Page 489 - SAIT Compendium 2016 Volume2

IN 51 (3) Income Tax acT: InTeRPReTaTIon noTes IN 51 (3)
‘What the evidence does clearly establish is that during 1988 the respondent had no premises, no equipment, no stock, no staff and, save for book debts, no assets. This is clearly indicative of a company which is not trading.’
Thus, depending on the nature of the trade, the absence of some or all of these factors (premises, equipment, trading stock and employees) may be indicative of a lack of trading activity. On the other hand, as indicated earlier, the derivation of income is not a prerequisite for carrying on a trade. It is thus possible that trade can commence before the rst sale is made. Schutz JA made the following obiter comment in Robin Consolidated Industries Ltd v CIR:*
‘In year one a retailer acquires premises, employs staff and buys stock, but does not open his doors until the beginning of year two. On the authority of Sub-Nigel Ltd v CIR 1948 (4) SA 580 (a) at 589-590 he would clearly be entitled to deduct the expenditure incurred in year one from revenue earned in year two.’
Although it was dealing with the ‘in production of income’ requirement of section 11(a), the court seems to have accepted without question that the trade requirement was met in year 1. Taxpayers rendering a service must at least hold themselves out as ready to provide services (in other words, such persons must have opened their doors for business).†
4.2.2 Abandonment of a project before the commencement of trade
Pre-trade expenses relating to a project that is abandoned before the commencement of the relevant trade are not deductible under section 11A.
4.2.3 Change in intention or in the nature of the trade
Both section 11A(1)(a) and (b) refer to ‘that trade’. The references to ‘that trade’ mean that only pre-trade expenses actually incurred in the preparation for carrying on that trade will be allowed as a deduction from the income resulting from that speci c trade.
Example 2 – Preparatory activities comprising the carrying on of a trade
Facts:
A taxpayer acquires a farm and plants trees which will only bear fruit in 10 years’ time. During the 10-year period the taxpayer incurs recurring expenditure on salaries and wages, fertilizer and pesticides and also claims wear-and-tear on equipment.
Result:
It is considered that trading commences with the preparation of the land for planting the trees.2
Example 3 – Abandonment of a project before the commencement of trade
Facts:
X began preparations for the operation of a business to be commenced and incurred pre-trade expenses of R100 000. X decided to abandon the project before the commencement of the trade.
Result:
The pre-trade expenses will not be allowable as a deduction under section 11A because the trade to which they relate never commenced.
Example 4 – Change in nature of the trade
Facts:
Company X began an airport project and incurred expenses of R5 million for technical staff salaries, telephone costs and rates and taxes (all pre-trade expenses) while the application for the airport operating licence was being considered by the relevant authorities. The licence was nally declined and the project abandoned. Two months after the project was abandoned, Company X decided to use the land and buildings for a document-storage business. This business generated income of R230 000 against which Company X sought to claim the amount of R5 million as a deduction.
Result:
The pre-trade expenses of R5 million incurred in preparing for the airport operation are not allowable as a deduction against the income from the document-storage business since section 11A(2) only permits a set-off of pre-trade expenses against income from the same trade, namely, the airport project.
4.2.4 Meaning of ‘that trade’
The opening words of section 11A(1) refer to taxable income derived during any year of assessment by a person from carrying on ‘any trade’. Section 11A(1)(a) then refers to expenditure and losses –
‘actually incurred by that person prior to the commencement of and in preparation for carrying on that trade’.
The question arises whether the words ‘that trade’ refer to the taxpayer’s trade generally or the carrying on of trade in relation to a speci c asset. For example, a taxpayer may let out three properties and then commence to erect a fourth building for the purposes of letting it when completed. Any expenses such as interest, insurance and rates incurred before the fourth building is brought into use will be of a capital nature and not in the production of income. Since the taxpayer is already carrying on a trade of letting of property concern has been expressed that the taxpayer will not be entitled to claim the expenses under section 11A(1).
By way of background, section 11(bA) used to grant a deduction for pre-production interest when a qualifying asset was brought into use. It was deleted with effect from years of assessment commencing on or after 1 January 2012 because it was considered that any expenditure claimable under section 11(bA) could, subject to ring-fencing, be claimed under section 11A. Similarly, the ambit of paragraph 20(1)(g) of the Eighth Schedule was restricted to exclude from base cost
* [1997] 2 All SA 195 (a), 59 SATC 199 at 206.
† A similar approach is taken in the United States.
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