INCOME

INCOME

Outcomes
After you have completed this learning unit, you should be able to
• manage and evaluate information regarding the requirements, including applicable
case law, of the definition of Gross income.
• apply special inclusions to the definition of gross income in the calculation of
"income".
• apply exempt income in the calculation of "income"
 Exempt
Gross Income Income
income

General Specific
definition inclusions

• The structure or framework that must be applied to determine a taxpayer’s

taxable income was discussed in learning unit 1. Above is version of this
framework showing some of the components.
• In this learning unit, the first two components of the framework, namely gross
income (the general definition as well as specific inclusions) and exempt income,
will be discussed to show you how to calculate a taxpayer’s income for a year of
assessment
 GROSS INCOME

• Gross income represents all income items, whereas exempt income represents the income items
that are included in gross income (either by means of the general definition or specific
inclusions), but which should be deducted from gross income as a result of their tax-exempt
status.
 GROSS INCOME- PRESCRIBED
TEXTBOOK

• Chapter 3 of the textbook

• Ignore these sections:
• 3.3
 GROSS INCOME

• For tax purposes, income is made up of gross income and exempt income.
• In this learning unit, we will look at what each of these terms means and what is included or
excluded by these terms.
• Gross income is a definition contained in section 1 of the Income Tax Act, but before we
discuss the definition of gross income, you need to understand the concepts of resident and non-
resident.
• This is necessary because the gross income definition distinguishes between South African
residents and non-residents.
• The implication of this is that the rules used to calculate gross income for South African
residents differ to those used for the calculation of the gross income of non-residents.
 RESIDENT VS NON-RESIDENT

• A person other than a natural person (in other words, a business entity such as a company or a
close corporation) is a resident of the Republic of South Africa if it is:
• incorporated, established or formed in the Republic, or
• has its place of effective management in the Republic
• The first requirement is a matter of fact and is therefore not really open to any interpretation.
• The second requirement, namely the place of effective management, is not always as easily
determinable and therefore, SARS has issued interpretation note 6 to clarify what is meant by
"place of effective management".
https://www.sars.gov.za/wp-content/uploads/Legal/Notes/LAPD-IntR-IN-2012-06-IN-6-Resident-
Place-of-effective-management-companies.pdf
• Read paragraph 4.2 of this document specifically to gain an understanding of which
circumstances may indicate the place of effective management of an entity. You will not be
required to list these circumstances, but they will give you a better understanding of what this
term means.
 RESIDENT VS NON-RESIDENT

• You first need to determine whether an entity is a resident for tax purposes, because
• residents are taxed on all (worldwide) income, according to the residence basis of taxation
• non-residents are taxed on income received from a South African source only, or income which
is deemed to have been received from a South African source
• The source of income is where the income has its origin. To determine the source of income,
two aspects need to be considered:
• the cause of the income
• the location of that originating cause
The source rules do not form part of this module. For the purposes of this module, you will only
be required to apply the gross income definition to residents.
 RESIDENT VS NON-RESIDENT

• You first need to determine whether an entity is a resident for tax purposes, because
• residents are taxed on all (worldwide) income, according to the residence basis of taxation
• non-residents are taxed on income received from a South African source only, or income which
is deemed to have been received from a South African source
• The source of income is where the income has its origin. To determine the source of income,
two aspects need to be considered:
• the cause of the income
• the location of that originating cause
The source rules do not form part of this module. For the purposes of this module, you will only
be required to apply the gross income definition to residents.
 GR OSS INCOME

• Once you have established that the taxpayer is a resident of the Republic, you need to consider whether an
amount which is received by the taxpayer, must be included in its gross income or not.
• We now turn to an explanation of the definition of gross income as it applies to residents.
Below is an extract from the Income Tax Act (s 1), which contains the definition of gross income.
 GR OSS INCOME

From the above definition, you can see that before an amount may be included in the gross income of a taxpayer,
that amount must comply with all the requirements or criteria for the definition of gross income, namely
• the total amount
• in cash or otherwise
• received by, accrued to, or in favour of a person
• during the year of assessment
• excluding amounts of a capital nature

Over and above these requirements, which must ALL be met, the definition also includes
• amounts (whether of a capital nature or not), which are specifically listed after the definition
We refer to this list as specific inclusions. We will discuss these specific inclusions later in this learning unit.
 GR OSS INCOME

From the above definition, you can see that before an amount may be included in the gross income of a taxpayer,
that amount must comply with all the requirements or criteria for the definition of gross income, namely
• the total amount
• in cash or otherwise
• received by, accrued to, or in favour of a person
• during the year of assessment
• excluding amounts of a capital nature

Over and above these requirements, which must ALL be met, the definition also includes
• amounts (whether of a capital nature or not), which are specifically listed after the definition
We refer to this list as specific inclusions. We will discuss these specific inclusions later in this learning unit.
 GR OSS INCOME

• The criteria contained in the definition of gross income have to be complied with, and the interpretation of each
concept contained in the definition has been tested in the South African courts over decades.
• Not all the criteria are easily interpreted in different situations and as a consequence of decided tax cases, many
important legal principles have been established.
• It is the application of this legal precedent that informs us how to apply some of the principles of the definition
of gross income in situations where interpretation is not straightforward.
• You will need to learn the names of the tax court cases mentioned in this learning unit, as you will be required
to list them under the appropriate criteria for the gross income definition when you consider whether an
amount should be included in gross income or not.
• Details of the court cases will be covered in 3rd year.
 GR OSS INCOME

REMEMBER: Requirements or criteria for the definition of gross income:

• the total amount
• in cash or otherwise
• received by, accrued to, or in favour of a person
• during the year of assessment
• excluding amounts of a capital nature

We will now discuss each of the criteria for the definition of gross income separately. Then we will introduce to
you some applicable court cases that will provide insight when applying the criteria.
 T O TA L A M O U N T I N C A S H O R O T H E RW I S E ( S E C T I O N 3 . 4 )

• Determining an "amount" is not always straightforward, we apply the ruling in Commissioner for Inland
Revenue v Butcher Bros (Pty) Ltd 13 SATC 21 (A) 1944.
• In this court case it was established that where an asset is received other than in cash, an "ascertainable money
value“ needs to be determined and the onus is initially on the Commissioner to prove that an "amount“ has
accrued to the taxpayer.
 T O TA L A M O U N T I N C A S H O R O T H E RW I S E ( S E C T I O N 3 . 4 )

Example: Mr C, an architect, designed all the houses in a golf course development as well as the gold course and
the clubhouse. He was to receive one of the houses as payment once it is built.
Assume that the accrual takes place when Mr C transfers the house into his name.
The value of the house on date of transfer is R2.8million.
Required: What should be included in Mr C’s gross income?

Solution: The receipt is in a form other than cash and has to be valued at the earlier date of accrual of receipt. The
general principle is to use the market value on date of accrual thus R2.8million has to be included in Mr C’s gross
income.
 RECEI VED BY, A CCRU E D TO , O R I N FAV OU R OF ( SECTI O N 3. 5)

• In Geldenhuys v Commissioner for Inland Revenue 14 SATC 419 (A) 1947, it was suggested that an amount is
only "received" by a taxpayer if it is received by him (her) "on his (her) own behalf and for his (her) own
benefit".
• In CIR v People's Stores (Walvis Bay) (Pty) Ltd 52 SATC 9, it was confirmed that the meaning of "accrued to"
is the amount "to which he has become entitled".
• An amount must be included in income at the earliest date of it being received or accrued.
• Therefore, if an amount has accrued on 1 April, but it was only received on 30 April, then the amount is
regarded as income on 1 April. It will not be included again on 30 April, as it has been taken into account
already.
RECEIVED BY, ACCRUED TO, OR IN FAVOUR OF (SECTION 3.5)
RECEIVED BY, ACCRUED TO, OR IN FAVOUR OF (SECTION 3.5)
 YEAR OF ASSESSMENT(SECTION 3.6)

• This criterion is implied in the definition because tax payable is calculated on an annual basis,
therefore we need to decide into which "tax year" an amount of income will fall. This could have
implications if the rate of tax were to change.
• A company's year of assessment is the same as its financial year. For example, if the company’s
financial year end is on 31 March 2022, then the year of assessment will be 1 April 2021 to 31
March 2022.
• Only an amount received or accrued in a particular year of assessment will be included in gross
income for that year of assessment.
 EXCLUDING AMOUNTS OF A CAPITAL NATURE(SECTION 3.7)

• Capital is compared to a tree and revenue to the fruit of the tree (CIR v Visser 8 SATC 271).
• As the capital nature often depends on many variables, the courts have established tests that can
be used to assist in deciding whether income is of a capital nature or not. These tests are often
loosely grouped into two main groups:
• subjective tests
• objective tests
 EXCLUDING AMOUNTS OF A CAPITAL NATURE(SECTION 3.7)

• The subjective tests that are applied to determine whether an amount is of a capital nature or not
relate to the
• nature of the receipts
• sale of assets
• intention
• continuity
• change of intention
 EXCLUDING AMOUNTS OF A CAPITAL NATURE(SECTION 3.7)

• When the courts look at objective tests (matters of fact) they will consider the following as
indications:
• manner of acquisition
• period for which the asset is held
• manner of disposal
• nature of the asset disposed of
• reason for the receipt
• legal nature of the transaction
• accounting treatment of the transaction
Case study

Mint (Pty) Ltd has been carrying on the business of growing herbs for many years on the land it
owns. This is the only business of the company. During the 2012 year of assessment, Mint (Pty)
Ltd bought an additional farm from a deceased estate at a favourable price. At the time, the
company did not need the additional land, but it decided to hold it until it was required for planting
herbs at a later stage. Because of the economic recession, the company decided that it no longer
required the land for future use and sold the farm in February 2022 as land suitable for livestock
farming. The amount was received in cash by Mint (Pty) Ltd on 5 March 2022.

REQUIRED
Would the amount received by Mint (Pty) Ltd for the sale of the farm be capital in nature for the
year of assessment ended 31 March 2022?
Solution
In order to determine whether an amount received by a taxpayer is of a capital nature, you need to apply
the subjective and objective tests and base them on all the facts to determine the nature of the amount.
• Manner of acquisition – The property was acquired by means of a market related transaction.
• Intention on acquisition – The taxpayer's intention was to acquire the farm as an income-producing
asset (an investment intention).
• Change of intention – The fact that the taxpayer acquired the farm knowing that he could sell it at a
profit is not a clear indication that the asset was acquired with a speculative intention (in other words,
buying an asset at a favourable price for the purpose of selling it shortly afterwards at a profit). In
addition, the fact that it has decided to sell the farm would not automatically indicate a change in the
taxpayer's intention.
• Period for which the asset was held – The company held the asset for almost eight years.
• Nature of the asset disposed of – The asset is a farm, which can be used as an income-producing asset
in Mint (Pty) Ltd’s business.
On the given facts, it can be argued by Mint (Pty) Ltd that it acquired the farm with the intention of
developing it as a produce farm. Owing to the economic recession, however, this did not transpire, and
since the land was surplus to its requirements, a decision was made to sell the property.
The sale of the property amounted to the sale of a capital asset and not the sale of an asset to make a
profit. The proceeds would therefore be of a capital nature and not included in gross income.
 STUDY ADVICE

When studying the definition of gross income, make a detailed summary of each criterion that an
amount must comply with before it can be included in gross income. You should be able to apply
the principles discussed to determine whether an amount should be included in the gross income of
a taxpayer and state the applicable case law.
PRACTICAL EXAMPLE:
Gross income

Bank A receives a deposit of R1 000 on 1 March from Trading (Pty) Ltd. This money is deposited into a
savings account at the bank as an investment. Six months later, Trading (Pty) Ltd withdraws the amount
and the bank pays the company an amount of R1 050, comprising R1 000 original capital invested and
R50 interest earned.
REQUIRED
Determine, giving reasons, whether
(a) the amount of R1 000 received by Bank A will be gross income
(b) the amount of R1 050 received by Trading (Pty) Ltd is gross income
PRACTICAL EXAMPLE SOLUTION:
To establish whether the money received by Bank A on 1 March and the money received by Trading
(Pty) Ltd six months later should be included in the gross income of the respective taxpayers, the
following approach may be followed:
• What is the specific principle, from the definition of gross income, which applies to the amount or
receipt?
• How can this specific principle be applied to this amount or receipt?
• What is the conclusion if the principle is applied?

(a) The receipt of R1 000 by Bank A

Principle: “Received” means that a taxpayer receives an amount for his/her own benefit (Geldenhuys v.
Commissioner).
Application: Bank A receives the amount on behalf of Trading (Pty) Ltd to keep as a deposit in its name.
Conclusion: The amount is not received on behalf of and for the benefit of Bank A; therefore, it will not
be included in the gross income of Bank A.
PRACTICAL EXAMPLE SOLUTION:
To establish whether the money received by Bank A on 1 March and the money received by Trading (Pty)
Ltd six months later should be included in the gross income of the respective taxpayers, the following
approach may be followed:
• What is the specific principle, from the definition of gross income, which applies to the amount or
receipt?
• How can this specific principle be applied to this amount or receipt?
• What is the conclusion if the principle is applied?
(b) The receipt of R1 050 by Trading (Pty) Ltd
Principle: Capital amounts are excluded from gross income. Capital represents the "tree" and the income
derived from the capital represents the "fruit" of the tree (CIR v. Visser).
Application: The original amount invested, namely R1 000, represents the “tree” (capital) which has
earned “fruit” (interest) of R50.
Conclusion: The invested capital received by Trading (Pty) Ltd will be excluded from gross income, since
it is capital in nature, but the income (interest) will be included in gross income, as it is revenue in nature.