Ring-fencing trading losses

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Top-rate taxpayers need to watch out for Section 20A

Section 20 of the Income Tax Act 58 of 1962 deals with the set-off of losses from a trade against other income.  In general, such set-off is allowed (see sub-paragraph (1)(b)), provided that the loss is incurred in the taxpayer’s own name (i.e. not in a company, CC, or trust).  The loss must also have been incurred with-in the Republic of South Africa to qualify for set-off.

The claiming of losses is subject to the provisions of Section 20A, the ring-fencing provisions.  This Section however only applies to taxpayers whose taxable income (before the setting-off of the loss) falls within the top bracket at which the marginal rate reaches its maximum (currently 45% at a taxable income of R1 731 601 per annum).

If a loss was incurred in a previous year, an individual taxpayer may be able to carry forward such loss even if no income was earned during the year of assessment.

This is in contrast with the rules applicable to corporate taxpayers, whereby there is a requirement for the taxpayer to carry on a trade (even if such trade resulted in a further loss) for the assessed loss to be carried forward.  If a corporate taxpayer does not continue to carry on any trade, the assessed loss brought forward from previous years is forfeited.

Definitions:

Assessed loss

An assessed loss arises when the deductions provided for under Sections 11 to 19 of the Income Tax Act exceed the income against which such deductions are entitled to be claimed.

Ring-fencing

This is the practice whereby an assessed loss from one trade may not be set off against the taxable income from another trade.  Under Section 20A, such losses may be carried forward, and provided that taxable income is derived from the same trade in a future year, the loss can be set off against such income (but not against any other income).

The Section applies only to individual taxpayers on the maximum marginal rate of tax, and also applies only to losses incurred from specific trades, which are:

  • sporting activities;
  • dealing in collectibles;
  • rental of residential accommodation (unless at least 80% thereof is used by persons who are not relatives of the taxpayer for at least half of the tax year);
  • showing of animals;
  • part-time farming or animal-breeding;
  • performing or creative arts; or
  • betting or gambling.

Trade

The term ‘trade’ refers to any active income-generating venture, interpreted in a fairly wide sense.

In terms of Section 1, a 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 57 of 1978, or any design as defined in the Designs Act 195 of 1993, or any trade mark as defined in the Trade Marks Act 194 of 1993, or any copyright as defined in the Copyright Act 98 of 1978, or any other property which is of a similar nature”.

Although the earning of interest income is not specifically included in the definition of ‘trade’, the courts have held that earning interest does in fact constitute a trade, and any expenses incurred directly in the production of the taxable portion of such interest income would qualify for deduction against such income.

For example, if you manage to borrow money at 4% and invest it at 8% (ignoring the interest exemption for individuals), the interest paid can be claimed as a deduction against the interest earned.

While every reasonable effort is taken to ensure the accuracy and soundness of the contents of this publication, neither writers of articles nor the publisher will bear any responsibility for the consequences of any actions based on information or recommendations contained herein. Our material is for informational purposes and should not be construed as financial advice.

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