Significant changes to South Africa’s rules that restrict the ability of companies to set off assessed losses carried forward from a previous year of assessment (YOA) against current year taxable income were enacted under the Taxation Laws Amendment Act of 2021 and are now in effect for YOAs ending on or after 31 March 2023. Specifically, an assessed loss incurred by a company in a previous YOA now may only be set off against 80% of taxable income or ZAR 1 million, whichever is higher, with any remaining losses carried over to the next year.
Section 20 of the Income Tax Act (ITA) previously allowed most taxpayers carrying on a trade to set off assessed losses brought forward from prior YOAs against taxable income in the current YOA, with any unutilised portion of the assessed loss available for carry forward to subsequent YOA. The 2020 budget contained a proposal that loss carry forwards would in future be restricted in the case of companies, but this was put on hold due to the COVID pandemic. According to the Explanatory Memorandum to the Draft Taxation Laws Amendment Bill (TLAB) of 2021, the rationale for the proposed changes was to allow for a proposed reduction in the corporate tax rate from 28% to 27%. The rate reduction is considered necessary to improve South Africa’s competitiveness, promote foreign investment and economic growth, and reduce drivers towards base erosion and profit shifting.
The Explanatory Memorandum cited the global trend to restrict the use of assessed losses carried forward: out of 34 OECD and non-OECD countries surveyed, 16 were found to restrict carry forward periods to between three and 20 years, while eight countries limit the number of tax losses that can be offset in any given year. Jurisdictions that limit the use of assessed losses usually do so by one of three methods, or a combination thereof:
- Limiting the carry forward period to a prescribed number of years;
- Restricting a specified percentage of accumulated assessed losses that can be used to reduce taxable income; and
- Restricting the setoff of accumulated assessed losses to a specified percentage of taxable income.
The third method is considered the most appropriate policy stance for South Africa since it will affect businesses more equally, rather than restrict the number of years for carrying forward assessed losses, which would disproportionately harm businesses with large initial investments or long lead times to profitability. This proposal was finally enacted and is now in effect.
Overview of the new rules
The restriction on the setoff of losses applies only to companies that have incurred an assessed loss in a previous YOA. As noted above, the setoff of carried forward assessed losses against current year taxable income may not exceed the higher of 80% of the current year taxable income or ZAR 1 million, whichever is higher.
The main points to note are as follows:
- As the rule applies only to companies, other taxpayers, such as individuals and trusts, are not impacted and may continue to fully set off assessed losses carried forward from previous YOA against taxable income earned in the current year.
- The rule first applies to YOAs ending on or after 31 March 2023. In the case of a 12-month YOA, this means it applies to YOAs commencing on or after 1 April 2022.
- The rule does not apply to assessed capital losses, which in most cases, remain fully available for setoff against capital gains.
- If the current year’s taxable income before the setoff of the assessed loss is ZAR 1 million or less, the assessed loss brought forward may be fully set off against the taxable income. The ZAR 1 million de minimis threshold was introduced to provide relief for companies experiencing cash flow challenges.
- In the case of mining companies, the legislation has been clarified to state that the deduction of mining capital expenditure is calculated after the setoff of the assessed loss. The balance of unredeemed capital expenditure will then be carried forward to the following YOA.
- If the current year’s taxable income calculation results in an assessed loss before taking into account losses carried forward from the previous YOA, the rule does not apply. In such a case, the full amount of the current year’s assessed loss is added to the previous year’s assessed loss and the entire balance of assessed loss is carried forward to the following YOA.
- As before, a company may only set off an assessed loss against income derived from a trade. Further, if a company does not carry on a trade at all during a YOA, it will not be able to carry forward an assessed loss from a previous YOA to the next YOA. In such a case, the assessed loss will be forfeited.
Below are examples to illustrate the operation of the new rule:
Comments
Another part of the bargain, purportedly to achieve revenue neutrality in the reduction of the corporate income tax rate, was a considerable broadening of the scope of the provision in the ITA (section 23M), which restricts the deductibility of a company’s interest expense in circumstances where there is a controlling relationship with the creditor or other parties if the interest is not fully taxed in the hands of the creditor. Given the meagre one percentage point reduction in the corporate income tax rate as compared to the combined effects of the assessed loss limitation and the broadening of section 23M, it appears that the bargain has considerably favoured the fiscus in this case.
David Warneke
BDO in South Africa
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