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If You Like it then You Should Put a Ring-Fence on it

24 July 2017   (0 Comments)
Posted by: Author: Nicci Courtney-Clarke
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Author: Nicci Courtney-Clarke (nicci@taxtim.com)

A look at what ring-fencing is and when it may apply to your tax situation.

 

When starting up your own business, there is a good chance that it will take some time for your venture to break even. This often means that you face financial loss. The same may hold true for a property you are renting out, where the rental income does not cover the interest on the mortgage bond as well as the other related property costs, such as rates, electricity, maintenance and levies.

 

For tax purposes, an overall loss on your business activity for a tax year is called an “assessed loss”. In the case of such an assessed loss, there are three possible scenarios:

  1. If you have no other income, the loss is simply carried forward to the following year, but not ring-fenced for deduction from a specific income source in the next year.
  2. If you have any other forms of income, such as a salary or interest, the loss may be deducted from this income. This would reduce your overall taxable income and, therefore, your tax liability.
  3. The loss is ring-fenced until a future tax year.

What does ring-fencing a loss really mean?

 

Ring-fencing the assessed loss simply means that the amount is carried over to the following year and can only be set off against income from the same trade. Ring-fencing a loss only applies to individuals (natural persons) and not to registered companies. In other words, this is only a consideration for an individual who is involved in some form of a business to generate income. It would, therefore, be applicable to sole proprietorships, freelancers and property owners who rent out their property to tenants.

 

Example to better illustrate the concept of ring-fencing

Felicity owns a flat, in addition to her primary residence, which she rents out to a tenant. In the 2016 tax year, the flat rental generated an assessed loss of R10 000. This was mainly due to substantial maintenance costs during the year. SARS ring-fenced this amount, meaning that Felicity could not deduct the loss from her annual salary from her employer and the amount was carried forward to the 2017 tax year as a rental income loss of R10 000 to be set off against future rental profits.

 

In the 2017 tax year, Felicity was able to charge a significantly higher rental amount and had little in the way of maintenance expenses. As such, she made a total profit of R35 000 from the rent of the property. In Felicity’s 2017 tax return, she set off the R10 000 ring-fenced loss against her R35 000 profit, giving her a net profit of R25 000 to be included with her annual taxable income.

 

When should you ring-fence your loss?

 

While SARS does ask you on your tax return whether “the assessed loss should be ring-fenced”, the decision is not ultimately yours to make. That is not to say that an assessed loss is automatically ring-fenced either.

 

The provisions of section 20A of the Income Tax Act will determine whether the loss should be set off against income in the current tax year or ring-fenced to be deducted from future profits from the same trade.

 

SARS takes a number of factors into consideration, including, but not limited to, the following:

  • Your overall income tax bracket
  • The nature of the business activity
  • The number of times you have made a loss over a certain period of years
  • Your business plan, active marketing activities and promotion

The provisions of section 20A are complicated and various scenarios related to the assessed loss will result in different outcomes.

 

Refer to the infographic (on the opposite page) to see whether your assessed loss should be ring-fenced or if you can set it off against your overall annual taxable income for the tax year.

 

Ring-fencing and provisional tax

 

A quick word of caution for provisional taxpayers (i.e., those taxpayers who earn income in addition to a salary and consequently pay provisional tax twice a year). It is important to keep the ring-fencing provision in mind when making provisional tax payments. SARS will be quick to penalise you if you automatically deduct your assessed loss from your other income to reduce your overall taxable income and, therefore, pay less tax if the ring-fencing provisions of the Income Tax Act prevent you from doing so.

 

Rather be on the safe side and check whether you need to ring-fence your loss by working through the helpful infographic included in this article.

Please click here to complete the quiz.

 

This article first appeared on the July/August 2017 edition on Tax Talk. 


 

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