SARS has decided that in certain cases, losses incurred from certain business will be ringfenced, in other words, you will not be allowed to deduct the loss from other business profits or from your salary.
This new law only starts on 1 March 2004, for tax years on or after this date.
It has to be noted that not every activity meets the requirements of a “trade”. The section of the income tax act that will deal with this new laws is Section 20A, which aims to improve the integrity of the tax system by preventing expenditure and losses normally associated with suspect activities (i.e. disguised hobbies etc) from being deducted as means to reduce taxable income. Subsection 1 of section 20A set the general rules to prevent theses losses being deducted from other income. It has to be noted that this law only applies to natural person, in other words, if you have a sole proprietorship or earn income in your name from rental properties etc. If you business or assets are run in a close corporation, company or trust this rule will not affect you. You will not loose the losses you have made, it will be ringfenced, e.g. it will be carried forward to the following year to when that trade that made the loss makes a profit again.
There is also a 2 part threshold that is looked at before ringfencing can be applied to you.
- Your taxable income level, and
- Loss generating activity
1. YOUR TAXABLE INCOME – this section can only apply to you if your taxable income equals or exceeds the amount at which the marginal tax rate becomes applicable, which is currently 40% on amounts exceeding R255000). Obviously before the set off of any assessed losses.
2. LOSS GENERATING ACTIVITY – only losses from certain trade (suspect trade) is subjected to these provisions. The list is as follows:-
- Sporting activities:- either practice by the taxpayer or relative, from which he receives income and creates a loss
- Dealing in collectibles:- example collecting cars, stamps, coins, antiques, militaria, art, wines etc.
- The rental of residential accommodation:- unless at least 80% of the accommodation is used by any other person except the taxpayer or his relatives, for at least more than 6 months a tax year. Included in residential accommodation is holiday homes, bed and breakfast establishments, guesthouses, dwelling houses etc.
- The rental of vehicles, aircrafts and boats:- Unless more than 80% of the asset is used by any other person accept the taxpayer and his relatives for more than 6 months in a tax year.
- The showing of animals in competitions:- by the taxpayer or his relatives i.e.. show horses, dogs, cats etc.
- Farming or breeding of animals:- includes casual farming or weekend farming by the taxpayer but excluding if on a full time basis.
- Performing or creative arts:- Practised by the taxpayer or his relatives i.e. acting, singing, film making, photography, writing, pottery etc
- Gambling or betting:- Trying your luck at the casino on a regular bases, card laying, lottery and sports betting.
A loss activity is also treated under this list if assessed losses arise during 3 out of 5 years, including the current tax year.
Subsection 3 provides an escape route, by proving that the activity is a legitimate trade despite being classified as suspect. The activity must constitute a business and it must have a reasonable prospect of generating taxable income within a reasonable period. Facts and circumstances that will be taken into account are as follows:-
- Proportionality of losses to income:- if a taxpayer has small amounts of income but high deductions, this highlights a risk. If the taxpayer has high income and low deductions then this is favourable.
- Advertising and selling:- trading requires selling and marketing. The taxpayer must demonstrate selling/advertising efforts in terms of activities performed or expenses incurred.
- Commercial manner:- Is the activity run in a business like manner.
- number of full time employees, excluding domestic servant and residential gardening workers
- where is the business located – in a commercial or residential area and its appearance
- the amount and the value of the equipment used exclusively for business purposes
- the amount of time the taxpayer spends at the premises to conduct the activity
- Proportionality of period of losses to the duration of the activity:- the number of years in which the activity incurs losses in proportion to the total number of years the business was running. Consideration will be given to:-
- any unforeseen events that give rise to losses i.e.. heavy rains, droughts etc
- nature of the activity
- The taxpayers future plans:- favourable consideration is given if you have a business plan and steps in place to prevent or limit losses.
- Availability of property for recreational or personal use:- you will have to proof that the property was unavailable to yourself and your relatives for recreational or private purposes, i.e., that you and your family does not use your holiday home etc.
SIX OUT OF TEN YEAR LOSS TRADERS:-
The above escape route will not apply to taxpayers that have incurred 6 out of 10 years losses
Although the losses incurred may not be offset against other income but only against that specific trades income, the losses may however be offset against recoupments. Recoupments are when you sell an asset of your business and make a profit on it. That profit made is taxable, therefore the loss of that business can be off set against that profit on sale of your assets of the business.
Any queries can be referred to me.
Kind Regards
Teresa Louw
Worldwide Tax Solutions
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