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Tax implications of closing down a business

Should all expenses a company incurs in limiting further losses by closing down be deductible for income tax?

By Elizabeth Lombaard

It is something that seems to be happening more and more these days – businesses starting up and then closing down. And, as a tax professional, I have been approached a number of times for advice as to the tax implications of closing down or winding up a business. Does it seem a simple question? Surely all expenses the company incurs in limiting further losses by closing down would be deductible for income tax?

However, as with most things in tax, the answer turns out to not be simple.

Generally, by the time a decision is made to close down a business, management and shareholders have tried various actions to save the business and have run out of ideas. The last option is to make the tough decision to close up shop and let people go. Typically, one would expect the following types of expenses to be incurred subsequent to the decision to close the business:

  • Lease cancellation costs or penalties
  • Retrenchment packages
  • Legal and advisory fees
  • Contract cancellation penalties
  • Garden leave (or paying out accrued leave balances)
  • And, because the business would still need staff to help it close down, retention bonuses for those required to stay till the end

In South African income tax, the first rule to be considered in respect of any deduction is colloquially referred to as the ‘general deduction formula’. It is found in section 11(a) of the Income Tax Act 58 of 1962 (the Act), read with section 23(g) of the Act.

The first (section 11(a)) part of the general deduction formula reads as follows: ‘For purposes of determining the taxable income derived by any person from carrying on any trade, there shall be allowed as deductions from the income of such person so derived, expenditure and losses actually incurred in the production of the income, provided such expenditure and losses are not of a capital nature.’ Section 23(g) then prohibits a deduction in respect of ‘any moneys, claimed as a deduction from income derived from trade, to the extent to which such moneys were not laid out or expended for the purposes of trade’. More succinctly, this is referred to as the ‘for purposes of trade’ requirement.

Thus, in order for any expense incurred by a taxpayer and, in this case, a company, to be deductible for tax purposes, all of the following requirements must be met (these also apply to expenses incurred in closing down a business):

  1. There must be an expense or loss
  2. That is actually incurred
  3. That is not of a capital nature
  4. That is expended for purpose of trade, and
  5. Which is in the production of income

If any one of the above requirements is not met, the expense is only deductible if a specific section in the Act provides for the deduction. An example is section 12C which provides for a deduction (or allowance) in respect of capital manufacturing equipment.

For purposes of this article, it is assumed that the first three requirements above have been met by the company that has made the decision to close down its business, and which is incurring the various expenses to minimise further losses.

  1. The company has an expense because it has paid for the lease cancellation, leave pay, legal fees, etc.
  2. The company has actually incurred the expense because the lease has been cancelled, the legal services have been provided, and the accrued leave has been cashed out. The company is not entitled to claim the payments back.
  3. The intention with incurring these expenses is to minimise further losses and not to create or maintain an asset of any kind (that is, the income-producing structure that is the business). The expenses are therefore not of a capital nature.

The remaining requirements to be met in order for the expenses to be deductible are requirements 4 (expended for the purpose of trade) and 5 (in the production of income).

For purpose of trade

In order for a taxpayer to be able to claim an income tax deduction, the taxpayer must be carrying on a trade. In this case, the company is closing down its business, ceasing its trade. The company intends to no longer earn any income and its activities are limited to winding up operations. In order to determine whether the expenses are incurred for purposes of trade, the question which must be answered, is when does trade cease?

There are differing views and court cases as to when trade ceases. Some cases support that trading only ceases once all debts have been paid and all receivables have been collected. The South African Supreme Court of Appeal has, however, on various occasions, held that the collection of trade debts is not the carrying on of a trade.  When a business collects debts in the process of closing down, the aim of collecting such debts is exactly that – to close down the business. It is not for the purpose of carrying on a trade. This view seems to be supported by the South African Revenue Service in its Interpretation Note 33. Thus, while differing views exist, it is submitted that trade ceases when a company conducts activities only for the purpose of winding down its business.

As a general rule, therefore, expenditure incurred after trade has ceased is non-deductible because it is not incurred for the purpose of trade. However, that does not necessarily mean that the company may no longer claim any tax deduction for expenses incurred while in the process of closing down its operations.

Per Silke on South African Income Tax,  ‘it would appear that the general principle in operation is that an expenditure incurred under an obligationassumed – in the production of income and wholly and exclusively for the purposes of the trade conducted in that business – during the course of its existence will continue to be deductible despite the cessation of that business’.

ITC 729 provides an example of this. The taxpayer, while carrying on its normal business, undertook to pay pensions to certain retired employees until their respective deaths. When the taxpayer sold the business, the obligation of paying these pensions was not assumed by the purchaser and remained a continuing obligation of the taxpayer. Here, the court held that the taxpayer had undertaken this obligation while conducting its trade, for purposes of its trade, when it had originally undertaken the obligation to pay the pensions. Therefore, the settlement of the obligation remained a payment by the taxpayer for the purpose of its trade.

Thus, in determining whether an expense incurred in the winding up of a business is incurred for the purpose of trade, one should consider whether the obligation under which the payment is made was undertaken during the normal course of trade. If such circumstances exist, an argument may be made that such obligation, once discharged, continues to be for purpose of trade.

In the production of income

The last requirement that needs to be met for an expense to be deductible in terms of the general deduction formula is that the expense must be incurred in the production of income. In this regard, it is submitted that one cannot argue that an expense is incurred in the production of income if the expense is incurred for the purpose of winding down a business. The expense is specifically incurred to cease the trade and not to produce income. However, per the authors of Meyerowitz, the same test as applied for the trade requirement above can be applied to determine whether an expense has been incurred in the production of income:

‘If the obligation was incurred prior to the cessation of the trade and for the purpose of earning the income, there is no reason in principle why such expenditure cannot be regarded as incurred in the production of income and, therefore, as deductible.’

It is worth noting that it is not necessary for income to have been actually produced in the year in which the expense has been incurred, for an expense to be considered to be incurred in the production of income. It can relate to the production of income in a prior or future year.


In general, it is likely that most expenses incurred in the closing down of a business would not be deductible for income tax purposes. However, it is submitted that the nature of each expense must be analysed in detail to determine its deductibility for income tax purposes.

For example, if an employment contract binds the employer to a specific package in the event of retrenchment, or South African labour law requires a minimum severance payment per period worked, an argument may be made that such obligation, once discharged, was discharged for the purposes of trade and in the production of income. The same argument could potentially be made if a lease agreement has been entered into for a fixed period, meaning that the obligation to continue paying the rent is being discharged for purposes of trade.

However, in respect of expenses such as legal and consulting fees incurred in winding down the business, it is clear that such expenses are not incurred in the production of income and not for purposes of trade, and therefore no argument exists to deduct such expenses for income tax purposes.

Elizabeth Lombaard is a SAICA National Tax Committee Member

This article was originally published in the June 2019 issue of ASA.