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Jumping fences: Section 20A of the Income Tax Act and ring-fenced losses

Monday, 19 February 2018   (0 Comments)
Posted by: Authors: Louis Botha and Louise Kotze
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Authors: Louis Botha and Louise Kotze (CDH)

In South Africa’s current challenging economic climate, the risk of suffering losses in business is higher than normal. From a tax perspective, persons are generally allowed to set off losses incurred in respect of one trade against the income derived from another trade, to reduce their tax liability. However, the extent to which taxpayers can do this is limited and in this regard taxpayers, specifically natural persons, should be aware of the provisions of s20A of the Income Tax Act, No 58 of 1962 (Act). In terms of s20A, losses incurred by natural persons in respect of certain trades will be ring-fenced under certain circumstances, meaning that such losses cannot be offset against income derived from other trades carried on by such natural persons. 

Rationale behind s20A

In terms of the Explanatory Memorandum on the Revenue Laws Amendment Bill, 2003 (Memorandum), s20A was introduced to curb the practice where natural persons pursued ventures that, for the most part, consisted of hobbies disguised as trades, referred to in the Memorandum as suspect trades. The Memorandum states that private consumption can be disguised as trade so that individuals, especially wealthier individuals, can set-off the expenditures from this trade against other income such as salaried or professional income. Section 20A addresses this by stating that losses incurred in respect of a trade will be ring-fenced under certain circumstances.

When a loss is ring-fenced, that loss may not be set off against the other income of the natural person in order to reduce his tax liability. The loss may only be set off against the future income derived from the trade to which the loss relates. It follows that any balance of assessed loss pursuant to conducting that trade may, in future, also only be set off against the income derived from that trade. 

When will section 20A apply to a loss?

Section 20A(2) sets out the requirements that, if met, will result in the relevant loss being ring fenced. 

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