We all want to save tax and use every opportunity to utilise our losses in accordance with the income tax act.
When can we carry forward these losses and what does the Act say?
Section 20 of the Income Tax Act, 1962 (ITA). Set-off of assessed losses.—(1) For the purpose of determining the taxable income derived by any person from carrying on any trade, there shall, subject to section 20A, be set off against the income so derived by such person—
(a) any balance of assessed loss incurred by the taxpayer in any previous year which has been carried forward from the preceding year of assessment:
Section 1 – Definition of “trade”
“trade” includes every profession, trade, business, employment, calling, occupation or venture, including the letting of any property and the use of or the grant of permission to use any patent as defined in the Patents Act, 1978 (Act No. 57 of 1978), or any design as defined in the Designs Act, 1993 (Act No. 195 of 1993), or any trade mark as defined in the Trade Marks Act, 1993 (Act No. 194 of 1993), or any copyright as defined in the Copyright Act, 1978 (Act No. 98 of 1978), or any other property which is of a similar nature;
The meaning of “assessed loss” and “balance of assessed loss”
The term “assessed loss” is defined in section 20(2), and refers to the tax loss that arises in the current year after deducting the admissible deductions in section 11 from the income against which they are admissible. The definition does not contain either a “trade” or an “income from trade” requirement, but the carrying on of a trade is generally a requirement for deductibility under section 11.
A “balance of assessed loss” refers to the assessed loss that is brought forward from the preceding year.
Application of the law
Carrying forward a company’s tax loss requires a continuity of trading plus the derivation of some income. The general rule of income tax is that a taxpayer’s taxable income is determined for each tax year in isolation. In other words, each tax year is a closed compartment, not affected by tax events that occurred in previous tax years. Thus, the general rule is that, in a given tax year, a taxpayer can claim a deduction in respect of expenditure only if it was incurred in that tax year.
An important exception to this rule is that the Income Tax Act (“the Act”) permits taxpayers, both individuals and companies, to carry forward the balance of an assessed loss incurred in the previous tax year into the current tax year, to be off-set against the income of the latter year.
In so far as companies are concerned, section 20(1)(a) of the Act allows an assessed loss incurred by the taxpayer company to be carried forward and set-off against income of a later year which is derived from carrying on any trade.
By implication, therefore, such a balance of assessed loss cannot be set off against income derived otherwise than from trade. Moreover, if the company has not traded at any time during the current year, there can be no set-off of prior years’ losses in computing the taxable income of the current year.
It was held in the court case, SA Bazaars (Pty) Ltd v CIR (1952) 18 SATC 240, that section 20(1)(a), properly interpreted, means that where a taxpayer has not traded at any time during the current tax year, there is nothing against which the assessed loss brought forward from previous years can be set-off in that year.
These principles are extremely important in corporate tax planning.
In relation to taxpayers other than companies, section 20(2A) explicitly nullifies the requirement that a taxpayer can only set-off the balance of an assessed loss against income from “trade”, but this restriction is operative in relation to companies.
Consequently, if a company fails to trade for an entire tax year, it loses forever the right to carry forward any balance of assessed loss from a previous year, even if it thereafter resumes trading.
The following extract from Interpretation Note No. 33 provides some prospect of sanity, and demonstrates the approach of SARS to the issue:
“SARS is of the view that section 20 contains a trade requirement and an income from trade requirement. Both these requirements must be satisfied before an assessed loss may be carried forward. SARS does, however, accept that this may have some unintended results.
In dealing with the problem, SARS will accept that as long as the company has proved that a trade has been carried on during the current year of assessment, the company will be entitled to set off its balance of assessed loss from the preceding year, notwithstanding the fact that income may not have accrued from the carrying on of that trade. This concession is limited to cases where it is clear that trade has been carried on. SARS will apply an objective test in order to determine that a trade has in fact been carried on. It will not be sufficient that there was a mere intention to trade or some preparatory activities. The fact that no income was earned during the year of assessment must be incidental or result from the nature of the trade carried on by the company.”
In Interpretation Note 33, SARS gave notice that it took the view that section 20 of the Act imposed both a trading requirement, and an income requirement.
Practice Notes and Interpretation Notes do not have the force of law; they merely indicate how, as a matter of practice, SARS interprets provisions of the Act which interpretation is still uncertain.
It seems clear that, notwithstanding the decisions in the courts, SARS will not universally adopt an “all or nothing” approach on the income requirement, but will be prepared to allow an assessed loss where it may be clearly demonstrated that the lack of income was reasonable in the circumstances, provided that a trade is being carried on.
Integritax, Issue 112
Interpretation Note 33, Issue 2
Income tax act, 1962
This article is a general information sheet and should not be used or relied on as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice.