An Analysis Of The Term Actually Incurred

In Section 11(a) Of Income Tax Action
Act No 58 Of 1962 Essay, Research Paper

An Analysis of The Term Actually Incurred In Section 11(a) of Income Tax Action

Act 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

BY

PETER CRAWFORD

STUDENT NO. CRWPET005

APRIL 1996

I certify that the report is my own work and all references used, are

accurately recorded.

1.SYNOPSIS

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

events;

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

derived-

(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

been: Actu

ssme

nt

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

income.

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

resolved.

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

one.

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

certain.

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 exist side by side

with the

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

provisions.

The traditional approach to the interpretation of statutes, often

referred to as the

Cardinal rule, holds that 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

statutory

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

the intention

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

unconditional.

The Members Handbook of the Institute of Chartered Accountants also spells out

that:

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

as follows:

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

actually incurred.

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

agent abroad.

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