TAX3701/102

LEARNING UNIT 1
Learning unit

 INTRODUCTION
 LEARNING OUTCOMES
 PRESCRIBED STUDY MATERIAL FOR THIS
LEARNING UNIT
 SECTIONS OF THE PRESCRIBED
TEXTBOOK THAT CAN BE IGNORED

CONTENT OF LEARNING UNIT 1

1.1 Background
1.2 The accounting basis
1.3 Tax periods, returns, penalties and refunds
1.4 Output VAT
1.4.1 Supply of goods and services in the
course or furtherance of an enterprise
1.4.2 Importation of goods and services
1.4.3 Output VAT: zero-rated supplies
1.4.4 Output VAT: exempt supplies
1.4.5 Output VAT: deemed supplies
1.4.6 Output VAT: non-supplies and no
apportionment
1.5 Time of supply
1.6 Value of the supply
1.7 Input tax
1.7.1 Documentation
1.7.2 Determination of input VAT
1.7.3 Input VAT denied
1.7.4 Deemed input
1.8 Special rules
1.9 Adjustments
1.10 Tax rulings
1.11 Tax avoidance and unprofessional conduct
1.12 Influence of VAT on income tax calculations
1.13 Summary
Value-Added
WRAP-UP
SELF-ASSESSMENT QUESTIONS Tax (VAT)
ASSESSMENT CRITERIA

Open Rubric
 INTRODUCTION

Generally, tax can be classified into two groups, namely direct taxes and indirect taxes. Indirect
taxes are included in the price you pay for the consumption of goods or services. Value-Added
Tax (VAT) is an example of an indirect tax.

In this learning unit, the calculations relating to Value-Added Tax (VAT) will be investigated. The
Value-Added Tax Act No. 89 of 1991 contains the details of how the VAT system works and how
the VAT Act should be applied. VAT is a separate tax from income tax, and it has its own rules,
based mainly on how and when goods or services are supplied. The VAT rate changed on 1 April
2018 to 15%.

It is important to understand how to calculate the VAT amount (that is, the portion of the tran-
saction value/amount that constitutes Value-Added Tax). The VAT amount is calculated by
multiplying the transaction amount by the tax fraction. The tax fraction is discussed below. When
calculating the VAT on a transaction, it is important to establish which amount was provided: It
could be the amount before VAT is added (the VAT exclusive selling price) or the amount after
VAT has been added (the VAT inclusive selling price). The following basic structure can be used
to calculate the different amounts:

Selling price excluding VAT R100

Add: VAT at 15% R 15
Selling price including VAT R115

This framework can be used to calculate any amount, for example if the selling price (including
VAT) is R230, the VAT and the selling price excluding VAT can be calculated as follows:

Value (selling price excluding VAT) R100 R200 (R230 x 100 / 115)
Add: VAT at 15% R 15 R 30 (R230 x 15 / 115) or (200 x 15 / 100)
Consideration (selling price including VAT) R115 R230

When an amount includes VAT (i.e. VAT inclusive amount), the tax fraction will
be as follows: 15/115 (as shown in the example above: R230 x 15/115 = R30).

When an amount excludes VAT (i.e. VAT exclusive amount), the tax fraction will
be as follows: 15/100 or 15% (as shown in the example above: R200 x 15/100 =
R30).

VAT is a tax that is levied at every stage of the production process; therefore, every time a VAT
vendor (an entity that is registered for VAT purposes) sells goods or services, VAT must be levied
(called output tax). The VAT vendor buying the goods or services will be allowed to claim back
the VAT paid (called input tax).

Goods and services sold → Levy OUTPUT TAX

Goods and services purchased → Claim INPUT TAX

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Let us look at the practical example of a business entity (a registered VAT vendor) that manufac-
tures and sells wooden tables. The selling price of a table is R2 000, but the entity must add the
VAT amount (R2 000 x 15% = R300) to the selling price in order to calculate the consideration
that the customer must pay, therefore R2 300. Although the entity received R2 300, it must pay
the VAT (output tax) portion of R300 to SARS and account for income of only R2 000 in its income
statement. This amount (i.e., R2 000) will also form part of the entity’s gross income for income
tax purposes.

Assume the customer, who purchased the table and paid R2 300 for it, is also a registered VAT
vendor and a furniture dealer. The customer can claim the VAT (input tax) portion of R300 back
from SARS and thus enter an expense of only R2 000 in its income statement. This is the amount
(i.e., R2 000) that will be deductible for income tax purposes.

Did you notice that each transaction has a VAT effect on the seller and the buyer? When you do
your calculations for a question on a business entity, you must consider each transaction to estab-
lish whether that entity needs to account for output tax (selling) or input tax (buying).

Work through section 2.1 and 2.2 of the prescribed textbook.

Work through the following:

EXAMPLE 1

Information

You are investigating a business supply chain for mince used in a local pie shop.
You have identified the following activities that took place during the 2023 year of
assessment:

 Eric, a farmer, produces cattle that he sells to the Witbank Abattoir for R16 000.
 The abattoir slaughters the cattle and sells the meat for R20 000 to a local but-
cher.
 The butcher makes mince from the meat and sells it to the local pie shop for
R28 000.
 The pie shop makes pies from the meat, sells them to the public and receives
R40 000 from the cash sales.

Required

Calculate the input and output tax for each stage of the process. All amounts ex-
clude VAT, except for the amount relating to the pie shop.

1. Eric
2. Abattoir

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 3. Butcher
4. Pie shop

SOLUTION TO EXAMPLE 1

Eric: Output tax: R16 000 x 15% = R2 400

Abattoir: Output tax: R20 000 x 15% = R3 000

Less: Input tax: R16 000 x 15% = (R2 400)
Amount to be paid to SARS R 600

Butcher: Output tax: R28 000 x 15% = R4 200

Less: Input tax: R20 000 x 15% = (R3 000)
Amount to be paid to SARS R1 200

Pie shop: Output tax: R40 000 x 15/115 = R5 217 (rounded)

Less: Input tax: R28 000 x 15% = (R4 200)
Amount to be paid to SARS R1 017

LEARNING OUTCOMES

After completing this learning unit, you must be able to:

 discuss the workings of the Value-Added Tax system of South Africa,

 classify goods and services as standard-rated, zero-rated or exempt supplies,
 discuss the application of different VAT rules in different scenarios,
 calculate the VAT payable by or refundable to a vendor in a practical scenario,
 discuss and apply the effect of VAT on business income tax calculations.

PRESCRIBED STUDY MATERIAL FOR THIS LEARNING UNIT

Study chapter 2 in the prescribed textbook ("Value-Added Tax (VAT)").

SECTIONS OF THE PRESCRIBED TEXTBOOK THAT CAN BE IGNORED

The following sections in the textbook can be ignored:

[Link] Indirect exports (par (d))

[Link] Goods delivered by a vendor to a foreign-going ship or aircraft

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[Link] Goods supplied under a rental agreement

2.25 Foreign suppliers of electronic service

CONTENT OF LEARNING UNIT 1

Textbook sections: 2.6.3, [Link] [Link]

1.1 BACKGROUND
and 2.3

An entity must register as a VAT vendor before it can charge and/or claim VAT. VAT vendors
must charge VAT on all goods or services supplied, unless they are VAT exempt. Vendors can
also claim back the VAT they pay if the goods or services that they acquire meet the input tax
requirements. The net amount of tax due must be paid to SARS within 25 days following the end
of each tax period (last day of the month following the end of the VAT period if payments and
returns are submitted/ made via e-filing).

VAT RATE CHANGE

Please take note:

From 1 April 2018 the VAT rate changed from 14% to 15%.
This means that from 1 April 2018 VAT is levied at 15%. For most of your calculations you
will use 15%, however there will be questions where assets were purchased before 1 April
2018. If an asset was purchased before 1 April 2018, and the purchase price includes VAT,
the VAT will be levied at 14%.

Example 1:
Sahara (Pty) Ltd purchased a second-hand manufacturing machine on 1 January 2019 for
R287 500 (including VAT). Calculate the capital allowance for the 2023 year of assessment.
The company has a February year-end.

Calculation:
Cost price: R287 500 x 100/115 = R250 000
*Allowance - 2023: R250 000 x 20% = R50 000*

Example 2:
Sahara (Pty) Ltd purchased a second-hand manufacturing machine on 1 January 2018 for
R287 500 (including VAT). Calculate the capital allowance for the 2023 year of assessment.
The company has a February year-end.

Calculation:
Cost price: R287 500 x 100/114 = R252 193
*Allowance -2023: Nil as the machine was fully written-off in 2022*

*Capital allowances will be discussed in detail in learning unit 6.

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The Value-Added Tax Act No. 89 of 1991 (“the VAT Act”) provides for two types of supplies for
VAT purposes, namely:

 taxable supplies, which comprise of

o standard-rated supplies taxed at 15%
o zero-rated supplies taxed at 0%

 exempt supplies, which are not subject to VAT

In terms of the VAT Act, registered VAT vendors must levy (charge) output tax on all their taxable
supplies, that is, on the value of goods and services that they sell or provide. Vendors are then
allowed to claim the input tax they have paid on goods and/or services bought or received from
other VAT vendors.

The following is a mind map – for VAT purposes – of the supply of goods and services:

Supply of goods and services

Exempt supplies Taxable supplies

Standard- Zero-rated
No output rated supplies
tax charged supplies (0%)
(15%)

VAT is calculated in three phases:

VAT
Output Input
less add/less Adjustments equals payable/
tax tax
refundable
Complete
(textbook, (textbook, 2.17 (textbook,
VAT201
2.4 to 2.16) to 2.25) 2.26 to 2.32)
return

When total output tax payable is > total input tax claimable → VAT is payable to
SARS by the vendor.
When total input tax claimable is > total output tax payable → VAT is refundable to
the vendor by SARS.

Work through examples 2.7 and 2.8 in the prescribed textbook.

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1.2 THE ACCOUNTING BASIS Textbook section: 2.3.1, [Link], [Link]

The accounting basis, that is, the invoice basis or payments basis, will determine when VAT will
be payable.

According to the invoice basis, vendors must account for the full amount of VAT included in the
price of goods or services supplied in the tax period in which the time of supply has occurred.
This applies to the output tax liability on cash and credit sales as well as to the input tax that may
be claimed on cash and credit purchases.

According to the general time of supply rule on the invoice basis, a supply occurs at the earlier
of the following events:

 the time that an invoice is issued; or

 the time that any payment is received by the supplier

All vendors must account for VAT on the invoice (or accrual) basis, unless requirements for regis-
tering on the payments basis are met.

On the payments basis, VAT is accounted for when payments are made (i.e. for purchases) or
received (i.e. for sales). The invoice date is irrelevant.

Work through examples 2.1 to 2.4 in the prescribed textbook.

Did you notice that, in example 2.1, VAT is accounted for on the earlier of invoice
date or payment of the consideration?

Did you also notice that, in example 2.2, the payments basis is subject to very
strict rules as to when it can be used? This is to prevent abuse of the system.

In example 2.4, a person moves from the payments basis to the invoice basis. A
similar calculation can be done for a person who moves from the invoice basis to
the payments basis. The effect will simply be that the person will now have to pay
the output tax at the date that payment is received from the debtor instead of
having to pay it over at the invoice date.

1.3 TAX PERIODS, RETURNS, PENAL-

Textbook sections: 2.3.2 to 2.3.5
TIES AND REFUNDS

The VAT Act provides for different tax periods in order to accommodate different types of busines-
ses. For example, large businesses prepare monthly reports and can therefore submit VAT201
returns monthly. Farmers, on the other hand, do not generally prepare monthly financial informa-
tion about their businesses and they are accommodated by having to submit VAT201 returns only
every six months.

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The VAT system is a self-assessment system. This means that the vendor completes the VAT
return (VAT201) and submits it to SARS. SARS accepts the document and assesses the vendor
based on the information supplied. SARS does not request supporting documents but will per-
form an audit from time to time to confirm that all the requirements have been met. In order to
ensure the proper working of the system, there are various regulations dealing with how and when
to submit documents.

Work through the table under section 2.3.3 in the prescribed textbook.

Work through example 2.5 in the prescribed textbook.

You will note that if the input tax (i.e. VAT claimed on goods or services purchased)
exceeds the output tax (i.e. VAT paid on goods or services sold), SARS will refund
the difference to the vendor.

1.4 OUTPUT VAT Textbook sections: 2.4 and 2.5

The first component of the VAT system is the output tax. In this section, we will look at the various
aspects of output tax.

VAT
Output Input
less add/less Adjustments equals payable/
tax tax
refundable

Requirements for levying output tax

For the purposes of our initial discussion, we will assume that the person under discussion is a
registered VAT vendor and must charge VAT on sales. In order to know the amount of output tax
that must be levied, it is important to know the types of supplies the vendor is providing.

The VAT Act provides for two types of supplies, namely:

 taxable supplies, which include:

o supplies at the standard rate (presently 15%), or
o supplies at the zero rate (0%)

 exempt supplies, that is, supplies upon which no output VAT is chargeable.

Always remember that the VAT system works with two persons (or entities): the person selling
and the person buying. If a person sells goods or services that are subject to VAT at the zero
rate, the person who is buying the goods or services will also be subject to VAT at the zero rate.

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The person buying the goods or services therefore cannot claim back input VAT at 15%, as he/she
actually paid 0%.

Generally speaking, before output tax can be levied, all the following requirements must be met:
• the supply of
• goods or services in South Africa
• by a vendor
• in the course or furtherance of an enterprise carried on by him.

Work through example 2.6 in the prescribed textbook.

Remember:
 The Minister of Finance can change the rates applicable to standard-rated and
zero-rated supplies at any stage.
 Exempt supplies, however, can never be subject to VAT.
 If the standard rate is changed (for example, from the current 15% to 16%), the
tax fraction will change from 15/115 to 16/116.

1.4.1 Supply of goods and services in the

Textbook sections: 2.6.1, 2.6.2 and 2.7
course of an enterprise

The term “supply” is widely defined in the Act to include transactions under any sale, rental
agreement and instalment credit agreement. It also includes all other forms of supply, whether
voluntary, compulsory or by operation of law, irrespective of where the supply is effected, and
includes any derivative of the term.

The definition of “goods” includes corporeal movable things, fixed property, any real right in such
thing or property and electricity.

The definition of “services” is very wide and the supply of services would typically include (without
being limited to) the following:

 royalties – granting the right to use intellectual property, that is, patents, trademarks, know-
how and copyrights
 sale of intellectual property
 commercial services – by electricians, plumbers, builders
 professional services – by doctors, accountants, lawyers
 services rendered by advertising agencies
 acceptance of a restraint, including agreeing not to act or to act in a particular way
 acceptance of damages or compensation, including the cancellation of agreements
 provision of facilities by clubs, churches, charities and other non-profit organisations

Take note that this does not mean all of the above services are taxable supplies – it merely means
that they will constitute services for the purposes of the VAT Act.
The exclusion of the term “money” from the definitions of “goods” and “services” means that no
VAT implications will arise in respect of its supply. This is important because it means that when

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goods are purchased from a vendor, the initial supply of the item will attract VAT, whereas the
subsequent payment for those goods will not.

Work through the remember block under section 2.7.1 in the prescribed textbook.

1.4.2 Importation of goods and services Textbook sections: 2.8 and 2.9

When vendor A buys goods from vendor B (and both vendors are registered in the Republic of
South Africa), vendor A will pay the output VAT levied by vendor B on the purchase price. Where
an individual imports a product, the foreign seller will not charge any VAT. However, the govern-
ment levies VAT as if it were selling the goods to the person who has imported them.

If, for example, a person buys goods from a South African vendor for R115 and pays the vendor
the full R115, the vendor will have an income of R100 and will be required to pay the R15 VAT
portion to SARS as output tax within 25 days following the end of the VAT period (last day of the
month following the end of the VAT period if payments and returns are submitted/ made via e-
filing). The rule regarding the importation of goods aims to achieve the same thing. An individual
might buy goods from a foreign seller for R100 and in such a case, the buyer would pay the seller
R100. The foreign seller would then have to declare the income of R100 to SARS, and the buyer
would be required to pay the VAT of R15 directly to SARS upon importation of the goods.

Provided the goods are taxable supplies used in the course and furtherance of the buyers’ enter-
prise, the buyer would in both cases be able to claim the VAT paid (R15) back from SARS and
the seller would retain a R100 income.

The Act contains specific rules for calculating the VAT that must be paid when goods are impor-
ted. There is also a section setting out the method for dealing with services that are being im-
ported.

Work through examples 2.9 and 2.10 in the prescribed textbook.

Remember, the 10% customs duty value that is added to the calculation of the
VAT on imported goods will never be paid over, as it simply forms part of the
method used to do the calculation. Therefore, in example 2.9, the R120 000 will
be paid to the seller, the R5 600 to the customs and excise section at SARS and
the 15% VAT levied to the VAT section at SARS.

Textbook sections: 2.10, 2.10.1, [Link],

1.4.3 Output VAT: zero-rated supplies
2.10.2, 2.10.3 and 2.10.4

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Textbook, section 2.10.2

As discussed earlier, a supply will either be taxable (at a standard rate of 15% or at a zero rate of
0%) or will be VAT exempt. By default, a supply will attract VAT at 15%, unless it is zero rated
or exempt. The VAT Act specifically lists supplies that are zero-rated and those that are exempt
from VAT. It is therefore very important to know exactly which supplies are zero-rated or exempt,
as all other supplies will be taxable at a standard rate of 15%.

VAT is charged on zero-rated supplies, even though the Minister has set the rate at 0%. This is
done for two main reasons:

 Firstly, it determines whether VAT can be claimed back on goods or services purchased.
 Secondly, it determines what percentage should be used when making apportionments with
regard to input tax.

If a business sells goods or services that are classified as zero-rated supplies, that business will
still be able to claim back all the input tax (at 15%) related to the goods or activities. This is
because zero-rated items are classed as taxable supplies.

This section contains a couple of important aspects that you must ensure you under-
stand:

 In the case of a direct export, VAT is charged at 0%. In the case of an indirect export, VAT is
charged at 15% and is then reclaimed when the goods leave the country. Whether an export
is direct or indirect is determined by the location at which the risk of ownership of the goods
being exported is transferred. If ownership changes once the goods are outside of South
Africa, the export is a direct export. If ownership changes in South Africa, the export is an
indirect export ([Link]). NB! Indirect exports are not part of your TAX3701 syllabus.

 When a business is sold as a going concern, the zero-rating principle is applicable only if all
the requirements laid down in the VAT Act are met. You must know what these requirements
are. "For example, if an examination question, in referring to a going-concern sale, says 'some
of the assets necessary for carrying on the enterprise are sold separately from the business',
you should know immediately that the sale will not qualify for the zero rate because of the
requirement that all the assets must be sold. In other words, the word 'some' in the question
is the clue telling you that the sale will not qualify for the zero-rating." (Note that this example
is different to the one referred to in the prescribed textbook (2.10.3)).

 One of the criteria for the sale of a business as a going concern is that both parties should be
registered VAT vendors (section 11(1)(e)). If a person who is not a registered VAT vendor
wishes to purchase an enterprise as a going concern, it is catered for by the possibility of
voluntary registration. Such a person may apply for registration, provided certain conditions
are fulfilled: He or she must intend to purchase the enterprise as a going concern and to
continue the trading activities of that enterprise as from a specified date. In addition, the total
value of taxable supplies made by the supplier of the going concern must have exceeded (or

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 must reasonably be expected to exceed) R50 000 over a period of 12 months. Provided these
conditions are fulfilled, it is possible for both parties to be registered and for the enterprise to
be supplied as a going concern (section 23(3)(c)).

 It is important to note that if a going concern is supplied to a vendor at the zero rate, but the
recipient will only use it partially (less than 50%) for purposes of making taxable supplies, an
adjustment to the recipient’s output tax must be made in terms of section 18A of the VAT Act.
(This is discussed in detail in chapter 2.30 of the prescribed textbook. See also section 1.9 of
this learning unit.)

 When an enterprise is sold as a going concern, assets that are not related to going concern
activities can sometimes be sold together with the assets that do relate to going concern
activities. If the value of the taxable supplies concerned with the going concern activities totals
more than 50% of the total supplies, the total selling price will be taxed at the zero rate
([Link]).

Note that certain basic foodstuffs are zero-rated, provided they

 are not supplied for immediate consumption (for example, sandwiches and
other take-away foods) OR
 are not added to a standard-rated supply (for example, a gift hamper contain-
ing a basket of fruit)

Work through examples 2.11 and 2.13 to 2.17 in the prescribed textbook and
make a list of all the zero-rated supplies for yourself.

1.4.4 Output VAT: exempt supplies Textbook section: 2.11

If a business sells only goods or services that are classified as exempt supplies, it is not permitted
to charge any output tax on goods or services supplied and it will not be able to claim back any
of the input tax that was paid on purchases.

Make a list for yourself of all the exempt supplies. It is important to know these
items, as examination questions may contain some of them and you will have to
identify them.

This section contains several important aspects that you must ensure you understand:

 Not all services provided by a financial institution are exempt from VAT. You must be able to
identify which are exempt and which are not. If you refer to example 2.18 in the prescribed
textbook, you will see that in some questions we will supply you the expenses that were
incurred and you have to decide if they were exempt or not (2.11.1).

 When studying section 2.11.3 (dealing with accommodation), ensure that you know what the
differences are in respect of VAT for the following:

o residential accommodation

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o commercial accommodation less than 28 days

o commercial accommodation more than 28 days

Remember that in situations of a business having a taxable supply (commercial accommo-

dation) and an exempt supply (residential accommodation), the input tax that relates to both
types of supplies must be apportioned (see section 2.20). Note that the output tax is not
apportioned – either the full VAT amount is charged (for taxable supplies) or no VAT is charged
(for exempt supplies), unless an exception applies.

 Note that the supply of public transport by road or rail is exempt from VAT if the transportation

o takes place between two places within the RSA

o is of fare-paying passengers and their personal effects
o is supplied in the course of operations of a transport business, in a vehicle operated by the
supplier of the transportation service, or by a person acting as the supplier's agent

Take note of some of the above used terms or descriptions:

Fare-paying passengers
When the operator of the vehicle (in which passengers are transported) charges a consideration
for the service, the passengers will be regarded as fare-paying.

Operation of a transport business

In order to qualify for the exemption, the supplier of the transport service must be the operator of
the vehicle in which the passengers are transported. The supplier does not necessarily have to
be the owner of the vehicle or even the employer of the driver, but must be commercially respon-
sible for the transporting of the passengers.

When the supplier of the vehicle does not operate the vehicle himself, but rents or hires it to a
third party who uses it for the transport of passengers, the exemption does not apply.

Examples of exempt transport services

 passenger transport in South Africa by taxi, bus, or train for a consideration

 ambulance services – transporting of patients in an ambulance for a consideration

Examples of taxable transport services (not exempt)

 passenger transport by air or sea

 courier services and the transportation of parcels by road, rail or sea
 game-viewing excursions

Work through examples 2.18 to 2.222 in the prescribed textbook.

When answering a question, remember to provide a reason, for example, “exempt

supply- financial services” when an amount is nil. If you only answer Rnil, you
may lose marks.

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 Textbook sections: 2.12, 2.12.1, 2.12.2,
1.4.5 Output VAT: deemed supplies
2.12.3, 2.12.4 and 2.12.5

When a vendor sells goods to a person and that person takes ownership of the goods, a supply
has taken place; the vendor has supplied the goods (or services) to its customer. However, in a
number of situations it is not always clear whether a supply has taken place or not. To prevent
any dispute arising as to whether a supply has taken place or not, the Act includes specific things,
which will always qualify as a supply.

You will note that for each of the situations in which the deemed supply takes place, the value
that should be used and the time when the VAT must be recorded, are given.

To help you study this section, complete the following table:

Deemed supply When it will apply Value of supply Time of supply

Ceasing to be a vendor

Indemnity payments

Supplies to independent branches

Fringe benefits

Payments exceeding consideration

Work through examples 2.23 to 2.34 in the prescribed textbook.

The four items listed below will make sense only if read in conjunction with the examples in the
textbook.

Ceasing to be a vendor – example 2.23

 The value of the supply when a person ceases to be a vendor is effectively the open-market
value of transactions with connected persons ([Link]).
 There is relief available to vendors who deregister because their turnover is less than
R1 million (vendors who deregister because they intend to register as micro businesses) or
less than R50 000 (vendors who deregister solely because their turnover is less than the pre-
scribed threshold or voluntarily threshold) ([Link]).
 If a person who ceases to be a vendor disposes of any goods or rights after the cancellation
of his registration (and thus after the deemed supply has been accounted for), that person will
not be seen as carrying on an enterprise for VAT purposes and, therefore, no VAT will be due
on the supply of the goods or rights.

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 The general rules for deregistration (for VAT purposes) will not apply where a person ceases
to be a vendor because of death or insolvency, provided the enterprise is thereafter continued
by or on behalf of his executor or trustee.

Indemnity payments – examples 2.24 to 2.26

 Not all insurance payments received are deemed supplies. Did you notice that long-term insu-
rance (life insurance, for example) is not subject to VAT? To know whether VAT is payable
on short-term insurance compensation, you must know how the compensation was received
and by whom. Ensure you know the VAT consequences of each option.

 Where an indemnity payment relates to the total reinstatement of goods stolen or damaged
beyond economic repair AND/OR the vendor was denied an input tax credit on its acquisition
(for example, a motor car), no deemed supply will arise in the hands of the insured. A pay out
in respect of the repair of an asset will thus give rise to a deemed supply (an output tax), since
an input tax could be claimed on the repair expenses.

 Where the insurer replaces the damaged goods, the insured is not deemed to have made a
supply, as the replacement of goods does not constitute an indemnity payment. However, the
insurer will have made a taxable supply of the replacement goods to the insured, but for a Rnil
consideration. The insurer will be entitled to an input tax deduction on the acquisition of the
replacement goods.

Indemnity payment

Replacement of asset Pay-out

No VAT All other assets – Asset on which input VAT was

deemed supply denied (such as motor cars and
entertainment assets) – no
deemed supply

Supplies to independent branches – example 2.27

 Three types of costs can be included when making supplies to independent branches. Do
you know what they are ([Link])?

Fringe benefits – examples 2.28 to 2.32

 The normal rule is that the calculation of the value of the fringe benefit is the same as the
calculation used for income tax purposes. (For the purposes of this course, the amount will
be provided/supplied.) The exception to this rule is a right to the use of a motor vehicle.

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 The consideration in money for the supply of a fringe benefit other than motor vehicles is
deemed the cash equivalent of the benefit (as used for income tax purposes) multiplied by the
tax fraction.

 The value of the supply for right of use of motor vehicles is calculated differently. You should
be able to identify in which situations you must use the 0,3% and when to use the 0,6%
([Link]). Take note that this is a monthly percentage. Remember, when calculating the
value of the motor vehicle benefit, the first step is to remove the VAT from the vehicle value
to determine the value that should be used for the next steps – but note that this is not the
actual VAT calculation. The actual VAT calculation is only done in the fourth step. You might
think you are calculating VAT twice but remember that step 1 obtains the value of use and that
step 4 is the VAT calculation ([Link]). You can claim the R85 for maintenance costs only
and not for fuel costs as well. The percentage usage refers to the percentage of the input tax
that the vendor will be able to claim ([Link]).

In an examination question, you must be

able to identify which fringe benefits are
subject to VAT and which are not.

Payments exceeding consideration – example 2.33

 When a vendor receives a payment that exceeds the consideration charged for a standard
rated (15%) taxable supply of goods or services (i.e., double payment), output tax is
payable by the vendor if the excess payment is not refunded within four months.

 In the excess payment is refunded on a date after the output tax is accounted for (i.e., after
the 4 months period lapses), the vendor becomes entitled to claim an additional input tax
credit ([Link]).

 Since payments exceeding consideration qualify as deemed supplies, the related time of
supply and value of supply should be noted ([Link]) and ([Link]).

Textbook, section 2.12.6

1.4.6 Output VAT: non-supplies and no

Textbook sections: 2.13 and 2.14
apportionment

If, at the time of the initial purchase of goods or provision of services, the input tax was denied in
terms of the VAT Act, no output tax must be levied on the subsequent supply of such goods. The
rules as to when input tax cannot be claimed are discussed in section 1.7.3.

If a vendor acquires goods or services partly for the purposes of making taxable supplies and,
subsequently sells these goods, the vendor will be deemed to be making a taxable supply of
goods or services in the course of his enterprise and the total consideration received for such a
supply will be subject to VAT.

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 TAX3701/102

Work through examples 2.35 and 2.36 in the prescribed textbook.

1.5 TIME OF SUPPLY Textbook section: 2.15

The time of supply is important for VAT purposes, as it determines when you must pay the output
VAT and when you can claim the input VAT. The general rule is that the time of supply is the
earlier of
 the date of the invoice; or
 the date at which the payment of the consideration is received by the supplier

After studying this section, you should be able to answer the following questions:

1. What is the time-of-supply rule for a connected person?

2. What is the time of supply for a rental agreement?

1.6 VALUE OF THE SUPPLY Textbook section: 2.16

As mentioned earlier, to calculate the VAT on the value of a supply (which is the selling price
excluding VAT), multiply the value by the applicable tax fraction (in this case, 15/100).

To calculate the VAT portion of the consideration (which is the selling price including VAT),
multiply the consideration by the tax fraction (in this case, 15/115).

The value of the supply of goods or services is either

 the amount of money if the consideration is in money
OR
 the open-market value of the consideration if the consideration is not in money
LESS
 the amount of VAT included in the consideration

Work through examples 2.37 to 2.41 in the prescribed textbook.

After studying this section, you should be able to answer the following questions:

1. What is the value-of-supply rule for a connected person?

2. What is the value-of-supply rule for entertainment?

1.7 INPUT TAX Textbook section: 2.17

25
The second component of the VAT system is the input tax; in this section, we will look at the
different aspects relating to input tax.

VAT
Output Input
less add/less Adjustments equals payable/
tax tax
refundable

Work through example 2.42 in the prescribed textbook.

1.7.1 Documentation Textbook sections: 2.18 and 2.19

Have you noticed that to be able to claim input VAT, you must have documentation relating to the
transaction? We will now look at the documentation that is required.

Three main types of documents are used in the VAT system, namely tax invoices, debit notes
and credit notes. Remember, certain other documents can also be used in specific situations, for
example a rental agreement.

For an example of a full tax invoice on which the consideration exceeds R5 000, refer to page
117 of the VAT404 Guide for Vendors. (The guide can be found at [Link] under Types
of Tax, select Value-Added Tax and click on VAT404-Guide for Vendors.)

Work through examples 2.43 and 2.44 in the prescribed textbook.

1.7.2 Determination of input VAT Textbook section: 2.20

If a vendor uses goods or services wholly (100%) in the course of making taxable supplies
(standard rated or zero-rated), that vendor will be entitled to claim the full input tax that was incur-
red when acquiring those goods or services. If a vendor uses the goods or services wholly in the
course of making exempt supplies, that vendor will not be entitled to claim any input tax.

If a vendor uses the goods or services only partially in the course of making taxable supplies,
either one of the following input tax deductions can be made:

 the full input tax (so-called de minimis rule) – if the taxable use is 95% or more of the total
intended use; or

 the portion of the input tax that relates to the taxable supplies – if the taxable use is less
than 95% (the input tax being apportioned by the vendor)

A vendor must use the turnover-based method of apportionment unless it does not yield a fair
approximation. In such a case, an alternative apportionment method can be used if it has been

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 TAX3701/102

pre-approved by SARS. You will be provided with the apportionment percentage in any question
that you need to answer for this module’s purpose.

Work through example 2.45 in the prescribed textbook.

Remember that if there is a question in which input tax must be apportioned, you
must first decide if the cost only relates to a taxable supply, exempt supply or both.

 If the cost is incurred only to make taxable supplies, the full input tax can be
claimed, for example, in respect of maintenance on commercial accommoda-
tion. The input tax must therefore not be apportioned.

 The converse applies when costs are incurred solely for the making of exempt
supplies. In such a case, no input tax can be claimed, for example, in respect
of maintenance on residential accommodation.

 If the cost relates to both a taxable supply (i.e., commercial accommodation)

and an exempt supply (i.e. residential accommodation), then it must be appor-
tioned. For example, the input tax paid in respect of a computer used to pre-
pare accounts for both commercial and residential accommodation (example
2.45) must be apportioned between taxable and exempt usage.

Note that only input tax is apportioned. The output tax of a vendor is not appor-
tioned – it is charged at either 15% or 0%, or not charged at all (Rnil for exempt
supplies).

Example of input tax apportionment

Zethu Pty (Ltd) owns a three-storey building. The ground floor and the first floor
accommodate various businesses, while the second floor is comprised of flats
rented out as residential units. The SARS Commissioner has agreed to an input
tax apportionment of 80%. The following information has been provided to you for
the two-month tax period ended 31 March 2023 (all amounts exclude VAT):

DESCRIPTION

Receipts R

Commercial rental received 240 000

Residential rental received 60 000

Payments made

Insurance (building) 6 500

Repairs and maintenance (residential units) 15 250
Advertising (commercial business units) 7 850
Electricity and water (building) 22 875

27
 Bank charges 725

Required

Calculate the VAT payable by Zethu (Pty) Ltd for the two-month tax period ended
31 March 2023.

Solution

Output tax R
Commercial rental received (R240 000 x 15%) 36 000
Residential rental received (exempt supply) -
36 000

Input tax
Insurance (R6 500 x 80% x 15%) 780
Repairs and maintenance (input denied – exempt supply) -
Advertising (R7 850 x 15%) 1 178
Electricity and water (R22 875 x 80% x 15%) 2 745
Bank charges (R725 x 80% x 15%) 87
4 790
VAT due to SARS 31 210

1.7.3 Input VAT denied Textbook section: 2.21

The VAT Act provides that, in certain situations, a vendor may not claim input tax. In such cases,
input tax is denied, even if the vendor has paid input tax and he will use the goods or services
wholly for the making of a taxable supply.

Input tax is denied for the following supplies:

 entertainment (2.21.1)
 club membership fees and subscriptions (2.21.2)
 motor cars (2.21.3)

The following is a list of goods or services that will be classified as being acquired for the purposes
of entertainment (and for which any input tax deduction will therefore be denied):

 food and other ingredients purchased in order to provide free meals to staff, clients and busi-
ness associates
 business lunches, golf days, or other entertainment for customers and clients in restaurants,
theatres and night clubs or at sporting events
 goods and services acquired for providing employees with subsidised (or free) meals if the
direct and indirect costs of providing those benefits and facilities are not covered by the price
charged, for example, catering services, furniture, equipment and utensils used in kitchens,
canteens and dining rooms
 beverages, meals, entertainment shows, amusements or other hospitality supplied to custo-
mers and clients at product launches and promotional events

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 TAX3701/102

 capital goods such as hospitality boxes, holiday houses, yachts and private aircraft that are
used for entertainment

After studying this section, you should be able to answer the following questions:

1. When will a person be able to claim input tax on entertainment expenses?

2. Can VAT be claimed on the following vehicles? Supply a reason for each
answer.

Yes/No
 Motor cycles
 Station wagons
 Caravans
 Minibuses
 Single cab bakkie/delivery vehicle
 Ordinary sedan-type passenger vehicle
 Double-cab bakkie

Work through example 2.46 in the prescribed textbook.

1.7.4 Deemed input Textbook section: 2.22

Textbook, section 2.22.1

When goods are acquired from a non-vendor, a vendor can usually not claim any input tax
because the non-vendor did not charge any output VAT. When second-hand goods are acquired
from a non-vendor who is a resident of South Africa, and the goods are situated in South Africa,
the VAT Act provides that a deemed input tax may be claimed, provided the goods will be used
in making a taxable supply.

Work through examples 2.47 to 2.49 in the prescribed textbook.

The tax fraction must be calculated on the lower of the purchase price and the
open-market value. For the purposes of this module, when the open-market value
is not supplied in a question, then use the purchase price.

1.8 SPECIAL RULES Textbook sections: 2.23 and 2.24

29
The VAT Act has a number of special rules that must be applied to certain types of assets. These
rules can influence the time or the value of supply.

Work through examples 2.50 to 2.52 in the prescribed textbook.

The special rules included in this section will override the rules that you have
studied up until now. Please ensure you know when to apply these rules.

Take special note of the distinctions between finance lease agreements and rental agreements.
In the case of a finance lease agreement, the stated or determinable sum of money payable at
stated dates over a period in the future (i.e., instalments) also includes finance charges. Should
any input tax be claimable, it will be claimed at the earlier of the time of delivery of the goods or
the time that any payment is received. In the case of a rental agreement, there will normally be
no finance charges applicable, and input tax can be claimed as and when the rental payment is
made.

1.9 ADJUSTMENTS Textbook sections: 2.26 to 2.32

The third component of the VAT system is adjustments. In this section, we will look at the different
adjustments that can be made to input and output tax.

VAT
Output Input
less add/less Adjustments equals payable/
tax tax
refundable

The adjustment rules apply when goods or services are acquired for a specific purpose (for
example, wholly for making taxable supplies), and a subsequent change in the use of the goods
or services arises, for example to being used wholly or partially for private purposes.

Work through examples 2.53 to 2.63 in the prescribed textbook.

When studying these rules, it is important to understand when will the adjustment
relate to input tax and when it will relate to output tax. If you refer back to the
VAT201 return, discussed at the beginning of this learning unit, you will note that
the adjustments are not done separately. Rather, they form part of the input and
output tax sections of your calculation.

1.10 TAX RULINGS Textbook section: 2.33

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 TAX3701/102

All written VAT rulings issued prior to 1 January 2007 have been withdrawn and they may no
longer be relied upon (with the exception of rulings specifically confirmed by the SARS Commis-
sioner). The advance ruling system previously regulated in the Income Tax Act and the VAT Act
is now incorporated in the Tax Administration Act No. 28 of 2011, which came into effect on
1 October 2012.

A binding ruling will provide a taxpayer with clarity and certainty on how SARS will interpret and
apply the various tax laws as they pertain to a proposed transaction.

1.11 TAX AVOIDANCE AND UNPROFES-

Textbook sections: 2.34 and 2.35
SIONAL CONDUCT

If a person enters into a scheme to avoid or reduce tax, SARS can apply the tax avoidance rules
to levy the VAT on the transaction in a manner that would have applied had it been carried out
for bona fide business purposes. If any person involved in such a scheme is a member of a
professional organisation, SARS can lodge a complaint with that organisation.

1.12 INFLUENCE OF VAT ON

Textbook section: 2.36
INCOME TAX CALCULATIONS

VAT has a direct influence on the calculation of income tax. The cost price to be used for capital
allowances (in the taxable income calculation) will depend on whether the enterprise has claimed
back the VAT on the asset or not.

The taxable income calculation of an enterprise that is also registered as a VAT vendor must,
where applicable, exclude VAT. However, this calculation must include VAT where the input tax
has been denied, for example in respect of motor vehicles, as defined.

If XYZ Company purchases a motor vehicle as defined for R322 000 (including VAT), the input
tax of R42 000 (R322 000 x 15/115) will be denied and the cost price of the motor vehicle for
income tax purposes will be R322 000. However, if the same amount was spent to purchase a
delivery vehicle (i.e., not a motor car as defined) to be used in the making of taxable supplies by
XYZ Company, it will qualify for an input tax deduction of R42 000. The cost price of the delivery
vehicle would thus be R280 000 (R322 000 less input tax of R42 000) for income tax purposes.

1.13 SUMMARY Textbook section: 2.37

Vendors levy VAT on all taxable supplies. Vendors who pay input tax on goods and services
supplied to them may claim such input tax against the output tax levied on taxable supplies.
However, the scope of the rules in the VAT Act is much more complicated. The VAT Act is indeed
a complicated, rule-based document with many exceptions. With regard to supplies made, great
care should be taken to distinguish between standard-rated supplies, zero-rated supplies and
exempt supplies.

With regard to input tax, VAT may be claimed only if it was levied on the supply of goods or ser-
vices, except in the case of second-hand goods acquired from non-vendors. In addition to these
basic principles, cognisance must be taken of the special rules concerning a change of use,

31
exports, accommodation, financial services, sale of going concerns, fringe benefits, indemnity
payments, instalment credit agreements, and so forth.

Work through question 2.1 in section 2.38 of the prescribed textbook.

Taxation and accounting are integrated subjects. You may therefore expect to
apply some accounting knowledge when answering a taxation question. For this
learning unit you are expected to be able to do journal entries. In the learning
units that follow, you will be expected to know the principles of preparing financial
statements to the extent that it relates to taxation.

The total amount included in a cashbook will generally be the amount including
VAT, as this represents the total amount received. If the information provided is
from a general ledger, it will exclude VAT, as VAT will have been recorded in a
separate general ledger account (such as the VAT control account). Remember,
these are the general rules: Always read the information provided carefully as
certain amounts may include VAT. For example, a question may state that the
amounts reflected are the totals of the relevant columns in the cashbook, which
would mean the VAT component has already been removed if there is a separate
VAT column in the cashbook.

WRAP-UP

In this learning unit, we investigated the different sections of the VAT Act. We also examined
each of the three components of the VAT system, namely output tax, input tax and adjustments.

You must now be able to answer the following questions:

 When does a person need to register as a vendor for VAT?

 How does the VAT system work?
 When and at what rate is VAT levied?
 How long is a VAT period?
 What are the requirements for the documents that are the driving force of the VAT system?
 When is a supply standard rated, zero-rated or exempt?
 When should output tax be accounted for?
 What constitutes a deemed supply?
 When should input tax be accounted for?
 Under which other special circumstances must output tax be raised?
 When will input tax be denied?
 What are the timing rules for supplies?
 How is the value of a supply determined?
 Which accounting basis may be applied in the VAT system?
 What do I need to know about returns, penalties and refunds for VAT purposes?

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 TAX3701/102

 Can there be avoidance schemes in respect of VAT?

 How does the VAT system influence income tax calculations?

33
 TAX3701/102

LEARNING UNIT 2 Learning unit

INTRODUCTION
LEARNING OUTCOMES
PRESCRIBED STUDY MATERIAL FOR THIS
LEARNING UNIT
SECTIONS OF THE PRESCRIBED TEXTBOOK
THAT CAN BE IGNORED

CONTENT OF LEARNING UNIT

2.1 Introduction
2.2 Qualifying as a micro business
2.3 Calculating taxable turnover
2.4 Registration and deregistration
2.5 Administration
2.6 Transitional provisions

POINTS TO PONDER
WRAP-UP
ASSESSMENT CRITERIA

Turnover tax

43
 INTRODUCTION

Turnover tax is a stand-alone tax that does not form part of the usual calculations for determining
income tax payable by a taxpayer (i.e., business entity) on its taxable income. Turnover tax is
calculated by simply applying a tax rate (see the table in section 9.4 of the prescribed
textbook) to a taxable turnover. The taxable turnover consists of the business’s turnover, with a
few specific inclusions and exclusions.

Receipts of a business forming part of the turnover tax system will therefore be exempt for pur-
poses of calculating a taxpayer’s income tax liability in terms of the Income Tax Act (Act No. 58
of 1962). For ease of reference, note that turnover tax is contained in the Sixth Schedule to the
Income Tax Act.

The following benefits of turnover tax are foreseen by SARS:

 It is simple: There are no complicated calculations. A taxpayer's tax liability is simply calcu-
lated on taxable turnover.

 It is quick: There is no intensive record-keeping required and the taxpayer only needs to submit
one annual return and make two six-monthly interim payments a year (if liable for such pay-
ments).

 It can save the taxpayer tax: Businesses with low turnovers and high profit margins can reduce
their tax liability with turnover tax.

 It can save the taxpayer money: If a taxpayer is paying for accounting and tax services, he/she
should save money because the requirements are much less time consuming for turnover tax
than for VAT, income tax, provisional tax, CGT, and dividends tax.

LEARNING OUTCOMES

After completing this learning unit, you must be able to:

 identify if a business qualifies as a micro business

 discuss why a business will be disqualified as a micro business
 calculate turnover tax payable in terms of the applicable legislation
 discuss the registration and deregistration process
 understand and apply the different transitional provisions when migrating from a normal
income tax system to a turnover tax system

PRESCRIBED STUDY MATERIAL FOR THIS LEARNING UNIT

Study chapter 9 in the prescribed textbook.

44
 TAX3701/102

SECTIONS OF THE PRESCRIBED TEXTBOOK THAT CAN BE IGNORED

The entire chapter 9 is important (i.e., you may not ignore ANY sections of this chapter).

CONTENT OF LEARNING UNIT 2

2.1 INTRODUCTION Textbook section: 9.1

A new, simplified tax system – called turnover tax – was introduced on 1 March 2009 and it is
available to any business that qualifies as a micro business. This system is a substitute for
income tax, CGT, dividends tax (only partially) and VAT. The turnover tax system is optional in a
sense that a micro business has the option to still be taxed under the normal tax system if it
prefers. Payroll taxes, such as employees' tax and UIF contributions, are excluded, as they are
taxes that employees generally bear and that employers collect on behalf of government.

If a business meets the qualifying turnover requirements, it can elect to be taxed under the
turnover tax system. Qualifying turnover is the total amount received by a taxpayer where such
turnover does not exceed R1 million in a year of assessment. Remember that qualifying turnover
refers to receipts and not to amounts received or accrued, as provided for in the definition of
gross income.

2.2 QUALIFYING AS A MICRO BUSI-

Textbook section: 9.2
NESS

Turnover tax is available to sole proprietors (individuals), partnerships, close corporations, co-
operatives and companies. Public benefit organisations and recreational clubs are not permitted
to use the turnover tax system, as they also conduct activities other than business activities and
they already enjoy special tax treatment.

When studying this section in the prescribed textbook, make a list of the following:

 amounts that are excluded from qualifying turnover (section 9.2.1)

 persons specifically included to be registered as a micro business (section 9.2)

 persons specifically excluded and disqualified from being registered as micro businesses
(section 9.2.2)

Qualifying turnover is merely a method to determine whether a person qualifies as a micro busi-
ness or not. The next step is to calculate the taxable turnover.

Work through example 9.1 in the prescribed textbook.

45
 2.3 CALCULATING TAXABLE TURNOVER Textbook sections: 9.3 and 9.4

Taxable turnover is calculated as follows:

Cash receipts from the carrying on of business activities (paragraph 5 of the 6th Schedule)

 include all amounts not of a capital nature that are

o received by a registered micro business (in cash only)
o received during that year of assessment
 include all amounts realised from the carrying on of business activities in South Africa
 exclude any amounts refunded to any person in respect of goods and services supplied
during the current or previous years of assessment

Plus: Inclusions (paragraph 6 of the 6th Schedule)

 50% of the proceeds received from the disposal of capital assets (including immovable
property but excluding trading stock and financial instruments) mainly used for business
purposes
 in the case of a close corporation, co-operative or company, 100% of the investment income
received, excluding dividends or foreign dividends

Less: Exclusions (paragraph 7 of the 6th Schedule)

 100% of investment income received by sole proprietorships (individuals) and partnerships

 certain government grants that are exempt from income tax in terms of the Income Tax Act
 any amount that accrued to the business prior to its registration as a micro business and
that was subject to tax in terms of the Income Tax Act
 salary income (excluding a notional salary payment made by a sole proprietor to himself or
herself) which will be taxed according to the current personal income tax system
 any refund received from any person for goods and services supplied to the micro business

Turnover tax is the tax payable by a registered micro business on taxable turnover and calculated
by applying the rates fixed annually in Parliament to the taxable turnover.

2.4 REGISTRATION AND DEREGISTRA-

Textbook sections: 9.5 and 9.6
TION

Registration for the turnover tax system is voluntary. However, a micro business that is registered
for turnover tax can be deregistered in one of the following ways:

 voluntary deregistration (section 9.6.1)

 compulsory deregistration (section 9.6.2)

Work through example 9.3 in the prescribed textbook.

46
 TAX3701/102

2.5 ADMINISTRATION Textbook section: 9.7

Although a micro business is not subject to the provisional tax requirements in the Act, paragraphs
11 and 12 of the 6th Schedule of the Act specifically provide for interim payments rules of the
turnover tax system:

 The first payment must be submitted to SARS within six months of the beginning of the year
of assessment (on/or before 31 August).

 The second payment must be submitted to SARS before the end of the year of assessment
(on/or before 28/29 February).

 An annual (final) tax return reflecting the actual amount of taxable turnover must be submitted
by the due date (as declared by SARS each year). A further payment will be necessary when
the assessed turnover tax on the actual taxable turnover for the year of assessment exceeds
the interim payments that were made.

 Additional tax of 20% may be charged if the estimate of the taxable turnover for the second
interim payment is less than 80% of the actual turnover for the year of assessment.

 Where a micro business is broken up between connected persons to ensure that the business
remains within the R1 million threshold, the turnover of all the business activities will be added
to determine the threshold.

Work through examples 9.4 and 9.5 in the prescribed textbook.

2.6 TRANSITIONAL PROVISIONS Textbook section: 9.8

Transitional rules have been put in place to cater for situations where micro businesses move
between the turnover tax system and the normal income tax system (whether or not they then
register as VAT vendors or continue under alternative provisions).

The transitional rules cover the process whereby a micro business needs to register or deregister
for turnover tax during the year of assessment.

Work through question 9.1 in section 9.10 in the prescribed textbook.

Did you note the following?

 Receipts from debtors are not included in taxable turnover, as they have already
been included in the turnover of the previous year.

47
  You should remember to include only 50% of the amount received for the dispo-
sal of certain business assets.

Work through practice question 1 uploaded under self-assessment questions on

myUnisa.

 Practice question 1 is a good question that deals with the difference between
normal tax payable and turnover tax payable.

 Also, note that in answering practice question 1, you should first discuss if a
business does qualify as a micro business.

Work through practice question 2 uploaded under self-assessment questions on

myUnisa.

 Note that the business referred to in practice question 2 was deregistered, as

it no longer qualified as a micro business.

POINTS TO PONDER

 What were the reasons for introducing turnover tax?

 Do you think all businesses should change to turnover tax if they qualify?
 Why do you think businesses are now allowed to be registered for both turnover tax and
VAT?

WRAP-UP

In this learning unit, we looked at turnover tax and ascertained when a business qualifies as a
micro business and how to calculate taxable turnover.

You must now be able to answer the following questions:

 Who will qualify as a micro business?

 How is turnover tax calculated?
 How are capital gains treated?
 What are the tax implications for dividends declared?
 What happens if a business no longer qualifies as a micro business?

48
 TAX3701/102

Learning unit
LEARNING UNIT 3

INTRODUCTION
LEARNING OUTCOMES
PRESCRIBED STUDY MATERIAL FOR THIS
LEARNING UNIT
SECTIONS OF THE PRESCRIBED TEXTBOOK
THAT CAN BE IGNORED

CONTENT OF LEARNING UNIT 3

3.1 Introduction
3.2 Gross income
3.3 Gross income: special inclusions
3.4 Exempt income
3.5 Foreign income
3.6 Non-residents

WRAP-UP
SELF-ASSESSMENT QUESTIONS
ASSESSMENT CRITERIA

Income of a
business
entity

51

Open Rubric
 INTRODUCTION

The Income Tax Act has a specified structure or framework that must be applied in order to deter-
mine the taxable income of a taxpayer. You will remember this framework from TAX2601. The
same framework is used in this module (TAX3701) to show you where the learning unit fits in.

Definition
Gross income
Specific
inclusions
Income Less:

Less: Exempt income

General
deductions
Deductions
Specific
deductions
Gives:
Capital
Taxable income allowances
before capital gain

Plus:

Taxable capital gain

Gives:

Taxable income
In this learning unit, the first component of the framework, namely income (comprising gross
income plus special inclusions less exempt income), is discussed and we will show you how to
calculate a corporate entity's income for any given year of assessment.

South African residents and non-residents are dealt with separately for income tax purposes. This
learning unit therefore also looks at the definition of a resident and discusses the tax liability of
residents and non-residents, respectively.

52
 TAX3701/102

LEARNING OUTCOMES

After completing this learning unit, you must be able to:

 state the requirements of the gross income definition (together with the applicable case law)
and apply it in a practical situation
 apply the special inclusions, exempt income and foreign income rules in a taxable income
calculation
 determine the taxable income of a non-resident
 determine the source of income

PRESCRIBED STUDY MATERIAL FOR THIS LEARNING UNIT

Study chapter 3 and section 4.7.5 of chapter 4 in the prescribed textbook.

SECTIONS OF THE PRESCRIBED TEXTBOOK THAT CAN BE IGNORED

3.2.1 Resident (only ordinary resident and physical presence test sections)
3.6.1 Net income from controlled foreign companies

CONTENT OF LEARNING UNIT

3.1 INTRODUCTION Textbook section: 3.1

Before we discuss gross income, special inclusions and exempt income, you need to understand
the concepts of residents and non-residents. In TAX2601, you were required to apply the gross
income definition to residents only. In this module, the principles for non-residents are added.

Since this module deals with the taxation of companies and close corporations (not natural per-
sons), you need to consider the requirements below only (and not the physical presence or
ordinarily resident test) to determine whether a company or close corporation is a resident of the
republic or not.

A person other than a natural person is a resident of the Republic if it is:

 incorporated, established or formed in the Republic, or

 effectively managed in the Republic

It is necessary to determine whether an entity is a resident for tax purposes for the following
reasons:

 Residents are taxed on all (worldwide) income. (Residents are covered in sections 3.2 to
3.5 of this tutorial letter.)

53
 Non-residents are taxed only on income received from a South African source, or on income
that is deemed to have been received from a South African source. (Non-residents are
covered in section 3.6 of this tutorial letter.)

Read section 3.1 in the prescribed textbook.

3.2 GROSS INCOME Textbook section: 3.2 and 4.7.5

You have already learned (in TAX2601) about the requirements that income must meet to be
considered gross income. This section is a revision of these requirements, and it is supported by
court cases additional to those that you encountered in TAX2601.

You will need to learn the name as well as the principle (conclusion) of each of the tax court cases
mentioned in the prescribed textbook. (Note that it is not necessary to learn the numbers
added next to the case names for completeness purposes.) In the examination, you may be
required to list the name and principle under the appropriate criteria for the gross income definition
when considering whether an amount should be included in gross income or not.

The following are the facts and the outcome of a court case that is important for this module (but
not mentioned in the prescribed textbook). It relates to the “in favour of” gross income require-
ment. In the examination, you may be required to discuss the facts briefly, as well as the issue
dealt with and the outcome of this court case.

COMMISSIONER FOR INLAND REVENUE v WITWATERSRAND ASSOCIATION OF

RACING CLUBS (23 SATC 380 (A) – 1960)

This case illustrates the problem that a taxpayer encounters when avoiding the accrual of income
by being obliged to pay such income to another person. Once a taxpayer receives an amount
beneficially or the amount accrues to the taxpayer, he is taxed on that amount, even though he
may have an obligation to pay it over to some other person.

Facts

The taxpayer, a non-registered association of racing clubs, organised a race meeting on the race-
course of the Johannesburg Turf Club, the proceeds of which were to be divided between two
non-profit charities. The proceeds of the meeting amounted to £7,906, which sum, together with
£369 received from donations, was divided between the two charitable bodies for whose benefit
the meeting was stated to be held. The Commissioner included the £7,906 in the taxpayer's gross
income.

Issue

Should the proceeds, which the racing association were obliged to pay over to the charities, be
included in the association’s gross income?

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 TAX3701/102

Outcome

Based on the facts, the Association had, in holding the race meeting, embarked upon a scheme
of profit making and was liable for payment of tax upon the proceeds of the meeting, notwith-
standing the moral obligation upon it to distribute the proceeds to the charities in accordance with
its declared intention. The Association acted as the principal in holding the race meeting, rather
than as an agent, and the proceeds were received beneficially.

Study section 3.2 (excluding the ordinary resident and physical presence test para-
graphs of section 3.2.1) in the prescribed textbook and work through question 3.1 of
section 3.9 of the textbook.

When working through this question, you should apply the requirements of the gross
income definition to each of the amounts received. Note that the question requires
you to determine Quella (Pty) Ltd’s gross income. In doing so, you need to whether
each amount is gross income or not, but you should also be able to give reasons for
your answer (similar to the explanations given in notes 1 to 3 of solution 3.1), by
referring to the principles contained in section 3.2 of the textbook.

Study section 4.7.5 of the prescribed textbook (the accrual and incurral
of interest).

Note that the interest received on a loan or investment (financial instrument) is tax-
able according to the gross income definition. Section 24J does not influence the
taxability of the amount, but it determines the timing of the accrual. According to this
section, the interest is spread on a daily basis over the term of the financial instru-
ment. In other words, the interest is regarded as received evenly during the year
and not only at the specific date at which the interest is attributed to the investor.

When studying the gross income definition, make a thorough summary of each crite-
rion with which an amount must comply before it can be included in gross income.
You must be able to answer a discussion question on the applicability of the gross
income definition (and discuss the applicable case law), as well as apply these prin-
ciples to determine whether an amount should be included in the gross income of a
taxpayer in a taxable income calculation question. (Taxable income calculations are
introduced later in this module – in other words, your knowledge of the gross income
definition will be integrated in another learning unit to enable you to calculate an
entity’s taxable income.)

Remember, although amounts of a capital nature are excluded from gross income, these amounts
could nevertheless be subject to income tax in accordance with the Eighth Schedule to the Act,
which regulates capital gains tax (CGT). This topic is discussed in learning unit 7 of this module.

3.3 GROSS INCOME: SPECIAL INCLUSIONS Textbook section: 3.3

Although an amount may be excluded from the definition of gross income as a result of not meet-
ing any of the definition criteria, the specific inclusions contained in paragraphs (a) to (n) of the

55
gross income definition have the effect that amounts covered by the provisions of these para-
graphs are nevertheless included in the gross income of the taxpayer. For example, if a person
sells a business, the proceeds from such a sale are likely to be regarded as a capital receipt and,
consequently, be excluded from gross income. However, if the purchase consideration is re-
ceived by the seller in the form of regular monthly repayments instead of a lump sum, the appli-
cation of paragraph (a) of the definition, which specifically includes annuities in gross income,
may result in these receipts, although capital in nature, being specifically included in the gross
income of the taxpayer.

Study section 3.3 in the prescribed textbook.

3.4 EXEMPT INCOME Textbook section: 3.4

Exempt income refers to certain types of income that are included in gross income but that the
Income Tax Act does not want to subject to tax. They are therefore deducted from gross income
to calculate total income.

The income tax legislation is an important mechanism by which government achieves a variety
of objectives. For example, by exempting a portion of interest income for individuals from taxation,
government encourages individuals to save, which will have a positive influence on the economy.
These exemptions are contained in section 10 of the Act; the taxpayer may be exempted from
normal income tax (for example, public benefit organisations) or the type of income (for example,
dividends received by a company) may be exempt fully or partially from normal income tax.

Although certain amounts may be exempt from income tax (for example, dividends
in certain circumstances), note that these amounts are nevertheless firstly included
in gross income. Once the second component of the framework, namely exempt
income, is calculated, the relevant exempt portions are deducted from gross income.
The result of this calculation is "income".

Study section 3.4 in the prescribed textbook.

3.5 FOREIGN INCOME Textbook sections: 3.6, 3.6.2 and 3.6.3

Because residents are taxed on all (worldwide) income, a resident's foreign income must also be
included in taxable income.

Study sections 3.6 (introductory section) and 3.6.2 in the prescribed textbook.

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 TAX3701/102

When a resident's foreign income has been taxed in the foreign country and it is then also included
in that resident's South African taxable income due to the worldwide income principle, the resident
may then claim a rebate (refund) in respect of foreign taxes paid.

Study section 3.6.3 in the prescribed textbook.

 The section 6quat rebate applies only in respect of foreign taxes paid. No
rebate applies in respect of penalties or interest paid on foreign taxes.

 If the foreign taxes exceed the calculated section 6quat rebate, taxpayers are
entitled to carry this excess forward to the following years of assessment and
to claim this excess as a rebate in future years.

Work through practical question 1 uploaded under learning unit 3 self-

assessment questions on myUnisa.
When working through this question, you should apply the principles relating to
foreign income received and the section 6quat rebate for which the taxpayer qua-
lifies. Note that the question does not specifically state that a section 6quat re-
bate should be calculated. You need to know when a taxpayer qualifies for the
rebate.

3.6 NON-RESIDENTS Textbook section: 3.7

The definition of gross income makes provision for the taxation of both residents and non-resi-
dents. Non-residents are taxed on all income from a South African source, or on income that is
deemed to be from a South African source. Consequently, it is important to study the concepts
of "source of income" as well as "deemed source" in order to establish the taxability of amounts
received by non-residents.

The source of income is where that income has its origin. To determine the source of income,
two aspects need to be considered:
 the cause of the income
 the location of that cause

Study the entire section 3.7 of the prescribed textbook.

(You do not need to memorise the court cases mentioned in this section of
the textbook)

Although the rules with regard to source and deemed source mainly serve the purpose of estab-
lishing whether such amounts will be subject to South African income tax in the hands of non-
residents, these source rules are also relevant in calculating the section 6quat rebate to which
residents only are entitled. This rebate is not granted in respect of foreign taxes paid on amounts,
which are from a South African source or are deemed to be from a South African source.

57
 Visit Learning Unit 3 on the myUnisa Discussion Forum and discuss any con-
cepts that you do not understand. If you do understand the concepts, then answer
students who have posted questions.

WRAP-UP

In this learning unit, we looked at the components of gross income, specific inclusions and exempt
income. Gross income represents all income items, whereas exempt income represents those
income items included in gross income (either by means of the general definition or specific inclu-
sions), but which should be deducted from gross income because of their exempt status.

The taxation of foreign income of residents and the taxation of non-residents' income were also
considered. The section 6quat rebate – in terms of which residents are subject to double taxation
– was explained. We also discussed the rules, which determine the source of income, as well as
the deemed source rules.

The Act makes provision for deductions against income as discussed in this learning unit. The
general deduction formula is dealt with in learning unit 4.

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 TAX3701/102

Learning unit

LEARNING UNIT 4

INTRODUCTION
LEARNING OUTCOMES
PRESCRIBED STUDY MATERIAL FOR THIS
LEARNING UNIT
SECTIONS OF THE PRESCRIBED TEXTBOOK
THAT NEEDS TO BE STUDIED

CONTENT OF LEARNING UNIT 4

4.1 Background
4.2 Specific transactions

WRAP-UP
SELF-ASSESSMENT QUESTIONS
ASSESSMENT CRITERIA

General
deduction
formula

61
 INTRODUCTION

A big retail company, Pick & Wear, selling branded clothing at outlets in all the major cities incurs
expenses relating to running the business. Sometimes the company pays the private expenses
of its directors, and the company's accountant, Mr Bean Counter, allocates these expenses to the
relevant expense accounts in the general ledger.

What would happen if Pick & Wear could claim any expenditure incurred as a taxable
deduction, regardless of whether such expenditure was for private or business purposes?

The issue here is about the general deduction formula governing the deduction of expenditure
incurred by a taxpayer in carrying on a trade in the production of income. The taxpayer would
ideally want to claim all expenses as tax-deductible expenditure, but not all expenses necessarily
qualify as tax-deductible expenditure. The taxpayer has to convince SARS that a certain expense
may qualify as a tax-deductible expense. SARS, on the other hand, would like to limit the
deductions that a taxpayer may claim as tax-deductible expenses, thus increasing the tax liability
of the taxpayer.

This learning unit explains when an expense will qualify for a deduction in the taxable income
calculation of a taxpayer. If you refer to the framework (introduced earlier in this module and
provided again below), this learning unit relates to the first category of allowable deductions,
namely the general deductions which are deductible if they meet all the requirements of the
general deduction formula.

Gross Definition
income
Specific
Income Less: inclusions

Less: Exempt income

General
deductions
Deductions
Specific
deductions
Gives:
Capital
Taxable income allowances
before capital gains
Plus:

Capital gain

Gives

Taxable income

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 TAX3701/102

LEARNING OUTCOMES

After completing this learning unit, you must be able to:

 discuss the requirements of the general deduction formula and apply the formula to a
practical situation.
 discuss whether an expenditure will be deductible according to the general deduction
formula.
 explain the working of section 23 (deductions not allowed in the determination of taxable
income) and how it affects deductions.

PRESCRIBED STUDY MATERIAL FOR THIS LEARNING UNIT

Study section 3.5 of chapter 3 in the prescribed textbook.

You need to learn and understand both the general deduction formula and the
prohibition of deductions in the determination of taxable income. You also need to
know how to apply the general deduction formula.

SECTIONS OF THE PRESCRIBED TEXTBOOK THAT NEEDS TO BE STUDIED

For the purposes of this learning unit, you need to study section 3.5 of chapter 3.

CONTENT OF LEARNING UNIT

4.1 BACKGROUND Textbook sections: 3.5.1 to 3.5.9

Allowable deductions represent the deductions from expenses incurred by the taxpayer “from
carrying on any trade” which, in terms of the Income Tax Act No. 58 of 1962 (“the Act”), may
qualify as deductions. These allowable deductions are deducted from "income" in the framework.
The result of this calculation (income less allowable deductions) is taxable income.

The Act makes provision for the general deduction formula according to which most of the opera-
ting expenses incurred by the taxpayer during the operation of an enterprise may qualify as allow-
able deductions.

The general deduction formula (section 11(a)) stipulates that:

 expenditure and losses

 that have actually been incurred

(meaning that they have been paid or that a liability to pay exists)

63
  that have arisen during the year of assessment

 that have been incurred in the production of income

(meaning that the income-producing action that gave rise to the expenditure was closely
connected to the income-producing activities)

 that are not of a capital nature

(meaning that the expenditure/loss is more closely related to the income-earning
operation than to the income earning structure)

 that do not form part of the fixed capital (such as non-current assets) but rather form
part of the floating capital (such as trading stock), and

 that do not create an enduring benefit

shall be allowed as deductions, provided that:

o a trade is carried on by the taxpayer, and

o income is to be derived from such trade.

Section 23(g) of the Act should also be adhered to when applying the general deduction formula.
This section prohibits the deduction of:

any moneys claimed as a deduction from income derived from trade to the extent that such
moneys were not laid out or expended for purposes of trade (meaning not closely
connected to the trade carried on)

Furthermore, specific provisions in the Act may allow specific expenditure as allowable deduc-
tions, although the expenditure might not be deductible according to the general deduction for-
mula. This category of deductions is dealt with in learning units 5 and 6. In this regard, it is
important to note that, where the Act makes specific provision for a specific deduction of expen-
diture (for example bad debts written off), the general deduction formula may not be used to
deduct such expenditure as an allowable deduction, and only the specific section in the Act may
be used. The Act also prohibits the double deduction of the same expense in terms of more than
one provision of the Act.

Study sections 3.5.1 to 3.5.8 of the prescribed textbook (which explains each of
the requirements that must be fulfilled before an expense will qualify as an allow-
able deduction according to the general deduction formula). It is important that
you know the names of the relevant court cases (you do not need to know the
number of the specific court case) and take note of related principles as you
read sections 3.5.1 to 3.5.8. A detailed discussion of the Port Elizabeth Electric
Tramway Co Ltd v CIR 8 SATC 13 is provided below.

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 TAX3701/102

 The general deduction formula comprises two elements, namely the positive test
with which an expense must comply (sections 3.5.1 to 3.5.7), and the section 23
negative test (sections 3.5.8) that may disqualify/prohibit a deduction as an
allowable deduction. These two elements must always be applied in conjunction
with each other in order to establish the deductibility of the expense. For example,
a stock loss suffered by an enterprise, which is subsequently compensated for by
an insurance payment, may in all respects be deductible according to the general
deduction formula (positive test). However, it will be disqualified as a deduction
in terms of section 23(c) since the loss has been recovered under an insurance
contract (negative test).

 The requirement that expenses be incurred in the production of income often

proves to be problematic in a practical situation. In this regard, important tests
have been established in the South African courts to determine whether an
expense, which has been incurred in the production of income and which has a
close connection with the operations of the enterprise, has indeed necessarily
been expended and incurred to earn income or to operate the business more
efficiently. At least one of these criteria must be satisfied before it can be con-
cluded that the expense has in fact been incurred in the production of income.

 Although expenses of a capital nature are not deductible according to the general
deduction formula, specific sections of the Act make provision for the deduction
of such expenditure. This is an example of an allowable deduction for which is
specifically provided in the Act. This category of allowable deductions will be dis-
cussed in learning unit 6.

Work through practical question 4.1 "KZN Tax consultants" uploaded under self-
assessment questions on myUnisa.

When working through the above question, you should apply the requirements of
the general deduction formula to each of the expenses by using both the positive
and the negative tests to establish the deductibility of the expense. Note that,
although the question requires that you determine whether each of the expenses is
deductible according to the general deduction formula, it is important that you should
also be able to give reasons – by referring to the principles contained in paragraphs
3.5.1 to 3.5.8 (including case law) – why you consider an amount to be deductible
or not. These reasons or arguments in accordance with the established principles
are to be found in the solutions to question 4.1, in which each item is fully discussed.

When an activity requires you to work through an example, it means that you must
attempt to answer the question without referring to the suggested solution. The
example is based on work that you have already studied and working through it like

65
 this, will help ensure that you understand that section of the work.

Various court cases have tested the practical application of the general deduction formula prin-
ciple. The most notable cases include the following, which should be studied:

 CIR v De Beers Holdings 46 SATC 47 (carrying on a trade)

 Joffe & Co (Pty) Ltd v CIR 13 SATC 354 (expenditure and losses)

 Caltex Oil (SA) Ltd v SIR 37 SATC 1 (actually incurred)

 Port Elizabeth Electric Tramway Co Ltd v CIR 8 SATC 13 (in the production of income)

 Sub-Nigel Ltd v CIR 15 SATC 381 (not of a capital nature)

We will now discuss the case of Port Elizabeth Electric Tramway Co Ltd v CIR 8 SATC in order
to explain the practical application of the general deduction formula. You must be able to discuss
the facts, issues and outcome of this court case in detail if you are asked to do so in the exami-
nation. First, the facts are presented, then the issue is being dealt with and, finally, the outcome
of the case is described:

Facts
The taxpayer company operated its business as a tramway company. In the course of the year
of assessment, the driver of one of its tramcars lost control of the tramcar while descending a
deep gradient. The tramcar ran into a building and the driver suffered injuries that subsequently
led to his death. The company was compelled by the court to pay compensation to the driver's
widow and it incurred legal costs in fighting the claim for compensation. The taxpayer company
claimed both the compensation amount paid and the legal costs incurred as tax deductions.

Issue
Would the company have been entitled to claim both the compensation paid to the driver's widow
and the legal expenses incurred in contesting her claim as being expenditure in the production of
income according to the general deduction formula?

Outcome
In this case, the judge held that the general deduction formula allows the deduction of all expen-
ses attached to the performance of a business operation performed bona fide for the purpose of
earning income, whether such expenses are necessary for its performance or attached to it by
chance, provided they are so closely connected with it that they may be regarded as part of the
cost of performing it. The company employed the deceased driver to drive the tramcar, thereby
earning an income for the company. The employment of the driver carried with it the potential
risk that the driver may be injured and, therefore, the payment of compensation would be regarded
as cost for the company’s operations for the purpose of earning income. The compensation paid
to the driver's widow was thus allowed as a deduction. However, the legal costs incurred in

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 TAX3701/102

opposing the compensation claim were not allowed as a deduction for tax purposes because the
costs were not expended in an operation entered into for the purpose of earning income.

Practical application of the general deduction formula

Pick & Wear Company has suffered a loss of R21 500 (excluding VAT) due to a fire that broke
out in its manufacturing area. Fortunately, the company was insured and the loss of R21 500
was covered under an insurance contract. The insurer has paid Pick & Wear Company an amount
of R19 750 to cover the determined loss of R21 500. What will be the amount that Pick & Wear
Company may claim as a deduction in terms of section 11(a)?

The first thing to determine in this example is whether Pick & Wear Company was covered for the
full loss of R21 500 under an insurance contract. The insurance company has paid Pick & Wear
Company an amount of R19 750 to cover the determined loss of R21 500. Thus, R1 750 of the
loss suffered could not be recovered from the insurance company. Pick & Wear Company cannot
claim for the part of the loss that was covered by the insurance contract (R19 750) but may claim
the uncovered part of the loss of R1 750 according to the general deduction formula as a deduc-
tion in terms of section 11(a).

4.2 SPECIFIC TRANSACTIONS Textbook section: 3.5.9

Some expenses incurred in carrying on a trade may not be deductible for tax purposes as a
specific deduction but could be deductible according to the general deduction formula. The tax
treatment of some specific transactions is explained in section 3.5.9 of the prescribed textbook.

The important question to ask when testing for a possible deduction is whether the expenses may

 create an asset of a permanent nature for the business, or

 create an enduring benefit

This means that the expenses would be of a capital nature.

Study section 3.5.9 in the prescribed textbook.

Visit Learning Unit 4 on the myUnisa Discussion Forum and discuss any con-
cepts that you do not understand. If you do understand the concepts, then
answer students who have posted questions.

67
 WRAP-UP

In this learning unit, the first category of allowable deductions, namely the general deduction for-
mula, was discussed. You should be able to answer any questions on the practical application
of the general deduction formula as well as any question on the possible prohibition of an expense
as a deduction for income tax purposes.

The Act makes provision for the deduction of specific expenditure, in addition to the provision
contained in the general deduction formula. Consequently, these specific provisions must also
be considered to establish the total allowable deductions for a taxpayer. We look at these specific
deductions in learning unit 5.

Now that you have completed this learning unit, revisit the learning objectives and
make sure that you have attained all of them.

This learning unit is a foundational learning unit, but your understanding of the principles that we
discussed here, especially the general deduction formula and the prohibition of certain deduc-
tions, is of the utmost importance in your journey with the principles of taxation from a business
perspective.

You will know you have mastered this learning unit if you can answer the following questions:

 When can an amount be claimed as an expense according to the general deduction for-
mula?
 Which costs are specifically prohibited as deductions for tax?

68
LEARNING UNIT 5

INTRODUCTION Learning unit

LEARNING OUTCOMES

PRESCRIBED STUDY MATERIAL FOR THIS

LEARNING UNIT

SECTIONS OF THE PRESCRIBED TEXTBOOK

THAT CAN BE IGNORED

CONTENT OF LEARNING UNIT 5

5.1 Background
5.2 Foreign exchange transactions
5.3 Trading stock
5.4 Employee-related expenses
5.5 Deductions relating to trade debtors and similar
matters
5.6 Expenditure and allowances relating to capital
assets
5.7 Other expenses
5.8 Double deductions (section 23B)
5.9 Value-added tax (VAT) (section 23C)
5.10 Prepaid expenses (section 23H)
5.11 Pre-trade expenditure (section 11A)
5.12 Assessed losses
5.13 Other allowances
5.14 Limitation of deductions by SMMEs (section
23O)

WRAP-UP

ASSESSMENT CRITERIA

SELF-ASSESSMENT QUESTIONS

Special
deductions

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 TAX3701/102

INTRODUCTION

In learning unit 4, we learnt that a taxpayer, after meeting specific requirements, might claim a
deduction according to the general deduction formula in respect of expenses actually incurred in
the carrying on of a trade. Not all expenses incurred in the carrying on of a trade meet the
requirements of the general deduction formula. Certain expenses may be excluded because they
are capital in nature or that they have not been incurred in the production of income. While such
expenses may be deductible in terms of special deductions allowed in terms of the Act (the
Income Tax Act 58 of 1962), others may not be deductible at all.

In this learning unit, we discuss some of these special deductions as contained in the Act. The
diagram below demonstrates exactly where we are in the taxable income calculation framework.

Definition

Gross income
Specific
inclusions
Income Less:

Exempt income
Less:
General
deductions
Deductions
Specific
deductions
Gives:

Capital
Taxable income allowances
before capital gains

Plus:

Taxable capital gain

Gives:

Taxable income

73
 LEARNING OUTCOMES

After completing this learning unit, you should be able to:

 apply the trading stock provisions to a taxable income calculation

 calculate the expenses and deductions in terms of the provisions contained in the Income Tax
Act
 discuss the expenses and deductions in terms of the provisions contained in the Income Tax
Act, with reference to relevant legislation and case law

PRESCRIBED MATERIAL FOR THIS LEARNING UNIT

Study chapter 4 in the prescribed textbook.

SECTIONS OF THE PRESCRIBED TEXTBOOK THAT CAN BE IGNORED

No sections in the textbook can be ignored.

CONTENT OF LEARNING UNIT

5.1 BACKGROUND Textbook section: 4.1

In this learning unit, we will cover special deductions. You may already be familiar with these
deductions from TAX2601, but in this module, we cover them in more detail. The tax legislation
changes every year and some of the sections of the Act may have undergone changes since you
last studied TAX2601. It is therefore very important that you revisit these sections and give them
the same level of attention that you give to the sections that were not covered in TAX2601 and
are new to you.

Read section 4.1 in the prescribed textbook.

5.2 FOREIGN EXCHANGE TRANSACTIONS

Textbook section: 4.2
(sections 1, 24I and 25D)

Foreign exchange transactions typically involve the purchase of an asset or trading stock from an
overseas supplier, with payment being made in a foreign currency. The payment must be trans-
lated or converted to South African currency (Rand) to determine the amount that is subject to
normal tax. For a capital asset, capital allowances may be allowed; for trading stock, provisions
of section 22 or section 11(a) may be applicable.

When converting the amount from a foreign currency to local currency, the purchaser can either
make a gain or incur a loss. It is important to identify the following dates for the purposes of

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 TAX3701/102

determining the said gain or loss:

 Transaction date: At this date, the debt is actually incurred (when it accrues). This date will
always be provided in the examination.
 Translation date: This is any year end after the transaction date and prior to the realisation
date.
 Realisation date: At this date, the transaction is finally concluded (i.e. the foreign currency
amount is paid).

The foreign exchange gain/loss will be the difference between the amount as at the realisation
date and the amount as at the transaction date. However, if the year of assessment ends before
the foreign amount is paid, then the foreign exchange gain/loss will be the difference between the
amount as at the translation date and the amount as at the transaction date. Another foreign
exchange gain/loss will be realised in the following year and it is calculated as the difference
between the amount as at the realisation date and the amount as at the translation date.

Study section 4.2 in the prescribed textbook.

Work through examples 4.1 and 4.2 in the prescribed textbook.

5.3 TRADING STOCK Textbook section: 4.3

In TAX2601, we learnt that section 22(1) of the Act specifically provides that closing stock is
income in the hands of the enterprise, and it must be added to taxable income. Conversely,
section 22(2) provides that opening stock may be deducted as an expense. TAX2601 also
covered the following sections with respect to trading stock:

 cost of trading stock

 stock acquired for no consideration
 private and domestic consumption of stock

In this module, we expand on the subject and introduce new topics such as section 23F (anti-
avoidance provision), section 19 (debt reduction), section 9C (share dealers) and so on. It is
therefore important that you work through these sections to familiarise yourself with the new
content.

Study section 4.3 in the prescribed textbook.

Work through examples 4.3 to 4.12 in the prescribed textbook.

75
 Take note of the “Remember” section at the bottom of example 4.11. Not only
does it relate to example 4.11, but it is also a summary of the trading stock
sections that you have just studied.

5.4 EMPLOYEE-RELATED EXPENSES Textbook section: 4.4

The Act provides for certain employee-related expenses that may not necessarily be deductible
according to the general deduction formula. You might have come across some of the sections
when studying TAX2601. However, in this module, we cover these sections in more detail. As
advised earlier, it is vital that you devote the same amount of time and effort to these sections as
you do to the sections that were not covered in TAX2601.

Study section 4.4 in the prescribed textbook.

Work through examples 4.13 to 4.18 in the prescribed textbook.

All employer contributions made to an approved pension, provident or retirement

annuity fund will be deductible in full in terms of section 11(l). These include
contributions made for current employees as well as for retired employees.
However, the contributions made by the employer will be taxed as a fringe benefit
in the hands of the employee.

Did you notice that a distinction is made between the two types of policies for the
purposes of section 11(w)? Did you also notice that an election to deduct the
premiums must be made by the employer in the policy agreement if it was
entered on or after 1 March 2012?

When dealing with a section 11(cA) (restraint of trade) deduction, consider the
following:

Is the restraint for a period of less than three years?

 If the answer is no, the deduction will be the amount received divided by
the number of years during which the restraint of trade will apply. (The
deduction is therefore claimed over the period of the restraint.)

 If the answer is yes, the deduction will be the amount received divided by
three. (The deduction is therefore claimed over three years.)

Do not forget that, irrespective of the terms of section 23B (prohibition of double
deductions), deductions under section 12H (learnership agreements) take place
on:
 entering into a registered learnership agreement
 completion of a registered learnership agreement

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 TAX3701/102

In addition, do not forget that different deduction amounts apply, depending on

whether a person entering the learnership agreement has a disability as defined.

For a learnership agreement entered on/after 1 October 2016, the deduction

for a person without a disability as defined will be as follows:
 Entering and completion allowance:
o For a learner who holds a qualification of the National Qualifications
Framework (NQF) levels 1 to 6, the allowance will be R40 000.
o For a learner who holds a qualification of the NQF levels 7 to 10, the
allowance will be R20 000.
For a learnership agreement entered on/after 1 October 2016, the deduction
for a person with a disability as defined will be as follows:
 Entering and completion allowance:
o For a learner who holds a qualification of the National Qualifications
Framework (NQF) levels 1 to 6, the allowance will be R60 000.
o For a learner who holds a qualification of the NQF levels 7 to 10, the
allowance will be R50 000.

For a learnership agreement that was entered before 1 October 2016, the
deduction will be R30 000 for a person without a disability as defined and
R50 000 for a person with a disability as defined.

5.5 DEDUCTIONS RELATING TO TRADE

Textbook section: 4.5
DEBTORS AND SIMILAR MATTERS

When a sale takes place, the amount is immediately taxable, even though the enterprise has not
received the money yet. Section 24 provides for a debtor’s allowance to provide relief to tax-
payers for amounts that are deemed to have accrued at the date of the agreement, but that have
not been received at the end of the year of assessment.

When a debtor cannot pay his/her account and his/her debt is written off, the debt is then allowed
as a deduction. In accounting, the same principle is normally also applied. Sales are recognised
as income as soon as the transaction takes place, even though the money has not yet been
received, and the amount is deducted again as an expense if the debtor cannot pay his/her
account and his/her debt is written off.

The amount of an irrecoverable debt, which is deducted as an expense in the statement of com-
prehensive income, is normally allowed as a deduction at the same amount for income tax pur-
poses (if the amount was never taxable as gross income, no bad debt may be deducted). How-
ever, this is not the case with “doubtful debts”, as they are not considered an expense.

The doubtful debt deduction is a tax allowance. Allowances such as these create a difference
between the net profit for accounting purposes and taxable income.

As from 1 January 2019 the allowance that can be claimed in respect of doubtful debts will be
split up between companies using International Financial Reporting Standards (IFRS) 9 and com-
panies not using IFRS 9 accounting standards for financial reporting purposes.

For companies using IFRS 9, where the companies will not have a lifetime expected credit loss

77
in respect of their debtors, the allowance will be 25% of the loss allowance relating to impairment.
For companies not using IFRS 9, the allowance will be 40% of the debt that has been in arrears
for 120 days or more and 25% of the debt that has been in arrears for 60 days or more.
There is another example for companies using IFRS 9 where the companies will have a lifetime
expected credit loss in respect of their debtors (e.g., banks), but for the purposes of this module,
you can ignore this example.

Study section 4.5 in the prescribed textbook.

Work through examples 4.19 to 4.23 in the prescribed textbook.

A reminder from TAX2601 that bears repeating: Do not confuse section 11(i) with
section 11(j) – one is a deduction for debts that have gone bad (i.e., that are not
recoverable), while the other is a deduction of the provision made by the taxpayer
for debts that are doubtful.

Remember to apply the doubtful debt deduction to the list of doubtful debts only,
and not to the full debtors’ balance. If a doubtful debt deduction is claimed in one
year, it must be added back to income in the following year.

Remember to exclude finance charges and VAT (if VAT was levied on the trans-
action) when calculating a section 24 debtors’ allowance.

5.6 EXPENDITURE AND ALLOWANCES

Textbook section: 4.6
RELATING TO CAPITAL ASSETS

In learning unit 4, we learnt that expenses of a capital nature are not deductible according to the
general deduction formula. However, as mentioned earlier, some items of expenditure, which are
of a capital nature, are allowed specifically as deductions or allowances by the Act. In this section,
we will look at the following examples of such expenditure:

 capital expenditure on patents, designs, trademarks, and copyright

 research and development expenditure
 business licence expenditure

Study section 4.6 in the prescribed textbook.

Work through examples 4.24 to 4.26 in the prescribed textbook.

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 TAX3701/102

Did you notice that deductions under section 11(gC) can be claimed for acquired
intellectual property rather than for developed intellectual property? Did you
also notice that this deduction is not available for the acquisition of trademarks?
Did you know that deductions in terms of section 11(gB) are available in respect
of trademarks? Have you considered the difference between section 11(gC)
and section 11(gB)?

5.7 OTHER EXPENSES Textbook section: 4.7

5.7.1 Legal expenses

You may remember this deduction from TAX2601. Legal expenses are, for example, the fees
attorneys charge when appearing in court and the costs of preparing legal documents such as
lease contracts.

Study section 4.7.1 in the prescribed textbook.

It is important to know which legal expenses are deductible and which are not.
Keep the following general rule in mind: If the expense, which caused the legal
expense, is deductible, the legal expense is also deductible and vice versa.

5.7.2 Donations

Section 18A(3A) deals with immovable property of a capital nature that is donated. The formula
A = B + (C x D) will be used to calculate the deduction.

Study section 4.7.2 in the prescribed textbook.

Work through examples 4.27 and 4.28 in the prescribed textbook.

Remember that a donation deduction can be allowed only if it is supported by a

section 18A receipt/certificate issued by the recipient of the donation.

Did you notice that when an amount is disallowed as a deduction, because the
donation exceeds the 10% allowable deduction, that amount can be carried for-
ward to the next year of assessment and it will be deemed a donation actually
paid in that year?

79
5.7.3 Unemployment insurance benefits

Study section 4.7.3 in the prescribed textbook.

5.7.4 Future expenditure on contracts (section 24C)

Long-term contracts, for example, the building of a new factory or office building, may have a
duration of a couple of years. A taxpayer building a new building, as in the example, often recei-
ves an amount at the start of the contract to finance future expenses that will be incurred. This
section provides for some deductions to be made against this income to prevent the taxpayer
from having to pay tax on the amount received and consequently, not having money to pay for
the actual expenses.

Study section 4.7.4 the prescribed textbook.

Work through example 4.29 in the prescribed textbook.

Did you see that you are effectively paying tax only on the profit section of the
amount received? Remember that the section 24C allowance you receive in the
current year must be added back in the following year and that a new allowance
must then be calculated.

5.7.5 The accrual and incurral of interest (section 24J)

Study section 4.7.5 in the prescribed textbook.

After working through this section, you will have noted the following:
 The provisions of the section are not applicable to savings accounts, call
accounts (deposits) and fixed deposits invested for 12 months or less.
 The section deals only with the timing of the accrual or incurral of interest
in connection with a qualifying instrument.
 It provides that interest should be accrued or incurred on a day-to-day ba-
sis.
 The section enjoys precedence over the actual timing of the payment
(incurral) and receipt of interest.
 The section does not influence the decision on the deductibility or non-
deductibility of the interest paid.
 The deductibility of the interest paid is regulated by the general deduction
formula (refer to section 3.5.9 of your prescribed textbook).

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 TAX3701/102

5.8 DOUBLE DEDUCTIONS (section 23B) Textbook section: 4.8

Study section 4.8 in the prescribed textbook.

5.9 VALUE-ADDED TAX (VAT) (section 23C) Textbook section: 4.9

Study section 4.9 in the prescribed textbook.

Work through example 4.30 in the prescribed textbook.

5.10 PREPAID EXPENSES (section 23H) Textbook section: 4.10

In TAX2601, we learnt that section 23H of the Act limits the amount that may be deducted relating
to a prepaid expense. The deduction is limited to the amount that relates to the goods or services
actually supplied during the year of assessment – therefore, the prepaid expense is not allowed
as a deduction.

This limit will not apply (in other words, the prepaid expense will be allowed as a deduction) if the
prepaid amount relates to goods or services that are to be rendered within six months after year
end, OR where the total of all the prepaid expenses does not exceed R100 000. In other words,
if only one of the limits is applicable, then the prepaid portion will be deductible, but if both limits
apply (> 6 months and > R100 000), the prepaid portion will not be deductible.

Study section 4.10 in the prescribed textbook.

Work through examples 4.31 and 4.32 in the prescribed textbook.

5.11 PRE-TRADE EXPENDITURE (section 11A) Textbook section: 4.11

Study section 4.11 in the prescribed textbook.

81
 Work through example 4.33 in the prescribed textbook.

Note that the types of expenses that are allowed as a deduction must be costs
that would have been deductible had trade commenced. Therefore, costs of a
capital nature will not be deductible.

5.12 ASSESSED LOSSES Textbook section: 4.12

An assessed tax loss arises when the deductions of a taxpayer exceed the income of a taxpayer
for a specific year of assessment. If a taxpayer subsequently produces income that is more than
the deductions allowed in that subsequent year, an assessed loss could be deducted against the
income.

Study section 4.12 in the prescribed textbook.

Work through example 4.34 in the prescribed textbook.

Note that this is the last deduction you do before calculating the normal tax of the
company.

5.13 OTHER ALLOWANCES Textbook section: 4.13

Other allowances are available to certain companies, and they are provided to encourage a spe-
cific type of investment, expense or saving. Protecting the environment has recently been empha-
sised greatly and several deductions are available in this regard.

Read section 4.13 in the prescribed textbook.

5.14 LIMITATION OF DEDUCTIONS BY

Textbook section: 4.14
SMMEs (section 23O)

A limitation is placed on deductions by small, medium and micro-sized enterprises (SMMEs) in

respect of amounts received or accrued from small business funding.

82
 TAX3701/102

Read section 4.14 in the prescribed textbook.

Visit Learning Unit 5 on the myUnisa Discussion Forum and discuss any con-
cepts that you do not understand. If you do understand the concepts, then answer
those students who have posted questions.

WRAP-UP

In this learning unit, certain business deductions were discussed. These expenses are those that
would not qualify for a deduction in terms of section 11(a) because they are of a capital nature
(such as patent development expenditure and fixed assets used for scientific research), or they
have not actually been incurred (such as provisions for doubtful debts and future expenditure on
contracts).

Remember that all the deductions provided for in section 11 of the Act can be claimed only if the
person is involved in a trade.

Read the summary in section 4.16. Make sure you fully understand how to deter-
mine and calculate each special deduction available for businesses.

Work through question 4.1 at the end of chapter 4 in the prescribed textbook. Try
not to look at the answers when attempting to answer the questions.

83
 6

LEARNING UNIT 6

Learning unit
INTRODUCTION

LEARNING OUTCOMES

PRESCRIBED STUDY MATERIAL FOR THIS

LEARNING UNIT

SECTIONS OF THE PRESCRIBED TEXTBOOK

THAT CAN BE IGNORED

CONTENT OF LEARNING UNIT 6

6.1 Background
6.2 Connected persons
6.3 Repairs and improvements (section 11(d))
6.4 Process of manufacture
6.5 Cost of an asset
6.6 Deduction in respect of improvements to assets
not owned by the taxpayer (section 12N)
6.7 Assets used by a small business corporation
(section 12E)
6.8 Assets used in a process of manufacture
(section 12C)
6.9 Wear-and-tear allowance (section 11(e))
6.10 Building allowances
6.11 Disposal of assets
6.12 Limitations of allowances
6.13 Leased assets

WRAP-UP

ASSESSMENT CRITERIA

SELF-ASSESSMENT QUESTIONS

Capital
allowances

Open Rubric
 7 TAX3701/103

INTRODUCTION

Your TAX2601 studies introduced you to capital allowances. Since expenditure of a capital nature
is not deductible under the general deduction formula, specific provisions have been included in the
Act. These provisions allow for a deduction with regard to capital assets used by a small business
corporation (s 12E); assets used in a process of manufacture (s 12C); wear-and-tear allowances (s
11(e)) for assets used by a taxpayer in the course of his/her trade; and several capital allowances
relating to buildings (s 13, comprising s 13, s 13quin, s 13sex and s 13sept).

In this module, we will revise these allowances and build on the knowledge that you have already
acquired. We will explain again how a depreciable asset will be treated if destroyed or disposed of,
in which case a possible recoupment or scrapping allowance must be brought into account when
calculating the taxable income. The more complicated tax treatment of a replacement asset and
the deferral of a recoupment will also be explained.

You will be introduced to the tax allowances for leased assets. These tax implications are also
complicated, and you must pay attention to the formulae used in each allowance.

Depreciation is calculated according to accounting principles, but capital allowances

are calculated in terms of the Income Tax Act. As a result, these calculations differ,
and accounting depreciation is not allowed as a deduction for income tax purposes.
The correct capital allowance determined in terms of the Income Tax Act will be an
allowable deduction from taxable income.

Note: you are not required to memorise the section numbers mentioned in the study guide and the
prescribed textbook, but you should be able to indicate the assets that are referred to (e.g.
manufacturing building allowances).

The following illustration indicates where this learning unit fits into the framework that must be ap-
plied in determining the normal income tax liability of a taxpayer.
Gross Definition
income
Less: Specific inclusions
Income
Exempt income
Less:
General
deductions
Deductions Specific
deductions
Gives:
Taxable income Capital
before capital gains allowances

Plus:

Capital gain
Gives

Taxable income
 8

LEARNING OUTCOMES

After completing this learning unit, you should be able to:

 identify the different types of assets and calculate the allowances applicable to each type by
applying the relevant provisions and case law.
 discuss and apply the provisions pertaining to depreciable assets and allowances with reference
to relevant case law.
 calculate the recoupment or section 11(o) scrapping allowance correctly, when an asset is
disposed of, as well as the deferment available on recoupment, if applicable.

PRESCRIBED MATERIAL FOR THIS LEARNING UNIT

Study chapter 5 in the prescribed textbook.

SECTIONS OF THE PRESCRIBED TEXTBOOK THAT CAN BE IGNORED

5.6 Special rules relation to the acquisition of assets

5.11 Assets used in the generation of renewable energy (sections 12B and 12U)
5.13.2 Limitation of losses on assets (section 20B)
5.13.3 Assets disposed of for unquantified amounts (section 24M)
5.14 Concession or compromise in respect of debt (section 19)

CONTENT OF LEARNING UNIT 6

6.1 BACKGROUND Textbook section: 5.1

As you know, the purchase price of an asset is not deductible for income tax purposes. Instead, the
cost is spread over the estimated life of the asset and is deducted as a capital allowance.

Study section 5.1 in the prescribed textbook and take specific note of the structure
given in the prescribed textbook, which will help you understand when to claim
which capital allowance.

When calculating the capital allowances for capital assets, it might be handy to use
a timeline to see the dates visually and calculate the correct rate for the specific
year of assessment. In the following example, the use of a timeline is illustrated.

Example
Company X purchased a delivery vehicle on 1 March 2021 for R120 000 and
brought it into use on the same day. In terms of Binding General Ruling (BGR)
No. 7, the write-off period for delivery vehicles is four years. The company sold
the vehicle on 30 April 2023. Company X has a year-end of 30 June.

Calculate the wear-and-tear allowance for each year until the vehicle is
sold.
 9 TAX3701/103

Timeline:

01/03/2021 01/07/2021 01/07/2022 30/04/2023

30/06/2021 30/06/2022
Purchased New year of New year of Vehicle
Year end Year end
vehicle assessment assessment sold

Solution

30/06/2021 = R120 000/4 x 4/12 = R10 000

30/06/2022 = R120 000/4 = R30 000
30/04/2023 = R120 000/4 x 10/12 = R25 000

Textbook section: 5.2

6.2 CONNECTED PERSONS

In certain cases, the Act makes provision for different allowances to be claimed by “connected per-
sons” and persons dealing “at arm’s length”.

Read section 5.2 in the prescribed textbook.

6.3 REPAIRS AND IMPROVEMENTS Textbook section: 5.3

Part of the cost of holding an asset is keeping it in good working order, in other words, repairing the
asset regularly. A repair is deductible immediately in full in the year of assessment during which the
repair was done. However, if it is classified as an improvement, it would be an expenditure of a
capital nature and the special provisions regarding capital allowances may apply.

Repairs are needed mainly owing to damage to or deterioration of capital assets; the intention of the
taxpayer is to restore the asset to its original condition, whereas an improvement is the creation of
a better asset. Note that although a taxpayer may use a different material to repair an asset (for
example, replace a damaged tin roof with a tiled roof), it remains a repair. The principle to look out
for is whether the working condition of the asset was enhanced by the repair/ improvement or
whether it remained functioning in the same manner. When a parking road surface is repaired and
an undercover roof is added, then the road surface will constitute a repair, while the additional roof
will be an improvement.

Study section 5.3 in the prescribed textbook.

Work through example 5.1 in the prescribed textbook.

Note: the important principles laid down by the two court cases described in the prescribed text-
book to distinguish between a repair and an improvement. You need to know the names of the
court cases and be able to discuss the principles arising from the court cases in a question, to
differentiate between a repair and an improvement.
 10

A repair must always be incurred for the purposes of the taxpayer’s trade.

6.4 PROCESS OF MANUFACTURE Textbook section: 5.4

The Act does not define what constitutes a process of manufacture, but the courts have established
guidelines that can be used.

Read section 5.4 in the prescribed textbook.

6.5 COST OF AN ASSET Textbook section: 5.5

A capital allowance is calculated on the cost price of an asset. It is therefore important to determine
which costs are included in or excluded from the cost price on which the wear-and-tear allowance
is calculated.

Study section 5.5 in the prescribed textbook and make sure you understand which
costs are included or excluded in the cost price of an asset.

Work through example 5.2 in the prescribed textbook.

Example 5.2 is a good illustration of how we can integrate VAT and capital allowances in a question.

Note: We will tell you in a question if you can ignore any VAT consequences. If we do not indicate
that you can ignore the VAT consequences, you will have to consider whether the taxpayer could
claim VAT. If VAT could be claimed, then you must exclude the input VAT amount from the cost
price of the asset before calculating the capital allowances. If the VAT could not be claimed, then
you would calculate the capital allowances on the cost including VAT.

Remember that the cost of moving an asset from one location to another will also
be included in the cost of the asset. If moving costs are incurred on an asset still
being written off, such costs will be written off over the remainder of the write-off
period. If the asset has been written off in full, the moving costs incurred will be
fully deductible during the year in which they were incurred.

Moving costs of R18 000 were incurred on 31 December 2022 when machine DD had
to be moved from the old factory to the new factory. Machine DD was used in the
factory and is considered a manufacturing machine. It was purchased new on
30 June 2022 for R320 000. The company has a 31 December 2023 year-end and it
is not a small business corporation.
 11 TAX3701/103

New manufacturing machines will have a capital allowance of 40% of the cost in year
one (1) and 20% in the next three (3) years (refer to section 6.7).
The allowances will be as follows:
2022 year of assessment
Manufacturing machine (R320 000 x 40%) R128 000
NB!! Moving costs will be written off over the remaining write off period of the
manufacturing machine (i.e. from the 2023 year of assessment)

2023 year of assessment

There will be three (3) years' useful life remaining on the manufacturing machine (to
be written off as 20%, 20%, and 20%)
Manufacturing machine (R320 000 x 20%) R64 000
Moving costs (R18 000 ÷ 3 years) R6 000

6.6 DEDUCTION IN RESPECT OF IMPROVE-

MENTS TO ASSETS NOT OWNED BY THE Textbook section: 5.7
TAXPAYER

In terms of section 12N, if a lessee has a contractual agreement with the lessor to make improve-
ments to the asset leased, the lessee is entitled to claim a capital allowance on these leasehold
improvements, provided the lessor includes the leasehold improvements in his/her taxable income.
This will be discussed in more detail in section 6.13.

Read section 5.7 in the prescribed textbook.

6.7 ASSETS USED BY A SMALL BUSINESS

Textbook section: 5.8
CORPORATION

The first thing you need to determine when answering a question on a company's taxable income is
whether it is a small business corporation. The question will clearly state when it is a small business
corporation. If nothing is mentioned, you may assume it is not. Small business corporations have
the following favourable capital allowance in respect of capital assets:

Manufacturing assets

 100% deduction of the cost of the asset

Non-manufacturing assets

Deduct
 50% of the cost of the asset in year 1
 30% in year 2
 20% in year 3

In practice, section 11(e) may also be used in determining the capital allowance for
non-manufacturing assets of a small business corporation, if it is more beneficial
to the taxpayer; in other words, if the cost of the asset can be written off over a
shorter period. However, for the purposes of this module, we expect you to use the
section 12E allowance for all small business corporation assets.
 12

Study section 5.8 in the prescribed textbook.

Work through example 5.4 in the prescribed textbook.

Note that both new and used (second-hand) assets may qualify for the section 12E
capital allowance. The taxpayer must own these assets.

A section 12E allowance can never be apportioned, even though the asset is used
only for part of a year.

Note: a small business corporation can also be a manufacturer. The section 12E
allowances will be applicable to a company like this and not the section 12C allow-
ance (explained in 6.8 below), since it is more beneficial to the company. Therefore,
when the company is a small business corporation, you will always claim the manu-
facturing asset allowance at 100%.

To test whether you understand the principles explained above, answer the following question:

XCC is 100% owned by Mr. Q and it is a small business corporation. Its state-
ment of comprehensive income for the year ended 28 February 2023 is as follows:

R
Consulting income 15 000
Sales of handbags 182 000
Interest income 3 000

Salary to Mr. Q (24 000)

Salary to Mrs. Q (24 000)
Office expenses (22 000)
Depreciation at 20% on furniture and office equipment
purchased for R30 000* on 1 May 2022 (that is, 10 months) (5 000)
Net profit 125 000

*This furniture consisted of an office chair that cost R3 000 and a filing cabinet that
cost R27 000.
Determine the taxable income for the 2023 year of assessment.
Tax calculation of XCC for 2023:
R
Net profit 125 000
Depreciation (added back) 5 000
130 000
Filing cabinet – section 12E = R27 000 x 50% (13 500)
Chair – section 11(e) (allowance is 100% because the chair ( 3 000)
is less than R7 000 – refer to lecturer’s note in 6.8 below)
Taxable income 113 500
 13 TAX3701/103

Note: the section 12E allowance is not apportioned, even when the asset is used
for only part of the year of assessment, or if it is brought into use during the year of
assessment. You will note that the depreciation of R5 000 is added back to the net
profit and that the section 12E allowance of R13 500 is deducted for tax purposes.
Depreciation is calculated for accounting purposes, while the section 12E allowance
is deductible for tax purposes. For this reason, the depreciation has to be added
back to cancel its effect on net profit.

6.8 ASSETS USED IN A PROCESS OF

Textbook section: 5.9
MANUFACTURE

Section 12C provides for a special deduction on new or used plant and machinery used directly in
manufacturing or similar process by a taxpayer and brought into use for the first time (whether new
or second-hand) by the taxpayer in his/her trade. A process must however meet certain criteria
before it may qualify as a manufacturing process for income tax purposes.

Make sure that you can identify that a question is dealing with a manufacturing
business either from the name or from the background information provided.
However, you do not have to know the criteria that needs to be met for a business
to qualify as a manufacturing business. You also do not have to study the court
cases mentioned in the prescribed textbook.

Study section 5.9, “Assets used in a process of manufacture”, in the prescribed

textbook.

Work through examples 5.5 to 5.7 in the prescribed textbook.

The write-off period can be either four years or five years, depending on whether the manufacturing
asset is new or used. The following table sets out the specifications:

DESCRIPTION FOUR YEARS FIVE YEARS

Nature of plant or machinery New or unused Used (second-hand)
Brought into use for the first time On/after 1 March 2002 Any date
Allowance 40%, 20%, 20%, 20% 20% for 5 years
Apportionment None None

Did you notice that the section 12C allowance could never be apportioned?
The taxpayer must own the manufacturing asset to be able to claim this allow-
ance.

TIP: Always consider when the asset was acquired and determine what the
allowance claimable would be in the current year of assessment. In the solution
to example 5.7, the removal costs are claimed over three years (2023–2025)
because the allowance on the machine is claimed until 2025 (20% in each of the
2021–2025 years of assessment).

6.9 WEAR-AND-TEAR ALLOWANCE Textbook section: 5.10

 14

Movable assets used by the taxpayer, which do not qualify for section 12C or 12E allowances, can
still qualify for a wear-and-tear allowance in terms of the general wear-and-tear provisions contained
in section 11(e). This allowance will be granted for movable assets (do not apply to structures of
a permanent nature) that are not used in a manufacturing or similar process. However, the asset
must be used for the purposes of trade. Binding General Ruling (BGR) No. 7 provides the accept-
able write-off periods, in years, for a wide range of capital assets.

In the examination, we will always provide you with the write-off periods as prescribed
by BGR No. 7; you do not need to memorise them. Remember that BGR No. 7 is
available on the SARS website.

Study section 5.10 in the prescribed textbook.

Work through example 5.8 in the prescribed textbook.

Small items costing less than R7 000 may be written off in full during the year of
purchase. Remember to consider this when you claim a section 11(e) allowance.

Note: this allowance is calculated pro rata for the period over which the asset was in use in the
year of assessment – thus, it is allowed as a deduction only for the number of months during which
the asset was used in the year of assessment.

Company X (a registered VAT vendor) purchased one mainframe computer on

1 August 2021 for R115 000 (VAT inclusive). The company has a March year-end
and BGR No. 7 allows a five-year write-off period in respect of these computers. The
company incurred a R9 000 fee on the same day for installing the computer.

On 1 June 2022, Company X moved the mainframe computer to its new offices and
incurred moving costs of R11 000.

Calculate the wear-and-tear allowance on the mainframe computers for the

2022 and 2023 years of assessment.

Year of assessment ended 31 March 2022

Cost of the mainframe computer R

Mainframe computer: R115 000 x 100/115 100 000
Plus: Installation costs 9 000
109 000
Section 11(e) allowance: R109 000/5 years x 8/12 14 533

Year of assessment ended 31 March 2023

Section 11(e) allowance – mainframe computer: R109 000/5 21 800

Section 11(e) allowance – moving costs: R11 000 x 10/50 2 200
 15 TAX3701/103

Note: the exclusion of VAT on the cost price as Company X is a registered VAT
vendor and was entitled to claim an input tax credit on the purchase price of the
mainframe computer. Moreover, take note of the apportionment of the allowance
only when the asset is brought into use in the 2022 year of assessment.

When moving costs are incurred on an asset, subject to wear-and-tear, the moving
cost forms part of the cost of the asset and it will be written off over the remainder of
the write-off period of the asset. Moving costs of R11 000 were incurred on
1 June 2022 for a mainframe computer purchased on 1 August 2021 (the asset will
be claimed over 5 years; thus, until 31 July 2026). Therefore, from the date at which
the moving cost was incurred, only 50 months remained to fully write off the computer
(1 June 2022 to 31 July 2026).

Therefore, the wear-and-tear to be claimed regarding moving costs will be 10/50 x

R11 000 = R2 200. Because the moving costs were incurred after the purchase date
of the asset, the allowance on the moving costs is calculated separately, although it
forms part of the cost of the asset (hence, the deduction of a wear-and-tear allowance
on the moving cost).

When calculating a capital allowance relating to movable assets, you should rem-
ember first to determine the tax status of the taxpayer (small business corporation
or not), then the type of asset (manufacturing or other), and lastly the purchase date
(for pro rata calculations, if applicable). Refer to the summary in section 5.17. Also,
take note of when a capital allowance must be apportioned.

6.10 BUILDINGS Textbook section: 5.12

Buildings used in a manufacturing process can also qualify for a capital allowance, but the taxpayer
must use the building in the course of his/her trade (other than mining or farming).

Section 13 of the Act sets out the provisions for all the different types of building allowances that can
be claimed, and we will give a recap below.

6.10.1 Manufacturing building allowances Textbook section: 5.12.1

Study section 5.12.1 in the prescribed textbook.

A taxpayer, incurring cost (which excludes the cost of the land, but which may include capitalised
finance costs) to erect or purchase a manufacturing building, may qualify for an annual allowance
of 5%, provided the building was erected on/after 1 October 1999 and is used “wholly or mainly”
(more than 50%) for carrying on a manufacturing process.

You will not be examined on manufacturing buildings erected before

1 October 1999. However, it is still necessary for you to be aware of the rates
applicable to the other dates of erection or improvement to manufacturing build-
ings, because you may come across these types of transactions in practice.
 16

This allowance is also claimable for improvements that the taxpayer made to an existing manufac-
turing building.
In terms of a lease agreement, the lessee of a building may effect improvements to the leased
property, and the cost of these improvements may qualify for a section 13 allowance in respect of
the portion of the cost that does not qualify as a deduction in terms of section 11(g) (explained in
section 6.13.2 below). These improvements are referred to as leasehold improvements. Therefore,
remember to claim this section 13 allowance on the cost of the leasehold improvements, which
exceeds the cost stipulated in the lease contract (on which the leasehold improvement deduction is
based).
Section 13 allowances are not apportioned, even when the asset is used for only
part of the year or is brought into use during the year. This is very important to
remember throughout the revision of building allowances.

6.10.2 Commercial buildings Textbook section: 5.12.2

Any new or unused commercial building will qualify for a capital allowance of 5% per annum. If a
taxpayer has acquired part of a building (without erecting or constructing it), the allowance will be
adjusted to 55% or 30%, depending on whether it was part of a building acquired or an improvement
effected.

Study section 5.12.2, “Deduction for commercial buildings (section 13quin)”, in the
prescribed textbook.
The section clearly states that no deduction will be allowed if another deduction can
be claimed. Therefore, if a question deals with a leasehold improvement to a com-
mercial building, you must first apply the leasehold improvement rules and then
section 13quin on the remaining cost if applicable.

Work through examples 5.9 and 5.10 on the commercial building allowance.

Note that the allowance is not apportioned, even when the asset is used for only
part of the year of assessment or is brought into use during the year of assess-
ment.

This allowance can be claimed only if the taxpayer owns the building and is claim-
able on buildings that are new or unused, and that were constructed/ erected after
1 April 2007.

6.10.3 Residential units and the sale of low-

Textbook sections: 5.12.3 and 5.12.4
cost residential units on a loan account

Tax relief in the form of an allowance is given to taxpayers who own residential units that were
acquired or erected on or after 21 October 2008.
 17 TAX3701/103

Study sections 5.12.3 and 5.12.4 in the prescribed textbook.

Work through examples 5.11 and 5.12 in the prescribed textbook.

Note: the requirements for section 13sex or section 13sept to apply. You will
have to determine, from the set of facts given in a question, which building allow-
ance is applicable.

AFD (Pty) Ltd built a block of 18 flats on 1 January 2023 at a total cost of R4,7 mil-
lion. The block consisted of ten bachelor flats that cost R150 000 each to build,
and eight larger flats that cost R400 000 each.
AFD (Pty) Ltd rents out the bachelor flats to tenants for R1 200 per month, and the
larger apartments for R4 000 per month. The company has a 30 June year-end.

Calculate the section 13sex allowances on the residential units for AFD (Pty)
Ltd for the year of assessment ending on 30 June 2023.

5% x R400 000 x 8 residential units = R160 000

10% x R150 000 x 10 low-cost residential units = R150 000

Because the bachelor flats cost less than R300 000 each and the monthly rent
charged is less than 1% of the cost, these units qualify as low-cost residential units.

The difference between section 13sex and 13sept is the following:

In section 13sex, the employer is the owner of the unit and rents it out at a low
cost to the employee and the employer can claim a deduction of 10% on the cost
of the unit. In section 13sept, the employer sells the unit to the employee on an
interest-free loan account and the employer can claim a deduction of 10% on the
amount owing to him/her (i.e., the employer).

Summarise all the different building allowances below:

Section Date Rate Conditions

13
13quin
13sex
13sept

6.11 DISPOSAL OF ASSETS Textbook section: 5.13

When a business's assets (on which a capital allowance was claimed previously) are sold, damaged
beyond repair, or removed from use, a recoupment or a section 11(o) scrapping allowance may
arise. You already encountered these concepts in TAX2601.
To summarise:
 18

Recoupment = Selling price > Tax value (limited to allowances previously claimed)
Scrapping allowance (section 11(o)) = Selling price < Tax value

A recoupment must be added to income and a scrapping allowance is an allowable deduction if the
taxpayer has elected section 11(o).

Note: if an asset is sold for an amount exceeding the original cost, a taxable capital
gain may arise. This taxable capital gain is calculated in terms of the provisions of
the Eighth Schedule to the Act (refer to learning unit 7).

6.11.1 Allowance on the disposal of assets

Textbook section: 5.13.1
at a loss

To calculate a scrapping allowance, first determine the cost of the asset and then deduct all the
capital allowances claimed on the asset. This will give you the tax value. If the proceeds are less
than the tax value, then a scrapping allowance will apply. Scrapping allowances apply to only certain
assets.

Study section 5.13.1 in the prescribed textbook.

Work through example 5.13 in the prescribed textbook.

The formula for calculating a scrapping allowance will be shown in the example below.

Sunshine (Pty) Ltd purchased electronic office equipment for R90 000, exclu-
ding VAT, on 1 July 2020 and brought it into use at that date. On 30 June 2023,
the equipment is sold for R15 000. Wear-and-tear allowances of R20 000 per
annum were claimed from 2021 to 2023.
Determine the scrapping allowance (section 11(o)) that Sunshine (Pty) Ltd
can claim

Year of assessment ended 30 June 2023

Cost R90 000
Less: Capital allowances = R20 000 x 3 (R60 000)
Tax value R30 000

Proceeds (selling price) R15 000

Less: Tax value (R30 000)
Scrapping allowance (R15 000)

6.11.2 Recoupment on the sale of assets Textbook section: 5.13.4

If an asset is sold for an amount exceeding the tax value (original cost price less allowances), the
net result represents a recoupment of the taxable allowances previously claimed. The recoupment
(limited to allowances previously claimed) should be included in gross income.
 19 TAX3701/103

Study section 5.13.4, “Recoupment on the sale of assets (section 8(4)(a)”, in the
prescribed textbook.

Work through example 5.14 in the prescribed textbook.

Company B purchased a used motor vehicle for use in its trade. The cost of the
vehicle was R250 000, excluding VAT, and wear-and-tear was claimed over
four years according to the straight-line method. The vehicle was brought into
use on 1 April 2019 and the company has a February year-end.

Calculate the amount that will be recouped and included in taxable income
if the vehicle is sold for R280 000 on 30 June 2022.

Year of assessment ended 28 February 2023

R
Cost on 1 April 2019 250 000
Wear-and-tear = 2020 (R250 000 / 4 x 11/12) ( 57 292)
2021 (R250 000 / 4) ( 62 500)
2022 (R250 000 / 4) ( 62 500)
2023 (R250 000 / 4 x 4/12) ( 20 833)
Tax value on 30 June 2022 46 875

Proceeds (selling price) 280 000

Less: Tax value ( 46 875)
Recoupment 233 125

Limited to previous allowances claimed 203 125

6.11.3 Replacement asset: Recoupment Textbook section: 5.13.5

When a recoupment is calculated on a manufacturing machine and this machine is replaced by

another (new or used) manufacturing machine, then section 8(4)(e) offers relief to the taxpayer if
the taxpayer elects that paragraph 65 or 66 of the Eighth Schedule should apply. This section
provides that in certain circumstances, this recoupment will not be included in full in the year during
which the old asset is sold, but that the recoupment can be spread over the same period during
which the capital allowance on the replacement asset will be claimed. As a result, the taxation
payable on the recoupment is effectively postponed to future tax periods.

Study section 5.13.5 in the prescribed textbook.

Work through example 5.15 in the prescribed textbook.

 20

The recoupment that should be included is directly linked to the capital allowance
that you have claimed on the replacement asset. It is therefore very important in
the examination to show that you are applying this principle (that is, show a clear
calculation).

Note: when the assignment or examination question does not state that the
taxpayer elected paragraph 65 or 66 of the Eighth Schedule, then this deferral of
the recoupment is not applicable and the normal rules for a section 8(4)(a) recoup-
ment applies.

Company C purchased a new manufacturing machine A from a registered VAT

vendor for R650 000 (excluding VAT) on 1 May 2022 and brought it into use on
the same date. This machine was destroyed in a fire on 1 January 2023 and
Company C received an indemnity payment of R480 000 from the insurance
company on 1 February 2023.

Machine A was replaced by machine B. Machine B was purchased second-hand

on 1 February 2023 for R850 000 (excluding VAT) and brought into use on the
same day.

Calculate the recoupment amount that must be included in Company C’s

taxable income for the year of assessment ending 31 March 2023, if
Company C elected that paragraphs 65 and 66 of the Eighth Schedule
should apply.

Machine A
R
Cost price 650 000
Less: Section12C allowance (2023: 650 000 x 40%) (260 000)
Tax value 390 000

Indemnity payment received 480 000

Less: Tax value (390 000)
Recoupment 90 000

Taxable recoupment in 2023 – par 65 elected (20% x R90 000) 18 000

Machine B
Section 12C allowance (R850 000 x 20%) (170 000)

Note: Can you see how the recoupment amount of R90 000 is spread over the
same period during which the capital allowance on the replacement asset will be
claimed?

6.11.4 Donations and dividends: Recoupment Textbook section: 5.13.6

Section 8(4)(k) is an anti-avoidance provision, which means that when a company donates depre-
ciable assets or distributes them as a dividend, such donation or distribution cannot take place with-
out a recoupment being recognised as if the asset had been sold.
 21 TAX3701/103

Read section 5.13.6 in the prescribed textbook.

6.12 LIMITATIONS OF ALLOWANCES Textbook section: 5.15

The Act contains several sections aimed at preventing people from receiving an unfair tax advan-
tage. The rules were developed based on practical situations that SARS investigated and in which
they wanted to prevent any possible abuse. For example, if a taxpayer sells an asset and leases it
back over a short period, he/she can effectively claim the capital cost over the short period. If
another business did not enter into this agreement, the taxpayer will only be able to claim the capital
cost over the period provided – see, for example, BGR No 7. This paragraph looks at the different
rules that can be found in the Act.

Study section 5.15.1 and 5.15.2 in the prescribed textbook.

Work through example 5.19.

6.13 LEASED ASSETS Textbook section: 5.16

A taxpayer can decide to rent the assets (or some of them) needed for his/her business activities
rather than to purchase them. If this is the case, the taxpayer will be the lessee. The following three
main types of expenses are related to leased assets:

 Rent paid (normally deductible according to the general deduction formula in s 11(a))
 Lease premium (deductible in terms of s 11(f))
 Leasehold improvements (deductible in terms of s 11(g))

6.13.1 Rental paid and lease premiums Textbook sections: 5.16.1 and 5.16.2

A lease premium is effectively an “upfront payment” of part of the rent that should
be paid. Normally, if a person pays a lease premium, the monthly rental he/she
pays will be less than that of a person who did not pay a lease premium.

When rent has been paid, you should always look at the information supplied to
determine if the asset was in use for the full period for which rent was paid. If this
is not the case, you can claim only that part of the expense that was incurred during
the period in which the asset was brought into use, that is, from the date at which it
was brought into use until the end of the year of assessment.

Study sections 5.16.1, “Rental paid (section 11(a)”, and 5.16.2, “Lease premiums
(section 11(f))”, in the prescribed textbook.
 22

Work through example 5.20.

You should remember that the lease premium is also calculated pro rata for the
period during which the asset was in use, that is, from the date at which it was
brought into use until the end of the year of assessment.

When a lease contract has the option to extend the original lease (for example, for
another 5 years), this extension period must always be added to the original lease
period (for example, 10 years) when the lease period (which will then be 15 years)
is used for the calculation of the lease premium deduction.

6.13.2 Leasehold improvements Textbook section: 5.16.3

Leasehold improvements refer to a situation where the person who is renting the premises must
either build a specific building or make certain improvements to the building or factory he/she is
leasing.

Study section 5.16.3 in the prescribed textbook.

Work through examples 5.21 to 5.22.

The following guideline could be of assistance when calculating the deduction for leasehold improve-
ments:

The original cost as stipulated in the contract (but limited to the actual cost of the improvements)
must be divided by the following period:

 the original period as determined in the contract

 minus the period from right of use until the date of completion of improvements

This gives the amount in respect of leasehold improvements that can be deducted (every year) over
the term of the contract.

If the improvements were brought into use in the current year for less than a full year, the amount
as calculated above must be multiplied by

 the period from the date of bringing the improvements into use until the end of the year of
assessment

Try converting the period of the contract into months; it may be easier for you to do
the calculation this way, as it will give you the amount per month. Just remember
not to divide the period you are claiming by 12 as you already have a monthly
amount.
 23 TAX3701/103

When dealing with leased assets, always draw a timeline of events to help you see
with which periods you are working. Be very careful when working with dates. Make
sure you know whether you started to use the leased asset in the current year or in
the previous year to decide whether you should claim for 12 months or only a portion
of the year.

Remember that the extension period stipulated by the lease contract must be added
to the original lease period when the total lease period is used for the calculation of
the leasehold improvement deduction.

If the taxpayer is leasing an asset to another taxpayer, the first taxpayer will then be a lessor. If
this is the case, any rental received, lease premium received and leasehold improvements “recei-
ved” will be deemed income in the hands of the lessor. Note the special allowance for lessors in
terms of section 11(h) with regard to leasehold improvements.

On 1 August 2022, Tirong (Pty) Ltd (Tirong) entered into a lease contract with
Rentals Ltd for a period of five years, with the option to extend the contract for
another five years. In terms of the contract, Tirong had to effect improvements
on the premises to the value of R450 000. The building improvements, which
commenced on 1 September 2022, were completed on 1 December 2022 and
were brought into use on 1 January 2023. The total cost of the improvements
was R480 000.

Determine the leasehold improvement amount that will be allowed as a deduction

for the year of assessment ending 28 February 2023 in Tirong (Pty) Ltd’s taxable
income calculation.
Leasehold improvement

R450 000 / 9 years 8 months x 2/12

Or R450 000 / 116 months x 2 R7 759

The 9 years and 8 months are determined as follows:

 the original period as determined in the contract
(5 years + 5 years’ extension = 10 years)
 minus the period from right of use until the date of completion of
improvements (from 1 Aug 2022 to 1 Dec 2022 = 4 months)
Therefore, 10 years minus 4 months = 9 years and 8 months

The two months (2/12) are determined as follows:

 the period from the date of bringing the improvements into use
(1 Jan 2023)
 until the end of the year of assessment (28 Feb 2023).
therefore, it is two (2) months

Try drawing and using a timeline for the above example and you will see how
much easier it becomes when you “see” the dates clearly indicated on it.

Visit Learning Unit 6 on the myUnisa Discussion Forum and discuss any con-
cepts that you do not understand. If you do understand the concepts, then
answer those students who have posted questions.
 24

WRAP-UP

 In this learning unit, we considered how to treat the cost of purchasing and holding an asset,
the implications of selling or disposing of an asset, and lastly, the cost of leasing an asset.

 To determine a capital allowance on movable assets, make sure that you first identify the tax-
payer's status. Once you have established this, it will be easier to determine which capital
allowance is applicable. If it is a small business corporation, section 12E will apply. If it is a
manufacturing business, section 12C will apply, and for all other businesses and on movable
assets, the section 11(e) wear-and-tear allowance will apply.

 A taxpayer can also claim a building allowance if the building is used for the purposes of his/her
trade. Make sure that you will be able to differentiate between the different section 13 allow-
ances available for buildings.

 When an asset is disposed of, a recoupment or scrapping allowance (section 11(o)) may arise.

 When a recoupment arises when an asset is replaced (section 8(4)(e)), the recoupment
amount can be deferred over the same period during which the capital allowance on the re-
placement asset will be claimed.

 Leasehold improvements are deductible under sections 11(g) and 11(h) and the cost must be
divided by the original period minus the period from right of use until the date of completion of
improvements.

Read the summary in section 5.17. Make sure you fully understand how to deter-
mine and calculate each capital allowance available for businesses.

Work through the integrated questions in section 5.18, "Examination prepa-

ration", at the end of chapter 5. Try not to look at the answers when attempting
to answer the question.
 38

LEARNING UNIT 7 Learning unit

INTRODUCTION

LEARNING OUTCOMES

PRESCRIBED STUDY MATERIAL FOR THIS

LEARNING UNIT

SECTIONS OF THE PRESCRIBED TEXTBOOK

THAT CAN BE IGNORED

CONTENT OF LEARNING UNIT

7.1 Background and revision

7.2 Proceeds
7.3 Base cost
7.4 Exclusions and limitation of losses
7.5 Assessed capital loss carried forward
7.6 Rollover of capital gain
7.7 Anti-avoidance

WRAP-UP
ASSESSMENT CRITERIA
SELF-ASSESSMENT QUESTIONS

Capital
gains tax
(CGT)

Open Rubric
 39 TAX3701/103

INTRODUCTION

Learning units 3 to 6 dealt with the income and deductions for a taxable income calculation. The
last item to be added to the taxable income calculation (as indicated in the tax framework below) is
the taxable capital gain on the disposal (selling) of assets.

Definition
Gross income

Income Less: Specific

Exempt inclusions
income
Less:
General
deductions
Deductions
Specific
deductions
Gives:
Capital
allowances
Taxable income
before capital gains

Plus:

Capital gain

Gives

Taxable income

The gain/profit received by or accrued to a taxpayer on the disposal of an asset is either revenue in
nature or capital in nature. If the profit is revenue in nature, thereby meeting the requirements of
the gross income definition, it is taxed by including the profit in gross income. If the disposal of an
asset is capital in nature, then capital gains tax (CGT) must be calculated. Once the taxable capital
gain has been calculated, the amount will be taxed by including it in the taxpayer's taxable income
for the relevant year of assessment. This learning unit will deal only with disposals of a capital
nature.

Note that CGT is not a separate tax. It forms part of the normal income tax calculation, although the
taxable capital gain calculation may be quite extensive with its own rules and provisions (as contain-
ed in the Eighth Schedule of the Act). The mechanisms of CGT will be discussed and, after maste-
ring the learning unit, you should be able to calculate a taxpayer's taxable capital gain in a case
study on CGT, as well as include the taxable capital gain in an integrated question, that is, as part
of the full taxable income calculation.

Take note: that you will be assessed on this topic during the examination only (and not in
Assignment 2, because the assignment is due before you study this topic). Therefore, it is of the
utmost importance that you work through the questions at the end of this learning unit to ensure that
you know how to approach a question on CGT.
 40

LEARNING OUTCOMES

After completing this learning unit, you should be able to:

 identify whether CGT is applicable and apply the framework to calculate the taxable capital gain
or loss.
 apply the principles to calculate proceeds for CGT purposes.
 apply the principles to calculate base cost for CGT purposes.
 apply the relevant exclusions and limitations in the calculation of the capital gain/loss.
 apply the rollover provisions in a case study on CGT, as well as in an integrated taxable income
calculation.
 apply the inclusion principles to a calculation of the taxable capital gain/loss in a CGT case study
and to an integrated taxable income calculation.

PRESCRIBED MATERIAL FOR THIS LEARNING UNIT

Study chapter 6 in the prescribed textbook.

SECTIONS OF THE PRESCRIBED TEXTBOOK THAT CAN BE IGNORED

6.5.3 Short-term disposals and acquisitions of identical financial instruments

6.5.6 Disposal of certain debt claims
6.6.3 Concession or compromise in respect of debt
6.6.4 Cancellation of contracts
6.6.6 Donations tax to be included in the base cost
6.8.2 TAB: Cost incurred before and after the valuation date
6.8.3 TAB: Depreciable assets
6.11.3 Base cost of a person who becomes a resident on or after the valuation date
6.11.4 Base cost for a debt-substitution transaction
6.11.5 Farming capital development cost
6.12.1 Exclusion: Primary residence
6.12.2 Exclusion: Personal-use assets
6.12.4 Exclusion: Disposal of a registered micro business's assets
[Link] Retirement benefits
[Link] Long-term insurance
[Link] Collective investment scheme
[Link] Exercising an option
[Link] Compensation for personal injury, illness or defamation
[Link] Gambling, games and competitions
[Link] Award for restitution in terms of the Restitution of Land Rights Act 22 of 1994
[Link] Disposal of equity shares in foreign companies
[Link] Disposal of section 8C restricted equity instruments
[Link] Disposal by trust in terms of a share incentive scheme
6.12.6 Annual exclusion
6.15.3 Disposal of immovable property by a share block company to a member
6.15.4 Mineral rights conversions and renewals
6.15.5 Disposals by recreational clubs
6.15.6 Disposals to a spouse
 41 TAX3701/103

CONTENT OF LEARNING UNIT 7

Textbook sections: 6.1, 6.2, 6.3, 6.4,

7.1 BACKGROUND AND REVISION
6.14, 6.16 and 6.19

CGT is levied on the net capital gains made on the disposal of certain assets. You have already
learnt most of the principles pertaining to CGT in TAX2601. Sections 7.1 and 7.2 of this learning
unit will revise what you already should know – but take note that it is important to learn these
principles again thoroughly, as you will need to apply them in the CGT calculations.

Study sections 6.1 and 6.2 in the prescribed textbook.

In the prescribed textbook, the calculation of capital gains is explained in a series

of steps, which you should find very useful in learning how to do CGT calculations.
However, ultimately and for examination purposes, you need to be able to calculate
CGT without following these steps in a parrot fashion. You must understand the
logic behind the calculations and be able to calculate CGT without referring to the
steps.

If you are interested, you can also look at the comprehensive guide to capital gains
tax on the SARS website. This is not compulsory, and you will not be tested on
this information, but it could be interesting and useful to know where to find this
information on the SARS website in future. Visit the website at:
[Link]

Before calculating CGT, you must first consider whether CGT is applicable. In this regard, you need
to know what constitutes an asset and a disposal.

Study section 6.3 in the prescribed textbook.

You must be able to determine if a transaction in a question is a disposal or a

deemed disposal and whether it is not perhaps one of the events that specifically
constitutes a non-disposal, meaning that no CGT should be calculated. You should
also be able to determine if the capital gain must be calculated for the current year
of assessment, the previous year of assessment, or the following year of assess-
ment.

When calculating the taxable capital gain of a company for a specific year of assessment, several
aspects need to be taken into account. These aspects are discussed in sections 7.2 to 7.6 in this
study guide. The process to be followed when doing a CGT calculation is briefly outlined below.
 42

For CGT purposes, each asset is dealt with separately (that is, on its own) and therefore, the follow-
ing calculation must be done separately for each asset:
R
Proceeds (that is, the selling price adjusted for CGT purposes)
(section 7.2 of this learning unit) XX
Less: Base cost (that is, the cost price adjusted for CGT purposes)
(section 7.3 of this learning unit) (XX)
Capital gain/(loss) XX

After the gain/loss has been determined for each asset individually, you need to determine whether
 any total or partial exclusions can be applied (section 7.4 of this learning unit)
 any part of the capital loss (if applicable) is limited (section 7.4 of this learning unit)
 any rollover relief exists (section 7.5 of this learning unit)
 any anti-avoidance rules apply (section 7.6 of this learning unit)

Thereafter, you will add all the capital gains and/or losses take the capital loss of the previous year
(section 6.14 of the prescribed textbook) into account and apply the inclusion rate (section 6.16
of the prescribed textbook).

Below is a framework to guide you when calculating the taxable capital gain.

Capital gain/loss on an individual asset

R R
Proceeds XXX
Less: Base cost (XXX)
Gives: Gain/(loss) XXX
Less: Specific exclusions (XXX)
Capital gain/(loss) on one asset XXX

Taxable capital gains/losses on all disposed assets

Sum of all capital gains for the year of assessment XXX

Sum of all capital losses for the year of assessment (XXX)
Aggregate capital gain/(loss) XXX
Less: Assessed capital loss brought forward from the previous year (XXX)
Net capital gain/(loss) - carried forward to the next year)) XXX
Multiply: Inclusion rate 80%
Taxable capital gain (to be added to normal income tax) XXX

Study section 6.4 in the prescribed textbook. This paragraph is an extract from the
Act. Read it carefully to understand the rules provided. Because you will learn
about the rules regarding the disposal of an asset in a previous year of assessment
(that is, where the capital gain is spread over more than one year) for the first time,
we have simplified it for you below.

When an asset is disposed of in a previous year of assessment, the capital gain or loss will have
been determined and taken into account in that year of assessment. However, if an event (such as
the receipt or accrual of further proceeds not previously accounted for or the recovery or recoupment
of part of the base cost not previously accounted for) occurs in a subsequent year, it will give rise to
a capital gain in that subsequent year as well. The recovery or recoupment may take place in the
form of a cash refund, repossession of the asset, or cancellation or reduction of all or part of the
debt incurred in acquiring the asset, whether by prescription or otherwise.
 43 TAX3701/103

Receipt or accrual of further proceeds not previously accounted for: The capital gain or loss is deter-
mined by taking into account the further proceeds (that is, adding the subsequent proceeds to the
original proceeds amount), and the previous capital gain or loss is reversed as a capital loss or gain,
respectively.

Recovery or recoupment of part of the base cost not previously accounted for: The capital gain or
loss is determined from scratch, taking into account the recovery or recoupment of the base cost.
At the same time, the previous capital gain or loss is reversed as a capital loss or gain, respectively.

Work through question 6.3 of section 6.19 in the prescribed textbook.

Study sections 6.14 and 6.16 in the prescribed textbook.

Note: A net capital loss is NOT included in taxable income but is carried forward to the following
years of assessment until the taxpayer has an aggregate capital gain. This carried-over assessed
capital loss is then used to decrease the aggregate capital gain.

Textbook sections: 6.5.1, 6.5.2, 6.5.4 and

7.2 PROCEEDS
6.5.5

Once an asset is disposed of, the amount that the seller of the asset receives, or which accrues to
the seller constitutes the proceeds from the disposal.

Read sections 6.5.2 and 6.5.5 in the prescribed textbook.

Study sections 6.5.1 and 6.5.4 in the prescribed textbook and work through
example 6.2.

Did you notice that, in certain circumstances, for example, when donations are
made, and transactions are concluded between connected persons, the actual sel-
ling price is disregarded and the market value is deemed the selling price?

Proceeds for CGT purposes are also not always equal to the actual selling price
received by or accrued to the taxpayer. The actual proceeds must be adjusted for
any recoupment and repayment/reduction in proceeds actually received.

Therefore, it means the following:

Adjusted proceeds (for CGT purposes) = Selling price – Recoupment

 44

You must be able to calculate the recoupment in respect of the disposal of the applicable asset. The
calculation of the recoupment was discussed in learning unit 6. Remember, the recoupment is
limited to the allowances previously claimed. You will also have to calculate these allowances
claimed (in the current year and in previous years) in respect of the asset.

The steps provided in the learning on CGT of TAX2601 for calculating adjusted proceeds are set
out again below. You need to memorise and understand this process to be able to calculate the
proceeds for CGT purposes.

The first step is to calculate the tax value at the date of disposal:

Cost of asset Rxxx

Less: All allowances claimed (R xx)
Tax value R xx

The second step is to calculate the recoupment:

Selling price Rxxx

Less: Tax value (as calculated above) (R xx)
Possible recoupment R xx

However, this amount is limited to all the allowances previously claimed.

The last step is to calculate the adjusted proceeds:

Selling price Rxxx

Less: Recoupment (R xx)
Adjusted proceeds R xx

The adjusted proceeds amount is used in all further CGT calculations. You will see later that when
you consider whether to use paragraph 26 or 27 in respect of assets acquired before
1 October 2001, you will have to compare the proceeds (as adjusted, that is, as calculated above)
to the total costs. You will thus not use the selling price as given in a question, but the adjusted
proceeds as calculated. You will also use the adjusted proceeds amount in the calculation of the
20%-rule (explained later) and not the selling price.

7.3 BASE COST Textbook sections: 6.6.1 and 6.6.2

You will remember from TAX2601 that the base cost of an asset is generally the expenditure actually
incurred in acquiring the asset together with expenditure directly related to its improvement, as well
as direct costs associated with its acquisition and disposal and certain costs pertaining to the holding
of the asset. The base cost does not include any amounts allowed as a deduction against ordinary
income, such as a capital allowance and a scrapping allowance. It is important to know which costs
to include in or exclude from the base cost.

Study sections 6.6.1 and 6.6.2 in the prescribed textbook. Make a summary for
yourself of the costs that may be part of the base cost and those that may not.
 45 TAX3701/103

The 7th bullet of section 6.6.1 and the first part of section 6.6.2 may appear to con-
tradict each other. The principle to keep in mind is that costs incurred for an asset
that is used wholly or exclusively for business purposes (for example, repair costs)
will probably be deductible for income tax purposes and will then not be allowed to
form part of the base cost. An expense like borrowing costs in respect of disposed
vacant land (that is, pre-production interest) will not be deductible for income tax
purposes (as the land was sold before trade commenced); therefore, it will be added
to the base cost.

The following sections will deal with the base cost formula, but it is important to remember to apply
the above principles to the costs that are given in the question. It means that you must first deter-
mine which costs can be taken into account, and whether these costs need to be reduced by any
amounts (for example, capital allowances). These calculated (adjusted) costs are then used in all
further CGT calculations.

The base cost of an asset is calculated differently for assets purchased before 1 October 2001 (pre-
valuation date assets) and on/after 1 October 2001. When you have to calculate the base cost, the
first thing that you need to ask yourself is, “When was the asset purchased/ acquired?”

7.3.1 Assets acquired on or after 1 October 2001 No prescribed text

The base cost formula for assets acquired on or after 1 October 2001 is as follows:

R
Cost of asset (all allowable costs) XXX
Less: All allowances claimed previously (XXX)
Base cost XXX

To determine the cost of the asset, you must apply the principles discussed in section 7.3 above.
All costs relating to this asset, which may form part of the base cost (for example, acquisition cost,
moving costs, valuation costs, sales commission, etc.), must therefore be added together. Remem-
ber that any costs related to improvements of, or additions to the asset must also be included.

You have already encountered the above principles (proceeds and base cost of as-
sets acquired after 1 October 2001) in TAX2601. To test whether you have mastered
these principles, answer the following question:

QUESTION 7.1

Betty B (Pty) Ltd (Betty B) manufactures lipsticks at its factories, and the company's
year of assessment ends on 31 December 2023.

Betty B purchased a portable generator from a South African company for R95 000
on 31 May 2023 and brought it into use on the same day. BGR7 accepts a five-year
write-off period for portable generators. Betty B sold the generator on 30 November
2023 for R200 000, as the company decided to purchase a more powerful generator
in the next year.

Betty B has an assessed capital loss from the prior year of assessment of R45 000.
 46

REQUIRED Marks

Calculate the taxable capital gain/loss for the 2023 year of assessment. 12

You will find the solution under the self-assessment questions tab on myUnisa.
Make sure that you first answer the question before looking at the solution.

Textbook sections: 6.6.3, 6.7, 6.8.1, 6.9,

7.3.2 Assets acquired before 1 October 2001
6.10 and 6.19

The base cost formula for assets acquired before 1 October 2001 is completely different from the
one explained above:
R
Valuation date value XXX
Plus: Allowable costs incurred on or after 1 October 2001 XXX
Base cost XXX

The valuation date value is the value of the asset on 1 October 2001. The valuation date value is
determined in terms of paragraph 26 and paragraph 27 of the Eighth Schedule of the Act. Paragraph
26 is applicable when the adjusted proceeds are more than the adjusted cost of an asset (in other
words, a profit), and paragraph 27 is applicable when the adjusted proceeds are less than the ad-
justed cost of an asset (in other words, a loss). These paragraphs contain provisions that serve as
anti-avoidance measures because a taxpayer can manipulate the market value of the asset to en-
sure that a capital loss is realised on the disposal of the asset. You already learnt about paragraph
26 in TAX2601. In this module, we will look again at the rules pertaining to paragraph 26 and deal
with paragraph 27 as well.

Read section 6.7 and the first paragraph of section 6.8.1 in the prescribed text-
book.

Study sections 6.6.3, 6.9 and 6.10 in the prescribed textbook and do example 6.8.

 20%-rule: You need to calculate this value as follows: 20% x (adjusted proceeds
less allowable costs (as calculated) incurred on or after 1 October 2001). Re-
member that you have to use the adjusted proceeds and the adjusted cost (that
is, after adjusting for recoupment and capital allowances).

 Time-apportionment base cost (TAB cost): For this module, you will not have to
calculate the time-apportionment base cost. This value will be supplied in a
question and you just need to know where to use it.

You can use the following summary to calculate the base cost of an asset purchased
before 1 October 2001.
 47 TAX3701/103

 Divide costs between the time before and the time after 1 October 2001.

 Remember to deduct capital allowances (if applicable).

 All the capital allowances relating to a specific asset must be deducted from costs incur-
red before 1 October 2001 – even the portion of the allowance that pertains to the period
after 1 October 2001. (Therefore, when a company with a March year-end purchased an
asset on 1 January 1999 and sold it on 1 February 2023, all capital allowances for the
1999 – 2023 years of assessment must be deducted from the pre-2001 costs, to deter-
mine the calculated pre-2001 costs. The capital allowances claimed after 1 October 2001
will not be regarded as post-2001 costs, as they relate to the pre-2001 asset.)

 Determine whether paragraph 26 or 27 of the Eighth Schedule apply.

 Paragraph 26: If proceeds (adjusted) > total expenditure as calculated in .

 Paragraph 27: If proceeds (adjusted) < total expenditure as calculated in .

 Determine the necessary values for

 the market value (will be given in the question);

 the time-apportionment base cost (TAB cost) (will be given in the question); and
 the 20%-rule, that is, 20% x (adjusted proceeds – costs incurred on or after
1 October 2001) (you will have to calculate this value).

 Choose the valuation date value (VDV) (par 26 or 27).

 These two paragraphs will help you select the VDV of the asset. Study the summary of
paragraphs 26 and 27 provided below. The extract from the Act will be provided in the
examination.

 Calculate the base cost.

 Base cost = VDV + Cost incurred on or after 1 October 2001.

 Do not forget to add the costs incurred after 1 October 2001 to the VDV you have se-
lected. You must know which costs are allowed to be included in the base cost.
 48

If you want to learn the rules of paragraphs 26 and 27 (instead of using the extract from the Act),
the following summary might help you:

Summary of paragraph 26
[If proceeds (adjusted) > total cost (as calculated)]

1. The VDV is the highest of

(a) market value; or
(b) the 20% rule, that is, 20% x (adjusted proceeds – costs incurred on or after
1 October 2001); or
(c) TAB cost

(If the costs before 1 October 2001 are not known [and therefore, the TAB cost cannot be
determined], then the VDV is the higher of either the market value or the 20% rule.)

2. If the market value is adopted as the VDV above,

- where proceeds (adjusted) > market value,
then the VDV = market value; or
- where proceeds (adjusted) ≤ market value,
then the VDV = proceeds (adjusted) – costs after 1 October 2001

Summary of paragraph 27
[If proceeds (adjusted) ≤ total cost (as calculated)]

1. If the market value was not determined,

then the VDV = TAB cost.

2. If the market value is given, then compare:

- cost before 1/10/2001 ≥ proceeds; AND
- cost before 1/10/2001 > market value.

(a) If “yes” to both above,

then the VDV = the higher of
market value; or
proceeds – costs after 1 October 2001.

(b) If “no” to any of the above,

then the VDV = the lower of
market value; or
TAB cost.

The application of paragraph 26 was dealt with in TAX2601. You can refer to that study guide for
revision questions, but you can also test whether you have mastered these principles by answering
question 7.3 in this learning unit, before looking at the solution (found under the self-assessment
questions tab on myUnisa). Calculate the taxable capital gain for the first year of assessment only
and do not calculate the rollover in the second year of assessment – this will be dealt with in section
7.5 of this learning unit.

The following question is a good example of how to apply paragraph 27:

 49 TAX3701/103

QUESTION 7.2

Zola Ltd, a registered VAT vendor, acquired a factory building at a cost of R5 000 000
on 1 May 2001. The building was used directly in a process of manufacture, and its
tax value when it was sold on 1 March 2023 was RNil. The building was disposed of
for R5 000 000. Valuation costs of R10 000 were paid to a sworn appraiser who deter-
mined the market value of the building as R700 000 on 1 October 2001. Zola Ltd's year
of assessment ends on 31 March 2023. All amounts exclude VAT. The TAB cost of
the building was R785 000.

REQUIRED
Marks
Calculate the base cost of the building for CGT purposes. Assume that the adjusted
proceeds for CGT purposes are RNil. 10

You will find the solution under the self-assessment questions tab on myUnisa.

Did you notice that the adjusted proceeds were given and that you did not need to
calculate it in this question (when the proceeds are used in the VDV calculation)? The
tax value of the building was also provided, which is the cost price less all capital
allowances. Therefore, you did not need to calculate the capital allowances in respect
of the factory building in this question. Remember to read your question very carefully,
so that you do not waste time on calculations not required.

To test whether you understand the principles explained above, do question 6.2 in
section 6.19 in the prescribed textbook. Make sure that you answer the question tho-
roughly before looking at the solution. Take note that you will not be required to calcu-
late the TAB cost (as indicated in note 10 of the solution). Assume that the TAB cost
is given in the question.

7.3.3 Base cost: special provisions Textbook section: 6.11.1, 6.11.2 and 6.11.6

When determining the base cost of an asset, some practical difficulties need to be considered. The
aim of these sections is to give guidance on how to apply the base cost rules for the identified
problem areas.

Study sections 6.11.1, 6.11.2 and 6.11.6 in the prescribed textbook.

7.4 EXCLUSIONS AND LIMITATION OF Textbook sections: 6.12.3, [Link],

LOSSES [Link], [Link], [Link] and 6.13

In certain situations, the gain that is made on the disposal of specific assets, or on the disposal by
and to specific entities, will not be taxable. These rules are referred to as exclusions.

Study sections 6.12.3, [Link], [Link], [Link] and [Link] in the prescribed
textbook.
 50

Limitation-of-loss rules apply to specific situations in which you will not be able to claim a loss in
your CGT calculation, although you have calculated that you have suffered a loss.

Study section 6.13 in the prescribed textbook.

7.5 ASSESSED CAPITAL LOSS CARRIED

Textbook section: 6.14
FORWARD

Familiarise yourself with the rules pertaining to the assessed capital loss amount that can be carried
forward to the next year of assessment.

Study section 6.14 in the prescribed textbook.

7.6 ROLLOVER OF CAPITAL GAIN Textbook sections: 6.15.1, 6.15.2 and 6.19

When an asset is disposed of involuntarily (paragraph 65), or when it is being replaced (paragraph
66), a rollover relief is given to the taxpayer. This means that the capital gain is not taxed when the
asset is disposed of, but that it is rolled over (postponed) until a future date. The taxpayer must
elect that paragraph 65 or 66 of the Eighth Schedule must apply before the rollover can be utilised.

Study sections 6.15.1 and 6.15.2 in the prescribed textbook.

If all the requirements as set out in sections 6.15.1 and 6.15.2 are met, capital gains
will be taxed only as follows:

 Capital gain on the involuntary disposal of an asset that is then replaced by a

non-depreciable asset: The capital gain is taxed when the replacement asset
is disposed of.
 Capital gain on the voluntary/involuntary disposal of an asset that is then
replaced by a depreciable asset: The capital gain is recognised in the same
ratio in which the capital allowance is granted in respect of the replacement
asset, and it is therefore taxed in future tax years. This means that the propor-
tionate capital gain will be taxable from the year that the replacement asset has
been brought into use and a capital allowance can be claimed on it.

To illustrate the principles explained above, answer the following question:

QUESTION 7.3

Player (Pty) Ltd manufactures golf balls. Its year of assessment ends on 28 February.
Player (Pty) Ltd's factory building was destroyed in a fire on 15 January 2023. The
factory building was insured against losses from fire, and the insurer made an indem-
nity payment of R2 200 000 (excluding VAT) to Player (Pty) Ltd on 15 February 2023.

The building was originally erected by Player (Pty) Ltd during March 2001, at a cost of
 51 TAX3701/103

R1 500 000, and it was taken into use immediately. The total amount of tax allowances
claimed in respect of this building for the 2002 to 2022 years of assessment is
R1 500 000. The market value of the building was R820 000 on 1 October 2001, and
the TAB cost was R800 000.

During June 2023, Player (Pty) Ltd contracted a builder to erect a new factory building
on the existing site. The cost of the newly completed building was R2 000 000, and
the building was brought into use on 1 December 2023 in a manufacturing process.

REQUIRED:
Marks
Calculate the taxable capital gain/loss for the 2023 year of assessment.
15
In terms of paragraph 65 of the Eighth Schedule, the company elects to defer any capi-
tal gains in respect of the destroyed factory.

You will find the solution under the self-assessment questions tab on myUnisa.

To test whether you understand the principles explained above, work through ques-
tion 6.1 of section 6.19 in the prescribed textbook. Make sure that you answer the
question before looking at the solution.

In question 6.1 of the textbook, the capital allowance in respect of the replacement
asset was claimed at 40% (new plant and machinery). Note that if this company was
a small business corporation, then the capital allowance in respect of the replace-
ment asset will be 100% (refer to learning unit 6). This means that there is still a
rollover of the capital gain, but that the full portion of the capital gain is included when
the replacement asset is brought into use, which can be in the same year as the
disposal. In a case like this, there is effectively no relief for this taxpayer.

7.7 ANTI-AVOIDANCE Textbook section: 6.17

Value shifting involves the effective transfer of value from one entity to another without constituting
an ordinary disposal for CGT purposes. Without specific anti-avoidance rules, entities could mani-
pulate the value of assets to obtain a CGT benefit. When a value-shifting agreement exists between
connected persons, the base cost is determined using the formula explained in section 6.17.1 of the
prescribed textbook.

Read section 6.17 in the prescribed textbook.

Visit Learning unit 7 on the myUnisa Discussion forum and discuss any concepts
that you do not understand – or if you do understand everything, then answer those
students who have posted questions.
 52

WRAP-UP

CGT is tax paid on the gains that are made when a person sells a capital asset. The gain is calcu-
lated as the adjusted proceeds less the adjusted base cost.

The first step is to calculate the adjusted proceeds. The formulas to calculate this amount always
stay the same, irrespective of whether the asset was purchased before or after 1 October 2001.

The second step is to calculate the adjusted base cost. The formula for this component depends
on whether the asset was purchased before or after 1 October 2001. For assets purchased before
1 October 2001, you will start by dividing all the allowable costs into categories of “before
1 October 2001” and “after 1 October 2001”, and will then use this together with the other information
provided in the question to determine the valuation date value (rules of paragraphs 26 and 27) and
the base cost. You also need to determine whether part or all of the capital gain will be rolled over
to a following year of assessment.

Apply these steps to every capital asset that has been sold during the year and then add these
capital gains/losses together to calculate the aggregate capital gain/loss. Follow the CGT framework
to calculate the taxable capital gain or loss. Remember, you are expected to know all the formulas
and the framework for examination purposes.

The CGT calculations can be asked in a separate CGT question or as part of the taxable income
calculation (where you first need to calculate the taxable capital gain separately and then include it
as income on the last line before adding up the taxable income).

ASSESSMENT CRITERIA

We could assess this learning unit in the examination by asking you to do the following:

 Calculate the adjusted proceeds of an asset.

 Calculate the base cost of an asset that was purchased after 1 October 2001.

 Calculate the base cost of an asset that was purchased before 1 October 2001.

 Calculate the capital gain or loss on one asset/more assets.

 Calculate the taxable capital gain/capital loss for the year of assessment.

 Indicate which assets or gains are not subject to CGT.

You will always be supplied with the following information in a question for this module on CGT:

 Time apportioned base cost, if applicable

 Market value, if applicable

Remember, the list above is by no means exhaustive of the manner of the assessment and merely
serves as guidance.
 53 TAX3701/103

Literature consulted

4. Income Tax Act No. 58 of 1962

5. [Link]

6. A Student's Approach to Income Tax (Business Activities edition) (2022)

 59 TAX3701/103

LEARNING UNIT 8

INTRODUCTION Learning unit

LEARNING OUTCOMES

PRESCRIBED STUDY MATERIAL FOR THIS

LEARNING UNIT
SECTIONS OF THE PRESCRIBED TEXTBOOK
THAT CAN BE IGNORED

CONTENT OF THE LEARNING UNIT

8.1 Background
8.2 Calculating tax liability
8.3 Dividends tax

WRAP-UP
ASSESSMENT CRITERIA
SELF-ASSESSMENT QUESTIONS

Taxation of
companies
and
dividends
tax
 60

INTRODUCTION

The type of entity that an enterprise assumes to operate has a direct influence on the tax liability of
the specific business or enterprise. Income tax legislation makes provision for various taxpayers,
namely, individuals (whether sole proprietors or partnerships), companies (including close corpo-
rations) and trusts. This learning unit will examine the normal income tax implications of the various
entity types and explain the tax consequences of each entity type. We also briefly consider the tax
implications for non-resident companies.

As discussed in previous learning units, the Income Tax Act No. 58 of 1962 has a specified structure
or framework that must be applied to determine the taxable income of a taxpayer. This learning unit
covers the last component of the framework, namely, taxable income (as well as tax liability) of
companies.

Gross GI Definition
income
Less: Specific
Income inclusions
Exempt
income
Less:
General
deductions
Deductions
Specific
deductions
Gives:
Capital
Taxable income allowances
before capital gains
Plus:

Capital gain

Gives

Taxable income

LEARNING OUTCOMES

After completing this learning unit, you should be able to:

 calculate the taxable income of a company by starting with the accounting net profit or loss.
 calculate the tax liability for different forms of enterprises (different taxpayers) in accordance with
current tax legislation.
 identify and discuss the income tax implications that are unique to dividends received and paid.
 discuss and apply the definition rules for dividends and contributed tax capital.
 interpret and apply the dividends tax rules.
 calculate the tax liability by applying the dividend rules.
 61 TAX3701/103

PRESCRIBED STUDY MATERIAL FOR THIS LEARNING UNIT

Study chapters 1 and 8 in the prescribed textbook.

SECTIONS OF THE PRESCRIBED TEXTBOOK THAT CAN BE IGNORED

8.4 Low-interest and interest-free loans to companies

8.6.1 Deemed disposal upon ceasing to be tax resident
8.6.2 Headquarter company
8.7 Venture capital company
8.11.8 Deemed beneficial owner of a dividend
8.12.1 Withholding of dividends tax by a regulated intermediary
8.15 Rebate in respect of foreign taxes on dividends
8.17 Deemed dividend on outstanding amounts
8.19 Dividend stripping

CONTENT OF THE LEARNING UNIT

Textbook sections:
8.1 BACKGROUND
1, 8.1 and 8.2

The legal form of an entity has a direct bearing on the way in which the business will be taxed. When
the taxpayer must decide on the form of business enterprise to set up, he/she has to consider a
number of factors. In this learning unit, we will concentrate on the taxation of companies and close
corporations.

Read sections 1.1 – 1.3, as well as sections 8.1 and 8.2 in the prescribed textbook.

Textbook sections:
8.2 CALCULATING TAX LIABILITY
8.3, 8.5 and 8.9

8.2.1 Tax implications for a company

Section 38 of the Act classifies companies as private or public companies and certain tax provisions
apply solely to the latter or the former. For tax purposes, close corporations are deemed private
companies.

Companies are usually liable for tax on taxable income at a fixed rate; however, different rates may
apply, depending on the type of company.

Study sections 8.3, 8.5 and 8.9 in the prescribed textbook.

 62

Work through example 8.3 in the prescribed textbook.

Did you notice that small business corporations (SBCs) are taxed on a sliding scale
as opposed to the 27% for companies with financial years ending on or after 31
March 2023? Did you also notice that SBCs are entitled to claim accelerated write-
offs on certain assets (as discussed in learning unit 6)? It is therefore very important
in an examination to identify whether a company in a scenario is a SBC.

The following summarises the income tax classification and rates for companies. (Remember, you
must be able to identify which type of company it is in the examination.)

Companies

Small
SA companies business Employment Non-resident
corporations companies companies

Fixed rate: Sliding scale * Fixed rate: Fixed rate:

27% 27% 27%

8.2.2 Calculating the taxable income of companies and close corporations using accounting
profits as a point of departure

Study sections 1.4 and 1.5 in the textbook.

Although you must be able to use the income tax framework for calculating taxable income and the
normal income tax liability of a taxpayer, you are also required to calculate taxable income using
accounting profit or loss as a point of departure and, accordingly, make the necessary adjustments
in order to calculate such taxable income. This method requires a thorough understanding of the
fundamental principles applied in calculating accounting profit or loss, as well as the taxation prin-
ciples studied in this module thus far.

When calculating taxable income and having to start with accounting profit, you must consider each
income and expense item separately. You will start by determining the accounting entry and consi-
dering how it affected the accounting profit. The next step is to determine what the correct treatment
will be from a tax point of view, that is, how the transaction will affect the calculation of taxable
income.

If the tax treatment (of income or an expense) is the same as the accounting entry, no adjustment
needs to be made to the accounting profit. However, if the tax treatment (of income or an expense)
is different from the accounting entry, an adjustment needs to be made to the accounting profit to
get to the taxable income. This adjustment is done by firstly cancelling (reversing) the accounting
effect and then applying the correct tax principle.
 63 TAX3701/103

Work through the example below.

Example

CS Traders Ltd had sales of R250 000 for the current year of assessment. The general expenses
in the business (excluding depreciation) amount to R110 000. Depreciation on the assets that the
company owns is R25 000 for the year. For income tax purposes, all income is taxable, and all the
general expenses are deductible. The assets qualify for a wear-and-tear allowance of R63 000 for
the current year of assessment.

REQUIRED:

1. Calculate the accounting net profit of the business. (Note that you will not be required to cal-
culate the accounting profit in the examination; it is done here only to illustrate the concept.)

2. Calculate the taxable income of the business starting with the accounting net profit of the busi-
ness.

3. Calculate the taxable income of the business starting with gross income.

Solution

1. Accounting net profit R

Sales 250 000
Less:
General expenses (110 000)
Depreciation (25 000)
Accounting net profit 115 000

2. Taxable income (starting with net profit)

Accounting net profit 115 000
Adjustments:
Sales (no adjustment – accounting and tax effect the same) -
General expenses (no adjustment – accounting and tax effect the same) -
Assets (The accounting and tax effect for assets differ; therefore, we first have
to cancel/ reverse the accounting entry and then deduct the amount allowed for
tax purposes.)
Plus: Depreciation (was previously deducted, but must now be added back to 25 000
reverse it)
Less: Wear-and-tear (deduct the amount allowed for tax purposes) (63 000)

Taxable income 77 000

3. Taxable income (starting with gross income)

Sales (gross income) 250 000
Less:
 64

General expenses (section 11(a)) (110 000)

Wear-and-tear (section 11(e)) (63 000)
Taxable income 77 000

You can see that the calculation of taxable income, when starting with gross income,
is very different from the calculation when you start with accounting net profit, al-
though you end up with the same taxable income amount in both methods. Read
the question carefully in the examination to ensure that you apply the right method.
If you apply the wrong method, you could lose up to 40% of the marks in a question.
These marks are normally the easy marks that will help you pass this module.

8.2.3 Collection of tax due by a company

Read section 8.8 in the prescribed textbook.

The collection of tax due by a company is usually in the form of provisional tax; payments (refer to
learning unit 9 for a detailed discussion on provisional tax).

8.2.4 Non-resident companies

Certain rules are applicable for companies that do not conform to the definition of "resident".

Read section 8.6 in the prescribed textbook.

Textbook sections: 8.10, 8.11, 8.12,

8.3 DIVIDENDS TAX
8.13, 8.14, 8.16, 8.18 and 8.21

Study section 8.10 in the prescribed textbook.

A dividend is not deductible for tax purposes since it is not an expense in the production of income,
but it merely represents a distribution of profits to shareholders.

A dividend is defined in section 1 of the Act, but in essence, it is any payment a company makes for
the benefit of a shareholder in respect of a share in that company (excluding the return of contributed
tax capital, that is, a consideration received by a company for the issue of shares). Dividends are
usually given as cash (cash dividend), but they can also take the form of an asset or other property
(in specie dividend).

Dividends tax is a tax levied on the beneficial owners of dividends (normally, the shareholders) in
respect of the amount of any dividend received from a company, and this tax became effective on
1 April 2012.

8.3.1 Definition of dividends tax

When computing dividends tax calculations, it is vital to know which distributions are "dividends" for
dividends tax purposes.
 65 TAX3701/103

Study section 8.11.1 in the prescribed textbook.

8.3.2 Contributed tax capital

To establish whether a distribution to a shareholder is a dividend, the contributed tax capital of the
distributing company must be determined first.

Study section 8.11.2 in the prescribed textbook.

A dividend excludes any amount that reduces contributed tax capital. Therefore, if
the distribution is made from contributed tax capital, no dividends tax will be levied.

If the dividend is greater than the remaining retained profits or reserves (after cal-
culating contributed tax capital), then the portion of the dividend paid from contribu-
ted tax capital will not be subject to dividends tax.

8.3.3 Levying of dividends tax

Dividends can be distributed either in cash or in specie (a distribution other than in cash). Since the
liability to pay dividends tax will depend on the type of distribution, it is important to identify whether
a distribution is in cash or in specie.

Study sections 8.11.3, 8.11.4 and 8.11.5 in the prescribed textbook.

Did you notice that the withholding mechanism does not apply to dividends in specie?
Instead, the distributing company is liable to pay dividends tax.

8.3.4 Exemptions from dividends tax

Certain shareholders are exempt from paying dividends tax. Study these rules carefully.

Study sections 8.11.6 and 8.11.7 in the prescribed textbook.

Work through the examples.

Did you notice that resident companies are exempt from dividends tax? In most
cases, only natural persons will be subject to dividends tax.

8.3.5 Withholding and refunding of dividends tax

Read sections 8.12 and 8.13 in the prescribed textbook.

 66

After reading this section, you should be able to answer the following questions:
Who must withhold the dividends tax? When is a taxpayer entitled to claim a refund
with respect to dividends tax? Did you notice that the shareholder receives the net
dividend (amount of dividend remaining after the dividends tax is deducted)?

8.3.6 Payment and recovery of dividends tax

Read section 8.14 in the prescribed textbook.

After reading this section, you should be able to answer the following questions:
Who is responsible for paying dividends tax?
When is dividends tax payable?

8.3.7 Dividends tax summary

This section of the learning unit discussed the calculation of dividends tax in respect of dividends
paid by a company. The definitions of dividend and exempt shareholders are some of the important
aspects to consider when determining whether a distribution to a shareholder is subject to dividends
tax. The company distributing the dividend must withhold the dividends tax, and the remaining
amount of the dividend (after deducting the dividends tax) is paid to the shareholder.

Study section 8.16 as it provides a good summary of how to calculate dividends tax.

Work through question 8.3 in section 8.21.

8.3.8 Tax implications of dividends for shareholders

When a taxpayer (shareholder) receives a dividend, it must be specifically included in his/her gross
income as per paragraph (k) of the definition of gross income (refer to learning unit 3, section 3.3,
"Gross income: Special inclusions"). The amount to be included is the gross amount before
deducting dividends tax.

The Act exempts certain dividends from tax, depending on the source of the dividend.

Study section 8.18 in the prescribed textbook to determine instances where divi-
dends will be fully or partially exempt from tax. In addition, study the sections on
taxable foreign dividends.

Did you note the instances in which a foreign dividend paid by a foreign company
will be exempt from tax in terms of section 10B of the Act?

Did you notice that dividends received by way of an annuity will lose their section
10(1)(k) exemption and will therefore be fully taxable?

Visit Learning unit 8 on the myUnisa Discussion forum and discuss any concepts
that you do not understand – or if you do understand everything, then answer those
students who have posted questions.
 67 TAX3701/103

WRAP-UP

In this learning unit, we looked at the calculation of taxable income and normal tax liability for compa-
nies, including non-resident companies. We discussed the requirements for a company to be clas-
sified as a SBC and the resultant tax benefits.

We also considered the limitations on utilising assessed losses in respect of taxable income as well
as at dividends tax.

ASSESSMENT CRITERIA

We could assess this learning unit in assignments or in the examination by asking you to do the
following:

 Calculate the taxable income of a company or a close corporation.

 Calculate the tax liability of a company or a close corporation.
 Calculate the dividends tax liability in respect of dividends declared.

We may also ask you to discuss the tax implications of the content of this learning unit instead of
doing the calculations; therefore, it is important that you should know the principles of the sections
in this learning unit.

Remember, the list above is by no means exhaustive of the manner of the assessment and merely
serves as guidance.

Literature consulted

7. Income Tax Act No. 58 of 1962

8. [Link]

9. A Student's Approach to Income Tax (Business Activities edition) (2022)

 74

LEARNING UNIT 9
Learning unit
INTRODUCTION

LEARNING OUTCOMES

PRESCRIBED STUDY MATERIAL FOR THIS

LEARNING UNIT

CONTENT OF THE LEARNING UNIT

9.1 Provisional tax
9.2 Donations tax

POINTS TO PONDER

WRAP-UP

ASSESSMENT CRITERIA

SELF-ASSESSMENT QUESTIONS

Provisional
and
donations
tax
 75 TAX3701/103

INTRODUCTION

To ensure a continuous cash flow to SARS throughout the tax period, certain taxpayers are required
to make advance payments to SARS for a particular year of assessment. SARS provides two
methods for making such advance payments:

 payment of employees’ tax (for natural persons)

 payment of provisional tax

At the assessment date, the taxpayer’s normal tax liability is reduced by the employees’ tax deducted
from his/her remuneration and/or by the provisional tax payments made by the taxpayer for the year
of assessment. In this learning unit we will focus on provisional tax as it applies to businesses.

In this learning unit we will also look at donations tax to determine what triggers such a liability, who
is liable for it, and how to calculate it.

LEARNING OUTCOMES

After completing this learning unit, you should be able to:

 determine when a taxpayer qualifies as a "provisional taxpayer"

 determine whether the "provisional taxpayer" is exempt from paying provisional tax
 calculate the estimate of taxable income for all provisional tax payments
 calculate the provisional tax payable on the estimate of taxable income using the correct tax
rates and rebates applicable to the provisional taxpayer
 determine and calculate all penalties and interest payable on late or incorrect payments of
provisional tax
 identify when a disposal of property is a donation
 identify situations in which certain transactions could be deemed donations
 explain which donations are specifically exempt from donations tax
 calculate the amount of the general annual exemption from donations tax available to a taxpayer,
if any
 calculate the donations tax payable on any donation at the applicable tax rate
 identify the person liable for payment of donations tax and indicate the period in which donations
tax will be payable

PRESCRIBED STUDY MATERIAL FOR THIS LEARNING UNIT

There is no prescribed study material for this learning unit, as some section of the content are dealt
with in detail in TAX3702. Working through this learning unit should be sufficient for the purpose of
this module.
 76

CONTENT OF THE LEARNING UNIT

9.1 PROVISIONAL TAX No prescribed text

9.1.1 Introduction

Provisional tax, like employees' tax, is another method that SARS uses to ensure a continuous cash
flow throughout the tax period by collecting normal tax in advance. At the assessment date, the
taxpayer's normal tax liability is reduced by the provisional tax payments made by him/her for the
year of assessment.

The Act makes provision for the payment of two obligatory provisional tax payments:

i) First payment – due on or before the last day of the sixth month of the year of assessment, for
example, 31 August

ii) Second payment – due on or before the last day of the year of assessment, for example,
28 February.

The third payment is voluntary and is usually made to reduce or avoid interest on shortfalls. If the
entity’s year of assessment ends in February, the third payment is due on or before the last day of
the seventh month after the year of assessment (for example, 30 September). If the year of assess-
ment does not end in February, the third payment remains due within six months after the year of
assessment.

9.1.2 Liability to pay provisional tax

The following persons are liable to make provisional tax payments to SARS:
1. any person (other than a company) who receives income that does not constitute remunera-
tion, travel allowance, subsistence allowance, director's allowance or any advance contem-
plated in section 8 (1)

2. any company

3. any person who is notified by the Commissioner that he or she is a provisional taxpayer

The following entities are EXCLUDED from provisional tax:

1. approved public benefit organisations

2. approved recreational clubs
3. body corporates
4. share block companies
5. non-profit companies
6. persons exempt from payment of provisional tax in terms of paragraph 18, that is
i) owners or charterers of ships or aircraft, who are not residents of the Republic
ii) natural persons whose taxable income for the year of assessment does not exceed the tax
threshold and who do not derive any income from the carrying on of any business, if
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a) the taxable income of those persons for the relevant year of assessment, which is
derived from interest, foreign dividends and rental from the letting of fixed property will
not exceed R30 000

If a taxpayer is liable for provisional tax payments, he/she may request an IRP6 return (provisional
tax return) electronically via e-filing.

9.1.3 Calculation of provisional tax payments

The calculation of the first provisional tax payment is shown in the guidance below:

R
Estimated taxable income for the year of assessment (CANNOT BE LESS THAN xxx
THE BASIC AMOUNT). Usually the basic amount is used in this calculation.

Tax liability in respect of estimated taxable income (based on applicable tax tables
for small business corporations or applicable rates for companies
[28% or 27% depending on when the YOA ends] or trusts [45%]) xxx

Half of the normal tax payable (multiply tax liability by 50%) xxx

Less:
Tax proved to be payable to the government of any other country, which will qualify
as a foreign tax credit under section 6quat (xxx)

First provisional tax payment due to SARS by end of first period xxx

Notes:

1. The estimated taxable income for the first provisional tax payment is usually the basic amount.
The basic amount is deemed the taxable income assessed by the Commissioner for the "latest
preceding year of assessment" less any taxable capital gain included in terms of section 26A.

2. The “latest preceding year of assessment” means the latest year of assessment

 preceding the year of assessment for which the estimate is made, and

 for which the Commissioner issued a notice of assessment 14 or more days before the
date at which the estimate was submitted to the Commissioner.

3. The basic amount must be increased by 8% of the basic amount per year if

 an estimate is made for a period that ends more than one year after the end of the
latest preceding year of assessment

 the estimate is made more than 18 months after the end of that year of assessment.
 78

The calculation of the second provisional tax payment is shown in the guidance below.

R
Estimated taxable income for the year of assessment (minimum amount - see
below) xxx

Tax liability on estimated taxable income

(based on the applicable tax tables for small business corporations
or applicable rates for companies [28% or 27%] or trusts [45%]) xxx

Less:
First provisional tax payment made (xxx)

Less:
Tax proved to be payable to the government of any other country, which will
qualify as a foreign tax credit under section 6quat (xxx)

Second provisional tax payment due to SARS xxx

Taxpayers who must pay the minimum amount for the purposes of the second provisional tax pay-
ment are divided into two groups:

 taxpayers with a taxable income of less than R1 million for the current year of assessment
 taxpayers with a taxable income of more than R1 million for the current year of assessment

The minimum amount for taxpayers with a taxable income of less than R1 million is the lesser of

 the basic amount reflected on the return for payment of provisional tax issued by the Commis-
sioner (IRP6), or
 90% of the actual taxable income for the year of assessment

For taxpayers with taxable income of more than R1 million, the second provisional tax payment must
be based on the estimate of the taxpayer’s taxable income for the year of assessment.

The calculation of the third provisional tax payment is shown in the guidance below.

R
Actual taxable income for the year of assessment xxx

Tax liability in respect of estimated taxable income (based on the applicable

tax tables for small business corporations or applicable rates
for companies [28% or 27%], or trusts [45%]) xxx

Less:
First provisional tax payment made (xxx)

Less:
Second provisional tax payment made (xxx)

Less:
Tax proved to be payable to the government of any other country, which will
qualify as a rebate in terms of section 6quat (xxx)
 79 TAX3701/103

Third provisional tax payment due to SARS xxx

9.1.4 Late submission or late payment and inadequate estimate of provisional tax

If taxpayers do not adhere to the provisional tax requirements, SARS may levy additional taxes and
penalties.

Additional tax

SARS may levy additional tax of up to 200% of the provisional tax payable if the taxpayer

 does not submit the income tax return on time

 does not disclose all his/her income on the income tax return
 makes a false statement or declaration on the income tax return

SARS may also levy additional tax amounting to 20% of the provisional tax payable if the estimate
used for the second provisional tax payment is less than the "safe haven" amount.

This safe haven amount varies, depending on the provisional taxpayer’s taxable income.

Safe haven for taxpayers with a taxable income of R1 million or less

Should the taxpayer’s taxable income for the current year of assessment be less than R1 million,
the 20% additional tax will NOT be payable if the estimated taxable income used for the second
provisional tax payment is equal to the lesser of

 the basic amount; or

 90% of the actual taxable income for the year of assessment

Should the estimate used be lower than this amount, SARS will levy an automatic penalty of 20%
additional tax on the shortfall. The taxpayer may approach SARS for a full or partial reduction of the
penalty if the estimate was seriously calculated and not deliberately or negligently understated.

Safe haven for taxpayers with a taxable income of more than R1 million

Should the taxpayer’s taxable income for the current year of assessment be more than R1 million,
the 20% additional tax will NOT be payable if the estimated taxable income used for the second
provisional tax payment is at least equal to 80% of the actual taxable income for the year of assess-
ment.

Should the estimate used be lower than this amount, SARS may impose the 20% additional tax in
respect of the shortfall if it is not satisfied that the estimate was seriously calculated or not delibe-
rately or negligently understated. Therefore, this additional tax is discretionary.

Interest

SARS may charge interest at the prescribed rate if

 the provisional tax paid in respect of a year of assessment is not sufficient to offset the tax-
payer’s assessed final income tax liability in full
 the provisional tax is not paid on time
 80

The Minister of Finance determines this prescribed rate of interest from time to time.

Penalties

SARS may charge penalties in addition to interest. SARS regards failure by a provisional taxpayer
to submit an estimate (on an IRP6 tax return) of taxable income, as and when required under the
Act, as a criminal offence that is liable, on conviction, to a fine or imprisonment of 24 months. Fur-
thermore, SARS also regards this as an act of non-compliance (that is, non-compliance with proce-
dural or administrative action or duty imposed or requested by the Income Tax Act), which is subject
to a fixed-amount penalty, based on the taxpayer’s taxable income or assessed loss for the prece-
ding year. In addition to the fixed-amount penalty, the taxpayer also has to pay a penalty equal to
10% of the amount of the provisional tax that a provisional taxpayer fails to pay, as and when
required in terms of the Act.

Work through the following:

EXAMPLE 1

A company whose year of assessment ends on 31 December 2023 estimates on 30 June 2023 that
it will derive a taxable income of R2 000 000 for the year. Its last assessment reflected a taxable
income of R1 900 000, which represents its basic amount for the current year of assessment.
In March 2024, the taxable income of the company for the year of assessment ending on
31 December 2023 is calculated as R2 400 000.

What provisional tax payments should the company make in terms of the Act?

SOLUTION: EXAMPLE 1

First provisional tax payment (due on or before 30 June 2023) R

Estimated total taxable income for the year of assessment 1 900 000
(based on the basic amount)
Tax payable for the full year on taxable income
(27% of R1 900 000) 513 000
Provisional tax (50% of R513 000) to pay to SARS 256 500

Second provisional tax payment (due on or before 31 December 2023)

Estimated total taxable income for the year of assessment 2 000 000
Tax payable (27% of R2 000 000) 540 000
Less: First provisional tax payment (above) (256 500)
Provisional tax to pay 283 500

Third provisional tax payment (due on or before 30 June 2024)

As the company paid inadequate provisional tax, an additional provisional tax payment must be
made by 30 June 2024 to avoid a liability for interest in terms of section 89quat.

R R
Actual total taxable income for the year of assessment 2 400 000
 81 TAX3701/103

(as calculated)
Tax payable (27% of R2 400 000) 648 000
Less: First provisional tax payment made (above) (256 500)
Second provisional tax payment (above) (283 500) (540 000)
Provisional tax to pay to SARS 108 000

Notes:

1. The provisional tax payments, which the company made, will be taken into account in the deter-
mination of the tax amount due when the company is assessed for tax for the year. If these
payments exceed the assessed tax, the excess will be refunded to the company, but if they fall
short of the amount assessed, the company will have to pay the shortfall.

2. If an individual had derived remuneration from which employees' tax was deducted, he/she
would have reduced his/her first provisional tax payment by the employees' tax deducted up to
30 June 2023. In addition, he/she would have reduced his/her second provisional tax payment
by both the first provisional tax payment and the employees' tax deducted during the year of
assessment ended on 31 December 2023. The individual would have reduced his/her third pro-
visional tax payment by both the first and second provisional tax payments and the employees'
tax deducted during the year of assessment ended on 31 December 2023.

EXAMPLE 2

The following information is provided with regard to Lovebird (Pty) Ltd's most recent tax assess-
ments:
 2021 tax assessment issued on 21 September 2022, with a taxable income of R200 000.
 2020 tax assessment issued on 2 February 2021, with a taxable income of R160 000.
 the actual taxable income for the 2023 year of assessment was calculated to be R300 000 on
30 June 2023.

The first, second and third provisional tax payments should be calculated for the 2023 year of
assessment, which ends on 31 March 2023.

SOLUTION: EXAMPLE 2

The provisional tax payments would be calculated as follows:

2023 first provisional tax payment
R
Basic amount - taxable income as per 2020 assessment Note 1 160 000 (1)
Plus: (8% x R160 000 x 3 years) Note 2 38 400 (1)
198 400
Normal tax payable (R198 400 x 27%) 53 568 (1)
For six months (R55 552 x 50%) 26 784 (1)
The first provisional payment for 2023 is payable six months before the last day of the year of
 82

assessment, therefore on 30 September 2022.

2023 second provisional tax payment R

The lower of the basic amount or an estimate of taxable income
can be used:
- Basic amount - taxable income as per 2021 assessment Note 3 200 000 (1)
- Estimate for 2023 - not available
(at 31 March 2023), therefore use basic amount
Plus: (8% x R200 000 x 2 years) Note 3 32 000 (1)
232 000
Normal tax payable (R232 000 x 27%) 62 640 (1)
Less: First provisional payment (26 784) (1)
Second provisional payment due to SARS 35 856

The second provisional payment is due on the last day of the year of assessment, ending
31 March 2023.

2023 third provisional tax payment – due on 30 September 2023

R
Actual taxable income for 2023 300 000 (1)

Normal tax payable (R300 000 x 27%) 81 000 (1)

Less: First provisional tax payment (26 784) (1)
Less: Second provisional tax payment (35 856) (1)
Amount due to SARS 18 360

Notes:

1. The taxable income assessed in the 2020 assessment is used as the basic amount because the
2021 assessment, even though it had been assessed on 21 September 2022 (i.e. before the
first provisional payment was due), was received within 14 days before the provisional payment
is to be made (i.e. 30 September 2022).

2. The 2020 assessment is more than 18 months before the payment is due (i.e. from 31 March
2020 to 30 September 2022). Therefore, the basic amount according to that assessment must
be increased by 8% for each year, therefore 24%.

31/03/2020 31/03/2021 21/09/2022 30/09/2022 31/03/2023

2020 tax 2021 tax 2020 tax (1st payment) year-end
assessment assessment assessment (2nd payment)
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R160 000 R200 000 date

(year-end) (year-end)

< 14 days

>18 months

3. The basic amount for the 2023-second provisional payment must be adjusted by 8%, as the
2021 assessment is more than 18 months before the payment is due (i.e. 31 March 2021 to
31 March 2023). Therefore, the basic amount according to that assessment must be increased
by 8% for each year, that is, 16%).
4.

31/03/2020 31/03/2021 31/03/2022 30/09/2022 31/03/2023

2020 tax 2021 tax Year end (1st payment) Year end
assessment assessment (2nd payment)
R160 000 R200 000
(year-end) (year-end)

>18 months

9.2 DONATIONS TAX No prescribed text

9.2.1 Introduction

Donations tax is payable by residents only on the value of property disposed of by means of a
donation (whether directly or indirectly). It serves as an anti-avoidance provision by imposing tax
on persons who may want to donate their assets to avoid either income tax on income derived from
those assets or estate duty when such donated assets are excluded from their estates.

Donations tax is also payable on the value of property deemed to have been disposed of by means
of a donation. Where any property has been disposed of for a consideration that, in the opinion of
the Commissioner, is not adequate, such a disposal will be deemed a donation. The value of such
property will be reduced by the considerations paid. For example, if Mr. A sells property to Mr. B for
a consideration of R1 000 000 when the market value of such property is R1 500 000 at the date of
disposal, the disposal would be deemed to have been made by means of a donation for the purposes
of donations tax with a value of R500 000 (R1 500 000 - R1 000 000).
 84

The donor is liable to pay donations tax by the end of the month following the month in which the
donation was made. If the donor fails to pay the donations tax within this prescribed period, both
the donor and the donee will be jointly and severally liable for the tax.

The following decision tree provides guidance for simplifying understanding of donations
tax:

Has there been a disposal of

property under a donation OR a
deemed donation of property?

YES NO

Is the donation or deemed donation specifically exempt No donations tax is payable

from donations tax as per section 56 of the Income Tax Act
No. 58 of 1962?

NO YES

Follow the following steps in calculating No donations tax is payable

donations tax:

1. Identify donations in chronological order.

2. Determine the value of each donation.
3. Apply the general exemption.
4. Multiply the remaining value by the applicable rate(s).

9.2.2 Exempt donations

The following donations are specifically exempt from donations tax in terms of section 56 of the Act:

 donations to a spouse
 under a duly registered ante nuptial or postnuptial contract or under a notarial contract ente-
red into as contemplated in section 21 of the Matrimonial Property Act 88 of 1984 (s 56(1)(a))
 provided that the parties are not separated under a judicial order or notarial deed of sepa-
ration (s 56(1)(b))

 a donation in contemplation of death (a donatio mortis causa) (s56(1)(c))

 a donation where the donee will not obtain any benefit from the donation until the death of the
donor (s56(1)(d))

 a donation that is cancelled within six months from the date at which it has taken effect
(s56(1)(e))

 a donation made by or to any traditional council or traditional community or any tribe as defined
in section 1 of the Act as referred to in section 10(1)(t)(vii) (s56(1)(f))
 85 TAX3701/103

a donation of any right in property situated outside South Africa, which was acquired by the donor
 before he/she became a resident of South Africa for the first time; or
 by inheritance from a person who at the date of his/her death was not ordinarily resident in
South Africa; or
 by a donation, if at the date of the donation the original donor was a person other than a
company not ordinarily resident in South Africa; or
 from funds derived by him/her from the disposal of any property referred to in the first three
items listed above; or
 from funds derived by him/her from the disposal of or from revenue from replacement pro-
perties, where the donor disposed of the property referred to in the first three items above
and replaced it successively with other properties (all situated outside South Africa and ac-
quired by him/her from funds derived by him/her from the disposal of any of the properties
referred to in the first three items above) (s56(1)(g))

 donations made by or to any person referred to in section 10(1)(a), (cA), (cE), (cN), (cO), (d) or
(e), that is, the government of the Republic of South Africa in the national, provincial or local
sphere; political parties; public benefit organisations; etc. (s56(1)(h))

 a voluntary award that is required to be included in the gross income of the recipient or donee
in terms of one of the following paragraphs of the definition of "gross income" in section 1:
 paragraph (c) (certain amounts derived for services rendered), or
 paragraph (d) (certain amounts derived on, amongst others, the termination of services), or
 paragraph (i) (taxable fringe benefits) (s56(1)(k)(i))

 a voluntary award that is required to be included in the income of the donee in terms of sections
8A, 8B or 8C (s56(1)(k)(ii))

 distributions by a trust to the beneficiaries of the trust (excluding donations by a donor to a trust)
(s56(1)(l))

 a donation of a right (other than a fiduciary, usufructuary or other similar interest) for use or
occupation of farming property to the donor’s child for no consideration or for an inadequate
consideration (s56(1)(m))

 a donation made by a company regarded as a public company for tax purposes in terms of
section 38 (s56(1)(n))

 a donation of the full ownership in immovable property to a beneficiary who is entitled to a grant
or services in terms of an approved project under the Land Reform Programme (s56(1)(o))

 donations between companies, where the donor and the donee form part of the same group of
companies (as defined in section 1 of the Act) and the donee company is a resident (s56(1)(r))

 any bona fide contribution to the maintenance of any person, provided that the Commissioner
considers it reasonable, for example, payment of school fees of a child by a parent (s56(2)(c))

9.2.3 Donations by spouses married in community of property

When a spouse makes a donation out of the joint estate, each spouse is deemed to have made 50%
of the donation. In other words, if a husband makes a R100 000 donation out of the joint estate, he
and his wife are each deemed to have donated R50 000. When a spouse makes a donation out of
property that is excluded from the joint estate, it will be regarded as having been made solely by that
spouse. (s57A)
 86

9.2.4 Donations by companies on behalf of shareholders

When a company, at the instruction of its shareholder, makes a donation, the shareholder is deemed
to have made the donation in his/her personal capacity. The company would be deemed to have
declared a dividend of the value of the donation. Therefore, the transaction would trigger both divi-
dends tax and donations tax.

9.3.5 Calculation of donations tax

The following is an expansion of the steps noted in the decision diagram above on how to calculate
donations tax.

Step 1

After we have identified all the donations and deemed donations that are not specifically exempt
from donations tax, we list such donations in chronological order. This is important in order to apply
the general exemption (to be discussed in step 3) according to the order in which the donations were
made.

Step 2

The next step is to determine the value of the property donated that was not specifically exempt.
The value of such donated property will depend on the type of property donated. The following are
the types of properties and their values as identified in the Act:

 Property other than limited interests or annuities

The value to be attached to any property donated, other than limited interests, is the fair market
value at the date at which the donation takes effect. Immovable property, on which bona fide
farming activities are carried out, are valued at the fair market value, reduced by 30%.

 Annuity

The value of a donation of a right to an annuity is determined by capitalising the value of the
annuity at the rate of 12% over the period that is the least of
 the life expectancy of the donor
 the life expectancy of the donee
 the period of enjoyment of the right (if fixed)

For this module, you do not need to know how to calculate the value of an annuity for donations
tax. Such values will be provided in an examination.

 Fiduciary, usufructuary or other similar interests

A fiduciary interest is a limited interest in property that is owned by the fiduciary, usually in terms
of a will or trust deed, according to which the fiduciary is entitled to the fruits of the property
during his/her lifetime, but the fiduciary may normally not dispose of the property. A usufructuary
interest (usufruct) in property is also a limited interest, where full ownership of property consists
of two parts:

 Usufruct: This is use of the fruit or income from the property. The holder of this limited interest
cannot dispose of the property.
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 Bare dominium: This is ownership of property, without the benefit of the use of the fruit or
income from that property. The holder of this limited interest can only sell the property subject
to the usufruct, which belongs to someone else. The value of a fiduciary, usufructuary or other
similar interest in property is determined by capitalising the annual value of the right to enjoyment
of the property at 12% over a period that is the least of

 the life expectancy of the donor

 the life expectancy of the donee
 the period of enjoyment of the right (if fixed)

The value of the bare dominium donated is determined by subtracting the value of a usufruct
from the fair market value of the property in which such limited interest is donated. For example,
R donates property, subject to the usufruct of X, to K, and the fair market value of such property
is R1 000 000 and the value of the usufruct interest is R780 000. The value of the bare dominium
will be calculated as follows:

Value of full ownership of property R1 000 000

Less: Value of X’s usufructuary (R 780 000)
Value of donation R 220 000

For this module, you do not need to know how to calculate the value of fiduciary, usufructuary and
other similar interests where donations tax is concerned. Such values will be provided in an exami-
nation.

Step 3

Once we have determined the total value of properties donated by a taxpayer, we deduct from this
value the general exemption allowed. This exemption will be applied according to the order in which
the donations were made. The exemption allowed depends on whether the donor is a natural person
or not.

 General exemption for a donor other than a natural person

If the donor is not a natural person, the general exemption is R10 000 of the sum of all casual
gifts made by the donor during any year of assessment. SARS regards gifts such as wedding
gifts, birthday gifts and Christmas gifts as casual gifts. When the period concerned exceeds or
is less than 12 months – for example, when a company changes its financial year end – the
amount of R10 000 must be adjusted proportionately.

 General exemption for a donor who is a natural person

If the donor is a natural person, the general exemption is R100 000 of the sum of all property
donated during any year of assessment. The exemption does not apply to casual gifts only, but
to all property donated by a natural person. This exemption is not decreased proportionately
when the period of assessment is less than a full year.

Step 4

Multiply the value of the taxable donation by the relevant rate to determine the donation tax payable.

If the value of all property donated (on/ after March 2018) does not exceed R30 000 000:
 Multiply the aggregate value of all property disposed under taxable donations by 20% to
determine the donations tax amount;
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If the value of all property donated (on/ after March 2018) exceeds R30 000 000:
 Multiply the first R30 000 000 of the aggregate value of all property disposed under taxable
donations by 20%; and ADD
 The excess aggregate value of all property disposed under taxable donations multiplied by
25%.

Work through the following:

EXAMPLE 3

KMB (Pty) Ltd is a company that manufactures office equipment. It commenced business on
1 July 2020 and made the following donations for its year of assessment ending on
31 December 2023:
1. On 8 November 2023, a wedding gift with a fair market value of R11 850 to Mr. Y, an employee.

2. On 13 August 2023, a sum of R 8 500 to Children of Fire, a public benefit organisation.

3. On 21 September 2023, R7 000 to the son of a shareholder at the instruction of the respective
shareholder, to be used by him for school fees.

4. On 30 August 2023, property that is subject to a usufruct in favour of Ms. F, an employee, to

Ms. E, the kitchen assistant (The value of the property donated amounted to R90 000 and the
value of the usufruct amounted to R76 543.)

Calculate the donations tax payable by KMB (Pty) Ltd during the 2023 year of assessment.
Remember to use the decision tree demonstrated earlier to assist you in calculating donations tax
payable.

SOLUTION: EXAMPLE 3

13 August 2023 – Children of Fire R

Donations to a public benefit organisation is exempt from donations tax.

30 August 2023 – kitchen assistant

Value of entire property 90 000
Value of usufruct in favour of Ms F (76 543)
Value of a bare dominium 13 457

21 September 2023 – donation at instruction of shareholder

No donations tax consequence to KMB (Pty) Ltd; the donation deemed to
be made by the shareholder.

The shareholder will not be subject to donations tax, as the donation may
be seen as a bona fide contribution to the maintenance of his son.

8 November 2023 – wedding gift

Value of donation of wedding gift 11 850
Total value of donations 25 307
General exemption – This will be limited to R10 000 per annum only
against a casual gift, as KMB (Pty) Ltd is not a natural person. As a re-
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sult, the exemption will be applied only against the donation made on
8 November 2023, even though such a donation ranked last during
the year of assessment. (10 000)
Value of donations, subject to tax 15 307

Donations tax at 20% 3 061

After making a donation, a taxpayer is required to complete form IT144 and submit
it to SARS with payment within the prescribed period. After working through this
learning unit, go to the SARS website and download this form to see if you will be
able to complete it based on the knowledge that you have acquired.

In addition, visit Learning unit 9 on the myUnisa Discussion Forum and discuss
any concepts that you do not understand. If you do understand the concepts, then
answer those students who have posted questions.

POINTS TO PONDER

 What were the reasons for implementing provisional tax and donations tax?
 Do you think these taxes are additional taxes over and above the normal tax lia-
bility in respect of taxable income?
 Does donations tax in any way affect the section 18A deduction on donations by
a taxpayer to public benefit organisations?
 Why do you think non-residents are not liable to pay donations tax, even when donating
assets within the Republic of South Africa?

WRAP-UP

In this learning unit we discussed who is liable for payment of provisional tax and donations tax, and
we explained why these taxes should be paid and how they are calculated.

You should now be able to answer the following questions:

 What is provisional tax?

 Who is liable to make provisional tax payments?
 How are provisional tax payments computed?
 What are the implications of underestimating or overestimating taxable income in determining
provisional tax payments?
 What triggers donations tax?
 Who is liable to pay donations tax?
 Which donations are specifically exempt from donations tax?
 How is donations tax calculated?

ASSESSMENT CRITERIA

You will be competent in the calculation of provisional tax when you are able to do the following:
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 Determine whether a taxpayer qualifies as a "provisional taxpayer".

 Calculate the estimate of taxable income for all provisional tax payments.

 Calculate the provisional tax payable on the estimate of taxable income, using the correct tax
rates and rebates applicable to the provisional taxpayer.

 Determine and calculate all penalties and interest payable on late or incorrect payments of pro-
visional tax.

 Identify when a disposal of property is a donation.

 Identify situations in which certain transactions could be deemed donations.

 Explain which donations are specifically exempt from donations tax.

 Calculate the amount of the general annual exemption from donations tax available to a taxpayer,
if any.

 Calculate the donations tax payable on any donation at the applicable tax rate.

 Identify the person liable for the payment of donations tax.

 Indicate the period for which donations tax will be payable.

Remember, the list above is by no means exhaustive of the manner of the assessment and merely
serves as guidance.

Literature consulted

1. Income Tax Act No. 58 of 1962

2. [Link]

3. A Student's Approach to Income Tax (Business Income) (2022)