SARS Interpretation Note 51 Issue 6: Pre-trade expenditure and losses (source: https://www.sars.gov.za/legal-in-51-pre-trade-expenditure-and-losses/)
INTERPRETATION NOTE 51 (Issue 6)
DATE: 4 October 2023
ACT : INCOME TAX ACT 58 OF 1962
SECTION : SECTIONS 11, 11A AND 23
SUBJECT : PRE-TRADE EXPENDITURE AND LOSSES
Content
Preamble ................................................................................................................................. 2
1. Purpose ....................................................................................................................... 2
2. Background ................................................................................................................. 2
3. The law ........................................................................................................................ 2
4. Application of the law .................................................................................................. 3
4.1 Overview of section 11A(1) ......................................................................................... 3
4.2 Deduction of pre-trade expenses after trade has commenced [section 11A(1)] ......... 3
4.2.1 Commencement of trade ............................................................................................. 3
4.2.2 Abandonment of a project before the commencement of trade .................................. 7
4.2.3 Change in intention or in the nature of the trade ......................................................... 7
4.2.4 Meaning of “that trade” ................................................................................................ 8
4.3 Pre-trade expenses actually incurred before the commencement of and in
preparation for carrying on a trade [section 11A(1)(a)] ............................................... 9
4.4 Pre-trade expenses which would have qualified under section 11, 11D or 24J had
they been incurred after the trade had commenced [section 11A(1)(b)] ..................... 9
4.5 Pre-trade expenses not allowed as a deduction in the current or any previous year
of assessment [section 11A(1)(c)] ............................................................................. 15
4.6 Ring-fencing of the deduction for pre-trade expenses [section 11A(2)] .................... 15
4.6.1 Limitation of pre-trade expenses to taxable income from the relevant trade............. 15
4.6.2 Impact of assessed loss brought forward on ring-fencing ......................................... 16
4.6.3 Claiming of pre-trade expenses limited by section 11A(2) ........................................ 17
5. Conclusion ................................................................................................................ 17
Preamble
In this Note unless the context indicates otherwise –
• “pre-trade expenses” mean expenditure and losses actually incurred by a
person before the commencement of and in preparation for carrying on a trade;
• “post-trade expenses” mean expenditure and losses actually incurred after
the commencement of the trade;
• “section” means a section of the Act;
• “the Act” means the Income Tax Act 58 of 1962; and
• any other word or expression bears the meaning ascribed to it in the Act.
All interpretation notes referred to in this Note are the latest versions available on the
1. Purpose
This Note provides guidance on the deduction of pre-trade expenses (sometimes also
called start-up costs) under section 11A.
2. Background
Expenditure and losses are generally deductible only if incurred after the
commencement of trade. Trade includes every profession, trade, business,
employment, calling, occupation or venture, including the letting of any property and
the use of or the grant of permission to use any patent as defined in the Patents Act or
any design as defined in the Designs Act or any trade mark as defined in the Trade
Marks Act or any copyright as defined in the Copyright Act or any other property which
is of a similar nature. 1
Section 11A, however, permits the deduction of expenditure and losses actually
incurred prior to the commencement of and in preparation for the carrying on of that
trade in subsequent years of assessment if the requirements are met. The expenditure
and losses are deductible in the year of assessment in which trading commences,
irrespective of the year in which it was actually incurred.
3. The law
Section 11A
11A. Deductions in respect of expenditure and losses incurred prior to
commencement of trade.—(1) For purposes of determining the taxable income derived
during any year of assessment by a person from carrying on any trade, there shall be allowed
as a deduction from the income so derived, any expenditure and losses—
(a) actually incurred by that person prior to the commencement of and in
preparation for carrying on that trade;
(b) which would have been allowed as a deduction in terms of section 11 (other
than section 11(x)), 11D or 24J, had the expenditure or losses been incurred
after that person commenced carrying on that trade; and
Definition of “trade” in section 1(1).
(c) which were not allowed as a deduction in that year or any previous year of
assessment.
(2) So much of the expenditure and losses contemplated in subsection (1) as exceeds
the income derived during the year of assessment from carrying on that trade after deduction
of any amounts allowable in that year of assessment in terms of any other provision of this Act,
shall not be set off against any income of that person which is derived otherwise than from
carrying on that trade, notwithstanding section 20(1)(b).
4. Application of the law
4.1 Overview of section 11A(1)
A pre-trade expense qualifies as a deduction under section 11(A)(1) against the
income from the trade to which it relates subject to the following four key requirements:
• The trade, in respect of which the pre-trade expense was incurred, must have
been commenced by the taxpayer. 2
• The pre-trade expense must have been actually incurred before the
commencement of and in preparation for carrying on that trade. 3
• Had the pre-trade expense been incurred after the commencement of the trade
to which it relates, it would have been allowed as a deduction under section 11
[other than section 11(x)], 11D or 24J. 4
• The pre-trade expense must not have been allowed as a deduction in that year
or any previous year of assessment. 5
Once these requirements have been met, the pre-trade expense will be allowed as a
deduction under section 11A(1) in the year of assessment in which the trade to which
it relates commences, irrespective of when these expenses were incurred, but subject
to section 23H 6 and the ring-fencing requirements of section 11A(2).
Apart from triggering a deduction under section 11A(1), the time when trade
commences is important because, subject to certain exceptions, 7 any post-trade
expenses will not be ring-fenced against the income to which they relate.
4.2 Deduction of pre-trade expenses after trade has commenced [section 11A(1)]
4.2.1 Commencement of trade
There is not much direct precedent on exactly when trade commences in South African
case law. Nevertheless, some principles can be drawn from the few available cases.
In ITC 777 8 it was held that the mere intention to let property does not constitute the
carrying on of a trade. As the company had endeavoured to let the property, it was
Introduction to section 11A(1).
Section 11A(1)(a).
Section 11A(1)(b).
Section 11A(1)(c).
See section 23H(1)(a).
The Act contains a number of other ring-fencing provisions such as those in paragraph (b) of the
proviso to section 20(1), sections 20A, 23A and 36 and paragraphs 8 and 11 of the First Schedule.
(1953) 19 SATC 320 (T).
held that the company did carry on a trade. In ITC 1476 Kirk-Cohen J stated the
following: 9
“In my view the carrying on of a trade involves an active step – something far more
than merely watching over existing investments which are not, and are not intended or
expected to be, income producing during the year in question.”
The active step must comprise more than the mere laying of plans. In C: SARS v
Contour Engineering (Pty) Ltd, Eksteen AJ stated the following: 10
“There is, however, a vast difference between the mere laying of plans for the
respondent’s future, on the one hand, and the commencement of preparatory activities
for a future venture, on the other.”
In South Africa the absence of productive assets has been found to be an indicator of
the absence of trading activity. In ITC 697 Price J stated the following: 11
“If a taxpayer has no asset with which he can trade then he cannot be trading.”
For an in-depth examination of this topic, see Interpretation Note 33 “Assessed
Losses: Companies: The ‘Trade’ and ‘Income from Trade’ Requirements”. 12
It is not a prerequisite for income to have been earned before a trade can be said to
have commenced. South African courts have consistently drawn a distinction between
the “trade” requirement and the “income from trade” requirements in section 20. 13
Expenditure incurred in expanding an existing trade
The courts have interpreted the Act as requiring that a person’s taxable income be
determined on a trade-by-trade basis with the overall taxable income being determined
by aggregating the results from the separate trades, 14 subject to certain ring-fencing
provisions such as those applicable to foreign assessed losses. 15
In the context of a company, the trade-by-trade requirement is recognised in
section 20(1)(b) which permits the set-off of an assessed loss derived from “any other
trade” against income from any trade. It provides that for the purpose of determining
the taxable income derived by any person from carrying on any trade, there shall,
subject to section 20A, be set off against the income so derived by such person –
“any assessed loss incurred by a person during the same year of assessment in
carrying on any other trade either alone or in partnership with others, otherwise than
as a member of a company the capital whereof is divided into shares”.
The question arises whether expenditure incurred in expanding an existing trade of a
specific type (for example, property letting) is a pre-trade expense. In ITC 984 16 the
appellant company sought to deduct estate agent’s commission which it had incurred
in securing a tenant for a building to be erected on land it had acquired for that purpose.
The court held that the amount was not of a capital nature. The question whether the
amount was a pre-trade expense was not considered and appears to have been
(1989) 52 SATC 141 (T) at 148.
(1999) 61 SATC 447 (E) at 456.
(1950) 17 SATC 93 (T) at 96.
In 4.1.7.
ITC 1679 (1999) 62 SATC 294 (O); ITC 1830 (2007) 70 SATC 123 (G).
ITC 729 (1951) 18 SATC 96 (N); C v COT 1966 (3) SA 6 (RAD), 28 SATC 127.
Paragraph (b) of the proviso to section 20(1).
(1961) 25 SATC 59 (C).
accepted as a fait accompli. This was probably because the company was already
carrying on a pre-existing trade of property letting and the expense in question was
more related to the derivation of future rental income than for the purpose of developing
an income-producing asset.
In Reef Estates Ltd v CIR 17 the taxpayer company carried on the business of letting
property, and for this purpose held 10 properties, eight of which were township stands
with the other two being farming properties.
One of these properties, which consisted of a vacant stand 485, situated in an out-of-
the-way side street, was purchased by the taxpayer in 1935. No income was derived
from this site until 1948 when it was let as a parking site for motor vehicles at an annual
rental of £15. The taxpayer had acquired the stand with the intention of building shops
on it as an investment, and deriving rental from them. During the year in question, the
taxpayer had incurred expenditure of £366 for rates levied on the stand by the local
authority.
The taxpayer claimed a deduction for this expenditure, which the Commissioner
disallowed. The court dismissed the appeal, and held –
“that the expenditure had not been incurred for the purpose of earning the £15 of rental
received, but primarily for the purpose of holding the stand as an asset to be used at a
later stage for the purpose of earning income from buildings”.
The court held further that the expenditure was analogous to that incurred in the
creation or equipment of an income-producing asset and was therefore of a capital
nature.
On the question of whether the vacant stand was a separate business, Rumpff J stated
the following: 18
“The facts of this matter indicate that stand 485 was acquired and is still being held with
the intention of building shops thereon and deriving rentals therefrom. It is being held
in order that it may in future become an income-producing unit. Even if the other
properties of the appellant company together are considered as one business (a point
which we need not decide) it cannot be said that stand 485 has become qualified to be
regarded as part of that business.”
It follows that when a taxpayer expands an existing business by creating an asset for
use in that business, the expenditure incurred on that asset before it is brought into
use will be of a capital nature and not incurred in carrying on the existing trade.
Example 1 – Expenditure before the commencement of trade
Facts:
A company intended to carry on trade as a television station but had not yet secured
a television licence. There was no certainty that the television licence would be secured
because the company had to apply for it alongside a number of competitors. The
company incurred preparatory expenditure on staff salaries and training costs.
1954 (2) SA 593 (T), 19 SATC 153.
At 156.
Result:
The expenditure was not incurred in carrying on a trade, since the company did not yet
have an asset with which to trade (amongst others, the television licence). See the
United States case of Richmond Television Corp. v Commissioner 19 which dealt with
a similar situation.
Preparatory activities
As noted in C: SARS v Contour Engineering (Pty) Ltd 20 already considered in 4.2.1,
the court drew a distinction between the laying of plans and the commencement of
preparatory activities, in so doing implying that the commencement of preparatory
activities may constitute the carrying on of a trade. In order to answer the question
what sort of preparatory activities would signal the commencement of a trade it must
be determined whether the taxpayer has an asset (income-earning structure) with
which to trade. Much will depend on the facts and circumstances of the particular case.
The following extract from the Contour Engineering case provides some guidance on
when a wholesale or retail outlet commences to trade: 21
“What the evidence does clearly establish is that during 1988 the respondent had no
premises, no equipment, no stock, no staff and, save for book debts, no assets. This
is clearly indicative of a company which is not trading.”
Thus, depending on the nature of the trade, the absence of some or all of these factors
(premises, equipment, trading stock and employees) may be indicative of a lack of
trading activity.
The derivation of income is not a prerequisite for carrying on a trade. It is thus possible
that trade can commence before the first sale is made. Schutz JA made the following
obiter comment in Robin Consolidated Industries Ltd v CIR: 22
“In year one a retailer acquires premises, employs staff and buys stock, but does not
open his doors until the beginning of year two. On the authority of Sub-Nigel Ltd v CIR
1948 (4) SA 580 (A) at 589-590 he would clearly be entitled to deduct the expenditure
incurred in year one from revenue earned in year two.”
Although the court was dealing with the “in production of income” requirement of
section 11(a), it seems to have accepted without question that the trade requirement
was met in year 1.
Taxpayers rendering a service must at least hold themselves out as ready to provide
services (in other words, such persons must have opened their doors for business). 23
345 F.2d 901 (4th Cir. 1965). See Interpretation Note 33 for more details on this case.
(1999) 61 SATC 447 (E).
At 456.
[1997] 2 All SA 195 (A), 59 SATC 199 at 206.
A similar approach is taken in the United States.
Example 2 – Preparatory activities comprising the carrying on of a trade
Facts:
A taxpayer acquired a farm and planted trees which will bear fruit only in 10 years’
time. During the 10-year period the taxpayer incurred recurring expenditure on salaries
and wages, fertilizer and pesticides and also claimed wear-and-tear on equipment.
Result:
It is considered that trading commences with the preparation of the land for planting
the trees. 24
4.2.2 Abandonment of a project before the commencement of trade
Pre-trade expenses relating to a project abandoned before the commencement of the
relevant trade are not deductible under section 11A.
Example 3 – Abandonment of a project before the commencement of trade
Facts:
X began preparations for the operation of a new business and incurred pre-trade
expenses of R100 000. X decided to abandon the project before the commencement
of the trade.
Result:
The pre-trade expenses are not allowable as a deduction under section 11A because
the trade to which they relate never commenced.
4.2.3 Change in intention or in the nature of the trade
Both section 11A(1)(a) and (b) refer to “that trade”.
The references to “that trade” mean that only pre-trade expenses actually incurred in
the preparation for carrying on that trade will be allowed as a deduction from the
income resulting from that specific trade.
Example 4 – Change in nature of the trade
Facts:
Company X began an airport project and incurred expenses of R5 million for technical
staff salaries, telephone costs and rates and taxes (all pre-trade expenses) while the
application for the airport operating licence was being considered by the relevant
authorities. The licence was finally declined and the project abandoned.
Two months after the project was abandoned, Company X decided to use the land and
buildings for a document-storage business. This business generated income of
R230 000 against which Company X sought to claim the amount of R5 million as a
deduction.
For a case involving the incurral of expenses in maintaining a rubber tree plantation before the trees
were productive, see Vallambrosa Rubber Co., Ltd., v Farmer (Surveyor of Taxes) 5 TC 529.
Result:
The pre-trade expenses of R5 million incurred in preparing for the airport operation are
not allowable as a deduction against the income from the document-storage business,
since section 11A(2) permits a set-off of pre-trade expenses only against income from
the same trade, namely, the airport project.
4.2.4 Meaning of “that trade”
The preamble to section 11A(1) refers to taxable income derived during any year of
assessment by a person from carrying on “any trade”. Section 11A(1)(a) then refers to
expenditure and losses –
“actually incurred by that person prior to the commencement of and in preparation for
carrying on that trade”.
The question arises whether the words “that trade” refer to the taxpayer’s trade
generally or the carrying on of trade in relation to a specific asset.
For example, a taxpayer may let out three properties and then commence to erect a
fourth building for the purposes of letting it when completed. Any expenses such as
interest, insurance and rates incurred before the fourth building is brought into use will
be of a capital nature and not in the production of income. Since the taxpayer is already
carrying on a trade of letting of property, concern has been expressed that the taxpayer
will not be entitled to claim the expenses under section 11A(1).
By way of background, section 11(bA) used to grant a deduction for pre-production
interest when a qualifying asset was brought into use. It was deleted with effect from
years of assessment commencing on or after 1 January 2012 because it was
considered that any expenditure claimable under section 11(bA) could, subject to ring-
fencing, be claimed under section 11A. Similarly, the ambit of paragraph 20(1)(g) of
the Eighth Schedule was restricted to exclude from base cost specified recurring costs
incurred in relation to assets used exclusively for business purposes because such
expenses should also qualify for deduction under section 11A. 25
It is a factual question whether a person is carrying on a single trade of letting property
or whether each new property constitutes an independent or new trade. Having regard
to the above background and the overall policy objective, SARS is of the view that in
a situation such as that described in the above example, it is highly likely that the letting
of the new property will comprise a trade that is independent from the letting of the
existing properties. Consequently pre-production expenses contemplated in
section 11A will qualify for deduction notwithstanding that a person may be carrying on
letting activities in relation to other properties.
The amendment to paragraph 20(1)(g) applies to disposals made on or after 1 January 2014.
4.3 Pre-trade expenses actually incurred before the commencement of and in
preparation for carrying on a trade [section 11A(1)(a)]
The expenditure and losses must have been actually incurred by a taxpayer before the
commencement of and in preparation for the carrying on of that specific trade.
For an expense to be “actually incurred” there must be an accrued present obligation,
whether absolute or defeasible. 26
In Edgars Stores Ltd v CIR Corbett JA (as he then was) stated the following: 27
“Thus it is clear that only expenditure (otherwise qualifying for deduction) in respect of
which the taxpayer has incurred an unconditional legal obligation during the year of
assessment in question may be deducted in terms of s. 11(a) from income returned for
that year. The obligation may be unconditional ab initio or, though initially conditional,
may become unconditional by fulfilment of the condition during the year of assessment;
in either case the relative expenditure is deductible in that year. But if the obligation is
initially incurred as a conditional one during a particular year of assessment and the
condition is fulfilled only in the following year of assessment, it is deductible only in the
latter year of assessment (the other requirements of deductibility being satisfied).”
In order for preliminary expenditure to qualify as a deduction under section 11A(1) it
must be incurred in preparation for the carrying on of a trade. The word “preparation”
requires an act of preparation, and there must be a close link between the expenditure
and the trade to be undertaken. The expenditure incurred in Reef Estates Ltd v CIR 28
considered in 4.2.1 would, probably not have qualified under section 11A(1), since it
was not incurred in preparing for the trade of letting. Preparation for carrying on a trade
involves an active step taken – something more than just passively holding a piece of
land for many years until the conditions are conducive for preparatory activities to
begin.
4.4 Pre-trade expenses which would have qualified under section 11, 11D or 24J
had they been incurred after the trade had commenced [section 11A(1)(b)]
In order for any pre-trade expenditure and losses to qualify as a deduction under
section 11A(1), a pre-trade expense must pass a “post-trade” test under one of a
number of specified sections, namely –
• section 11 (general deduction), excluding section 11(x);
• section 11D (deduction for scientific or technological research and
development); or
• section 24J (incurral and accrual of interest).
Section 11(a)
Sections 11(a) and 23(g) read as follows:
11. General deductions allowed in determination of taxable income. —For the
purpose of determining the taxable income derived by any person from carrying on any trade,
there shall be allowed as deductions from the income of such person so derived—
(a) expenditure and losses actually incurred in the production of the income,
provided such expenditure and losses are not of a capital nature;
Hoexter JA in Nasionale Pers Bpk v KBI 1986 (3) SA 549 (A), 48 SATC 55 at 71.
1988 (3) SA 876 (A), 50 SATC 81 at 90.
1954 (2) SA 593 (T), 19 SATC 153.
23. Deductions not allowed in determination of taxable income.—No deductions
shall in any case be made in respect of the following matters, namely —
(a) to (f) . . .
(g) any moneys, claimed as a deduction from income derived from trade, to the
extent to which such moneys were not laid out or expended for the purposes of
trade;
In determining a person’s taxable income derived from carrying on any trade, the
general deduction formula in section 11(a) requires that the expenditure and losses
must be actually incurred in the production of income, be laid out or expended for
purposes of trade and must not be of a capital nature. In addition, expenditure and
losses must be claimed during the year of assessment in which they are actually
incurred.
Section 23(g) prohibits the deduction of moneys not expended for the purposes of
trade.
The exclusion of section 11(x) from expenditure that would have qualified under
section 11 but for the trade requirement
Section 11(x) provides for a deduction as follows:
11. General deductions allowed in determination of taxable income.—For the
purpose of determining the taxable income derived by any person from carrying on any trade,
there shall be allowed as deductions from the income of such person so derived—
(x) any amounts which in terms of any other provision in this Part, are allowed to
be deducted from the income of the taxpayer.
The words “in this Part” refer to Part I (Normal Tax) of Chapter II of the Act which
consists of sections 5 to 37G.
Section 11D(2)
Section 11D provides for a special research and development 29 incentive regime for
companies.
The following requirements must be met for a deduction of research and development
expenditure under section 11D(2)-
• it must actually be incurred by a taxpayer
• directly and solely for research and development undertaken in the Republic,
• in the production of income and
• in the carrying on of any trade
• the research and development must be approved by the Minister of Science
and Technology and
The term “research and development” is defined in section 11D(1).
• such expenditure must be incurred on or after the date that the Department of
Science and Technology receives the application for approval of the research
and development.
Section 24J(2)
Interest 30 income and expenditure are generally dealt with under section 24J.
Section 24J(2) does not draw a distinction between interest of a capital or revenue
nature. It permits a deduction of the amount of interest which is deemed to have been
incurred during a year of assessment, from the income derived from carrying on any
trade of the “issuer” in relation to an “instrument”, 31 if that amount was incurred in the
production of the income.
Section 11A(1)(b) has the effect that any pre-trade expenses falling outside
sections 11(a) to (w), 11D and 24J do not qualify for a deduction under section 11A.
Examples include the depreciation deduction granted under either section 12B or 12C
which have their own “brought into use for the purposes of trade” requirements.
Pre-trade expenses of a capital nature
Pre-trade expenses often form part of the cost of creating a source of income. These
expenses are therefore mostly of a capital nature.
In ITC 697 32 the appellant company commenced to demolish its old building on
1 December 1947 after which it immediately began the erection of a new building. The
new building was completed in October 1948, after which it was let to tenants. For the
year of assessment ended 30 June 1948, the appellant claimed deductions for rates,
sanitary fees and interest totalling £1 110. The Commissioner disallowed the portion
of the expenditure for the period 1 December 1947 (when demolition began) to 30 June
1948 (the end of the 1948 year of assessment by which date the erection of the new
building had not been completed). Price J stated the following: 33
“The items disallowed by the Commissioner were disallowed because for a
proportionate period in respect of which the expenditure was incurred the building was
in the course of erection and was not an asset which could be used to let and to produce
income, and that the expenditure, therefore, was of a preliminary or capital nature. It
seems to me clear that until the asset becomes an asset capable of producing income
any expenditure upon it is of a preliminary nature and is not deductible... If a taxpayer
has no asset with which he can trade then he cannot be trading. The expenditure was
incurred in the creation or equipment of an asset which was intended to be used at a
later stage for the purpose of earning income. It was initial or preliminary expenditure
designed to extend the scope of the business or to improve its earning capacity. It was
money spent in an attempt to create a source of income or to acquire an advantage for
the benefit of the business which was later to be undertaken.”
As defined in section 24J(1).
As defined in section 24J(1).
(1950) 17 SATC 93 (T).
At 96.
A similar outcome prevailed in Borstlap v SBI. 34 In August 1974 the appellant in that
case, a dentist, purchased a property with the intention of erecting flats on it for rental
purposes. The plot contained an old dwelling and some outbuildings which were let for
the first five months of the 1976 year of assessment at R250 a month after which the
dwelling was occupied by a family of vagrants who managed to make use of the water
and electricity. Demolition of these structures commenced in December 1975 and
erection of the flats began during the first quarter of 1976 with the first flats being let
during the 1978 year of assessment. During the 1976 year of assessment the
appellant claimed a rental loss made up as follows:
R R
Rental income (5 × R250) 1 250
Less:
Interest on bonds used to purchase erf 1456 3 435
Insurance 161
Rates 796
Water and electricity (while dwelling occupied by vagrants) 53
Approval of building plans 108 (4 553)
Rental loss (3 303)
The Commissioner disallowed the rental loss, in so doing allowing only R1 250 of the
expenditure as a deduction under section 11(a). Having lost his appeal in the Income
Tax Special Court the appellant appealed directly to the Appellate Division. The court
held that the amounts expended on water and electricity and building plans had to be
excluded from consideration because the first was incurred when no trade was carried
on while the second was clearly of a capital nature.
The appellant argued that the expenditure was incurred in the production of income,
since income would be derived in the form of rent once the building was completed.
It was also argued that the expenses were not of a capital nature because the appellant
already had an asset in the form of erf 1456. On these arguments Corbett JA (as he
then was) stated the following: 35
“The first argument, in my view, runs counter to a series of previous decisions, including
a decision of this court. The general approach of the courts is that where a stand is
acquired with the object of erecting a building on it and to let it – and to derive an income
from it – expenditure such as interest on a bond, municipal rates, etc that is incurred
before the development has taken place and has produced income, is expenditure of
a preliminary nature and not deductible under section 11(a) (see Income Tax Case No
697 17 SATC 93 and the cases therein cited, Income Tax Case No 736 18 SATC 207
to 209; Reef Estates Ltd v CIR 1954 (2) SA 593 (T), CIR v Allied Building Society 1963
(4) SA 1(A) at 18–19).”
(Translated from the Afrikaans.)
The court went on to cite ITC 697 (above) with approval, noting that the facts were in
all material respects identical to those in the instant case.
1981 (4) SA 836 (A), 43 SATC 195.
At SATC 204.
The court concluded as follows: 36
“Such expenditure can be regarded as capital expenditure and it can also rightly be
said that it was not actually incurred in the production of income nor incurred exclusively
for the purposes of trade.”
(Translated from the Afrikaans.)
This principle was also confirmed in Reef Estates Ltd v CIR 37 which is considered in
4.2.1.
In ITC 1593 Heher J stated that – 38
“it is well established in our law that one cannot be involved in the performance of
income-producing operations unless such operations are underway. It is not sufficient
that one has the intention to set up an income-producing operation and in the course
of fulfilling that intention to expend money and then to claim that as revenue”.
The post-trade test
Since this “post-trade test” focuses only on the trade requirement of the specified
sections, it becomes necessary to consider whether the test overcomes other
requirements of these sections such as –
• the “production of income” requirement of section 11(a);
• the bar on the deduction of expenditure of a capital nature, as for example, in
sections 11(a) and (c);
• the requirement that the deduction applies to “expenditure and losses”; and
• the “use” requirement of, for example, section 11(e).
Whether these requirements are met must be determined by the facts and
circumstances of each case.
In most situations it should be a relatively simple matter to show that once trade
commences the relevant expenditure would have been capable of producing income
if incurred at that time.
Recurring-type expenditure incurred before trade commences invariably takes on the
character of expenditure of a capital nature because it is incurred in the setting up of
an income-earning structure. 39 The effect of the post-trade test on such expenditure is
to change it to a revenue nature because the presumption is that it is incurred after the
income-earning structure has been established. Examples of pre-trade expenses
qualifying under section 11A(1)(a) typically include the cost of accounting and audit
services, advertising and marketing, electricity and water, insurance, rates, rent,
salaries and wages, staff training, trading stock acquired before the commencement
of trade and telephone costs.
However, pre-trade expenses that retain their capital nature even if incurred after trade
commences will not qualify for deduction under section 11A(1). Examples include the
cost incurred by a lessee in drawing up a lease agreement, 40 the legal costs incurred
At SATC 207.
1954 (2) SA 593 (T), 19 SATC 153.
(1994) 57 SATC 251 (T) at 256.
See Borstlap v SBI 1981 (4) SA 836 (A), 43 SATC 195.
ITC 50 (1926) 2 SATC 123 (NA) ; ITC 215 (1931) 6 SATC 133 (U).
in securing a trading licence, 41 the cost of drawing up building plans 42 and the cost of
a feasibility study. Such expenses are incurred once-off and are a direct cost of setting
up the income-earning structure and cannot be divorced from it by the post-trade test.
Section 11A(1)(b) refers to “expenditure and losses”. The question is whether this
wording includes an “allowance” as opposed to “expenditure”. Examples of allowances
include the allowance for any lease premium granted under section 11(f) and the
allowance for specified intellectual property granted under section 11(gA). Despite an
allowance sometimes colloquially being understood to be an otherwise inadmissible
expense, the section 11 allowances are in principle deductible as pre-trade expenses,
because of the wording of section 11A which refers to “expenditure . . . allowed as a
deduction”. The allowances granted under section 11(cA); (e) (subject to what is stated
below), (f), (g), (gA), (gC), (gD) or (hB) will therefore potentially qualify for deduction
under section 11A(1) after the particular trade has commenced
A taxpayer may thus be entitled to claim amounts that could not previously be claimed
during the pre-trade period.
Although the wear-and-tear or depreciation allowance in section 11(e) is based on the
“value” of an asset rather than on its cost, SARS in most instances interprets the term
“value” to mean “cost to the taxpayer” for the purpose of determining the allowance.
However, section 11A will not apply to the wear-and-tear or depreciation allowance on
assets that do not have a cost to the taxpayer, such as those acquired by donation or
inheritance, since in these instances the allowance will be based on market value and
not actual expenditure.
In addition, it is a requirement of section 11(e) that the asset be “used” by the taxpayer
for the purposes of the taxpayer’s trade. Thus, an asset acquired before the
commencement of trade that is not “used” during the pre-trade period will not qualify
for a deduction under section 11A. This could happen if the asset is, for example,
placed in storage pending the commencement of trade.
Example 5 – Wear-and-tear allowance qualifying for deduction under
section 11A
Facts:
Company A’s financial year ends on the last day of February. On 1 September 2021
Company A hired premises for the purposes of carrying on trade as a general dealer.
Before trade could commence, Company A had to install various shop fittings and
equipment such as cash registers and refrigerators. On 1 September 2021 Company A
purchased a delivery vehicle for R200 000 which it used during the pre-trade period to
transport shop fittings and equipment to its premises. On 1 March 2022 the company
commenced trading. Interpretation Note 47 provides that delivery vehicles may be
written off over four years under section 11(e).
ITC 1224 (1974) 37 SATC 30 (T).
See Borstlap v SBI above.
Result:
Year ended 28 February 2022
Company A is not entitled to the wear-and-tear allowance for the six-month period
1 September 2021 to 28 February 2022 because it did not trade during this period.
Year ended 28 February 2023
On 1 March 2022 the company is entitled to a deduction under section 11A(1) of
R25 000 (R200 000 × 25% × 6 / 12) for the wear-and-tear allowance applicable during
the pre-trade period 1 September 2021 to 28 February 2022. The company also
qualifies for the wear-and-tear allowance for the 12 months ended 28 February 2023
under section 11(e) of R50 000 (R200 000 × 25%). Thus in the 2023 year of
assessment the company is able to claim wear-and-tear allowances totalling R75 000
(R25 000 + R50 000).
4.5 Pre-trade expenses not allowed as a deduction in the current or any previous
year of assessment [section 11A(1)(c)]
Only pre-trade expenses which were not allowed as a deduction in the current or any
previous year of assessment will qualify for a deduction under section 11A.
4.6 Ring-fencing of the deduction for pre-trade expenses [section 11A(2)]
4.6.1 Limitation of pre-trade expenses to taxable income from the relevant trade
Section 11A(2) limits the deduction allowable under section 11A(1) to the taxable
income from the relevant trade. If the pre-trade expenses exceed the taxable income
of that trade, the excess pre-trade expenses may not be set off against the income
from any other trade notwithstanding section 20(1)(b). Section 20(1)(b) permits a
taxpayer to set off an assessed loss incurred in one trade against any income from
another trade derived during the same year of assessment. Any pre-trade expenses
not allowed because of insufficient taxable income from the particular trade must be
carried forward for set-off against any future taxable income from that trade (see 4.6.3).
Pre-trade expenses cannot create an assessed loss in respect of the trade to which
they relate, and cannot increase an assessed loss from that trade.
It is, therefore, possible for a taxpayer to carry forward an assessed loss and any pre-
trade expenses from the same trade at the same time. The assessed loss brought
forward would result from post-trade expenses, while the pre-trade expenses carried
forward would arise from the limitation under section 11A(2).
Example 6 – Limitation of deduction of pre-trade expenses
Facts:
The following details relate to Company X, which commenced trading during the
current year of assessment.
R
Pre-trade expenses 100 000
Income from trade 150 000
Deductible post-trade expenses 80 000
Result:
R
Income from trade 150 000
Less: Deductible post-trade expenses (80 000)
Subtotal before deducting pre-trade expenses 70 000
Less: Pre-trade expenses of R100 000 limited (70 000)
Taxable income Nil
Pre-trade expenses 100 000
Less: Pre-trade expenses deducted limited (70 000)
Balance of pre-trade expenses carried forward 30 000
The balance of the pre-trade expenses of R30 000 will be carried forward and will be
available for set-off against future taxable income from this trade.
4.6.2 Impact of assessed loss brought forward on ring-fencing
Any assessed loss brought forward from the previous year of assessment (referred to
as any “balance of assessed loss” in section 20) must be allocated between the various
trades to which it relates in order for section 11A(2) to be applied. The deduction for
pre-trade expenses relating to a particular trade is limited to the taxable income from
that trade which remains after the set-off of any balance of assessed loss incurred in
that trade.
Example 7 – Assessed loss brought forward
Facts:
References in this example to years 1, 5 and 6 are to the respective years of
assessment ending on the last day of February.
Company Y carries on two trades, A and B. Trade B commenced during year 1 while
Trade A commenced during year 5. At the end of year 5 the company had assessed
losses carried forward of R50 000 from Trade A and R10 000 from Trade B. The
company had unclaimed pre-trade expenses of R40 000 from Trade A at the end of
year 5. During year 6 the company had income of R100 000 from Trade A and
R200 000 from Trade B. Allowable post-trade expenses incurred during year 6 for
Trades A and B amounted to R20 000 and R50 000 respectively.
Result:
Company Y’s taxable income for year 6 is determined as follows:
Trade A Trade B
R R
Income 100 000 200 000
Less: Allowable post-trade expenses (20 000) (50 000)
Assessed loss brought forward (50 000) (10 000)
Subtotal 30 000 140 000
Pre-trade expenses brought forward 40 000
Less: Pre-trade expenses deducted
in current year (30 000) (30 000)
Balance of pre-trade expenses
carried forward 10 000
Taxable income Nil 140 000
Under section 11A(2) the balance of pre-trade expenses of R10 000 from Trade A may
not be set off against the taxable income of R140 000 from Trade B.
4.6.3 Claiming of pre-trade expenses limited by section 11A(2)
The mechanism for claiming pre-trade expenses limited under section 11A(2) is
contained in section 11A(1). The opening words of section 11A(1) refer to the
determination of taxable income derived during any year of assessment in which the
trade is being carried on. The words “any year of assessment” could be either the year
of assessment in which trade commences or any subsequent year of assessment.
5. Conclusion
While this Note provides general guidance on the application of section 11A, the facts
and circumstances of each case must be considered in determining when and if pre-
trade expenses will qualify for a deduction under this section.
Leveraged Legal Products
SOUTH AFRICAN REVENUE SERVICE
Date of 1st issue : 4 November 2009
Date of 2nd issue : 4 February 2014
Date of 3rd issue : 22 July 2014
Date of 4th issue : 5 May 2017
Date of 5th issue : 27 June 2018
Diamond Export Levy Act, 2007
