Section 20 of the Income Tax Act allows, in most circumstances, for taxpayers carrying on a trade to set off assessed losses brought forward from prior years of assessment against taxable income in the current year of assessment. At present, any unutilised portion of the assessed loss may be carried forward to the succeeding year of assessment. However, the Draft Taxation Laws Amendment Bill of 2021(‘Draft TLAB of 2021’) which has been recently released for public comment, proposes significant changes to the treatment of assessed losses in relation to companies.
The proposal is that a limitation will apply, such that a company seeking to set off a balance of assessed loss brought forward from a preceding year against current year taxable income, will be liable to income tax on a minimum of twenty per cent of the company’s current year taxable income. In other words, a balance of assessed loss that is brought forward from a previous year of assessment may only be utilised to shield a maximum of eighty percent of current year’s taxable income. The portion of the assessed loss balance that is not allowed to be set off against current year income may be carried forward to the following year of assessment, so it will not be lost to the company, provided that the company earns income from trade in the succeeding year of assessment.
This proposal was first outlined in the 2020 Budget Review but was delayed due to the COVID pandemic. The Explanatory Memorandum to the Draft TLAB of 2021 indicates that the rationale for this amendment is to create the fiscal space to allow for a proposed reduction in the corporate tax rate from 28% to 27%. The reduction in the corporate tax rate is seen as necessary to improve South Africa’s competitiveness, to promote foreign investment and economic growth and to reduce drivers towards base erosion and profit shifting. In other words, the loss to the fiscus as a result of the proposed reduction in the corporate tax rate will be neutralised, at least to some degree, by the proposed limitations on the use of corporate assessed losses. Both are seen as part of a ‘corporate income tax package’ aimed at facilitating the reduction in the corporate tax rate in a revenue neutral manner. We hope that the reduction in the corporate income tax rate will be enacted in due course, as the second part of this package.
If enacted, the changes will come into effect for years of assessment commencing on or after 1 April 2022. The Explanatory Memorandum makes it clear that the new limitation will apply to a company’s balance of assessed loss as at the date of the enactment of the amendment and not only to assessed losses accumulated from the date of the enactment.
The Draft Explanatory Memorandum provides the following useful examples which illustrate the effect of the limitation in various scenarios:
Company B1 has a year of assessment starting on 1 April 2022. It has R500 of taxable income before offsetting accumulated losses of R1,000. The accumulated loss balance exceeds current year taxable profit – and, by implication, is more than 80 per cent of taxable income.
Company B1 will be required to pay corporate income tax (‘CIT’) on the portion of its current- year taxable income that exceeds 80 per cent of taxable income, (i.e. on 20 per cent of taxable income). As a result, Company B1 will be required to pay CIT of R28 (CIT rate of 28 per cent applied to taxable income of R100).
The remaining balance of the assessed loss can be carried forward to the following year of assessment.
Company B2 has a year of assessment starting on 1 July 2022. It has taxable income of R500 prior to setting off assessed losses of R475. The balance constitutes 95 per cent of current-year taxable income – exceeding the proposed 80 per cent restriction. As a result, Company B2’s assessed loss balance which can be set off against its taxable income will be limited to R400 (80 per cent of its taxable income), with the remaining balance of R75 carried forward to future years. Company B2 will pay CIT of R28 (CIT rate of 28 per cent applied to taxable income of R100).
Company B3 has a year of assessment starting on 1 October 2022. It also has taxable income of R500 before offsetting the assessed loss balance. However, its assessed loss balance is R200, which is less than 80 per cent of taxable income. Company B3 will be able to use its total assessed loss balance of R200 to reduce its taxable income.
As the Draft Explanatory Memorandum notes, there has been a global trend to restrict the use of assessed losses carried forward.
Overall, a broadening of the tax base in order to reduce the corporate income tax rate is a sensible approach. We hope that the reduction in the corporate income tax rate will in fact be enacted in due course, as the second part of this ‘package’.
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