Careful tax strategies can save businesses from incurring unnecessary non-deductible expenses

2009-06-30 00:00

IN these difficult economic times it is wise to think twice before spending money. This obvious statement pertains to everyone in South Africa, especially business owners and managers, who need not only to reduce expenditure where possible, but also to adopt a prudent tax strategy in order to ensure expenses incurred are tax deductible.

So declares David Warneke, tax partner at Cameron & Prentice Chartered Accountants, who says that it can be extremely unpleasant for business owners and managers to find out that expenses incurred under the misconception that they are tax-deductible are not deductible.

“Directors or owners of businesses are often only alerted to the tax status of an expense by their auditors, when it is too late to do anything about it …

“It is invaluable to understand the main principles that govern the deductibility of expenditure and also to be aware of commonly encountered types of non-deductible expenses,” says Warneke.

“A bar to the deductibility of expenditure is the further Income Tax Act requirement that the expenditure must not be ‘of a capital nature’.

“Expenditure will be considered to be ‘of a capital nature’ if it is more closely aligned to structure of a business than the business’s operations: for example, company formation expenditure and the purchase of fixed assets (capital) compared with rent or advertising (non-capital).

“However, many corporate decision-makers are unaware that the test for capital expenditure extends to expenditure such as travel expenses,” explains Warneke.

“So, for example, if a delegation is sent overseas with the purpose of exploring or setting up a potential new market, the expenditure would be of a capital nature and not deductible. The same result is achieved if a director is sent abroad to negotiate the purchase or disposal of a major asset. It has also been found by the Tax Court to be the position where a company sent employees overseas to gain knowledge of the latest developments in the products manufactured by the company”.

Another common example of capital expenditure is a lease premium. However, even though a lease premium is spending of a capital nature, the taxpayer qualifies for a deduction under a specific section of the Act, which grants the lessee a deduction provided that the lessor is not a tax-exempt institution (e.g. a pension fund).

“The expenditure cannot be deducted upfront, though, and has to be claimed over the lease period, with a maximum spread of 20 years. This has negative cash flow implications for the lessee. The lessor, on the other hand, is taxed on the full amount of the lease premium received upfront.”

“Where expenses cannot be avoided, business owners and managers should ... ensure that anticipated expenditure is structured in the most tax-friendly way possible,” says Warneke.

*David Warneke is a well-known tax partner at Cameron & Prentice Chartered Accountants.

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