6 May 2021 by Tax and Exchange Control Alert

Circumstances in which the utilisation of an assessed tax loss can be disallowed

An assessed loss is incurred by a taxpayer (such as a company) when the deductions claimed by that company exceed its income for the relevant year of assessment (YOA). In terms of section 20 of the Income Tax Act 58 of 1962 (Act), in order to determine its taxable income from trade, a taxpayer is permitted to set off inter alia any assessed loss (or balance of an assessed loss) brought forward from the previous YOA.

In terms of section 20(1)(a) of the Act, before a company can carry forward its assessed loss from the immediately preceding YOA (the “balance of assessed loss”), it must have carried on a trade during the current year of assessment. If it fails to do so, it will forfeit the right to carry forward its balance of assessed loss under section 20(1)(a).

In addition to the trade requirement, a further question arises, namely whether a company that has traded during the current YOA but has derived no income from trade during that period is denied the opportunity to carry forward its assessed loss from the preceding YOA i.e. the taxpayer has genuinely attempted to trade, but has been unsuccessful in its endeavours. This is referred to as the “income from trade” requirement.

Taxpayers, when considering whether they are entitled to carry forward an assessed loss (and whether they have satisfied the “trade” and “income from trade” requirements), should have regard to established principles which emanate from case law over the years such as: 

  • a company which seeks to set off an assessed loss from a previous YOA cannot merely “keep itself alive” in the YOA which it seeks to carry forward the assessed loss. Compliance with minimum regulatory obligations and the maintenance of a bank account will not constitute the carrying on of a trade even if the taxpayer intended to resume trading in the future;
  • the holding of meetings, appointment of directors and/or arranging for financial statements to be prepared, will on its own unlikely constitute the carrying on of a “trade”. Passive behaviour absent of any active endeavour to carry on a trade will not be sufficient to argue that a trade is being conducted;
  • if a taxpayer does not have any assets with which it can engage in a trade then it will be difficult to argue that it is actively carrying on a trade. For example, in circumstances where a taxpayer has no premises from which to trade, no equipment, no stock and no staff, it is likely that a court will deem this indicative of a company which is not trading. Accordingly, the absence of productive assets has been found to be an indicator of the absence of trading activity;
  • in respect of the income from trade requirement, courts have found that even an unsuccessful endeavour to trade can constitute trading even if no expenditure is outlaid (in certain circumstances) and no income is derived. The crux of the argument is that a company should be able to strike a balance even if its income so derived is nil provided that there was some attempt to trade; and
  • the discontinuation of a taxpayer’s main business operations may not in itself be deemed to be the cessation of trading if the taxpayer undertook other activities such as the continued employment of staff to realise assets and collect trade receivables. However, where a taxpayer’s only activities comprised of the collection of trade receivables and it had no stock, employees, or fixed assets of any significance, it is likely that the taxpayer will not meet the “trade” requirement.

Accordingly, taxpayers should be certain that they will satisfy the trade and income from trade requirements before relying on the provisions of section 20(1)(a) to carry forward an assessed loss from the previous YOA. An incorrect determination could result in the South African Revenue Service (SARS) disallowing the carry forward of the assessed loss resulting in significant adverse consequences for the taxpayer’s business.

In addition to the requirements above, taxpayers should also be aware that SARS can still invoke section 103(2) of the Act to disallow the utilisation of an assessed loss notwithstanding compliance with the trade and income from trade requirements where SARS is of the view that: 

  • an agreement affecting any company has been concluded; or
  • a change of shareholding has occurred;
  • the agreement or change of shareholding directly or indirectly results in the receipt or accrual of income or proceeds by that company; and
  • such agreement or change of shareholding was mainly or solely entered into for the purpose of utilising any assessed loss incurred by that company in order to avoid, postpone or reduce liability for tax for any person.

Therefore, whilst it may be beneficial for taxpayers to try to utilise an assessed loss within a group of companies, taxpayers should be aware that if there is not robust commercial justification for the utilisation of the assessed loss where one of the above factors are present, then there is a real risk that SARS will invoke the provisions of section 103(2).

Similarly, robust commercial justification would also be applicable in the context of an acquisition of a company with an assessed loss. In this instance, SARS may disallow the utilisation of the assessed loss where it is of the view that the company was acquired for solely or mainly for the purpose of using the assessed loss to avoid tax.

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