Page 491 - SAIT Compendium 2016 Volume2

IN 51 (3) Income Tax acT: InTeRPReTaTIon noTes IN 51 (3)
This must be determined by the facts and circumstances of each case. In most cases it should be a relatively simple matter to show that once trade commences the relevant expenditure would have been capable of producing income if incurred at that time. Recurring-type expenditure incurred before trade commences invariably takes on the character of expenditure of a capital nature because it is incurred in the setting up of an income-earning structure (see Borstlap’s case discussed in 2). The effect of the post-trade test on such expenditure is to change it to a revenue nature because the presumption is that it is incurred after the income-earning structure has been established. Examples of pre-trade expenses qualifying under section 11A(1)(a) typically include the cost of accounting and audit services, advertising and marketing, electricity and water, insurance, rates, rent, salaries and wages, staff training, trading stock acquired before the commencement of trade and telephone costs.
However, pre-trade expenses that retain their capital nature even if incurred after trade commences will not qualify for deduction under section 11A(1). Examples include the cost incurred by a lessee in drawing up a lease agreement,* the legal costs incurred in securing a trading licence,† the cost of drawing up building plans‡ and the cost of a feasibility study. Such expenses are incurred once-off and are a direct cost of setting up the income-earning structure and cannot be divorced from it by the post-trade test.
Section 11A(1)(b) refers to ‘expenditure and losses’. The question is whether this wording includes an ‘allowance’ as opposed to ‘expenditure’. Examples of allowances include the allowance for any lease premium granted under section 11(f) and the allowance for certain intellectual property granted under section 11(gA). Despite an allowance sometimes colloquially being understood to be an otherwise inadmissible expense, the section 11 allowances are in principle deductible as pre-trade expenses, because of the wording of section 11A which refers to ‘expenditure . . . allowed as a deduction’. The allowances granted under sections 11(cA); (e) (subject to what is stated below), (f), (g), (gA), (gC), (gD) or (hB) will therefore potentially qualify for deduction under section 11A(1) after the particular trade has commenced. A taxpayer may thus be entitled to claim amounts that could not previously be claimed during the pre-trade period. Although the wear-and-tear or depreciation allowance in section 11(e) is based on the ‘value’ of an asset rather than on its cost, SARS in most instances interprets the term ‘value’ to mean ‘cost to the taxpayer’ for the purpose of determining the allowance. However, section 11A will not apply to the wear-and-tear or depreciation allowance on assets that do not have a cost to the taxpayer, such as those acquired by donation or inheritance, since in these instances the allowance will be based on market value and not actual expenditure.
In addition, it is a requirement of section 11(e) that the asset be ‘used’ by the taxpayer for the purposes of his or her trade. Thus, an asset acquired before the commencement of trade that is not ‘used’ during the pre-trade period will not qualify for a deduction under section 11A. This could happen if the asset is placed in storage pending the commencement of trade.
Example 5 – Wear-and-tear allowance qualifying for deduction under section 11A
Facts:
Company A’s nancial year ends on the last day of February. On 1 September 2012 Company A hired premises for the purposes of carrying on trade as a general dealer. Before trade could commence, Company A had to install various shop ttings and equipment such as cash registers and refrigerators. On 1 September 2012 Company A purchased a delivery vehicle for R200 000 which it used during the pre-trade period to transport shop ttings and equipment to its premises. On 1 March 2013 the company commenced trading. Interpretation Note No. 47 (Issue 3) provides that delivery vehicles may be written off over four years under section 11(e).
Result:
Year ended 28 February 2013
Company A is not entitled to the wear-and-tear allowance for the six-month period 1 September 2012 to 28 February 2013 because it did not trade during this period.
Year ended 28 February 2014
On 1 March 2013 the company is entitled to a deduction under section 11A(1) of R25 000 (R200 000 × 25% × 6 / 12) for the wear-and-tear allowance applicable during the pre-trade period 1 September 2012 to 28 February 2013. The company also quali es for the wear-and-tear allowance for the 12 months ended 28 February 2014 under section 11(e) of R50 000 (R200 000 × 25%). Thus in the 2014 year of assessment the company is able to claim wear-and-tear allowances totalling R75 000 (R25 000 + R50 000).
4.5 Pre-trade expenses which were not allowed as a deduction in the current or any previous year of assessment [section 11A(1)(c)]
Only pre-trade expenses which were not allowed as a deduction in the current or any previous year of assessment will qualify for a deduction under section 11A.
4.6 Ring-fencing of the deduction for pre-trade expenses [section 11A(2)]
4.6.1 Limitation of pre-trade expenses to taxable income from the relevant trade
Section 11A(2) limits the deduction allowable under section 11A(1) to the taxable income from the relevant trade. If the pre-trade expenses exceed the taxable income of that trade, the excess pre-trade expenses may not be set off against the income from any other trade notwithstanding section 20(1)(b). Section 20(1)(b) permits a taxpayer to set off an assessed loss incurred in one trade against any income from another trade derived during the same year of assessment. Any pre- trade expenses not allowed because of insuf cient taxable income from the particular trade must be carried forward for set-off against any future taxable income from that trade (see 4.6.3). Pre-trade expenses cannot create an assessed loss in respect of the trade to which they relate, and cannot increase an assessed loss from that trade.
* ITC 50 (1926) 2 SATC 123 (NA); ITC 215 (1931) 6 SATC 133 (U). † ITC 1224 (1974) 37 SATC 30 (t).
‡ See Borstlap’s case above.
saIT comPendIum oF Tax LegIsLaTIon VoLume 2 483