on 11(a) of Income Tax ActionAct No 58 of 1962
A TECHNICAL REPORT TO BE PRESENTED TO
THE DEPARTMENT OF ACCOUNTING
UNIVERSITY OF CAPE TOWN
IN PARTIAL FULFILMENT OF
THE REQUIREMENTS FOR THE
BATCHELOR OF COMMERCE (HONOURS)
DEGREE IN TAXATION
STUDENT NO. CRWPET005
I certify that the report is my own work and all references used, are
Generally Accepted Accounting Practice includes statement AC000: Framework for
the preparation and presentation of financial statements. This sets out broad
and definitive rules governing the recognition of liabilities and income and
expenditure in financial statements. Specifically the following paragraphs need
to be considered:
Recognition of liabilities:
91. A liability is recognised in the balance sheet when it is probable
that an outflow of resources embodying economic benefits will
result from the settlement of a present obligation and the amount
at which the settlement will take place can be measured reliably…
Recognition of expenses:
94. Expenses are recognised in the income statement when a decrease in
future economic benefits related to a decrease in an asset or
an increase of a liability has arisen that can be measured
reliably. This means in effect that recognition of expenses
occurs simultaneously with the recognition of an increase
or a decrease in assets
95. Expenses are recognised in the income statement on the basis
of a direct association between the costs incurred and the and the
earning of specific items of income. This process, commonly
referred to as the matching of costs with revenues, involves the
simultaneous or combined recognition of revenues and expenses that
result directly and jointly from the same transaction or other
The fisc takes little notice of these rules when it comes to the recognition of
expenditure for the purposes of taxation. It is the part of these rules that
govern the general deduction provision that this report will examine.
Section 11(a) of the South African Income Tax Act No. 58 of 1962 (as amended)
reads as follows:
11. General deductions allowed in the determination of taxable income.-
For the purpose of determining the taxable income derived by any
person from the carrying on of any trade within the Republic, there
shall be allowed as deductions from the income of such person so
(a) expenditure and losses actually incurred in the Republic in the
production of the income, provided such expenditure and losses
are not of a capital nature.
The section defines the conditions that must be met for expenditure and losses
to be allowed as deductions from income. The expenditure or losses must have
In the Republic of South Africa.
In the production of the income.
Such expenditure or losses must not be of a capital nature.
The section has to be read together with s23(g)
23. Deductions not allowed in the determination of taxable income.-
No deductions shall be made in respect of any moneys, claimed
as a deduction from trade, to the extent to which such monies
were not laid out or expended for the purposes of trade.’
This report will focus on the meaning of the term “actually incurred” (as a
critical part of the recognition process) and not on the other requirements. It
will explore the difference between the accounting requirements for expenditure
and liabilities to be recognised, and the requirements for recognition for
Income Tax purposes. It will try to better understand the meaning and
implications of this phrase, with a view to be able to better manage and control
its impact on the recognition of expenditure and losses. It will also explore
some of the grey areas that can and have caused the taxpayer and the fisc
considerable problems in the past. In concluding, some of the recent legislative
changes will de discussed and considered.
2. ACTUALLY INCURRED IN THE CONTEXT OF SECTION 11(a).
Section 11(a) of the South African Income Tax Act No. 58 of 1962(as amended),
reads as follows:
11. General deductions allowed in determination of taxable income.-
For the purpose of determining the taxable income derived
by any person from the carrying on of any trade within the
Republic, there shall be allowed as deductions from the
income of such person so derived-
(a) expenditure and losses actually incurred in the Republic in the
production of the income, provided that such expenditure and
losses are not of a capital nature.
Section 11(a) is broadly referred to as the general deduction provision. It is
intended to cover the requirements for expenditure and losses to be deductible
in the determination of taxable income. Whilst the section is comprehensive as
it stands, there is a further critical requirement that the expenditure and
losses have been incurred during the year of assessment. This is not expressly
stated in the section, but it is considered to be implicit that expenditure is
only deductible for tax purposes, in the year in which it is incurred.
Significant important case law exists to support this contention. Thus, should
expenditure, usually deductible under s11(a), not be claimed as a deduction in
the year in which it is incurred, it may not be claimed in any other year,
unless the Act provides otherwise.
The recognition or deductibility of expenditure, provided all the other
requirements are met, is triggered by incurral. This report will focus on three
main issues surrounding incurral:
a. Was expenditure actually incurred? To establish this, one needs to
understand and define
exactly what constitutes actual incurral.
b. When did incurral take place?This will lead to understanding exactly
when the action or
actions which triggered incurral, took place. The timing of incurral will
determine the year of
assessment in which the expenditure or loss may be deductible in the
determination of taxable
In the Caltex Oil case Botha J.A. made the point that income tax is
assessed on an annual
basis , this lends support to the contention that expenditure incurred in a
particular year of
assessment is only deductible in that same year. The determination of the
year in which the
expenditure or loss is actually incurred, brings more problems to be
c. There is the problem of expenditure in respect of which the obligation
to pay is, or during
the year, becomes, unconditional, but which cannot be quantified until
after the termination of
the year of assessment.
This again leads to a plethora of problems to resolve. The second year
problem being but only
All the issues give rise to thorny problems. There are many more issues. The
courts and the legislature have battled. Some of the problems encountered have
been raised by the two most recent Commissions of Inquiry such that legislation
has recently been introduced to resolve them in the future. This will also be
discussed and considered.
The primary objective of this report is to try to help to better understand this
fundamentally critical area of the tax law.
Planning to avoid future problems is easier then dealing with a problem
after it has arisen, because history cannot be changed except in exceptional
circumstances To be able to plan so that the occurrence of incurral can be
planned rather then simply to be in the lap of the Gods. This is infinitely
better then defending past actions. It is both cheaper and the outcome much more
3. WHY IS “ACTUALLY INCURRED” SUCH A CRITICAL PROVISION:
3.1 What does it mean to be actually incurred .
In interpreting a fiscal statute,
It is important to distinguish between the presumptions of statutory
interpretation and the
rules or canons of construction. The presumptions have obligatory force,
being legal rules
derived from the common law. They are intrinsic to the principle of
legality because they
qualify parliament s legislative enactments and existside by side
provisions of all statutes. The rules or canons of construction, on the
other hand, have no
status as legal rules and are merely conceptual models applied(or not
applied as the case may
be) by judges grappling with the meaning of particular legislative
The traditional approach to the interpretation ofstatutes, often
referred to as the
Cardinal rule, holdsthat the literal meaning of the wording of a
provision must be
ascertained by the use of ordinary grammatical rules. If the meaning of
the words is clear,
then this meaning represents the intention of Parliament, the object of
interpretation always being to stamp a particular meaning with the
Legislature s impramatur
by means of the fiction of parliamentary intent.
Considerations of equity, hardship, or social policy are irrelevant once
of Parliament is unambiguously established. .
In Partington v Attorney General, Lord Cairns stated that
if a person sought to be taxed comes within the letter of the
law, he must be taxed, however great the hardship may appear
to the judicial mind to be. In other words, if there may be an
equitable construction, certainly such a construction is not
admissible in a taxing statute.
In Cape Brandy Syndicate vs IRC Rowlatt J. 71 said:
In a taxing Act one has to look merely at what is clearly
said. There is no room for any intendment. There is no
equity about a tax. There is no presumption as to tax.
Nothing is to be read in, nothing is to be implied. One can
only look fairly at the language used.
Given some of the rules of interpretation above, it must be apparent that great
care must be taken when trying to establish the meaning of fiscal statutes. The
end result does not have to be equitable or reasonable. It is therefore
critically important to understand the law so that the taxpayer is able at the
outset to properly plan his affairs so as to achieve tax efficiency, while at
all times keeping within the law. In IRC v Duke of Westminster Lord Tomlin said
at 19 TLR 472,
Every man is entitled, if he can, to order his affairs so
that the tax attaching under the appropriate Acts is less
than it otherwise would be .
To have been actually incurred , means that an unconditional legal liability to
pay now or at some other time has arisen. Payment does not have to have been
effected for incurral to have occurred. Once the events that constitute incurral
have taken place, the expenditure or loss has been actually incurred , and the
expense or loss will be recognised in the determination of taxable income, given
the assumption that all other requirements have been met. Thus incurral can be
seen to be that which triggers recognition.
GAAP lays down very clearly that:
Recognition of liabilities A liability is recognised in the balance
sheet when it is probable that an outflow of resources embodying
economic benefits will result from the settlement of a present
obligation and the amount at which the settlement will take place
can be measured reliably.
Thus, probability can precipitate recognition in the financial statements. This
is then brought to account by raising provisions to cater for anticipated
probable expenditure. The Act very clearly in Section 11(a), requires actual
incurral, and as if that were not enough, Section 23(e)spells out the negative
test loud and clear:
23. Deductions not allowed in the determination of taxable
income.- No deductions shall in any case be made in respect
of any of the following matters, namely- (e) income
carried to any reserve fund or capitalised in any way.
The Tax Act requires that unconditional legal liability exists before an expense
has been incurred. Probability however likely, does not meet the bill. An
expense or loss which is contingent upon the happening of an uncertain future
event is not actually incurred. The liability therefor is not absolute and
The Members Handbook of the Institute of Chartered Accountants also spells out
The amount of a contingent loss should be provided for by a charge
in the income statement if:
it is probable that future events will confirm that, after taking
into account any related probable recovery, the value of an asset
has been impaired or a liability has been incurred at the balance
sheet date, and a reasonable estimate of the amount of the
resulting loss can be made.
Again, here is the contrast between a contingent liability and one which,had
been encountered, run into or fallen upon.
In the Australian case, FCT vs James Flood (Pty) Ltd, the taxpayer sought to
deduct in the year of income in question, amounts in respect of annual leave
which were due for payment to employees only in the following fiscal year. In
terms of the applicable industrial agreement these amounts were only payable to
employees at a future date , and under a variety of circumstances an employee
who did not serve his full period might not become entitled to anything. The
company sought to deduct a proportion , equivalent to the period of service in
the year of assessment, of the amount which would become payable if the
employee in the course of the next year, completed the required 12 months
service. The court accepted that a liability can be incurred although it may
not be due and payable. In respect of the leave payment due to employees in the
following fiscal orchard held that there was no debitum in praesenti solvendum
in futuro (a debt or obligation complete when contracted, but of which
performance cannot be required until some future period), because their period
of service had not yet qualified them for annual leave. To qualify for deduction,
the liability must have been incurred in the sense that it had been
encountered, run into or fallen upon . The taxpayer must have completely
subjected himself to the expenditure although it need not be an immediate
obligation enforceable at law and it need not be indefeasible. The appeal by the
Commissioner was allowed.
In Caltex Oil (SA) Ltd vs SIR ,the appellant company obtained supplies of crude
oil and other products from Caltex (UK) Ltd and Caltex Services Ltd, both
located overseas. Invoices would be rendered to the appellant in British
Sterling, immediately the goods were shipped. Upon receipt of the invoices, the
appellant would convert the purchase price into SA Rands at the rate of exchange
ruling on the date of shipment. Entries were made in the appellant s books at
this time. The value so recorded was never altered despite fluctuations in the
Rand currency between the date of purchase and the end of the appellant s
financial year on 25 December of each year.
On 19 November 1967, the rate of exchange between the Rand and the pound
sterling changed from R2 =1 , to R1.7207 = 1. As a result of this, the amounts
owing to the overseas companies reduced. The debt due to Caltex Services Ltd
reduced by R14,031, and the debt due to Caltex (UK)Ltd reduced by R1,336,271.
The debt to Caltex Services was settled before the end of the financial year.
The other debt remained outstanding.
The respondent added back the sum of the two amounts in the determination of the
appellants liability for tax for 1967. The sole issue that was put before the
Appeal Court, was whether thee two sums, which the appellant. by reason of the
devaluation of sterling, was not required to pay, could be said to be part of
the expenditure actually incurred. Botha J.A. summed the unanimous judgement up
The appellant actually discharged its liability to Caltex Services
Ltd after the devaluation and before the end of the 1967 tax year
by expending R14,031 less than the amount of R98,217 entered in
its books of account. It seems quite impossible to say that merely
because the higher amount of R98,217 was entered in appellant s
books of account as the equivalent, as at the date of the relevant
transactions, of 48,925 sterling, the expenditure actually
incurred in connection with the Caltex Services Ltd transactions,
was anything more than the amount actually expended by the appellant.
He went on further:
the amount of expenditure actually incurred for the purpose of
s11(a) can only be the amount required in rands to discharge
that liability in the tax year in which it was incurred.
With regard to the second larger liability which was still outstanding at the
end of 1967;
It was at the end of the 1967 tax year that the amount of the
expenditure actually incurred during the year had to be determined
and brought into account The appellant never incurred a liability
to pay an amount of R9,353,920 to Caltex UK Ltd, but was an amount
expressed in sterling which, for the purposes of the Income Tax Act,
had to be reflected in the equivalent thereof in rands converted at
the date at which the expenditure actually incurred is required
to be quantified and brought into account for the purposes of
s11(a) of the Act, or at the date of the discharge of that
liability within that fiscal year.
To sum it up simply, with regard to the debt paid during the year, the amount
actually incurred was the amount paid in settlement thereof. In respect of the
liability unsettled at the year end, only the amount calculated as being payable
at the end of the year, was the amount actually incurred. The balance of the
amount claimed was dependant upon an uncertain future event, and had not been
In Nasionale Pers vs KBI the appellant undertook to pay its employees a 13th
cheque after the completion of a full year of service, or pro rata thereof for
shorter service. The bonuses were paid on 30 September of each year. It was a
condition of the payment thereof that the company was entitled to recover
bonuses from employees not still in the employ of the company on the 31 October
following. The financial year of the company ended on 31 March of each earth
company sought to claim a pro rata portion of the bonuses (6/12) as a deduction
in the year ending March previously. The appeal was based on two contentions:
I. The issue of bonuses was a commercial reality – they would have to be paid;
the majority of the workforce would qualify.
ii. The taxpayer s liability to pay a bonus for each month of service existed
subject only to a resolutive condition in the event of him/her leaving the
employ of the taxpayer before 31 October. Thus the expenditure had been actually
incurred. Hoexter J.A. , held that:
The obligations to employees were individual and not collective.
Thus the liability to the employees as a group was no more than the
liability would be to each individual employee. The future
uncertain event (whether the employee would be in the appellants
employ on 31 October) which would give rise to the obligation to
pay a holiday bonus, was an event which fell outside the tax year
of the applicant.
In simple words, the conclusion drawn, was that at the end of March, there was
no unconditional obligation to pay a bonus to any employee. Whilst it was
probable that the company would be required to pay bonuses of the quantum
calculated, to the majority of the workforce, there was no unconditional
liability to pay any single employee a bonus ,in existence at the end of the
financial year in question. Thus the expenditure could not have been actually
incurred in the year in question.
The appellant in ITC 1531, had received R360,000, on 1 August 1983, being the
proceeds of a loan raised in Germany. The loan was repayable in Deutschemarks
(DM)in the future. Between 1 August 1983 and 31 December 1983, the Rand had
declined against the DM. The effect of the devaluation was that the indebtedness
to the lender, expressed in SA Rands as at 31 December 1983, was R370,509.16.
During 1984 a further loan was raised in Germany. The proceeds in SA Rands was
R200,000. The further loan was also repayable in DM.
On the last day of the 1984 year of assessment, the indebtedness of the
appellant, based on the rate of exchange rate prevailing amounted to,
R730,382.65. In effect, the adverse movement in the exchange rates, the
appellant s liability had been increased in the 1984 year by R159,873.49. No
further loans were made. On the last day of assessment for 1985, the amount,
owed by the appellant, according to the exchange rates then prevailing, amounted
to R1,195,199.33. A further fall in the value of the Rand against the DM during
the 1985 year had increased the liability of the appellant by R464,816.68. The
appellant claimed the R464,816.68 as a deduction from income in the 1985 year.
The appellant contended that he was entitled as a matter of principle, to claim
a deduction in respect of an unrealised loss resulting from a variation in the
rates of exchange during the year of assessment in issue. No part of the loan
was paid or discharged during the 1985 year.
The Commissioner contended that the words actually incurred in s11(a) do not
mean that the expenditure must be due and payable at the end of the year in
question. There must be a clear liability to pay existing at the end of the year
in question, even though the payment thereof may only fall due in later years.
For such a liability to be incurred, it must not be subject to a contingency, ie
an uncertain future event. It was contended that the foreign exchange losses,
were notional losses and were conditional upon the rate of exchange prevailing
at the time of payment.
In the judgement handed down it was held that:
When a taxpayer owes an amount expressed in a foreign currency, the amount is
owed unconditionally and uncontingently. There is with certainty, an amount of
expenditure incurred. Fluctuations in the rate of exchange can only effect the
amount or quantification of the certain liability. It is only the quantification
that is contingent. The liability itself is absolute. The unrealised foreign
exchange loss incurred by the appellant was deductible from its income under
s11(a). The appeal was allowed.
The case was taken on appeal. The issue before the court depended on whether the
unrealised foreign exchange loss constituted an expenditure or loss actually
incurred in the Republic in the production of income as envisaged by s 11(a).
Corbett CJ pointed out that the real question was whether by reason of currency
fluctuations the taxpayer had actually incurred in the Republic in the
production of the income, during the year of assessment concerned any outgoing
or liability in respect of its foreign loan that could be classed as either an
expenditure or a loss in the production of the income.
It was held that the loss would only be deductible in the year in which the loan
was repaid, because only then would such a loss have been actually incurred. The
conversion of the loan proceeds into local currency was merely part of the
practical mechanics of giving effect to the loan. The decision in the Caltex
case was distinguished as being different because it was in respect of the
acquisition of stock in trade which had to be quantified at the end of the year
of assessment. The appeal was allowed.
In ITC 1444 a manufacturer of products entered into agreements with overseas
suppliers of raw materials to supply fixed amounts of raw materials at fixed or
determinable prices at future dates. This was done to protect the manufacturer
against price fluctuations and to guarantee the availability of supply. Payment
for the goods was to be cash against documents .
The taxpayer deducted from its 1983 year of assessment amounts in respect of
contracts concluded for the purchase of future supplies of materials. In the
judgement handed down, McCreath J. held that:
The question to be determined in the instant case is therefore
whether it can be said that by concluding the contracts to which
I have referred the taxpayer, during the year of assessment ending
31 December 1983, incurred an absolute and unqualified legal
liability in respect of the expenditure arising out of the said
contracts or whether such expenditure was conditional upon the
happening of some future event.
the taxpayer was only required to pay the purchase price of the
production materials forming the subject matter of the said
contracts, against receipt of the bills of lading and invoices
relating to the production materials to be supplied in terms thereof
the taxpayer was not required to effect payment until the bills
of lading and invoices in respect of each quantity of the
production materials had in fact been received by the taxpayers
it is clear from the evidence of Mr A that no unconditional legal
obligation rested upon the taxpayer to effect payment prior to
the receipt of the said documents.
In essence the judgement took the view that the only time that an unconditional
obligation arose, was at t