be written off at 5%, even if
to a part of the building
 Cost is the lesser of actual cost or the market value at the date of the transaction. Thus if such a
building was donated, no allowance may be claimed by the done.
 No scrapping allowances can be claimed on these buildings
 There is no apportionment of the building allowance. Thus a full amount is claimed even if the
building is not used for a full year.
 The buildings are written down to a nil book value.
 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.

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5. RESIDENTIAL BUILDINGS

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
 5% X cost for residential buildings erected stand alone unit with a cost of less than or equal
by the taxpayer to R300,000, or an apartment with a cost of less
than and equal to R350,000
 5% X cost for residential buildings if the
and
whole building was acquired Rental charged of less than or equal to 1% of the
 55% X 5% X cost if part of a residential cost of the unit
building was acquired.
 30% X 5% X cost if an improvement part Low cost buildings are written off in a similar
of a residential building was acquired. manner to residential buildings, but 10% may be
written off per annum, not the 5%.

OTHER CONSIDERATIONS

 Any erection or improvement by the taxpayer must have commenced from 21 October 2008
 This only applies to units in SA
 The taxpayer needs to own 5 or more residential units
 Cost is the lesser of actual cost or the market value at the date of the transaction. Thus if such
a building was donated, no allowance may be claimed by the donee.
 The new or unused building must be used by the taxpayer as part of their trade. This can
come from two possible uses:
o Rented out by the taxpayer
o Taxpayer allows staff to reside in the residential building
 No scrapping allowances can be claimed on these buildings
 There is no apportionment of the building allowance. Thus a full amount is claimed even if the
building is not used for a full year.
 The buildings are written down to a nil book value.
 The cost of a building includes transfer duties and vat. Note that input vat cannot be claimed
for residential buildings

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6. LOANS ON LOW COST HOUSING

SECTION 13 SEPT

This section (section 13 sept) only applies to transactions on or after 21 October 2008.

DEDUCTION

If
an employer
sells a low cost residential unit
to an employee
at an amount less than or equal to the cost of the building
via an interest free loan,
an amount equal to 10% of the loan may be deducted each year
based on the balance on the loan at the end of the year of assessment
over a period of 10 years.

CAPITAL GAIN/LOSS TRANSACTION

Upon sale to the employee, the capital gain or loss on sale should be calculated

RECOUPMENT

If the employee repays the loan, an amount is recouped equal to the lesser of:
 amount claimed as a deduction over the life of the loan not yet recouped, or
 the amount of the loan repaid.

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7. WEAR AND TEAR

WEAR AND TEAR DEDUCTION

(SECTION 11e)
SAICA LEVEL 3

 Wear and tear is claimed on moveable tangible assets where no other section applies
 Interpretation note 47 gives the number of years each asset can be written off. This is
provided to students in the examination. If an asset is not mentioned on interpretation note
47, the taxpayer must reasonably estimate the period that the asset should be written off.
 The write off is usually based on the cost of an asset. However for assets that do not have a
cost, value may be used for the write off.
 The write off is apportioned for part of a year. The asset can only be written off is the asset
is used for the taxpayer. Thus an asset that is acquired on 1 January, but brought into use
on 1 March, will be written off X 4/12 if the year end is June.
 If an asset is improved, the cost of the asset improvement is written off over the asset’s
remaining useful life.
 Wear and tear assets are written down to R1.
 Assets under R7,000 can be written off in full. This is for stand alone assets that are not part
of a set. Thus if a desk is acquired for R6,000, it can be written off in full. However if a asset
was acquired for R80,000 and an improvement was made costing R3,000, the R3,000
cannot be written off as the asset cost more than R7,000. The asset should be written down
to R1.
 Allowances under this section can only be claimed on moveable assets. There are no s11(e)
deductions allowed in respect of immovable property such as buildings.

Note that you will be given the time elapsed in an exam.

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8. LEASED ASSETS
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 The asset is owned by the lessor. At
lessor. At the end of lease, asset end of lease, asset usually These agreements place
is taken back by the lessor. transferred to lessee ownership of the asset into
the user’s hands with a clause
Operating lease payments are Finance lease payments are stating that in the event of
deductible in the hands of the deductible in the hands of the non payment, the asset is
taxpayer. taxpayer. returned to the seller. Thus
the user will claim
Note the nature of the asset for Note that for a finance lease, vat is depreciation/wear and tear
vat. Operating lease payments claimed up front on the asset. See and interest and not the lease
for a motor car will be the capital allowances example to payments as a deduction
deductible inclusive of vat as vat see how vat is removed from lease
cannot be claimed on a motor payments for assets where vat was
car claimed upfront.

RENT LEASED ASSET WITH LEASE PREMIUMS AND IMPROVEMENTS EXCESS

AMOUNTS
Rent is deductible if the SPENT
property is used in the LEASE PREMIUMS LEASE IMPROVEMENTS
production of income. If a lessee spent
Lease premiums are lump sum When a lease is entered into, a more on
Thus if a plot of vacant amounts paid at the inception of term of the lease may be that improvements
land is rented subject to the lease. improvements are effected to the than the
an improvement being leased property. contracted
placed thereon, the rent These lease premium lump sum amount, such
will not be deductible amounts can be written off over These improvements effected may amounts may be
until the improvement is the probable duration of the be deducted from when the claimed as an
brought into use. lease whilst the asset is used in improvements on the property are asset allowance.
the production of income. finished till the end of the lease.
If a factory is leased Thus if an extra
subject to an Formula Formula R200,000 is spent
improvement being added Lower of amount spent and amount on a factory
to the factory, rent can be Lease premium amount X per contract improvement,
deducted immediately 1/probable duration of lease X 1/probable duration of the lease 200,000 X 5% can
provided the existing (max 25 years)X (max 25 years) X be claimed on
factory is used no months used/12 No months used / 12 the excess
immediately.

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9. LESSEE RECOUPMENTS

When leases come to an end, usually the lessee has 3 possible options:
 buy the asset for a residual
 the asset is abandoned to the lessee
 the lessee can continue to rent the asset at a nominal rental
A recoupment is calculated upon the lessee exercising any of the 3 above options

Situation 1 Situation 2 Situation 3

Buy the asset for a Asset abandoned to the Asset continued to be leased for a
residual amount lessee nominal rental

If the asset is bought If the asset is abandoned, If the asset is continued to be leased
for a residual, there there is a lease recoupment at a nominal rental of less than 10%
is a lease equal to the lesser of of market value, there is a lease
recoupment for  cost – 20% reducing bal recoupment equal to the same as
Market value less for each completed year situation 2.
Amount paid limited  Limited to market value If the rental exceeds 10% of the
to rentals paid  Limited to lease rentals market value of the asset per annum,
paid there is no recoupment.

Wear and tear can be claimed on the assets in situations 1 and 2 above. Wear and tear cannot be
claimed where the lessee continues to rent the asset at a nominal rental. The rental will be treated
as a deduction.
The recoupment is limited to the market value of the asset on the date the recoupment takes place.
In addition, the recoupment is limited to the lease deductions previously claimed on the leased
asset.

ILLUSTRATION – RECOUPMENT WITH A RESIDUAL

A Ltd leases a car to B Ltd. At the end of the lease, B Ltd buys the car for R5,000. The market value of the car at
this date was R20,000. What are the tax implications for B Ltd?

SUGGESTED SOLUTION

B Limited will include an amount of R15,000 (R20,000 - R5,000) into income in terms of the section 8(5) lease
recoupment. A section 11(e) wear and tear allowance based on R20,000 will be allowed on the asset.

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ILLUSTRATION – LEASE RECOUPMENT WHERE RECOUPMENT IS LIMITED TO DEDUCTIONS PREVIOUSLY CLAIMED

A Ltd leases a car to B Ltd. At the end of the lease, B Ltd buys the car for R5,000. The market value of the car at
this date was R70,000. In the past, R50,000 has been allowed as a deduction for the taxpayer. What are the tax
implications for B Ltd?

SUGGESTED SOLUTION

B Limited will include an amount of R50,000 into income in terms of the section 8(5) lease recoupment. The
taxpayer only recoups the deductions that have been claimed previously

ILLUSTRATION – ASSET ABANDONED

A Ltd leases a car that cost R50,000 to B Ltd for three years. The lease rental is R20,000 per annum. At the end of
the 3 years, the lessor abandons the asset to the lessee. The market value on this date is R24,000. Calculate the tax
effects of the lessee for the three years.

SUGGESTED SOLUTION

Year 1 Deduction of R20,000 for lease rentals;

Year 2 Deduction of R20,000 for lease rentals;
Year 3 Deduction of R20,000 for lease rentals;
Recoupment calculation
Cost less 20% reducing balance = 50,000 X 0,8 X 0,8 X 0,8 = R25,600 limited to market value of R24,000 limited to
lease rentals of R20,000 X 3 = R60,000

Thus recoupment of R24,000.

In addition, A Ltd can claim a section 11(e) wear and tear allowance on the car from the date that they have
acquired the asset and brought it into use utilizing a R24,000 value.

ILLUSTRATION- LEASED AT A NOMINAL RENTAL

A Ltd leases a car that cost R50,000 to B Ltd for three years. The lease rental is R20,000 per annum. At the end of
the 3 years, the lessor continues to lease the asset for R100 per annum to the lessee. The market value of the car
is R30,000. Calculate the tax effects of the lessee.

SUGGESTED SOLUTION

Year 1 Deduction of R20,000 for lease rentals;

Year 2 Deduction of R20,000 for lease rentals;
Year 3 Deduction of R20,000 for lease rentals;
Recoupment calculation
Cost less 20% reducing balance = 50,000 X 0,8 X 0,8 X 0,8 = R25,600 limited to market value of R24,000 limited to
lease rentals of R20,000 X 3 = R60,000

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Thus recoupment of R24,000.

Year 4 Deduction of R100 lease rental.

No wear and tear allowance would be granted to A Ltd as they do not own the car.

10. INTANGIBLES
INTANGIBLE ASSETS

INTANGIBLES INTERNALLY DEVELOPED

(RESEARCH AND DEVELOPMENT)
PURCHASED
No longer examinable
INTANGIBLES

Intangibles Intangibles (patents,

(other than inventions, design,
trademarks) copyright, technical
costing knowledge) bought
R5,000 or for greater than
less are R5,000
written off

Purchased Purchased Purchased

patents, designs trademarks
inventions, are are not
copyrights written off allowed to
are written at 10% be written
off at 5% off

These allowances are not apportioned for

periods of less than 1 year.

Renewal costs (even for trademarks) are

deductible in full.

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11. BIO RENEWABLE ENERGY ASSETS (SECTION 12 B)

New and unused assets for the production of bio-diesel, bio-ethanol, windmill energy creation or other forms of
environmentally friendly sources such as solar energy qualifies to be written off 50: 30: 20.

Photovoltaic cells below 1 megawatt are written off in full.

12. GOVERNMENT LEASEHOLD IMPROVEMENTS

When leasehold improvements are made on government land, a leasehold improvements deduction is
not claimed.

The enterprise that effected the improvements may claim a capital allowance.

ILLUSTRATION

A Ltd effected leasehold improvements of R2,000,000 by building a factory on a piece of land owned by
the government.

The lease is for 10 years and improvements took 4 months to build.

What are the tax implications?

SUGGESTED SOLUTION

A 5% factory allowance is claimable on the factory building

13. SHIPS AND AIRCRAFT

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Any ships and aircraft brought into use for the first time by the taxpayer will be allowed a section 12C
20% per annum straight line allowance over 5 years. (not 40:20:20:20)

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14. HOTELS
Any machinery, implement, utensil or article brought into use for the first time by the taxpayer who runs
a hotel (either owner of the hotel or lessee of the hotel) will be allowed a section 12C 20% per annum
straight line allowance over 5 years. (not 40:20:20:20)

This excludes any vehicles, and any equipment for offices, managers and servants rooms. These assets
will qualify for a wear and tear allowance.

If a hotel is a small business corporation, hotel assets will qualify for the 50:30:20 allowance.

15. SECTION 40CA EXCHANGE OF SHARES OR DEBT FOR ASSETS

When shares or debt are issued to pay for an asset, special rules apply
 Where shares are issued to pay for an asset, the asset is deemed to be acquired for the market
value of the shares immediately after acquisition
 Where debt is issued to pay for an asset, the asset is valued at the cost of the debt

ILLUSTRATION – SECTION 40CA

For the following 2 situations, at what amount will the assets be recognised for tax purposes
1. Plant acquired with the issue of 1,000 shares. The selling price of the plant was listed at R305,000 at
the business that sold the plant. The market value of the shares immediately after this transaction
was R300 a share.
2. Plant was acquired and debentures worth R250,000 were issued to the seller. The debentures are
repayable in 5 years’ time. The plant was usually sold by the seller for R270,000.

SUGGESTED SOLUTION

1. R300 X 1,000 shares = R300,000 “cost” for the asset

2. R250,000 “cost” for the asset

16. VAT CONSIDERATIONS

It should be noted whether an amount includes vat or not and whether the taxpayer is a registered
vendor for vat or not. (This assumes a knowledge of vat)

ILLUSTRATION – VAT CLAIMS

A Ltd, a registered vat vendor, bought the following assets:

 A truck for R114,000 from a vat vendor
 A motor vehicle for R228,000 from a vat vendor
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 New furniture from a non vendor for R11,400

 Second hand furniture from a non vendor for R22,800

What will the cost/value be from which a deduction in terms of section 11(e) can be claimed? Assume all
amounts include vat where applicable.

SUGGESTED SOLUTION TO ILLUSTRATION

The truck was bought from a vat vendor and an amount of R114,000 X 100/114 = R100,000 may be
deductible in terms of section 11(e).

The motor vehicle was also bought from a vat vendor. However there is a denial of input vat that may be
claimed by a vendor when a motor vehicle is purchased. Thus the amount that will be subject to section
11(e) is R228,000.

The new furniture is bought from a non vendor. No vat claim may be made when purchasing new goods
from a non vendor. The amount subject to a section 11(e) allowance is R11,400.

The purchase of second hand furniture constitutes a purchase from a non vendor on which a notional
input vat could be claimed. R22,800 X 100/114 = R20,000 will be deductible in terms of section 11(e).

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CHAPTER 13-2
THE TAXATION OF LESSORS

Table of Contents
1. RENT RECEIVED ................................................................................................................................................... 2
2. LEASE PREMIUM ................................................................................................................................................. 2
3. LEASEHOLD IMPROVEMENTS ............................................................................................................................. 2
4. RELIEF FOR LESSOR ............................................................................................................................................. 4
5. SECTION 23A (only 4862) .................................................................................................................................... 5
6. SECTION 23D - SALE AND LEASEBACK (only 4862) ............................................................................................. 6

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1. RENT RECEIVED
Rent received by the lessor is included in gross income.

2. LEASE PREMIUM
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

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). 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

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.

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4. RELIEF FOR LESSOR

Section 11(h) provides some relief for the lessor in certain circumstances.
NOTE THE AMOUNT OF THIS DEDUCTION WILL BE GIVEN IN AN EXAM. REMEMBER IF THEY GIVE OPTIONS, USE
THE ONE DISCOUNTED BY 6% AND REMEMBER NO ALLOWANCE MAY BE CLAIMED WHERE THE TRANSACTION
IS BETWEEN CONNECTED PERSONS.

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.

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. The amount of the 11(h) allowance will be
given in a question.

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

The answer you get is R60,658. The section 11(h) relief is thus R80,000 - R60,658 = R19,342.

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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.

5. SECTION 23A (no longer examinable)

Section 23A is a tax anti avoidance section. The following discussion discusses how section 23A works on a
basic level and shows why section 23A was promulgated.

Discussion

Consider the following. A Ltd have a taxable income for the current December year end of R10,000,000.

B Ltd want to buy a machine that costs R30,000,000 but need to obtain finance to get the machine. On 1
December, they enter into a lease agreement with B Ltd whereby they agree to pay a monthly lease amount of
R1,000,000 a month for the next 36 months to obtain use of the asset. Ignore VAT. The first lease payment is
paid on 1 December and the new machine is brought into use by B Ltd on 5 December. Assume that the
40:20:20:20 section 12C allowance may be claimed on the machine by the lessor.

A Ltd will include the R1,000,000 lease rental into gross income. A Ltd will claim a section 12C allowance of
R30,000,000 X 40% = R12,000,000.

A Ltd will have a taxable income of R10,000,000 + R1,000,000 – R12,000,000 = R1,000,000 assessed loss.

Clearly this is not in the interests of SARS.

Section 23A is a section that tries to limit the deduction in respect of leased assets to the amount of the gross
income received.

With the application of section 23A, R1,000,000 is included in gross income and as such only R1,000,000 will be
allowed as a section 12C deduction. The remaining section 12C deduction of R11,000,000 will be carried
forward to the next tax year.

In the next tax year, a further R12,000,000 will be included in gross income. A further 20% X R30,000,000 =
R6,000,000 will be claimed in terms of section 12C. Thus there will be R17,000,000 (R11,000,000 carried
forward and R6,000,000 current) section 12C deduction available. R12,000,000 deduction will be set off
against the R12,000,000 gross income and the remaining R5,000,000 will be carried forward to the next tax
year.

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A summary of this process is as follows:

Year 1 Year 2 Year 3 Year 4
Rentals received R1,000,000 R12,000,000 R12,000,000 R11,000,000

12C carried forward R11,000,000 R5,000,000

Total section 12C R12,000,000 R6,000,000 R6,000,000 R6,000,000
12 C deduction claimed(R1,000,000) (R12,000,000) (R11,000,000) (R6,000,000)
12C carried forward R11,000,000 R5,000,000 R NIL R NIL

Net taxable income NIL NIL R1,000,000 R5,000,000

As can be seen, the total taxable income from years 1 to 4 is R6,000,000. This makes sense as R1,000,000 was
received for 36 months creating gross income of R36,000,000 whilst the cost of the machine of R30,000,000
was written off resulting in R6,000,000 taxable income.

Section 23A defers taxation till the year sufficient income is received.

6. SECTION 23D - SALE AND LEASEBACK (only 4862)

A sale and leaseback arrangement is any arrangement where:
- a seller disposes of an asset to a purchaser; and
- the seller (or any connected person to the seller) hires the asset from the purchaser.

For example, if A Ltd purchased a machine and then sold it to B Ltd and then hired it from B Ltd, it would be a
sale and leaseback arrangement.

s23D is applicable when a taxpayer lets a depreciable asset to a person who had owned the asset within two
years before the start of the lease. This also includes licensing transactions where an asset is licensed to a
licensee.

s23 limits the amount of deductions that the lessor can claim on the machine that is being leased. The cost of
the machine used when calculating the allowances cannot exceed:

Cost of the asset to the other party (the lessee)

LESS
all deductions and allowances to the other party
ADD
the recoupment on sale of the asset
ADD
the taxable capital gain to the other party

It should be noted that in a sale and leaseback transaction that a lessee is bringing an asset into use for the 2 nd
time. (originally brought the asset into use and then sold it. Leased the asset back and brought it into use for
the 2nd time.)

Revising section 12C, an allowance cannot be claimed in terms of section 12C if the asset has already been
brought into use by the taxpayer before. Thus section 11(e) has to be used.

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ILLUSTRATION – SALE AND LEASEBACK

C Ltd bought a 2nd hand machine for R60,000 on 1January 20X1. They used the asset for 10 months, but then
entered into a sale and leaseback agreement with D Bank where D Bank buy the asset from C Ltd for R55,000.
The market value was R58,000 on 1 November 20X1. C Ltd and D Bank have a 31 December year end. The
machine has an expected useful life of 5 years. The lease is for a period of 50 months at R1,300 per month.

Show how the above will affect their tax calculations for the 20X1 tax year

SUGGESTED SOLUTION

C Ltd (The lessee)

Section 12 C allowance (20% X R60,000) (R12,000)

Recoupment on sale of the machine (R55,000 – R48,000) R 7,000
Lease deduction (R 2,600)

D Bank (The lessor)

Lease income R 2,600

Wear and tear (2/50 X 55,000) (R 2,200)

The lessor cannot claim the s12C allowance as it was already claimed once by the lessee. s12C states that
amounts can only be claimed once by a person and/or his lessee. The allowance is thus calculated under s11(e)
over the remaining period of the useful life of the machine (60 months originally but the lessee had used it for
10 months).

The amount that D Bank can use cannot exceed:

The original cost to the lessee 60,000

LESS allowances to the lessee (12,000)
ADD recoupments 7,000
ADD taxable capital gain 0
TOTAL 55,000

The cost to D Bank (R55,000) and the limit agrees in this case.

D Bank (The lessor)

Lease income R 2,600

Wear and tear (2/50 X 55,000) (R 2,200)

Note that no section 12 C allowance can be claimed as the asset has been brought into use by C Ltd before.
Section 11(e) is claimed.

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 CHAPTER 13-3
DISPOSAL OF CAPITAL ASSETS -
RECOUPMENTS, SCRAPPING ALLOWANCES,
CAPITAL GAINS AND CAPITAL LOSSES ON
THE SALE OF CAPITAL ASSETS

Table of Contents
1. SCRAPPING ALLOWANCES AND CAPITAL LOSSES........ Error! Bookmark not
defined.
2. PROFIT ON SALE OF ASSETS............................................................................. 5
3. DEFERRALS ........................................................................................................ 12
 2

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

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)
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

ILLUSTRATION – SCRAPPING ALLOWANCE AND CAPITAL LOSSES

A machine is bought on 1 January 20X7 for R200,000 and sold on 1 February 20X8 for R15,000.
Assume a scrapping allowance can be claimed. Assume that allowances are claimed 40/20/20/20 for
a new machine

What are the CGT implications. The company has a December 31 year end.

SUGGESTED SOLUTION

Calculate the tax value

Cost R200,000
Less: Section 12 C for 20X7 tax year (R 80,000)
Less: Section 12 C for the 20X8 tax year (R 40,000)
Tax value on sale R 80,000

The asset was sold for R15,000 and as such a scrapping allowance of R80,000 – R15,000 = R65,000
can be claimed.

The proceeds will be R15,000.

For base cost purposes,

Cost R200,000
Less: Capital allowances to date (R120,000)

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Less: Scrapping allowance (R 65,000)

Base cost R 15,000

The capital gain will be R15,000 – R15,000 = Rnil.

ILLUSTRATION – CAPITAL LOSSES

A used factory building is acquired on 1 January 2009 for R970,000. Input vat of R80,000 was paid
and legal costs to register the property into the name of the company were R30,000. The company is
a vat vendor.

The factory was erected in 1994. The factory was sold on 15 September 2011 for R300,000. The
company has a December year end. 5% could be claimed on the building per annum.

You are required:

a) What are the CGT implications?
b) How would the CGT implications change if the building was acquired on 1 January 2000. The
following have been presented to you and you can assume it is correct. The market value on 1
October 2001 was R1,100,000 and the time apportioned base cost is R390,000.

SUGGESTED SOLUTION

Part a

Cost of the factory will be R970,000 + R30,000 + R97,000 – R97,000 = R1,000,000.

Note the transfer duty is claimable as vat.

Cost R1,000,000
Less: Building allowance (1,000,000 X 5% X 3) (R 150,000)
Tax value on the date of sale R 850,000

No scrapping allowance can be claimed as the building has more than a 10 year useful life.

The proceeds are R300,000. There is no tax effect on sale as the scrapping allowance was denied.
The base cost is R850,000 (asset acquired after 1/10/2001).

There is a capital loss of R850,000 – R600,000 = R250,000.

Part b

Cost R1,000,000
Less: Building allowance (1,000,000 X 5% X 10) (R 500,000)
Tax value on the date of sale R 500,000

No scrapping allowance can be claimed as the building has more than a 10 year useful life.

The proceeds are R300,000. There is no tax effect on sale as the scrapping allowance was denied.

The asset was acquired before 1 October 2001.

Proceeds are R300,000. Tax base cost is R500,000. Thus expenditure exceeds proceeds and
paragraph 27 is followed.

Market value is R1,100,000 at 1 October 2001 and as such base cost will be the lower of time
apportioned base cost and market value at 1 October 2001.

Thus base cost is R390,000 given.

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There is a capital loss of R390,000 – R300,000 = R90,000.

ILLUSTRATION – SECTION 20B DEFERMENT OF SCRAPPING ALLOWANCE

A Ltd sell a machine for R20,000 plus an amount of R2 per item produced over the next 3 tax years.

The machine cost R450,000 and had a tax value of R180,000 on the date of sale.

The additional amounts received in terms of the sale contract are as follows:
 R30,000 in year 1,
 R35,000 in year 2
 R25,000 in year 3

What are the taxation implications?

SUGGESTED SOLUTION

Year 1

As the asset is being disposed for a loss, a scrapping allowance is calculated on the date of disposal.

Cost of the asset for tax purposes R450,000

Less: Capital allowances allowed to the date of disposal (R270,000)
Less: Proceeds on disposal (R 20,000)
Loss claimable for tax purposes R160,000

This loss cannot be claimed immediately as the transaction has unquantified amounts that will be
received over the next 3 years. The loss is thus deferred in terms of section 20B.

An additional quantified amount of R30,000 is received during year 1. This is set off against the
R160,000 present scrapping allowance and R130,000 is carried forward to year 2.

Year 2

R35,000 becomes quantified and is set off against the R130,000 carried forward.

A scrapping allowance of R95,000 is carried forward in terms of section 20B.

Year 3

R25,000 becomes quantified and is set off against the R95,000 carried forward.

A scrapping allowance of R70,000 remains in terms of section 20B.

As this transaction is now closed, the R70,000 scrapping allowance will be allowed as a deduction in
this tax year.

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2. PROFIT ON SALE OF ASSETS

RECOUPMENTS CAPITAL GAINS TAX ON DISPOSAL OF ASSETS
SECTION 8(4)(a)
Capital gains need to be calculated when
Tax allowances that have been allowed are  an asset is sold for more than its original cost or
recouped in terms of this section.  when an asset has been acquired prior to 1 October 2001 and the valuation date rules for CGT apply to the asset.

The section does not apply only to fixed The following format may be used for calculating capital gains or losses on the disposable of tax deductible assets
assets but any allowances that may have
been granted such as capital allowances, or For each asset disposed of
bad debts or other deductions. 1. Calculate tax value. Split tax value between pre 1 October 2001 and post 1 October 2001.
 This is needed as post 1 October 2001 base cost is calculated differently from pre 1 October 2001 base cost. Also the
When a tax depreciable asset is sold for more
tax value is needed to calculate the recoupment or scrapping allowance per step 2
than tax value, a recoupment occurs.
2. Calculate the recoupment or the scrapping allowance. This is done by taking the lower of cost or selling price and deducting
Recoupments are limited to the allowances the tax value.
that were previously granted on the asset  This step is needed to calculate the amount included in gross income on disposal of an asset. This is used in step 3.
being disposed of.  If there is a scrapping allowance, it is taken off the base cost in step 4
 Scrapping allowance cannot be claimed on a building.
Thus if a machine costs R100 and has been
written off by 60, and the machine is sold for 3. Proceeds = Selling price less amount included in gross income.
R110, the recoupment cannot be larger than  The amount included in gross income is usually the recoupment of allowances on sale
60. 4. Calculate Base cost (Pre + Post 2001 base costs)
 Base cost post 1/10/2001 is cost less allowances that have been granted to date for assets acquired on or after 1
The recoupment is calculated as follows: October 2001
Cost 100
 For base cost pre 1/10/2001, use the table in the CGT notes for valuation date value assets
Less: Allowances ( 60)
Tax value on disposal 40 5. Capital gain or loss for the asset = proceeds – base cost
Sold for 6. Exclude any amount that may be deferred on disposal
use lower of cost/sell price 100 7. Add all capital gains and losses together
Recoupment – limited to 60 8. If the taxpayer is an individual, take off the annual exclusion (as in the chapter on CGT)
9. Take off assessed capital losses carried forward
The other 10 profit will be subject to capital 10. X 25% for individual or X 50% for companies and trusts and Include the amount in taxable income if there is a capital gain,
gains provisions.
otherwise carry a capital loss forward.

Section 8(4)(k) deems an asset that has been donated, or any asset that has been declared as a dividend in specie to be sold at market value. Thus if a fixed asset with a cost of R10,000,
a tax value of R1 and a market value of R6,840 (incl VAT) is declared as a dividend, it will be deemed to be sold for R6,000 (ex vat) and a recoupment of R5,999 will result. (VAT claimed as
change in use).Dividends tax of R6,000 X 15% will also be payable. Thus if a fixed asset is donated when it cost R100,000, had a tax value of R40,000 and had a market value of
R110,000, then there will be a R60,000 recoupment and R10,000 capital gain as the asset is deemed to be disposed of for R110,000.

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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

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 of R2,000. (See later for a calculation of this)

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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 100/114 = R200,000.

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 – LOCK STOCK AND BARREL SALES

If there is a lock stock and barrel sale, where prices are not quoted for individual assets, the
Commissioner may apportion fair prices to the assets sold. These values as assigned by SARS will
then be used to determine profit or loss.

B Ltd sold the all the assets of their operation to C Ltd. The only assets of the operation was
machinery which had a cost of R200,000 and a tax value of R80,000 and stock which had a cost of
R50,000. The entire operation was sold for R300,000. The Commissioner believed that R60,000 of
the purchase price related to stock, R140,000 of the purchase price related to the machine and
R100,000 to goodwill. Assume the cost of the machine was R300,000. What are the tax implications
of the above? Ignore CGT

SUGGESTED SOLUTION

B Ltd will include R60,000 into gross income as relates to the sale of stock and get a stock deduction
of R50,000 for the stock sold.

A recoupment of an amount of R60,000 in respect of the machine will also be included in gross
income. (R140,000 proceeds less R80,000 tax value)

The sale of goodwill is capital and not subject to income tax, although it may be subject to capital
gains tax.

ILLUSTRATION – DOMESTIC ASSETS SUBSEQUENTLY USED FOR BUSINESS USE

Mr A bought an asset for R20,000 and used it for domestic use. 2 years later when the asset was
worth R10,000, the asset was brought into Mr A’s business and was allowed wear and tear on the
R10,000 value.

R3,000 wear and tear was allowed up till the date that the asset was sold for R14,000. What are the
tax implications?

SUGGESTED SOLUTION

A personal use asset has been converted to business use. At the date the assets ceases to be used
for personal use, the asset is deemed to be sold and re-acquired for the market value of R10,000.
(See CGT notes)

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From a tax perspective, a loss has been made based on the R20,000 original price, but there is a new
deemed cost of R10,000.

Section 8(4)(a) operates by comparing the lower of proceeds and “deemed cost” of R10,000 to the
tax value.

The R3,000 allowed as wear and tear will be recouped. The R4,000 will be subject to capital gains tax
notwithstanding the fact that the asset originally cost R20,000.

ILLUSTRATION – DEPRECIABLE CGT ASSET BOUGHT POST 1 OCTOBER 2001

A machine was bought new on 1 November 20X1 for R200,000 and was sold on 12 January 20X4 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.

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 of the current year 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 current year of assessment (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 tax effects on sale

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

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%) 64,000

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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.

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)
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)
R3,360,000

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

ILLUSTRATION – DIVIDEND IN SPECIE

A Ltd is owned 100% by Mr A. The company owns an asset that cost R100,000 and has a
R10,000 book value. The company wants to sell the asset. B Limited has offered the
company R60,000 for the asset. The company realizes it will pay tax of R14,000 (R50,000 X
28%) on the R50,000 profit.

Mr A therefore decides to declare the asset as a dividend in specie of R10,000 to himself.

There is thus a dividend of R10,000.

Mr A then sells the asset to B Limited for R60,000.

What are the tax implications of the transaction?

SUGGESTED SOLUTION

The asset is deemed to be sold for R60,000. The company will have a deemed recoupment
of R50,000. They will nevertheless pay tax of R14,000 due to the provisions of section
8(4)(k).

Note the same would apply for an asset that is donated.

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3. DEFERRALS
Deferral of recoupments and capital gains

ASSET DESTROYED (PARA 65 OF 8TH SCHEDULE) ASSET SOLD (PARA 66 OF 8TH SCHEDULE)

If an asset is destroyed, stolen or expropriated If an asset is sold

and: and:

1. A contract for any replacement asset must be concluded within 12 months, 1. Contract for replacement asset must be concluded within 12 months, and asset replaced
and asset replaced within 3 years (need not be the same type as the within 3 years AND
destroyed asset , but cannot be shares) AND 2. The replacement asset/s cost more than the proceeds received for the SOLD asset
2. The replacement asset/s cost more than the proceeds received for the 3. The asset sold and are 11(e) wear and tear assets, 12B assets, 12C Machines, 12E
destroyed asset AND Small bus corp assets AND
3. There must be a nil or positive capital gain 4. The asset they are replaced with are 11(e) wear and tear assets, 12B assets, 12C
Machines, 12E Small bus corp assets AND
then the recoupment and capital gain on old asset is deferred and recognized as 5. There must be a nil or positive capital gain
the new asset is written off
CAPITAL GAIN = TOTAL DISREGARDED CAPITAL GAIN X CAPITAL ALLOWANCE REPLACEMENT ASSET ALLOWED IN THAT YEAR then the recoupment and capital gain on old asset is deferred and recognized as the new
TOTAL CAPITAL ALLOWANCE FOR THAT ASSET OVER ITS LIFE
asset is written off
CAPITAL GAIN = TOTAL DISREGARDED CAPITAL GAIN X CAPITAL ALLOWANCE REPLACEMENT ASSET ALLOWED IN THAT YEAR
For this section to apply, a machine that is destroyed could be replaced by a TOTAL CAPITAL ALLOWANCE FOR THAT ASSET OVER ITS LIFE

building, a truck could be replaced by a computer.

For this section to apply, a machine that is sold could be replaced by a furniture, a truck could
However no asset can be replaced by shares. This section will not apply for be replaced by a computer, and office equipment by a motor vehicle.
shares.

If the replacement asset is disposed of and not replaced, any amounts not yet recognised in income or capital gains are calculated immediately.

If the replacement asset is disposed of and replaced (and paragraph 65 or 66 apply), any amounts not yet recognised in income or capital gains are combined with the profits and
capital gains of the original assets and written off over the new replacement asset’s life.

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ILLUSTRATION – APPLICATION PARAGRAPH 65

A Ltd had a fire at their factory. A machine acquired post 1 October 2001 was destroyed by fire and
the insurance company paid R120,000 ex vat to A Ltd. The machine cost R100,000 and had been
fully written off for tax purposes.

In addition, the insurance company paid out R100,000 for a motor vehicle that was also destroyed in
the fire. The motor vehicle was also acquired post 1 October 2001 for R150,000 and had a tax value
of R90,000 on the date of sale.

The insurance proceeds on these two assets were used to acquire a machine. 2 months after the
fire, a contract was signed to acquire a new asset and one month later the machine was brought into
use. The new machine cost R1,000,000 and qualified for the 40% section 12C allowance.

Will paragraph 65 apply to the transaction?

SUGGESTED SOLUTION

The requirements are as follows:

There must have been an involuntary disposal

The destruction of machinery and motor vehicles by fire will constitute an involuntary disposal.

The assets must be assets other than financial instruments

The assets are machinery and motor vehicles and as such are not financial instruments.

There must be a nil or positive capital gain

For the machine, there will be a recoupment of R100,000. Proceeds will be R120,000 – R100,000 =
R20,000. Base cost = R0. There will be a R20,000 capital gain and this requirement is fulfilled.

For the motor vehicle, there will be a recoupment of R10,000. Proceeds will be R100,000 – R10,000
= R90,000. Base cost will equal tax value = R90,000. The capital gain/loss = R90,000 proceeds –
R90,000 base cost = R0. As there is a nil capital gain, paragraph 65 will apply.

All proceeds on sale must be expended in replacing capital assets

The proceeds on disposal were R120,000 for the machine and R100,000 for the vehicle.

These proceeds of R220,000 were expended on buying a new machine that cost R1,000,000.

Thus all the proceeds were expended on the acquisition of a new asset.

A contract must be signed to replace the destroyed assets within 12 months

The replacement asset contract was entered into two months later.

The replacement asset must be brought into use within 36 months

The asset was brought into use after 3 months.

Conclusion

As all the requirements were met, paragraph 65 will apply.

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ILLUSTRATION – SHOULD PARAGRAPH 65 OR 66 BE USED

A Ltd have had their factory burn down in a fire on 12 January 20X1. The factory had cost the
company R2,000,000 originally and they have claimed R500,000 in capital allowances in the past.

The insurance company paid out R3,700,000 to the company. The client has presented you with a
base cost calculation and you have checked that it is correct at R1,800,000.

The client wants to know what options they have. They have bought a new building in Johannesburg
on 27 April 20X1 for R4,000,000 and can claim a 5% capital allowance on the new building.

The company has a 30 September year end. The client does not know of the provisions of paragraph
65 and 66.

What are the taxation implications of the above?

SUGGESTED SOLUTION

The company has two options:

o They can be taxed on the insurance proceeds or
o They can defer taxation by using paragraph 65 of the 8th schedule.

Taxed on insurance proceeds

The building will be deemed to be sold for the insurance proceeds of R3,700,000.

To calculate the recoupment on sale, the following calculation will be done:

 The selling of price of R3,700,000 limited to original cost of R2,000,000 less tax value of
R1,500,000 will be the recoupment.
 A recoupment of R500,000 will be reflected in the records of A Ltd due to the profit on disposal.

A capital gain will also have to be calculated.

Proceeds are R3,700,000 less the recoupment of R500,000 = R3,200,000.

Base cost as calculated is R1,800,000 leading to a capital gain of R1,400,000. (R3,200,000 –

R1,800,000).

80% of this capital gain will be added to A Ltd’s taxable income as a capital gain i.e. R1,400,000 X
80% = R1,120,000. (1)

Use paragraph 65 of the 8th schedule

Paragraph 65 of the 8th schedule requires:

 That an asset be expropriated, lost or destroyed
o The factory building was destroyed by fire and as such this requirement is filled.
o That the person receive compensation at least equal to the base cost of the asset
o A Ltd received compensation of R3,700,000 which exceeded the base cost of the
asset which was R1,800,000. This requirement is filled.
 The person must satisfy the Commissioner that the full proceeds will be re-invested in
replacement assets
 In this case, the full proceeds have been re-invested in a replacement machine, thus
this requirement has been met.
 The contract for the acquisition of the replacement asset must be concluded within 12 months (18
months with SARS approval)
o The asset has been bought within 4 months of the destruction of the old asset.
 The replacement asset must be brought into use within 3 years

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o The asset was brought into use within 3 years and this requirement has been filled.

As all the requirements of paragraph 65 have been filled, the recoupment and capital gain on disposal
can be deferred and recognised as the new asset is written off by the business.

In the current year, 5% on cost has been claimed on the new asset and the following will be the tax
effects:
 5% X R500,000 = R25,000 of the recoupment will be recognised.
 5% X R1,400,000,000 = R70,000 of the capital gain will be recognised. R56,000 (R70,000 X
80%) will be included into taxable income.

The R475,000 recoupment left and R1330,000 capital gain left will be carried forward to the next year.

The gain will be recognised annually or will be recognised in full when the new factory building is sold.

ILLUSTRATION – DEFERMENT OF GAINS ON SALE

A Ltd own a machine with a cost of R100,000 and a tax value of R40,000 on the date of sale.

The machine is sold for R110,000 ex vat and replaced by a truck that is purchased for R171,000
including VAT. The truck was acquired on 1 April.

What are the tax effects for the current and next year of assessment assuming the truck is used in
both years and not sold.

The company has a 30 September year end. Trucks are written off over 4 years for tax purposes.

SUGGESTED SOLUTION

Current year
Income tax calculation

There is a recoupment on the sale of the old machine of R100,000 (lower cost and selling price) –
R40,000 (tax value) = R60,000.

However this recoupment is deferred as paragraph 66 applies.

CGT calculation

Proceeds = Selling Price – Recoupment

= R110,000 – R60,000 = R50,000

Base cost = Cost – Allowances

= R100,000 – R60,000 = R40,000 (tax value)

Capital gain = Proceeds – Base Cost

= R50,000 – R40,000
= R10,000

However this capital gain is deferred as paragraph 66 applies.

What is included in the tax return

The new truck is written of for 6 months this year. The wear and tear allowance is R171,000 X
100/114= R150,000 ex VAT X ¼ X 6/12 = R18,750.

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The portion of the recoupment recognised is R18,750/R150,000 X R60,000 = R7,500.

The remaining R52,500 will be carried forward to next year.

The portion of the capital gain recognised is R18,750/R150,000 X R10,000 = R1,250.

The remaining R8,750 will be carried forward to next year.

Next year

The new truck is written of for 12 months next year. The wear and tear allowance is R171,000 X
100/114= R150,000 ex VAT X ¼ X 12/12 = R37,500.

The portion of the recoupment recognised is R37,500/R150,000 X R60,000 = R15,000.

The remaining R37,500 will be carried forward to next year.

The portion of the capital gain recognised is R37,500/R150,000 X R10,000 = R2,500.

The remaining R6,250 will be carried forward to next year.

ILLUSTRATION – REPLACEMENT ASSET DISPOSED OF

An machine is destroyed and a recoupment of R100,000 and a capital gain of R300,000 is made on
the disposal.

A replacement truck is acquired at a cost of R1,000,000. Wear and tear for 6 months was claimed in
respect of last year. Trucks are written off over 4 years.

In the current tax year, the truck was destroyed in an accident 9 months into the tax year and the
insurance company paid out R800,000 after VAT.

Paragraph 65 applied to the replacement transaction last year.

What are the tax implications for the current year if there is no intention to replace the truck upon
sale?

Suggested solution

Last year

In the past year, 6/12 X R1,000,000 X ¼ = R125,000 wear and tear was claimed on the replacement
truck.

Thus 125,000/R1,000,000 X R100,000 = R12,500 recoupment was recognised and

125,000/1,000,000 X R300,000 = R37,500 capital gain was recognised. (Note that R18,750 will be
included in taxable income after the 50% CGT application rate is applied.)

There will be R87,500 carried forward to the next tax year in respect of the recoupment and R262,500
of the capital gain.

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Current year

In the current year, 9/12 X R1,000,000 X ¼ = R187,500 wear and tear was claimed on the
replacement truck up till the date of destruction.

Thus 187,500/R1,000,000 X R100,000 = R18,750 recoupment was recognised and

187,500/1,000,000 X R300,000 = R56,250 capital gain was recognised. (Note that R28,125 will be
included in taxable income after the 50% CGT application rate is applied.)

There will be R87,500 – R18,750 = R68,750 of the recoupment not yet written off and R262,500 –
R56,250 = R206,250 of the capital gain not yet written off.

These will be written to income as the replacement asset has been sold and there is no intention to
replace the asset.

ILLUSTRATION - REPLACE ASSETS WITH 2 OR MORE ASSETS

A SA resident company sold a machine on 1 January 20x6 for R500,000. The company has a 31
December year end. There was a recoupment of R120,000 and capital gain of R90,000 on the
disposal of the asset. The company wants to replace the machine on 1 February 20X6 with two
machines and need advice from you as to the tax treatment of the replacement asset over the next
two years. One machine will be acquired for R180,000 new and the other for R360,000 second hand.
(The second hand machine is not used in a process of manufacture as it is used to repair items and is
written off in terms of section 11(e) over 12 years.)

They want to sell the replacement machines on 15 December 20X7. They expect to realise R130,000
on sale. (R70,000 for the new machine and R60,000 for the second hand machine)

They have asked you to discuss what the tax implications are. The client knows of what paragraph 65
and 66 contain. You need to provide the section within your discussion.

However the client would like to know what all the tax effects are of the above. Assume that there are
no other capital gains or losses for the 20X6 and 20X7 tax years.

Suggested solution

Paragraph 66 applies to the sale.

This is because:
o The asset was subject to a section 12C machinery allowance
o The replacement asset will be brought into use within 18 months of the disposal of the other
machine.
o The amount expended on replacement assets exceeds the receipt from the disposal of the old
asset
o The replacement assets are moveable assets of a SA resident.

The recoupments will be split over the values of the replacement machines. 180/540 X R120,000 of
the recoupment = R40,000 will be applied to the new machine and 360/540 X R120,000 = R80,000
will be applied to the second hand repair machine.

In addition, the capital gain will be split over the values of the replacement machines. 180/540 X
R90,000 of the recoupment = R30,000 will be applied to the new machine and 360/540 X R90,000 =
R60,000 will be applied to the second hand repair machine.

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New machine acquired

In respect of the new machine acquired, 40% X R180,000 = R72,000 will be claimed in the 20X6 tax
year.

A recoupment of 72/180 X R40,000 = R16,000 will be accounted for in the 20X6 tax year in
accordance with 8(4)(eB).

A capital gain (before the 50% inclusion) of 72/180 X R30,000 = R12,000 will be included in terms of
paragraph 66 of the 8th schedule.

In respect of the 20X7 tax year, a capital allowance of 20% X 180,000 = R36,000 will be claimed.

A recoupment of 36/180 X R40,000 = R8,000 will be accounted for in the 20X7 tax year in accordance
with 8(4)(eB).

A capital gain (before the 50% inclusion) of 36/180 X R30,000 = R6,000 will be included in terms of
paragraph 66 of the 8th schedule for the 2005 tax year.

When the asset is disposed of at the end of the 20X7 tax year, the following will result. A scraping
allowance may be claimed as:
o The asset was subject to a section 12C allowance,
o The asset has a write-off period of less than 10 years for tax purposes.

The scrapping allowance claimable is calculated as follows:

Original cost R180,000
Less: Capital allowances claimed to date (72,000 + 36,000) (R108,000)
Less: Proceeds on disposal (R 70,000)
Scrapping allowance claimable R 2,000

In addition, any amounts not yet added to income in terms of 8(4)(e) and paragraph 66 are added to
income. The remaining R12,000 capital gain and R16,000 recoupment will be added to income on
disposal.

Second hand machine acquired

In respect of the old machine acquired, 11/12 X R360,000 X 1/12 = R27,500 will be claimed in the
20X6 tax year.

A recoupment of 27,5/360 X R80,000 = R6,111 will be accounted for in the 20X6 tax year in
accordance with 8(4)(eB).

A capital gain (before the 50% inclusion) of 27,5/360 X R60,000 = R4,583 will be included in terms of
paragraph 66 of the 8th schedule.

In respect of the 20X7 tax year, a capital allowance of 1/12 X 360,000 = R30,000 will be claimed.

A recoupment of 30/360 X R80,000 = R6,667 will be accounted for in the 20X7 tax year in accordance
with 8(4)(eB). (1)

A capital gain (before the 50% inclusion) of 30/360 X R60,000 = R5,000 will be included in terms of
paragraph 66 of the 8th schedule for the 20X7 tax year.

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When the asset is disposed of at the end of the 20X7 tax year, the following will result. A scrapping
allowance may not be claimed as:
 The asset has a write-off period of more than 10 years for tax purposes.

In addition, any amounts not yet added to income in terms of 8(4)(e) and paragraph 66 are added to
income. The remaining R50,417 capital gain and R67,222 recoupment will be added to income on
disposal.

A capital loss can be claimed on the machine disposed of as no scrapping allowance could be
claimed.

The proceeds are R60,000 for the machine sale. Base cost will be R302,500 (R360,000 cost –
R30,000 – R27,500).

A capital loss of 302,500 – R60,000 = R242,500 may be claimed on the disposal of the second hand
machine. This will be set off against the gains of R73,417 already recognised prior in the
discussion(50,417 + 12,000 + 6,000 + 5,000).

An amount of R169,083 will be carried forward to the next year of assessment.

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CHAPTER 13-3
EXAMPLES ON THE DISPOSALS OF ASSETS

Table of Contents
1. PROFIT ON SALE OF ASSETS.................................................................................................................................................2
2. SCRAPPING ALLOWANCES AND CAPITAL LOSSES.............................................................................................................3
3. SUMMARY OF PROFITS AND LOSSES ON DISPOSALS OF FIXED ASSETS ......................................................................4
4. EXAMPLE ON DISPOSAL OF ASSETS ....................................................................................................................................5
5. SUGGESTED SOLUTION TO DISPOSAL OF ASSETS EXAMPLE ..........................................................................................6

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1. PROFIT ON SALE OF ASSETS

RECOUPMENTS CAPITAL GAINS TAX ON DISPOSAL OF ASSETS
SECTION 8(4)(a)
Capital gains need to be calculated when
Tax allowances that have been allowed are  an asset is sold for more than its original cost or
recouped in terms of this section.  when an asset has been acquired prior to 1 October 2001 and the valuation date rules for CGT apply to the asset.

The section does not apply only to fixed The following format may be used for calculating capital gains or losses on the disposable of tax deductible assets
assets but any allowances that may have
been granted such as capital allowances, or For each asset disposed of
bad debts or other deductions. 1. Calculate tax value. Split tax value between pre 1 October 2001 and post 1 October 2001.
 This is needed as post 1 October 2001 base cost is calculated differently from pre 1 October 2001 base cost. Also the
When a tax depreciable asset is sold for more
tax value is needed to calculate the recoupment or scrapping allowance per step 2
than tax value, a recoupment occurs.
2. Calculate the recoupment or the scrapping allowance. This is done by taking the lower of cost or selling price and deducting
Recoupments are limited to the allowances the tax value.
that were previously granted on the asset  This step is needed to calculate the amount included in gross income on disposal of an asset. This is used in step 3.
being disposed of.  If there is a scrapping allowance, it is taken off the base cost in step 4
 Scrapping allowance cannot be claimed on a building.
Thus if a machine costs R100 and has been
3. Proceeds = Selling price less amount included in gross income.
written off by 60, and the machine is sold for
R110, the recoupment cannot be larger than  The amount included in gross income is usually the recoupment of allowances on sale
60. 4. Calculate Base cost (Pre + Post 2001 base costs)
 Base cost post 1/10/2001 is cost less allowances that have been granted to date for assets acquired on or after 1
The recoupment is calculated as follows: October 2001
Cost 100
 For base cost pre 1/10/2001, use the table in the CGT notes for valuation date value assets
Less: Allowances ( 60)
Tax value on disposal 40 5. Capital gain or loss for the asset = proceeds – base cost
Sold for 6. Exclude any amount that may be deferred on disposal
use lower of cost/sell price 100 7. Add all capital gains and losses together
Recoupment – limited to 60 8. If the taxpayer is an individual, take off the annual exclusion (as in the chapter on CGT)
9. Take off assessed capital losses carried forward
The other 10 profit will be subject to capital 10. X 40% for individual or X 80% for companies and trusts and Include the amount in taxable income if there is a capital gain,
gains provisions.
otherwise carry a capital loss forward.

Section 8(4)(k) deems an asset that has been donated, or any asset that has been declared as a dividend in specie to be sold at market value. Thus if a fixed asset with a cost of R10,000,
a tax value of R1 and a market value of R6,840 (incl VAT) is declared as a dividend, it will2be deemed to be sold for R6,000 (ex vat) and a recoupment of R5,999 will result. (Input VAT as
there is a change in use).Dividends tax of R6,000 X 20% will also be payable. Thus if a fixed asset is donated when it costCHAPTER
R100,000, 13-3
had aDISPOSAL
tax value of
OF R40,000
ASSETS and had a market value of
EXAMPLE
R110,000, then there will be a R60,000 recoupment and R10,000 capital gain as the asset is deemed to be disposed of forFAMILY
LEVER R110,000.
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2. SCRAPPING ALLOWANCES AND CAPITAL LOSSES

SCRAPPING ALLOWANCES APPLICATION CAPITAL LOSSES
SECTION 11(o)
A current client of yours asks whether a scrapping allowance can be When a scrapping allowance is
Scrapping allowances can be claimed on all 12B assets, claimed on the following assets: not granted, a capital loss
12C assets, small business corporation assets per a) A machine depreciated in terms of section 12C could exist. The capital loss will
section 12E and all movable assets with a useful life of b) A machine depreciated in terms of section 11(e) be:
10 years or less per section 11(e) wear and tear c) Ship depreciated in terms of section 12C
d) Land Proceeds on disposal
Losses on disposal of assets may occur when there is e) Office building Less: Base cost
1. Sale of an asset, or f) A factory building Equals Capital loss
2. Abandonment of an asset or g) Trademarks
3. Simply ceasing to use an asset. h) Patents Note that capital losses in a
i) Motor vehicles written off over 5 years transaction with a connected
Scrapping allowances are determined as follows: j) Trucks written off over 4 years person are clogged and may
1. Determine whether the asset involved is a qualifying k) Computers written off over 3 years only be set off against gains
asset for which a scrapping allowance can be l) Research & Development from the same connected
claimed. m) Safe written off in terms of section 11(e) over 25 years person.
2. Determine the cost of the asset.
3. Determine the amount of capital allowances allowed Answer each part with either a yes or no.
DEFERMENT OF
on the asset up to the date of disposal.
SCRAPPING LOSSES
4. Determine the tax value ( 2 – 3) Suggested solution
SECTION 20B
5. Determine the proceeds that the asset was sold for.
6. The scrapping allowance will be the tax value less a) Yes
the proceeds on disposal (4-5) Losses incurred when selling
b) Yes
fixed assets cannot be claimed
c) Yes as a scrapping allowance until
This may be displayed as follows: d) No scrapping allowance on building
the transaction has been
e) No scrapping allowance on building
finalized.
Cost of the asset for tax purposes XXXX f) No scrapping allowance on building
Less: Capital allowances (XXX) g) No, intangibles are written off in terms of section 11(gA)
Any losses incurred prior to the
= Tax value XXX h) No, intangibles are written off in terms of section 11(gA))
finalization of the transaction
Less: Proceeds on disposal (XXX) i) Yes
are deferred and carried
= Scrapping allowance claimable XXX j) Yes
forward to the next year, where
k) Yes
any further payments are set
Note that scrapping allowances cannot be claimed if the l) No, research and development claimed in terms of 11D therefore
off against the losses carried
transaction with a connected person. no scrapping allowance
forward.
m) No as written off over 25 years therefore no scrapping allowance.
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3. SUMMARY OF PROFITS AND LOSSES ON DISPOSALS OF FIXED ASSETS

Loss on disposal Profit on disposal

Scrapping allowances If a scrapping If an asset is sold at a Per paragraph 66 of the 8th schedule and section Per paragraph 65,
(section 11(o)) can be allowance cannot profit and not 8(4)(e), if an asset is sold and: for assets stolen,
claimed on all section be claimed, a replaced, the 1. Contract for replacement asset concluded destroyed or
12B, section 12C, small capital loss can be recoupment and/or within 12 months, and asset replaced within expropriated, the
business corporation claimed. capital gain is reflected 3 years recoupment and
assets per section 12E in the income 2. Replacement asset costs more than receipts capital gain on the
and all movable assets Capital losses will statement and not on sale of old asset disposal of any
with a useful life of 10 be incurred on deferred. 3. 11(e) wear and tear asset, 12B asset, 12C asset (excluding
years or less as per losses incurred on (Example 5 and 14) Machine, 12E Small bus corporation asset to financial
section 11(e) wear and the sale of be replaced with an 11(e) 12B, 12C, 12E instruments) that is
tear (example 1) buildings, patents, If an asset is sold at a asset replaced with any
trademarks and profit and replaced 4. Proceeds on disposal to exceed or equal asset (excluding
Scrapping allowances designs sold at a with asset/s where base cost of asset sold financial assets)
cannot be claimed upon loss as a section the receipts on Then the recoupment (section 8(4)(e) and capital gain may be deferred if
sales between 11(o) scrapping disposal of the old (para 66 8th Schedule) on old asset is deferred and terms 1,2 and 4
connected persons allowance cannot assets are more than recognized as the new asset is written off. The (for assets sold in
(example 2) be claimed on these the amount spent on replacement asset need not be the same as the asset the diagram to the
assets. the replacement that was sold. (Example 7) left) are present.
Scrapping allowances assets, the
8(4)(e) allows athe
cannot be claimed Capital losses recoupment and/or For a factory building that is sold, recoupment may be recoupment to be
where a final selling between connected capital gain is reflected set off against the cost of replacement building if deferred.
price remains persons are in the income erected or acquired within 12 months (s13(3)) There See example
unquantified at year end clogged. statement and not is no deferment of the capital gain. (Example 8,9 and 10,11
(example 3) See example 4 deferred. (Example 6) 15)
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4. EXAMPLE ON DISPOSAL OF ASSETS

A Ltd, a vat vendor, has a 31 December 2017 year end.

A Ltd had a profit of R1,000,000 and a capital gain of R200,000 prior to the following items mentioned
below. All amounts exclude VAT unless otherwise stated:
1. A motor car was acquired on 1 July 2015 for R200,000 and sold on 31 March 2017 for R60,000.
 Motor cars are written off over 5 years .
2. Furniture with a cost of R30,000 and a tax value of R10,000 was sold for R8,000 to your
subsidiary on 1 January 2017.
 Assume furniture is written off over 6 years.
 During the current tax year, there was another transaction with this subsidiary that led to
a R900 capital gain. This R900 is included in the R200,000 above.
3. A new machine was acquired on 12 February 2016 for R1,000,000. The company realized that
they had made a mistake by buying the machine and sold the machine on 1 July 2016 for
R250,000 plus R1 for each unit produced on the machine for the next 2 years. 70,000 units were
produced by the buyer between July and December 2016 and 180,000 units were produced in
2017.
4. A factory building bought new for R1,800,000 on 17 November 2012 was sold on 12 January
2017 for R1,125,000. Assume these factory buildings are depreciated at 5% per annum for tax.
5. Machine A bought new for R100,000 on 1 February 2016 and sold on 31 August 2017 for
R86,000.
6. Machine B bought 2nd hand for R300,000 on 1 February 2017 was sold on 30 November 2017 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.
7. Truck that cost R125,000 on 1 October 2016 sold for R175,000 on 1 July 2017. The receipt was
used to buy a new machine X at a cost of R200,000. Trucks are written off over 4 years.
8. A factory was sold last year on 30 November 2016 for R6,400,000 and a R900,000 recoupment
and R400,000 capital gain was made. The company immediately entered into a contract to
replace the building and they moved into their new building on 15 January 2017 when the sale for
the new building went through. The new factory was acquired for R5,000,000.
9. An office building that was erected on 10 January 2017 at a cost of R4,000,000 was sold for
R5,000,000 on 12 December 2017after the company realized it was too small for the company.
The building was replaced with another office building that the company erected at a cost of
R6,000,000 on 15 December 2017.
10. A factory building was erected in 2015 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 2 nd hand
machine that cost R3,000,000 in the current year.
11. A machine was destroyed in the 2016 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.
12. A new machine that cost R1,000,000 on 1 October 2016 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. (not part of SAICA syllabus)
13. A machine was destroyed and replaced by a computer. The computer was sold this year for
R100,000 when R50,000 recoupment and R20,000 capital gain had yet to be recognised.
Recoupment on sale of the computer was R30,000. The computer was replaced by a new
machine at a cost of R200,000. (not part of SAICA syllabus)
14. A company entered into a 10 year lease on 1 October 2014 and paid a lease premium of
R300,000. On 31 March 2017 they vacated the premises when the shopping centre paid the
company R1,000,000 to vacate the shop to give it to another tenant.

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15. A machine was sold for R550,000 in the previous year and a recoupment of R400,000 and a
capital gain of R50,000 was deferred. The recoupment and capital gain were deferred when the
company decided to replace the machine by using the proceeds to buy a computer costing
R200,000 on 1 January 2017 and a motor vehicle costing R400,000 including vat on 1 May 2017.
Computers are written off over 3 years and motor vehicles over 5 years in terms of section 11(e)
wear and tear.

Calculate the income, deductions and capital gains of A Ltd.

5. SUGGESTED SOLUTION TO DISPOSAL OF ASSETS EXAMPLE

CGT Deduction Income

Profit 1,000,000
1 Motor car Cost R228,000
Less: Dep 2015
6/12 X 228,000 X 1/5
(R22,800)
Less: Dep 2016
12/12 X 228,000 X 1/5
(R45,600) (11.400)
Less: Dep 2017
3/12 X 228,000 X 1/5
(R11,400) (88,200)
Tax value R148,200
Sold for R 60,000 60,000
Loss 88,200
(60,000)
Proceeds = R60,000 – 0
Base cost = 228,000 – 22,800 –
45,600 – 11,400 -88,200 = 60,000

2 Furniture Tax value R10,000

Sold for R 8,000
Loss R 2,000

Scrapping allowance not claimable

as sold to a connected person

Proceeds R 8,000
Base cost R10,000
Capital loss (R
2,000)

However capital loss is ringfenced

as sold to a connected person. It
may only be set off against gains
made with the same connected
person. There is a capital gain with
the same taxpayer of R900 thus (900)
recognize R900. R1,100 carried
forward to next year. (Note R900 in
200,000 opening capital gain.)

No wear and tear as sold on 1

January 2017 thus not used this
year.

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CGT Deduction Income

3. Machine Cost 1,000,000
12C allowance @ 40% ( 400,000
400,000)
Tax value
600,000
Sold for 250K + 70K
320,000
Scrapping allowance 280,000

But scrapping loss deferred as sale

not yet quantified fully at end of the
2016 tax year

180,000 collected in 2017 tax year

set off against R280,000 scrapping
loss carried forward and 100,000
carried forward to next year.
4 Factory Cost
building 1,800,000
Less: Dep 2012 – 2016
5% X 1,800,000 X 5 (450,000)
Less: Dep 2017 (90,000)
5% X 1,800,000 ( 90,000)
1,260,000
Sold for 1,125,000
Loss 135,000

Scrapping allowances cannot be

claimed for buildings.

Proceeds 1,125,000
Less: Base cost (1,260,000)

5 Machine A Cost 100,000

Less: Dep 2016 (40,000)
Less: Dep 2017 (20,000) (20,000)
Tax value 40,000
Sold for 86,000
Recoupment 46,000 46,000

Proceeds(86,000-46,000) 40,000
Less: Base cost (100,000-60,000) (40,000)

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CGT Deduction Income

6 Machine B Cost 300,000
Less: Dep 2017 (60,000) (60,000)
Tax value 240,000

Lesser of cost/SP 300,000

Less: Tax value (240,000)
Recoupment 60,000 60,000

Selling price 340,000

Less: Recoupment (60,000)
Proceeds 280,000

Cost 300,000
Less: Allowances (60,000)
Base cost 240,000

Capital gain 40,000 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 100/114 (43,860)

7 Truck Cost 125,000

Dep 2016
3/12 X 125,000 X ¼ ( 7,813)
Dep 2017
6/12 X 125,000 X ¼ (15,625) (15,625)
Tax value 101,562

Lesser of cost/SP 125,000

Less: Tax value (101,562)
Recoupment 23,438
Recoupment deferred (s 8(4)(e)

Selling price 175,000

Less: Recoupment (23,438)
Proceeds 151,562

Base cost 101,562

Capital gain 50,000
Capital gain deferred para 66 Sch8

Note that a truck can be replaced

with a machine. The assets need
not be the same.
Machine X Depreciation 40% X 200,000 (80,000)

Recoupment
recognized 40% X 23,438 9,375

Capital
recognized 40% X 50,000 20,000

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CGT Deduction Income

8 New factory Cost 5,000,000
Less: Recoupment ( 900,000)
Revised cost 4,100,000
X 5% 205,000

The capital gain was recognized in

the previous year and the
recoupment can only be set-off
against the cost of the new building
if acquired within 12 months of the
disposal of the old building.

The cost price of the new building

need not be as much as the old
building’s selling price.

9 Office Cost 4,000,000

building Less: Dep 2017 ( 200,000)
Tax value 3,800,000
Lower of cost and SP 4,000,000
Recoupment 200,000 200,000

Building recoupments can be

deferred only if a factory is sold (s
13(3)) or any building is destroyed,
expropriated or stolen (para 65 8th
Sch). Para 65 also defers capital
gains.
This recoupment cannot be
deferred as it is not a factory
building, nor was it subject to para
65.
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.

Selling price 5,000,000

Less: Recoupment (200,000)
Proceeds 4,800,000

Base cost (4M–200K) (3,800,000)

Capital gain 1,000,000 1,000,000

This gain is not deferred as the

building was sold.

Buildings are section 13 assets.

Recoupments and capital gains on

buildings can only be deferred
when the building is destroyed or
expropriated
New office
building 6,000,000 X 5% (300,000)

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CGT Deduction Income

10 Factory Cost 2,000,000
building Dep 2015,2016 (200,000)
Dep 2017 (100,000) (100,000)
Tax value 1,700,000

Lower cost/SP 2,000,000

Less: Tax value (1,700,000)
Recoupment 300,000

Recoupment deferred

Selling Price 2,200,000

Less: Recoupment (300,000)
Proceeds 1,900,000
Base cost 1,700,000
Capital gain 200,000

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
machine 3,000,000 X 20% (600,000)

Deferral
recoupment 300,000 X 20% 60,000

Deferral
capital gain 200,000 X 20% 40,000

11 Residential
building 2,100,000 X 10% (210,000)

Recoupment
recognized 1,200,000 X 10% 120,000

Capital gain
recognized 400,000 X 10% 40,000

The recoupment and capital gain

are deferred until the new asset is
brought into use.

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CGT Deduction Income

12 Machine sold Cost 1,000,000
Less: Dep 2016 (400,000)
Less: Dep 2017 (200,000) (200,000)
Tax value 400,000
Sold for 780,000
Recoupment 380,000 380,000

Deferral recognized
Current year 250,000 X 20% 50,000
Remainder not yet recognized
recognized when replacement
asset is sold and not replaced
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

13 Computer 40% X R200,000 80,000

sold and
replaced by Deferred recoupment
machine 40% X (50,000 + 30,000) 32,000

Deferred capital gain

40% X 20,000 8,000
14 Lease Lease premium
300,000X1/10X3/12 7,500

Proceeds 1,000,000
Less: Base cost 7,5/10 X 300,000 (225,000)

15 Computer Wear and tear 200,000 X 1/3 66,667

Recoupment 400,000 X 2/6 X 1/3 44,444

Capital gain 50,000 X 2/6 X 1/3 5,555

15 Vehicle Wear and tear 400,000 X 1/5 X

8/12 53,333

Recoupment 400,000 X 4/6 X 8/12 35,556

X 1/5
4,444
Capital gain 50,000 X 4/6 X 8/12 X
1/5

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CHAPTER 13-4
UNQUANTIFIED AMOUNTS (ONLY 4862)

Table of Contents
1. WHAT IS SECTION 24M? ........................................................................................................................................................... 2
2. WHAT DOES THE ACT SAY?....................................................................................................................................................... 2
3. BASIC CONSIDERATIONS........................................................................................................................................................... 3
4. IMPACT ON CGT ....................................................................................................................................................................... 3
4.1 UNQUANTIFIABLE AMOUNTS SECTION 24M ................................................................................................. 4
4.2 UNQUANTIFIABLE AMOUNTS – CAPITAL GAINS PARAGRAPH 39A OF THE 8 TH SCHEDULE ............................... 5
5. RECOUPMENTS AND SCRAPPING ALLOWANCES ....................................................................................................................... 8
6. DEPRECIABLE ASSETS ............................................................................................................................................................. 10
7. TRADING STOCK ..................................................................................................................................................................... 11

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1. WHAT IS SECTION 24M?

Unquantified payments create a number of problems for both the seller and the purchaser with neither party being able to fully
predict the future.

The seller does not know how much to include into gross income.

Similarly the buyer does not what the cost of an item is.

Section 24M has been promulgated to deal with this problem

2. WHAT DOES THE ACT SAY?

If a person during any year of assessment disposes of an asset for consideration which consists of or includes an amount which
cannot be quantified in that year of assessment, so much of that consideration as—
a) cannot be quantified in that year must for purposes of this Act be deemed not to have been accrued to that person
in that year; and
b) becomes quantifiable during any subsequent year of assessment must for purposes of this Act be deemed to have
been accrued to that person from that disposal in that subsequent year.

Discussion

The Income Tax Act uses an open transaction basis of determining income.

When a transaction has unquantified amounts, the transaction remains open until all such unquantified amounts are known to
the taxpayer whereupon such transaction is closed.

Amounts will accrue to taxpayers in the year that they become entitled to such amounts. Note that there is no reference to gross
income or capital gains in paragraphs a and b above. As such, this legislation applies to both.

Such amounts so accrued will be gross income if items such as trading stock are sold, or proceeds/recoupments income if capital
assets are sold.

Illustration

Mr A sells a piece of his farm land next to a dam to a property developer who intends to sell plots with holiday homes next to the
dam for trout fishing enthusiasts.

Mr A receives R100,000 for the land plus 2% of the proceeds received by the developer from purchasers.

The amounts received representing 2% of sales equate to:

 Year 1 = R20,000
 Year 2 = R1,100,000
 Year 3 = R400,000

At the end of year 3, all the plots have been sold.

What amounts will be included into proceeds assuming that the farm land was held for capital purposes?

Suggested solution`

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The proceeds in year 1 will be the R100,000 quantified at the date of sale plus the R20,000 that was quantified after the date of
sale.

The proceeds in year 2 will be R1,100,000.

The proceeds in year 3 will be R400,000.

If a person during any year of assessment acquires an asset for consideration which consists of or includes an amount which
cannot be quantified in that year of assessment, so much of that consideration as—
(a) cannot be quantified in that year must for purposes of this Act be deemed not to have been incurred by that
person in that year; and
(b) becomes quantifiable during any subsequent year of assessment must for purposes of this Act be deemed to
have been incurred by that person in respect of the acquisition of that asset in that subsequent year.

Discussion

As amounts become quantifiable, they are included as:

 deductions,
 increases to base cost, or
 increase in the cost of a depreciable asset

Illustration 3A continued

What would the tax implications be for the person acquiring the land from the farmer?

Suggested solution

As the taxpayer is a property developer, the land would constitute trading stock. A section 11(a) deduction for acquisition of
trading stock is normally allowed as and when stock is acquired. In this case, a section 11(a) deduction will be allowed as follows:
 Year 1 – R120,000
 Year 2 – R1,100,000
 Year 3 – R400,000

The notes will hereafter deal with the treatment of non depreciable assets, depreciable assets and trading stock implications.

3. BASIC CONSIDERATIONS
Losses cannot be claimed until all payments are quantified.

It is possible for an asset to start with a loss and over time to record recoupments and then capital gains as amounts become
quantified.

4. IMPACT ON CGT
When determining capital gains and losses, there may be:
o quantifiable and
o unquantifiable amounts.
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If amounts are quantifiable, the calculation of capital gains and losses will simply be the proceeds less the base cost in the year
that the asset is disposed of.

Illustration

Mr A owns a commercial building that is not located in an urban renewal area. He bought the building for capital reasons.

He has never claimed any capital allowances on the building since he bought the building for R1,000,000 on 1 March 2003.

He sells the building for R2,300,000 in the current tax year.

What are the taxation implications assuming the building was acquired for capital reasons?

Suggested solution

Proceeds R2,300,000
Less: Base cost (R1,000,000)
Capital gain R1,300,000

However if a transaction is subject to unquantifiable amounts, the calculation of taxable gains and losses will change.

To understand the taxation implications of unquantifiable amounts, it is necessary to understand:

o section 24M and
o paragraph 39A of the 8th schedule.

4.1 UNQUANTIFIABLE AMOUNTS SECTION 24M

The following is an illustration of the CGT implications with unquantifiable amounts.

Illustration

A Ltd own a commercial building in Sandton. The building cost R2,000,000 on 1 December 20X1.

The building is sold in the 20x5 tax year for R2,400,000 plus 10% of the profits on rentals over the next 3 years.

The following profits actually are paid to A Ltd for the tax years:
20x5 – R400,000
20x6 – R600,000
20x7 – R650,000
20x8 – R125,000

What are the taxation implications of the above?

Suggested solution

The sale is a capital transaction and will be subject to capital gains. Receiving 10% of profits is not considered to be an annuity as
there is no fixed payment. As such the gross income special inclusion rules are ignored.

Section 24M applies because there are unquantified payments that are involved in the transaction.

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In terms of the legislation, a capital gain of R2,400,000 – 2,000,000 = R400,000 will be made on the date of sale. An additional
capital gain of R400,000 will be made on profit in the 20x5 tax year.

Capital gains of R600,000 will be accounted for in the 20x6 tax year.

Capital gains of R650,000 will be accounted for in the 20x7 tax year.

Capital gains of R125,000 will be accounted for in the 20x8 tax year.

4.2 UNQUANTIFIABLE AMOUNTS – CAPITAL GAINS PARAGRAPH 39A OF THE

8TH SCHEDULE
This paragraph limits the capital losses that can be set off against capital profits when transactions are involved that include
unquantifiable amounts.

Subsection (1) of paragraph 39A to the 8 th schedule states that where

o a person
o during any year of assessment
o disposes of an asset and
o all the proceeds from the disposal of that asset will not accrue to that person during that year,
o that person must, when determining the aggregate capital gain or aggregate capital loss for that year or any subsequent
year of assessment, disregard any capital loss determined in respect of that disposal.

Subparagraph (2) states that

o a person’s capital loss which is disregarded during any year of assessment in terms of subparagraph (1)
o which has not otherwise been allowed as a deduction
o may be deducted from that person’s capital gains determined in any subsequent year in respect of the disposal of the
asset contemplated in subparagraph (1).

Subparagraph (3) states that

o if during any year of assessment
o a person shows that no further proceeds will accrue to that person from the disposal contemplated in subparagraph (1),
o so much of the capital loss contemplated in that subparagraph as has not been deducted from any subsequent capital
gains as contemplated in subparagraph (2), may be taken into account in determining that person’s aggregate capital
gain or aggregate capital loss for that year of assessment.

Discussion

Losses on transactions that are unquantifiable in a current year of assessment are deferred and may not be set off against any
other capital gains. (Subparagraph 1)

If there is an extra amount paid on the same contract in future years that leads to a capital gain, the loss carried forward will be
realised to the extent of the capital gain on the same asset. (Subparagraph 2)

Once there cannot be any more gains on the asset, any remaining deferred loss will be recognised. (Subparagraph 3)

Illustration

A Ltd have a patent that they do not use. B Ltd would like to manufacture using the patent. The useful life of the patent is 22
months, after which the government has legislated that the product may no longer be sold because of changing legislation.

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A Ltd sell the patent to B Ltd according to the following terms:

o an amount of R130,000 will be paid upfront.
o An extra R1 will be paid per item sold for the next 22 months.
o No further amounts will be paid after 22 months have elapsed.

A Ltd have a 31 December year end.

The additional billings for the contract are as follows:

20X4 year – Nil
20X5 year – R18,000
20X6 year – R16,000

Assume the capital loss on the sale of the patent in the 20X4 year was R85,000.

The capital gains made by A Ltd were as follows (excluding the above transaction):
20X4 year – R100,000 capital gain
20X5 year – R60,000 capital gain
20X6 year – R90,000 capital gain

What are the capital gains or loss implications for the above transaction. A Ltd and B Ltd are not connected persons.

Suggested solution

The sale is a capital transaction and will be subject to capital gains.

Section 24M applies because there are unquantified payments that are involved in the transaction.

Explanation subparagraph (1)

The transaction will be subject to capital gains/losses as there is a capital asset of an organisation that is being sold and there is a
capital loss of R85,000 on sale (presumably as no scrapping allowance can be claimed on the sale of a patent).

In the 20X4 year, a loss of R85,000 has been made on the sale of the patent. There is a capital gain of R100,000 for the tax year.
However the loss of R85,000 cannot be set off against the capital gain as there are unquantified amounts still outstanding in
terms of the sale. A Ltd will be taxed on the R100,000 capital gain. The R85,000 loss will be carried forward.

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Explanation subparagraph (2)

In the 20X5 tax year, there is a capital gain of R60,000 before the patent transaction.

An additional R18,000 has been earned from the patent sale. This R18,000 capital gain is set off against the R85,000 carried
forward and an amount of R67,000 is carried forward to the next year. The capital gain of R60,000 will be taxed in the 20X5 tax
year.

In the 20X6 tax year, an additional R16,000 has been earned from the patent sale. This R16,000 capital gain is set off against the
R67,000 carried forward and an amount of R51,000 still remains.

Explanation of subparagraph (3)

As a capital gain of R90,000 has been made in the 20X6 year and there is no prospect of any further proceeds in respect of the
patent sale, the remaining R51,000 loss not yet claimed is now included in the capital gains calculation. The net capital gain of
R90,000 – R51,000 = R39,000 will be taxed in the hands of the company.

Illustration

A Ltd own a commercial building in Sandton. The building cost R2,100,000 on 1 December 2001.

The building is sold on 1 March 20x5 in terms of the following agreement:

o Four instalments of R250,000 to be paid in each year from 20x5 to 20x8, and
o 10% of the profits on rentals over the next 3 years.

The following profits actually are paid to A Ltd for the tax years:
20x5 – R400,000
20x6 – R600,000
20x7 – R650,000
20x8 – R125,000

What are the taxation implications of the above? A Ltd has a 31 December year end.

Suggested solution

The sale is a capital transaction and will be subject to capital gains.

Section 24M applies because there are unquantified payments that are involved in the transaction.

The fixed amount of the purchase price is R250,000 X 4 = R1,000,000. This amount is quantifiable.

The profits amounts are not quantifiable.

In terms of the legislation, a capital loss of R1,000,000 – 2,100,000 = R1,100,000 will be made on the date of sale. An additional
capital gain of R400,000 will be made on profit in the 20x5 tax year. This results in a net capital loss of R700,000 for the 20x5 tax
year. The 700,000 capital loss will not be set off against capital gains in terms of paragraph 39A of the 8 th schedule and will be
carried forward to the next tax year.

Capital gains of R600,000 will be accounted for in the 20x6 tax year. This will be set off against the capital loss of R700,000 carried
forward and R100,000 loss will be carried forward to the next tax year.

Capital gains of R650,000 will be accounted for in the 20x7 tax year. The R100,000 assessed capital loss carried forward will be set
off against this gain and there will be a capital gain of R550,000 in the 20x7 tax year.
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Capital gains of R125,000 will be accounted for in the 20x8 tax year.

Base cost for the purchaser

The base cost for the purchaser will increase over time.

At the end of year 1, the base cost will be R1,000,000 + R400,000 = R1,400,000.

At the end of year 2, R600,000 will be added to base cost resulting in a base cost of R2,000,000.

At the end of year 3, R650,000 will be added to base cost resulting in a base cost of R2,650,000.

At the end of year 4, R125,000 will be added to base cost resulting in a base cost of R2,800,000.

5. RECOUPMENTS AND SCRAPPING ALLOWANCES

Recoupments may be recognised over a number of tax years.

Illustration 5A

A machine that cost R100,000 and has tax value of R20,000 is sold by A Ltd for R42,000 plus R2 per unit produced by the
machine.

Additional amounts were received as follows:

 Year 1 – R22,000
 Year 2 – R38,000
 Year 3 – R6,000

What amounts will be included as recoupments for the tax years?

Suggested solution

In year 1, the amount of the sale that is quantified will be R42,000 + R22,000 = R64,000.

A section 8(4)(a) recoupment of R64,000 – R20,000 tax value = R44,000 will be included in gross income.

In year 2, R38,000 more is received. The proceeds will now be R102,000 (R64,000 + R38,000) limited to original cost of R100,000
for the purposes of calculating the recoupment. The recoupment will be R100,000 – R20,000 tax value – R44,000 recoupment
already recorded = R36,000 recoupment per section 8(4)(a).

The remaining R2,000 above cost will be a capital gain.

In year 3, the full R6,000 will be a capital gain.

If a scrapping loss is made, in terms of section 20B, such scrapping loss is deferred until such time as the transaction is closed.
Later amounts accruing to a taxpayer will be set off first against the scrapping loss carried forward.

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Illustration

A Ltd own a machine that has a cost of R1,000,000 and has a written down tax value of R400,000. The machine is sold to B Ltd for
the amount of R250,000 plus R10 per unit produced by the machine in the current and next 3 tax years.

Amounts received in each of these years are as follows:

 Year 1 – R40,000
 Year 2 – R200,000
 Year 3 – R370,000
 Year 4 – R310,000

What are the taxation implications of the above?

Suggested solution

Year 1

Proceeds on sale will be R250,000 + R40,000 = R290,000.

Tax value was R400,000.

There is a loss of R110,000. However in accordance with section 20B, such loss will be deferred and carried forward to the next
tax year as there are unquantified receipts still to come.

Year 2

There is an amount of R200,000 received. The first R110,000 will be set off against the scrapping allowance carried forward in
terms of section 20B and the remaining R90,000 will be a recoupment. (Note that the total amount of the recoupment is limited
to R1,000,000 cost – R400,000 tax value = R600,000 recoupment.

Year 3

R370,000 is received and this will be treated as a recoupment.

(There is still R600,000 – R370,000 – R90,000 = R140,000 of the recoupment still available in later years)

Year 4

R310,000 is received. R140,000 will be treated as a recoupment and the remaining R170,000 will be treated as a capital gain.

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6. DEPRECIABLE ASSETS
If an asset which was acquired by a person during any year of assessment upon which unquantified amounts are to be paid in the
future and such asset
(a) constitutes a depreciable asset; and
(b) any amount is deemed to have been actually incurred by that person in any subsequent year of assessment
which has not been taken into account in determining the amount of any allowance in respect of that
depreciable asset in any previous year and would have been so taken into account had that amount been
actually incurred by that person,
so much of the amount as would have been so allowed as an allowance in any previous year must be allowed in that subsequent
year of assessment.

Discussion

Depreciation is caught up on assets in later years of assessment if a depreciable asset is acquired and amounts are quantified in
later years.

Illustration continued

What capital allowances can be claimed by the acquirer of the machine in the example above?

Suggested solution

It should be noted that the asset is a machine that is acquired 2 nd hand. 2nd hand machines are written off at 20% per annum
straight line with no apportionment.

Year 1

Amount incurred was R290,000. Thus section 12C allowance will be 20% X R290,000 = R58,000.

Year 2

There was an increase to the cost of the asset of R200,000. The total cost of the asset is now R490,000.
Section 12 allowance will be 20% X R490,000 = R98,000.
An additional 20% X R200,000 = R40,000 will be caught up for year 1 in accordance with 24M(4).

Year 3

There was an increase to the cost of the asset of R370,000. The total cost of the asset is now R860,000.
Section 12 allowance will be 20% X R860,000 = R172,000.
An additional 20% X 2 years X R370,000 = R148,000 will be caught up for year 1 and 2 in accordance with 24M(4).

Year 4

There was an increase to the cost of the asset of R310,000. The total cost of the asset is now R1,170,000.
Section 12 allowance will be 20% X R1,170,000 = R234,000.
An additional 20% X 3 years X R310,000 = R186,000 will be caught up for year 1 and 2 and 3 in accordance with 24M(4).

Year 5
Section 12 allowance will be 20% X R1,170,000 = R234,000.

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Check
Year 1 R 58,000
Year 2 (98,000 + 40,000) R 138,000
Year 3 (172,000 + 148,000) R 320,000
Year 4 (234,000 + 186,000) R 420,000
Year 5 R 234,000
R1,170,000
The total section 12C after the full 5 years writing off the asset is R1,170,000.

7. TRADING STOCK
This section deals with unquantified amounts as discussed in section 24M as related to trading stock.

The provisions of this treatment are included in section 23F(2) of the Act.

First year treatment

Where trading stock is sold and the proceeds on sale are unquantifiable at year end, the amount of the trading stock sale that is
quantifiable will be included into gross income.

The trading stock is not owned by the taxpayer at year end. But the deduction allowed for the trading stock is limited to the
amount of the quantifiable trading stock income.

Subsequent years treatment

A deduction will be allowed in terms of section 23F(2A) of the amount of the unquantified income that becomes quantified. The
deduction cannot exceed the amount of the section 23(F)(2) Amount carried forward.

Once all amounts have been quantified

Once all amounts have been quantified, any amounts still not allowed as a deduction will be allowed as a deduction in terms of
section 23(F)(2B).

Illustration

A Ltd sell trading stock. The amounts of the proceeds are dependant 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

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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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CHAPTER 14-1
TRADING STOCK

TABLE OF CONTENTS
1. INTRODUCTION................................................................................................................................................... 2
2. BASIC TRADING STOCK RULES ............................................................................................................................ 2
3. VALUATION OF TRADING STOCK ........................................................................................................................ 2
4. DEDUCTIONS RELATING TO TRADING STOCK ..................................................................................................... 3
5. TRADING STOCK TREATED AS INCOME............................................................................................................... 5
6. SPECIAL RULES FOR MANUFACTURERS OR ASSEMBLERS OF GOODS ................................................................ 7
7. TRADING STOCK ANTI AVOIDANCE..................................................................................................................... 8
8. TRADING STOCK USED FOR BUSINESS PURPOSES ............................................................................................ 10

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1. INTRODUCTION
Trading stock is dealt with in section 22 to 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

2. BASIC TRADING STOCK RULES

There is no “cost of sales” in the Income Tax Act.

The following are the basic rules for all items of stock other than spare parts which are discussed separately.
 When trading stock is purchased, a deduction may be claimed in terms of the general deduction
formula
 The amount received from the sale of trading stock is treated as gross income.
 Any stock held at year end is treated as income (section 22(1) income)
 Opening stock is a treated as a deduction (section 22(2) deduction)

ILLUSTRATION – TREATMENT OF SALES, PURCHASED OPENING STOCK AND CLOSING STOCK

The following are the transactions of A Ltd, a retailer for the current tax year:
o Trading stock of R40,000 is bought 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

3. VALUATION OF TRADING STOCK

Trading stock is valued in accordance with the accounting statement on inventories.

It includes costs of acquisition, moving and production. Selling costs cannot be included in the cost of trading
stock.
Trading stock is valued at the lower of cost or market value.

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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

None of this stock was sold as at year end. Show the calculation of taxable income for A Ltd.

SUGGESTED SOLUTION

Stock purchased deducted per section 11(a) (R10,000)

Shipping costs deducted per section 11(a) (R 1,000)
Insurance deducted per section 11(a) (R 300)
Import duties deducted per section 11(a) (R 200)
Exchange differences per section 24I (R 100)
Transport to Johannesburg (R 200)
Add closing stock per section 22(1) R11,700
Taxable loss (R 100)

Note that all costs, excluding exchange differences, are included in the value of closing stock.

4. DEDUCTIONS RELATING TO TRADING STOCK

The following are treated as deductions
 Last year’s closing stock is treated as a deduction
 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)
 The cost of purchases of trading stock are treated as a deduction
 If finished goods are produced, production costs are treated as a deduction.
 If stock is received via donation or inheritance, the market value of the stock that is donated is treated as
a deduction.
 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 themselves at market value, and a deduction can be claimed on this market value of
trading stock acquired.

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ILLUSTRATION – CHANGE OF INTENTION AND DONATIONS/INHERITANCES RECEIVED

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.

ILLUSTRATION – MAKING YOUR OWN TRADING STOCK (AND CHANGE OF INTENTION)

A company owns land that cost R1,000,000 in 2004 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.

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.

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 plots of land is sold for R200,000 X 25 = R5,000,000. This amount will be treated as gross income.

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.

The R6,000,000 incurred on the land will also be treated as a deduction for the purposes of section 11(a).

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The closing stock of the land will be 70/100 X (R4,000,000 + R6,000,000) = R7,000,000.

Summarising this:

Gross income – sale of plots (25 X R200,000) R5,000,000

Less: Opening stock (R4,000,000)
Less: Development expense deductible (R6,000,000
Add: Closing stock (75/100 X R10,000,000) R7,500,000
Taxable income before capital gains R2,500,000
Capital gain
Deemed proceeds R4,000,000
Less: Base cost (R1,000,000)
Capital gain R3,000,000 X 66.6% inclusion rates R1.998,000
Taxable income after inclusion of capital gains R4,502,000

5. TRADING STOCK TREATED AS INCOME

Trading stock is treated as income in the following circumstances:
 Sale of trading stock is treated as income.
 Closing stock at the end of the year is treated as income.
 Spare parts are included in the definition of trading stock. Sale of spare parts is treated like the sale of
fixed assets (CGT and recoupment).
 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.
 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.
 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.
 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.
 If stock is given/donated to a 3 rd party at no cost, the stock is deemed to be sold at market value.
 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.
 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.

ILLUSTRATION – TAKE TRADING STOCK HOME FOR PERSONAL USE

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.

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ILLUSTRATION – TRADING STOCK GIVEN AS A FRINGE BENEFIT

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

ILLUSTRATION – TRADING STOCK GIVEN AS A DIVIDEND IN SPECIE

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).

ILLUSTRATION – VARIOUS TRADING STOCK EXAMPLES

B Ltd had the following transactions during the year. What are the taxation implications of:
(a) 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 (Transaction A).
(b) 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. (Transaction B)
(c) 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. (Transaction C)

What are the taxation implications of the above?

Suggested solution

Transaction A

R7,000 is deemed to be recouped in terms of section 22(8) as the prescribed certificate is received from the
public benefit organisation.

Transaction B

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.

Transaction C

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.

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ILLUSTRATION – SALE OF TRADING STOCK BELOW FAIR VALUE

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

The R11,000 will be included in gross income.

Part b

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).

6. 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.

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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

7. TRADING STOCK ANTI AVOIDANCE

Anti-avoidance Anti-avoidance (not examinable) Anti-avoidance (not examinable)

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)(not examinable)

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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8. 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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