Section 20A was inserted into the Income Tax Act 58 of 1962 (ITA) and applies to the 2005 and subsequent years of assessment. It applies to individuals whose taxable income places them in the highest tax bracket before considering any assessed loss or balance of assessed loss brought forward from the previous year of assessment. It is aimed at ring-fencing assessed losses when taxpayers make continuous losses. The person will potentially fall within the ambit of s 20A if they
- make losses in three out of five years of assessment; or
- carry on a suspect trade.
The individual can escape ring-fencing if they pass the ‘reasonable prospect of deriving taxable income within a reasonable period’ test. But that test does not apply when the person has made losses in six out of ten years of assessment, and they carry on one of the listed suspect trades. Farmers are excluded from the six-out-of-ten-year rule.
There are nine suspect trades, and these are listed in s 20A(2)(b). Section 20A(2)(b)(iii) treats as a suspect trade the rental of residential accommodation, unless at least 80% of the residential accommodation is used by persons who are not relatives of that person for at least half of the year of assessment.
The
Explanatory Memorandum on the Revenue Laws Amendment Bill, 2003, which supported Act 45 of 2003, stated the following:
‘Residential accommodation within this category is intended to include the rental of holiday homes, bed and breakfast establishments, guesthouses and dwelling houses. For instance, the bed and breakfast leasing of a few rooms within the taxpayer’s main home would fall under the suspect list. Holiday homes used by the taxpayer and not used by persons who are not relatives for at least half of the year of assessment would be similarly suspect.’
Thus, a person who lets immovable property and makes losses in three out of five years of assessment or lets residential accommodation to relatives as described above will potentially be subject to ring-fencing unless they can show that they have a reasonable prospect of turning a profit in a reasonable time. The ‘prospect of a profit’ escape route will, however, not avail a taxpayer that lets residential property as described in the list of nine suspect trades and makes losses in six out of ten years.
The effect will be that the rental losses will not be available for set-off against other income such as a salary or interest. The Explanatory Memorandum notes that
‘Ring-fenced losses falling within section 20A are ring-fenced forever and may only be offset against income from that trade. Taxpayers will never be able to use these ring-fenced losses against income from other trades either during the current tax year during which the ring-fenced losses occur or in a subsequent year (in the form of a carry forward)…’
When the person ceases the suspect trade and disposes of the immovable property, s 20A(6)(b) enables the taxable capital gain to be set off against the accumulated rental losses. It provides as follows:
‘(6) For the purposes of this section, and section 20, the income derived from any trade referred to in subsections (1) or (5), includes any amount—
(a)
[not relevant – deals with recoupments]; or
(b)
derived from the disposal after cessation of that trade of any assets used in carrying on that trade.’
Importantly, s 20A(6)(b) does not apply to the disposal of assets while the trade is being carried on. The trade must first cease, and then the assets associated with that trade must be disposed of.
The wording is somewhat strange in that it treats as income the amount derived from the disposal of the asset, regardless of whether it is of a capital nature. No doubt this was intended to encompass both trading stock and capital assets. What does the amount so derived refer to in the context of a capital asset? Is it the proceeds, the capital gain or the taxable capital gain? Cryptic drafting of this nature is unhelpful and best avoided. In practice SARS treats the amount as representing the taxable capital gain arising from the disposal of the asset used in the suspect trade. The taxable capital gain is determined by reducing the capital gain by the annual exclusion of R40 000 (assuming it has not been used against other capital gains) and then multiplying the result by the inclusion rate of 40%.
A question arises to how multiple loss-producing properties must be dealt with when one of them is sold at a taxable capital gain. In other words, are they all part of one rental trade or is each property a separate rental trade? It is submitted that a sensible approach to this issue is to regard each property as a separate trade. This view means that the taxable capital gain arising on any one of the properties may be set off only against the rental losses from that property. Were all the properties to be regarded as one trade, only the taxable capital gain on the last property sold could be set off against the ring-fenced rental losses under s 20A(6)(b), with set-off being denied on earlier disposals because the trade had not ceased at those times. This approach finds support in Interpretation Note 51 (Issue 6),1 which references the case of
Reef Estates Ltd v CIR.2 In that case the taxpayer company owned 10 rental properties. One of them was a vacant stand which was let as a parking lot in the interim. The company intended to build shops on the stand for the purposes of letting. The court refused to allow the rental loss on the property, notwithstanding that the company was trading with its other properties. On the question of whether the vacant stand was a separate business, Rumpff J stated the following:3
‘The facts of this matter indicate that stand 485 was acquired and is still being held with the intention of building shops thereon and deriving rentals therefrom. It is being held in order that it may in future become an income-producing unit. Even if the other properties of the appellant company together are considered as one business (a point which we need not decide) it cannot be said that stand 485 has become qualified to be regarded as part of that business.’
Section 20A emphasises the facts and circumstances of the trade. For example, s 20A(2)(b)(iii) designates residential property occupied by relatives as a suspect trade. Section 20A(3) excludes a trade in which there is a reasonable prospect of the business producing taxable income within a reasonable period, having regard to numerous factors. Simply lumping all rental properties in a pool would not advance the facts and circumstances approach inherent in s 20A because it would mean that profitable commercial properties could be used to absorb losses of suspect residential properties or losses of properties having no prospect of making a profit.
Disclosure in the income tax return
According to the
Comprehensive Guide to the ITR12 Income Tax Return for Individuals, the taxable capital gain (after applying the annual exclusion and inclusion rate) must be reflected as income in the ‘Local Business, Trade and Profession’ section of the return of income. The same unique identifier, description and source code of the particular trade (prior to cessation) must be used in order for the ring-fenced assessed loss brought forward to be used during the assessment. The amount should not be declared in the capital gains tax section of the return, since this will result in double taxation.
The first example below has been adapted from the SARS
Comprehensive Guide to Capital Gains Tax (Issue 9) in 5.9.4.
Example 1 – Set-off of taxable capital gain after cessation of suspect trade
Facts:
Roland owns a flat in Umhlanga that he bought for the stated purpose of letting to foreign tourists. However, he and his family occasionally used the flat as a holiday home when it was not let. As a result of the large bond used to finance the acquisition of the flat, it generated losses over three consecutive years at which point SARS informed Roland that his losses were to be ring-fenced. After a further three years of losses, Roland had accumulated a ring-fenced assessed loss of R100 000. He informed the letting agent that the flat was no longer available for letting, and he then sold it for an amount that gave rise to a taxable capital gain of R500 000.
Result:
Roland is permitted to set off the ring-fenced assessed loss of R100 000 against the taxable capital gain of R500 000.
Example 2 – Set-off of taxable capital gain after cessation of suspect trade: letting of multiple properties
Facts:
Amanda owns five properties in different locations which she lets out. Three of them have been producing rental losses which are ring-fenced under s 20A. She decided to dispose of one of the loss-producing properties and realised a capital gain of R840 000. The accumulated ring-fenced rental losses on the property disposed of amount to R100 000. Amanda is on the maximum marginal rate of tax of 45%.
Result:
If it is accepted that each property is a separate trade, Amanda can set off the ring-fenced rental loss from the property she disposed of against the taxable capital gain as follows:
| R |
| Capital gain | 840 000 |
|
Less: Annual exclusion |
(40 000) |
| Net capital gain | 800 000 |
| Inclusion rate | 40% |
| Taxable capital gain R800 000 × 40% | 320 000 |
|
Less: Ring-fenced assessed loss |
(100 000) |
| Taxable income after deduction of ring-fenced assessed loss |
(220 000) |
Conclusion
SARS last updated its Guide on the ring-fencing of assessed losses arising from certain trades conducted by individuals (Issue 2) in 2010. Unfortunately, it does not address the issue of the letting of multiple properties. It would be helpful if SARS could clarify its stance on the issue when it next updates the guide.
This article was first published by ASA in its
February 2025 issue.
