Ensuring the availability of assessed losses for set-off against future income: A brief note
Introduction
An assessed loss occurs when the deductions available will exceed the income to which they are attributable. A definition can be found in section 20 of the Income Tax Act 58 of 1962 (“the Act”).
In the past, an assessed loss would result in no taxable income for the taxpayer concerned. However, under the new dispensation, an assessed loss can now only be set off against 80% of taxable income or R1 million – whichever is higher – in the relevant tax year, with the remaining balance of assessed losses still rolling over.
The question is thus, how does one ensure that the remaining balance of assessed losses is carried or rolled over into the next year of assessment?
A balance of assessed losses is not defined in the Act but can be understood to be an assessed loss that has been carried forward into the succeeding Year of Assessment (“YOA” or "YOAs" for plural), and it is carried forward because there has been the carrying on of a trade in that succeeding YOA. Therefore, in order for a balance of assessed losses to be continuously carried forward into successive YOAs, it is of paramount importance that the carrying on of a trade in each of those YOAs is present.
It is thus clear that the carrying on of a trade as per section 20(1) (a) of the Act is a prerequisite for the carrying forward of a balance of assessed losses.
The carrying on of a trade
The term “trade” is given an extensive meaning in section 1 of the Act, which says:
“every profession, trade, business, employment, calling, occupation or venture, including the letting of any property and the use of or the grant of permission to use any patent as defined in the Patents Act, or any design as defined in the Designs Act, or any trade mark as defined in the Trade Marks Act, or any copyright as defined in the Copyright Act, or any other property which is of a similar nature.”
The case of Burgess v CIR (1993) (A) confirmed that the meaning of “carrying on a trade” has a wide definition and that this is a well – established principle. This case further confirmed that the meaning or definition is not exhaustive.
When trying to identify whether one is carrying on a trade, frequency and profit motive are not prerequisites although they are good indicators. Instead, there must be a consideration of all of the circumstances surrounding the case to see whether there is the carrying on of a trade and this was confirmed in Estate G v COT (1964 SR). In De Beers Holdings (Pty) Ltd v CIR (1985 AD) the court said that a taxpayer may elect to trade for some other commercial advantage, or he may be compelled to sell at a loss. This principle found its roots in Modderfontein Deep Levels Ltd v Feinstein (1920 TPD).
Suffice to say that trade does not mean that the activity must produce income. What is important is that the trade is aimed at producing income.
The case law
The seminal case with the regards to the requirement of carrying on a trade in order to carry forward a balance of assessed losses is SA Bazars (Pty) Ltd v CIR 1952 (4) SA 505 (A).
The facts of this case are that the taxpayer was a company in the Durban area involved in the retail business, and after a difficult period it closed down its retail business which had accumulated a balance of assessed losses amounting to £7 623 by the YOA ending June 1943.
From the YOAs 1944 to 1947 the taxpayer maintained its bank account, maintained its trading licences, paid income tax and licence duties, held meetings and prepared its statement of account which showed that it had assessed losses, but did not engage in the retail business trade or any other trade for that matter. However, during the 1948 and 1949 YOAs the taxpayer earned income from commission fees and sales of merchandise.
The issue that then arose was that the taxpayer, which had a balance of assessed losses in YOA ending June 1943 (following which it did not carry on trade from YOAs 1944 to 1947) wished to set off the 1943 balance of assessed losses against the income earned in the 1948 and 1949 YOAs.
In the judgement, Centrivres CJ held that the pertinent question is whether the taxpayer was entitled to carry forward the balance of assessed losses from 1943 into the succeeding YOA (ending June 1944). If the taxpayer would fail in that regard, then it followed that the taxpayer could not carry forward the balance of assessed losses into succeeding YOAs beyond 1943 to set-off against taxable income in 1948 and 1949.
In answering the question above, Centrivres CJ, at 1952 (4) SA p510 held:
“During the year ending on 30th June, 1944, the appellant did not carry on any trade. The mere fact that it kept itself alive during that and subsequent periods does not mean that during those periods it was carrying on a trade. It is clear from the stated case that it closed down its business and as long as it kept its business closed it cannot be said to have been carrying on a trade, despite any intention it might have had to resume its trading activities at a future date”
To reduce to plain words, what Centrivres CJ held was that during the impugned YOA (ending June 1944) and the following YOAs (1945 – 1947) the taxpayer did not carry on any trade and did not derive any income from any trade. The fact that the taxpayer carried on no trade in the impugned YOA (ending June 1944) meant that the set off of its assessed losses were not allowed in the YOA ending June 1944, consequently, this meant that the losses could not be carried forward to be set off against income in the succeeding YOAs. In effect, the assessed losses were extinguished for a lack of trade in the 1944 YOA.
In the case of New Urban Properties v SIR 1966 (1) SA 217 (A), Beyers JA succinctly summarised the point that Centrivres CJ made in SA Bazars by remarking that ‘if for any reason the assessed loss cannot be set off and balanced in any particular year, there is then no “balance of assessed loss” for that year which can be carried forward to the succeeding year...in other words, the essential continuity has been fatally interrupted’.
The meaning of trade revisited
In Robin Consolidated Industries Ltd v CIR 1997 (3) SA 654 (SCA) Schultz JA shed light on the meaning of trade within the context of assessed losses and held that the realisation of an asset in the process of liquidation cannot be said to constitute trade as this would result in the fallacy of equating realisation (forced sale) to trade.
In this case, Schultz JA held that the manner of realisation is an important one because if the liquidator continues to sell the assets in the traditional manner in which the company usually sells its assets, then that could be equated to trading. However, in this case, the liquidator sold the assets in a manner that minimised or nullified the risk of a loss to ensure that the asset sold was “cleared of the shelf” in an effort to rescue any funds left in the business in the process of winding up the company. The decision of the court was that there was no income derived from trading activities that the balance of assessed losses could be set off against.
Conclusion
For one to be able to utilise (set off) an assessed loss one must continue to trade (be in active business) with the aim of generating income (whether it is one transaction or multiple transactions in a year of assessment). This trade must take place in the year succeeding the assessed loss and must continue until such time one wishes to utilise (set off) the assessed loss or what has now become, in a subsequent year a balance of assessed losses.
In other words, you dare not interrupt the essential requirement of the continuity of trade.
Mabhelandile Ntuli Attorneys are registered tax practitioners who provide assistance on a range of tax matters. We approach tax and legal issues with certainty.