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Determining expenditure actually incurred using the General Deduction Formula

Thursday, 05 April 2012   (0 Comments)
Posted by: TaxFind™
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Determining expenditure actually incurred using the General Deduction Formula

To determine the tax liability of a taxpayer, it is required to establish the ‘taxable income’, which is the amount remaining after deducting all allowable deduction and allowances from the income of a taxpayer.The foundation for such deductions and allowances is the ‘general deduction formula’, and additional specific deductions and allowances to extend or limit deductions or allowances, such as Section 11(gA) of the Income Tax Act with regards to expenses incurred with reference to a trade mark.

The general deduction formula (Sections 11(a) read together with Section 23(g)) has the following pillars:
• Carrying on any trade;
• Expenditure and losses;
• Actually incurred;
• During the year of assessment;
• In the production of income;
• Not of a capital nature; and
• To the extent not laid out for the purposes of trade.

Expenditure and losses are not restricted to cash payments and losses, but include outlays of amounts in other forms.It has been the practice of SARS to allow the nominal value of the own shares issued for services rendered as a deduction.This practice is based on the judgment in ITC 703, 17 SATC 208.

However, some have held the opinion that a deduction should not be allowed as the company issuing the shares has not lent or parted with any asset and therefore, has not expended anything.Also, the meaning of‘incurred’ generally means paid or payable (liability to pay).

As the general deduction formula does not allow for a deduction in regards expenses incurred with regards to a trade mark, a special inclusion by means of an allowance is available.The following case further evolves our understanding and interpretation of the deduction rules, specifically with the regards the meaning of ‘expenditure’,which is not limited to an allowance for expenditure incurred for thepurposes of Section 11(gA) of the Income Tax Act.

In a recent decision of the Supreme Court of Appeal, in C: SARS v Labat Africa Ltd, the court was charged with the question of whether the issue by a company of its own shares in consideration for a trademark constituted ‘expenditure actually incurred’ for the purposes of Section 11(gA) of the Income Tax Act.The Commissioner for SARS had contended that no required expenditure had actually been incurred by the taxpayer, and therefore no deduction was available in terms of Section 11(gA).

The taxpayer (previously Acrem Holdings Ltd) purchased the business operations of Labat-Anderson (South Africa) (Pty) Ltd during mid 1999.The business operations of Labat-Anderson included all its tangible and intangible assets, which included its trade mark. The taxpayer therefore had acquired the trade mark ‘Labat-Anderson’ through assignment during the 2000 year of assessment, and claimed a deductible allowance in terms of Section 11(gA).

The taxpayer entered into a sale agreement in which the taxpayer agreed to purchase the business operations for a consideration of R120 million, which would be discharged by the issue of 133333 333 Acrem Holdings Ltd shares at an issue price of 90 cents per share.To give effect to the sale, the taxpayer increased and subdivided its authorised share capital.The agreed shares were issued.The value of the shares issued at the date of transfer was in excess of the issue price.

The sale agreement provided that the purchase price was to be apportioned to the net tangible assets (as per the values reflected in the accounts), then to the value of the trade mark (as determined by an independent qualified valuator), and the residue to be allocated as goodwill.The trade mark was valued at R44 462 000. The Section 11(gA) allowance was based on the valuation value, which was not in dispute. SARS had disallowed the taxpayer’s claim in terms of section 11(gA) on the grounds that no expenditure had actually been incurred by the taxpayer in acquiring the trade mark in question.The issue before the court was whether ‘any expenditure’ had ‘actually been incurred’ by the taxpayer.

The taxpayer appealed SARS’ decision to disallow the section11(gA) allowance to the Pretoria Tax Court, which upheld its appeal,whereupon SARS then appealed to a full bench of the North Gauteng High Court, which dismissed SARS’ appeal against the judgment of the Tax Court. SARS pursued an appeal with the Supreme Court of Appeal with special leave from that court.

The Tax Court was of the view that the issuing of shares with a value equal to that of the trade mark justified that the taxpayer had actually incurred expenditure in acquiring assignment of the trade mark. The court agreed with the Tax Court’s conclusion in that the taxpayer did actually incur expenditure in obtaining assignment of the trademark, with reference to Edgar’s Stores Ltd v CIR 50 SATC 81 and Nationale Pers Bpk v KBI 48 SATC 55 in that ‘expenditure actually incurred’ meant in context that the taxpayer must have incurred an unconditional legal obligation in respect of the amount and it was not required that the obligation be discharged. Once the obligation was incurred the expenditure should be deductible.

However, the Tax Court failed to deal with the meaning of ‘expenditure’, and only addressed the question of when the expenditure had actually been incurred.The issue to be addressed was whether the issuing of shares by a company amounted to ‘expenditure’ and not merely whether the undertaking to issue shares was an obligation.

The court identified that ‘expenditure’ required a diminution or some movement of assets of the party who expends.This would not mean that the taxpayer would be poorer as the result of the assignment of the trade mark would be of similar or greater value.The court, therefore, found that Labat-Anderson had assigned the trade mark as consideration for the shares it was issued, and the taxpayer did not in fact ‘expend’ any money, or assets in acquiring the trade mark. The allotment or issuing of shares did not reduce the assets of the company, although such may have reduced or diluted the value of the shares held by its shareholders.The court referred to CIR v Estate Kohler and Others 18 SATC 354 as authority that an allotment of shares did not diminish a company’s assets.

The Supreme Court of Appeal ruled that no expenditure had actually been incurred by the taxpayer in acquiring assignment of the trade mark, and therefore not permitted a section 11(gA) allowance.The appeal was upheld with costs.

 Source: SAIPA Tax Committee



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