Expenditure incurred in the production of income from an illegal source

Abstract

Income Tax Act 58 of 1962 (ITA) consolidates the law relating to the taxation of income, to provide for the recovery of taxes on persons. The ITA levies normal tax in respect of taxable income received by or accrued to any person during a 12-month period of an assessment year. The determination of taxable income takes into account the aggregate of the gross income amount as defined in section 1 of the ITA, less exempt income to derive an ‘amount’ less allowable deductions. The ITA does not expressly deal with the treatment of income received and deduction of expenses incurred in an illegal business. This study examines the tax treatment of income earned in an illegal business in relation to the gross income definition with specific emphasis on the “received” by or “accrued to” requirement in the South African context. It examines whether expenses incurred in the furtherance of an illegal business should be deductible with reference to South African case law and legislation. A comparative analysis is conducted on the tax treatment in South Africa with reference to the tax legislation and case law and compared to that of the United States of America (USA) and Australia. The lessons that South Africa can derive from the comparative countries are also discussed. The discussion is finalised with the examination whether it is in the interest of justice for a taxpayer to be denied a deduction on expenses incurred in the operation of an illegal business. It is examined on whether it is possible for a taxpayer to raise the double jeopardy rule when deductions are denied under section 11(a) of the ITA but after criminal sanctions have already been incurred. The study concludes with a summary of the findings that the South African tax legislation is on par with the comparative countries and that the South African courts have in a number of cases clarified on the treatment of illegal income. Clarity is however still required on the treatment of expenses. Lastly, it is recommended that it is undesirable for tax legislation to be utilised to punish wrongdoers, but instead harsher penalties and sentences are to be implemented through criminal law to deter wrongdoing.