Ring-Fencing of Assessed Losses of Certain Trades
Persons are generally allowed to set off any losses incurred in respect of one trade against the income derived from another trade, thereby reducing their overall tax liability.
However, section 20A of the Income Tax Act ring-fences losses incurred by natural persons from certain trades under specific circumstances. If applicable, the natural person will not be able to set off the loss incurred from that trade against the income from any other trade, but may only set off the loss against future income derived from the trade to which the loss relates.
The rationale for this provision was to disallow natural persons to conduct hobbies disguised as trades in order to set off expenses from that hobby against other income such as salary income or professional income.
The first requirement for section 20A to apply, is that the natural person must fall within the highest income tax bracket during the relevant year of assessment. For the 2019 year of assessment, the person’s taxable income and any assessed loss or balance of assessed loss of the taxpayer must be equal to or exceed R1.5 million.
The second requirement relates to the nature of the trade carried on by the natural person. In this regard, he or she (or any relative of that person) must be engaged in one of the following trades. These include the practising of any sporting activity, any dealing in collectables, any animal showing by that person, any form of performing or creative arts or any form of gambling or betting performed.
Also included are the rental of residential accommodation or vehicles, aircraft or boats (unless at least 80% of the accommodation, vehicle, aircraft or boat is used by persons who are not relatives of the natural person for at least half of the year). Farming or animal breeding will also fall within section 20A unless such activities are engaged in on a full-time basis.
The third requirement is that, he or she must have incurred an assessed loss in at least three of the preceding five years of assessment, ending on the last day of the relevant year of assessment.
All 3 requirements must be met in order for the loss in respect of the specific trade to be ring-fenced.
The take away is that taxpayers with additional income sources should carefully consider the provisions of section 20A to the extent that the current ITR12 income tax return for individuals require taxpayers to indicate whether or not the losses are ring-fenced. Taxpayers may also be requested by the South African Revenue Service to confirm why section 20A should not apply in instances where that question was answered ‘no’.