As noted in a previous article, the proposal whereby, in the case of companies, assessed losses carried forward from previous years of assessment would no longer be fully available for offsetting against current year taxable income, 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 indicated that the rationale for this amendment was 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 was seen as 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 to the 2021 Taxation Laws Amendment Bill noted that there has been a global trend to restrict the use of assessed losses carried forward. Out of thirty-four OECD and non-OECD countries surveyed, sixteen countries were found to limit carry-forward periods to between three and twenty 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 periods to a set number of years;
- basing a restriction on a specified percentage of accumulated assessed losses that may be used to reduce taxable income; and
- restricting the set off of accumulated assessed losses to a specified percentage of taxable income.
The Explanatory Memorandum concluded that the third method above was the most appropriate policy stance for South Africa since it would affect businesses more equally, rather than restricting the number of years for carrying forward assessed losses, which would have disproportionately hurt businesses with large initial investments or long lead times to profitability.
The proposal was enacted in terms of the Taxation Laws Amendment Act of 2021 and came into effect for years of assessment ending on or after 31 March 2023.
It only applies to companies that have incurred an assessed loss in a previous year of assessment and states that the set off of such assessed loss carried forward against current year taxable income may not exceed the higher of R1 million and 80 percent of the current year taxable income before the application of the set-off. The main points to note are as follows:
- The rule only applies to companies. Therefore, other taxpayers such as individuals and trusts are not affected and may as before, fully set off assessed losses carried forward from previous years of assessment against taxable income earned in the current year.
- The rule first applies to years of assessment ending on or after 31 March 2023. In the case of a 12-month year of assessment, this, therefore, means that it will apply to years of assessment commencing on or after 1 April 2022.
- The rule does not apply to assessed capital losses, which in most cases remain fully available for set-off against capital gains.
- If the current year’s taxable income before the set-off of the assessed loss is R1 million or less, then the assessed loss brought forward may be fully set off against the taxable income. The R1 million de minimus 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 the section 36 mining capital expenditure is calculated after the set-off of the assessed loss. The balance of unredeemed capital expenditure will then be carried forward to the following year of assessment.
- If the current year’s taxable income calculation results in an assessed loss before taking into account an assessed loss carried forward from the previous year of assessment, then 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 year of assessment.
- 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 year of assessment, in terms of the decision in SA Bazaars (Pty) Ltd v CIR (1952 (4) SA 505(A), it will not be able to carry forward an assessed loss from a previous year of assessment to the next year of assessment. In these circumstances, this assessed loss will therefore become lost to the company.
Below are examples to illustrate the workings of the amendment.
| Company A | Company B | Company C | Company D | |
| Current year taxable income / assessed loss | 500 000 | 2 000 000 | 4 000 000 | (3 000 000) |
| Assessed loss balance c/f | (1 000 000) | (3 000 000) | (1 000 000) | (2 000 000) |
| 80% of taxable income (A) | 400 000 | 1 600 000 | 3 200 000 | N/A |
| R1 000 000 threshold (B) | 1 000 000 | 1 000 000 | 1 000 000 | N/A |
| Loss setoff amount: greater of (A) and (B), limited to the assessed loss c/f | 500 000 | 1 600 000 | 1 000 000 | N/A |
| Taxable income | Nil | 400 000 | 3 000 000 | Nil |
| Assessed loss c/f to the following year of assessment | (500 000) | (1 400 000) | 0 | (5 000 000) |
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 section 23M of the Income Tax Act. This provision restricts the deductibility of a company’s interest expense in circumstances where a controlling relationship with the creditor or various other parties exists, 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 when 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.