Pre-production problems : is section 11A of the Income Tax Act a solution?

• Jurisdiction: South Africa
• Author: David Clegg
• DOI: 10.10520/EJC173414
• Published date: 01 March 2014
• Date: 01 March 2014
• Pages: 1-6
• Published By: Siber Ink

1

© SIBER INK

Pre-production Problems:

IS SECTION 11A OF THE INCOME TAX ACT A

SOLUTION?

DAVID CLEGG1

ABSTRACT

Expenditure incurred prior to the commissioning of an asset has been held by

the courts to be of a capital nature and incurred neither in the production of

income nor for purposes of trade.

The introduction of section 11(bA) was a partial solution to that problem

in relation to interest expenditure. The later introduction of section 11A dealt

with the related issue of expenditure incurred before the commencement of

trade. However, section 11(bA) was deleted with effect from January 2012 and

the question arises whether section 11A on its own, or in conjunction with

section 24J (for interest expenditure) provides any deduction for so-called

‘pre-production expenditure’ incurred in respect of new assets in an existing

trade. An analysis of the terms of both sections leads to the conclusion that a

significant risk exists that such expenses are not deductible at all.

However, true ‘pre-trade’ expenditure is generally deductible when trade

commences. Knowledge of when that can be said to occur, is essential.

This article deals with the deductibility in terms of section 11A of the

Income Tax Act, of various expenditures incurred prior to the commis-

sioning of an asset and which may be of a capital (or other, equally non-

deductible) nature.

A short case-law and legislative history lesson is necessary to set the

scene:

Most readers of this journal will be familiar with the case of CIR v

Genn and Co (Pty) Ltd2 and the notion, raised in that decision, that interest

expenditure may sometimes be of a capital nature.

That notion lay dormant for many years until the Appellate Division

(‘AD’ — now the Supreme Court of Appeal — ‘SCA’) in CIR v Allied Building

Society,3 considered the question of security expenditures incurred by a

property owner prior to the commencement of construction of an office

block for its staff. The court found4 that these expenses were not incurred

in the production of its income from trade in the year concerned and were

more closely linked to the creation of a new source of income and hence

of a capital nature.

1

B Comm (Tax Hons) LLB, Tax Counsel; Consultant to Ernst & Young.

2

1955 (3) SA 293 (AD), 20 SATC 113.

3

1963(4) SA 1 (A), 25 SATC 343.

4

At SATC 365 and 366.