Gross Income Definition Based On Court Cases

1
Gross Income:
Definition of a ‘resident’
• Principle? (ordinarily resident – test)

– A person is ‘ordinarily resident’ in the place where
he will return to after his ‘wanderings’ (his home)
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3
Gross Income:
Definition of a ‘resident’
• Principle? (ordinarily resident – test)

– A person is ‘ordinarily resident’ where he normally
resides, apart from temporary or occasional
absences
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4
5
Gross Income:
There must be an amount!
amount
• Principle?
─ The onus is on the Commissioner (SARS)
to determine the ‘amount’
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6
7
Gross Income:
There must be an amount in cash or otherwise!
otherwise
• Principle?
– The right to an interest free loan is
• an amount and
• this right has value in money!
money
9
Gross Income:
Meaning of ‘accrued’
• Principle?
– ‘Accrued’ refers to the amount ‘to which
the taxpayer has become entitled to’
11
Gross Income:
• Principle?
─ ‘Accrued’
Accrued means ‘entitled to’ which is not
the same as ‘due and payable’
payable
─ This means that amounts not yet payable and
outstanding at the end of a year of assessment,
accrue to the taxpayer and should be included in the
taxpayer’s gross income in that year of assessment
13
Gross Income:
• Principle?
─ Meaning of ‘accrued’ is extended to
• ‘unconditionally entitled to’ payment
15
Gross Income:
• Principle?
– ‘Accrued’
Accrued refers to amounts accrued to or in
favour of the taxpayer
– Once the taxpayer becomes entitled to the amount as
principal it becomes gross income in his hands even
though he may have an obligation to pay it over to
some other person
17
Gross Income:
Meaning of ‘received’
• Principle?
• An amount is only received by the taxpayer, if it is
received
• on his own behalf
and
• for his own benefit
19
Gross Income:
• Principle?
• An amount has only been received by the
taxpayer if such taxpayer has intended to receive
the amount for his or her own benefit
• The issue is whether the thief intended to keep the
money to benefit from it
21
Gross Income:
• Principle? (deposits)
– Deposits are amounts received and
should be included in gross income
• unless they are deposited into a
separate trust account set up
specifically for deposits received
My
intention
is…
23
Gross Income:
Meaning of ‘not of a capital nature’
• Principle? (intention)
– The intention of the taxpayer,
taxpayer both at the time
of acquiring the asset and at the time of its sale,
is of great importance
– If the intention is…
• Speculation = not of a capital nature
• Investment = of a capital nature
I can
change my
intention
25
Gross Income:
• Principle? (change of intention)

– The test to determine whether a taxpayer
has gone over from realising an asset to
his best advantage to a profit-making
scheme is one of degree
Richmond
Richie Rich
Director
27
Gross Income:
• Principle? (intention in the case of a company)

company
– A company is an artificial person ‘with no body to kick
and no soul to condemn’
– The intention of a company is determined from the
directors’
• formal acts (resolutions of directors), and
• informal acts (actions of directors)
Richmond Can a
taxpayer
change its
intention ?
Richie Rich
Director
29
Gross Income:
‘not of a capital nature’
• Principle? (change in intention)

– A taxpayer can change his intention, but the mere
fact that a taxpayer sells his capital asset at a profit
cannot per se make the profit subject to tax
31
Gross Income:
• Principle? (mixed intentions)

– Determine the main purpose (dominant
intention) why the taxpayer acquired the
asset and tax accordingly
• If there is no dominant intention,
intention speculation
would be considered the dominant intention
and the amount will be revenue of nature
33
Gross Income:
• Principle? (scheme of profit-making)

– Where the taxpayer participates in a scheme of
profit-making,
profit-making the proceeds are revenue of nature
(not of a capital nature) and taxable as gross income
35
Gross Income:
• Principles? (intention)
1. The intention of the taxpayer at the date of
acquisition is crucial, unless the intention of the
taxpayer changed prior to sale
2. Every taxpayer is entitled to realise such asset to
his best advantage without it being considered a
change in intention
#1
Good #2
Sell at a profit
investment
when the
with regular dividend yield
dividends! becomes
unsatisfactory!
37
Gross Income:
• Principle? (alternative intentions)

– If an individual has an original intention which is
capital in nature and a secondary intention which is
revenue in nature and the two purposes are pursued
simultaneously
• the secondary intention would affect the primary
intention and result in profits being taxed as revenue
in nature
x
39
Gross Income:
• Principle? (change in intention)

─ If a taxpayer changes intention from holding a capital
asset to embarking on a scheme of profit-making in
selling the asset (‘cross the Rubicon’),
Rubicon’ the profits will
be of a revenue nature and fall into gross income
• Look at the nature and extent of the taxpayer’s
operations to determine whether the taxpayer
‘had crossed the Rubicon’ and started a ‘scheme
of profit-making’
41
Gross Income:
• Principle? (change in intention (realisation

company)
– The mere use of a realisation company to realise a
capital asset, does not indicate a change in intention
as to engage in a scheme of profit-making
• Where a realisation company is merely used to
realise the capital asset to the best advantage, the
profit will be capital of nature
43
Gross Income:
• Change in intention (realisation company)

• Principle?
– Where there is no justification for forming a
realisation company (like there was in the Berea West
case), the intention of the original entity cannot be
rolled over to the realisation company
• The realisation company will then stand in its own
shoes: if it acquired the asset with the intention to sell
it at a profit, the profit will not be of a capital nature
45
Gross Income:
• Principle? (change in intention (meaning))

– The mere change of intention to dispose of an asset
hitherto held as capital does not per se subject the
resultant profit to tax. Something more is required in
order to metamorphose the character of the asset
and so render its proceeds as gross income.
47
Gross Income:
• Principle? (nature of the asset)

– ‘Income’ is the ‘fruit’
fruit produced by ‘capital’ (the ‘tree’)
– ‘Capital’
Capital is the ‘tree’
tree which is the income-producing asset
• How to use this case?
─ Income from selling fruit would be ‘gross income’
─ Proceeds from selling the ‘tree’ (income-producing asset) is
not ‘gross income’, i.e. capital of nature
Fixed capital versus floating capital
49
Gross Income:

– The sale of fixed capital assets is of a capital nature,
and
– The sale of floating assets (like trading stock) is of a
revenue nature
51
Gross Income:

─ An asset acquired with the intention to own it as an
investment will remain capital in nature where the
disposal of it occurs due to unusual/special
circumstances
53
Gross Income:
• Principle? (damages and compensation)
– A distinction must be drawn between two types of
agreements
1. a contract directed by its performance towards making a profit –
for example a normal lease agreement, and
2. a contract which establishes an income-producing asset – for
example a franchise agreement
– Received for the cancellation of
1. the first agreement, would be revenue of nature
2. the second agreement, would be capital of nature
55
Gross Income:
• Principle? (damages and compensation)

– Where compensation is paid in respect of a capital
asset (in this case, the exclusive right to distribute
Bell’s whisky), it is acceptable that the capital asset is
valued with reference to future profits (profits
expected from Bell’s whisky sales)
– The compensation in respect of the capital asset (the
impairment of the taxpayer’s business) will still be
regarded capital of nature
57
Gross Income:
The amount must be received or accrued!
• Principle? (the legality of income)

─ Illegal receipts would also constitute gross
income…
• The legality of income is irrelevant to the
question of the liability of that income for tax
purposes
59
Gross Income:
The amount must be received or accrued!
• Principle? (the legality of income)

─ Illegal receipts would also constitute gross
income…
• if such taxpayer has intended to receive the
amount for his or her own benefit
61
Gross Income:
paragraph (a)
• Principle? (What constitutes an annuity?)

– An annuity has three characteristics:
1. it is an annual payment
2. it is repetitive
3. it is chargeable against some person
63
Gross Income:
paragraph (n)
• Principle? (recoupment)
─ ‘Recover or recoup’ means to ‘return to the
taxpayer’s pocket’ something which had previously
been an expense
65
Gross Income:
paragraph (c)
• Principle? (voluntary payments)

– Any voluntary payment by a company to a taxpayer
that is directly linked to the taxpayer’s services
• is taxable in terms of par (c) of the gross income
definition
Timing is everything!!
67
General Deduction Formula:
Meaning of ‘during the year of assessment’
• Principles?
1. Expenditure is only deductible during the year of assessment that
it was incurred
• It cannot be carried forward to claim in a subsequent year or carried
backward to claim in a previous year
2. To be deductible, it is not necessary that expenditure produce income
in the year it was incurred
• The income may be earned only in future years, as long as the expenditure
has been laid out for the purpose of earning that income
69
Meaning of ‘trade’
• Principle?
─ The definition of ‘trade’ should be given the widest
possible interpretation and includes any profitable
activity
• even if it was a single activity
71
Meaning of ‘in the production of income’
• Principle?
─ Two aspects must be investigated:
1. Firstly, the purpose of the expense (act that lead to expense)
must be determined
2. Secondly, it must be determined if this expense (act) is
closely linked to the business operations of the taxpayer
─ If the answer is positive, the expenditure is deductible
● In other words, the expenditure is an inevitable concomitant
of the income-producing operations of the taxpayer
73
Meaning of in the production of income
• Principle?
─ The court felt that the expenditure arose out of
negligence of the taxpayer (engineering firm), and
─ The taxpayer was unable to show that such
negligence was a necessary concomitant of their
trading operations
75
• Principle? (amounts paid to former

employees)
– Amounts paid to former employees in recognition of prior
services rendered will not qualify as a deduction, because
it is not in the production of any current or future income
– If, however, the expenditure is incurred to induce all
employees to enter and remain in the service of the
taxpayer (happy staff),
staff) the expenditure may qualify as a
deduction since the purpose is to produce current or
future income
77
• Principle?
– The ‘income’ referred to is gross income less exempt
income
• The portion of any expenditure relating to
dividend income should therefore be disallowed
and the remainder relating to income-producing
activities should be allowed
• The court held that the a reasonable
apportionment method be used as yardstick on
which apportionment must be based
nemojim
79
• Principle?
─ Expenditure with a dual purpose that cannot
accurately be appropriated either to income or to
exempt income, should be apportioned
81
Meaning of ‘actually incurred’
• Principle?
─ Actually incurred = unconditional liability
─ Distinguish between the liability itself being conditional (like in
Nasionale Pers) and the amount being uncertain
• If a liability is unconditional (certain) but the amount cannot be quantified,
─ the amount must be estimated based on available information and
claimed in that tax year
(be aware of s 24M)
83
• Principle?
─ Actually incurred = unconditional liability
• Before an expense can be deducted, it must be unconditional
• The expense must not be contingent on a future event
─ In this case the bonuses were only payable if the
employees were still in the service of the taxpayer after
year end and therefore the bonuses were not deductible
Golden Dumps
85
• Principle?
─ A deduction in respect of a disputed claim cannot
be claimed if the outcome of the dispute is
undetermined at the end of the tax year
LABAT
87
• Principle?
─ The issuing of shares by a company does not amount to
expenditure ‘actually incurred’
─ ‘Actually incurred’ means either
• expenditure for which a liability has been incurred
OR
• the action of spending funds (diminution of assets)
─ The issuing of shares is neither. It does not reduce the assets
of a company even though it may reduce the value of the
shares held by its shareholders.
New State Areas 89
Meaning of not of a capital nature
• Principle?
– Distinguish between:
• Cost of performing income-earning operations (laying of
eggs)
– Of a non-capital nature and deductible
• Cost of establishing or improving income-earning assets
(goose)
– Of a capital nature and non-deductible
Rand Mines Watering tree, etc. =
working the income-
earning structure
Buying tree = acquiring

income-earning structure
91
• Principle?
– The expenditure in this case was held to be capital in
nature because it was a cost expended to acquire or
create an income-earning structure
– Distinguish this from expenditure incurred to work the
income-earning structure (revenue of nature)
nature
BP Southern Africa
93
• Principle?
─ Where no new capital asset for the enduring benefit
of the taxpayer has been created, the expenditure
tends to assume more of a revenue character
Flemming
95
Special Deductions:
Meaning of repair (s 11(d))
• Principle?
─ If the taxpayer cannot prove that something went
wrong with the asset itself (it had become
defective and required replacement), expenditure
was not incurred on the repair of the asset
African Products
97
Special Deductions:
Meaning of repair (s 11(d))
• Principles?
1. Repair is restoration by renewal or replacement
of subsidiary parts of the whole,
whole which does not
result in an improvement in the asset
2. In the case of repairs affected by renewal,
renewal it is
not necessary that the materials used should be
identical with the material replaced
99
Special Deductions:
Meaning of trading stock (s 22)
• Principle?
─ Section 22 does not apply to trading stock if acquired
and wholly disposed of during the same year of
assessment
• The court held that sand (removed from the ground by a
transport contractor who took it away and paid the farmer
for the sand) only became trading stock when taken from
the ground
• BUT because it was taken away in the same year of
assessment, s 22 of the Income Tax Act could not apply to it
101
Special Deductions:
Trading stock acquired for low consideration
• Principle?
– In practice SARS allows a s 11(a) deduction of the trading
stock at date of acquisition
• The market value (s 22(4)) is used where the trading
stock was acquired for no consideration
– but where the trading stock was acquired for a
consideration (even if low or not stipulated in
contract), it is deductible at cost price (s 22(2)(b))
103
Trading stock:
Value of ‘closing stock’
• Principle?
• Closing stock should be valued at cost price
(not at lower of cost or net realisable value)
• The value of trading stock can only be reduced below
cost price if the trading stock is worth less due to
damage, deterioration, change in fashion, decrease in
market value or any other reason accepted by the
Commissioner
105
Prohibition of Deductions:
Non-trade expenditure (s 23(g))
• Principle?
─ Where social responsibility expenditure is incurred
to ensure the company’s trading success (prevent
the loss of its status as a subsidiary of the US
parent), the expenses are incurred for the purposes
of trade and in the production of income
107
Prohibition of Deductions:
Non-trade expenditure (s 23(g))
• Principle?
─ Interest cost on a loan in close proximity of a
dividend declared are incurred for the purposes
of trade provided
─ sufficient cash was available in the company to pay the
dividend declared without having to obtain the loan
─ and
─ the company would still have been able to conduct its
normal trading activities without the loan
SA BAZAARS
109
Balance of Assessed Loss:
S 20 - right to carry forward
• Principle?
─ Where a company does not carry on trade in
any one year, it loses the right to carry forward a
balance of assessed loss beyond that year
Robin Consolidated
Industries
111
Balance of assessed loss:
s 20 - right to set-off
• Principle?
─ The taxpayer is only entitled to the set-off of a balance
of assessed loss
• against income derived from trade
and
• if carried forward from the preceding year of
assessment
= s7
application
Aunty
Avoidance
113
Section 7 Application:
interest free loans
• Principle?
– An interest-free loan advanced by the taxpayer is also
regarded as a continuing donation
• The resulting income must be included in the
taxpayer’s income in terms of section 7
3%= s 25B
application Aunty
Avoidance
2%= s 7
application
115
Section 7 Application:
low interest loans
• Principles?
1. In the case of a low interest loan, the resulting income
that must be included in the donor’s income (in terms of
s 7) is limited to the gratuitous interest portion
• Gratuitous interest is calculated annually, based on
market-related interest less actual interest
– The in duplum rule does not apply to s 7
1. The in duplum rule prohibits the accrual of interest
when interest due exceeds capital outstanding
SARS v British Airways
117
VAT:
Recovery of VAT
• Principle?
─ A single supply of service may only be split into
different supplies (as per s 8(15)) WHERE
• the vendor himself provides more than one supply
AND
• each supply attracts a different tax rate
119
VAT:
Commercial Accommodation
• Principle?
• The supply of the use of a building by a vendor to an
institution cannot constitute a “dwelling” or
“commercial accommodation” if the lessee (the
institution) is a juristic person who is by its nature
incapable of living in the accommodation
121
VAT
Zero-rated
Zero services
• Principle?
– The supply of the exclusive distribution right (to distribute
Bell’s whisky) by SFW was subject to VAT at the zero rate,
rate
because
• it is the supply of services to a non-resident; not
directly in connection with property situated in the
Republic (incorporeal property registered in the United
Kingdom)
• and falls within the purview of s11(2)(l)(ii) of the VAT
Act
123
VAT
Zero-rated
Zero services
• Principle?
– The supply of services (in this case foreign exchange
services in the duty free area of an international airport)
is not subject to VAT at the zero rate,
rate because
• the non-resident is present in the Republic at the time the
services are rendered (the duty-free area of an international
airport is not regarded to be outside the Republic)
• The service therefore falls outside the purview of s11(2)(l) of
the VAT Act
– VAT at the standard rate will thus be levied
125
VAT
Zero-rated
Zero services
• Principle?
– The supply of services to foreign tour operators is not
subject to VAT at the zero rate,
rate if the services are rendered
to persons present in South Africa at the time the services
are rendered
– The benefit of the services rendered is therefore
enjoyed and consumed in South Africa
• This means that the service falls outside the purview of
s11(2)(l) of the VAT Act and VAT at the standard rate will thus
be levied
127
VAT
Barter transactions
• Principles?
– In an arms’ length barter transaction the value that the
parties have attributed to the goods or supplies are a
reliable indicator of their market value (in the absence of
any contrary indication)
129
VAT:
For the purpose of making taxable supplies
• Principle?
─ Certain foreign and local advisory services acquired
were not incurred in the course of and furtherance
of De Beers’ diamond mining enterprise ( taxable
supplies)
supplies
• but were rather acquired for the benefit of the
departing shareholders (exempt supplies)

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1

• Principle? (ordinarily resident – test)

• Principle? (ordinarily resident – test)

• Principle? (change of intention)

• Principle? (intention in the case of a company)

• Principle? (change in intention)

• Principle? (mixed intentions)

• Principle? (scheme of profit-making)

• Principle? (alternative intentions)

• Principle? (change in intention)

• Principle? (change in intention (realisation

• Change in intention (realisation company)

• Principle? (change in intention (meaning))

• Principle? (nature of the asset)

• Principle? (nature of the asset)

• Principle? (nature of the asset)

• Principle? (damages and compensation)

• Principle? (the legality of income)

• Principle? (the legality of income)

• Principle? (What constitutes an annuity?)

• Principle? (voluntary payments)

• Principle? (amounts paid to former

Buying tree = acquiring

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