An assessed loss for income tax purposes is a potentially valuable asset: it represents past losses made by a taxpayer which is able of being carried forward to subsequent tax years against which future taxable profits are able of being set off. The set-off of historic losses – in the form of an assessed loss – against existing taxable income has the obvious benefit of resulting in a reduced income tax charge against current and/or future taxable income generated from trade.
It is therefore quite common that such an assessed loss is assigned a determinable value (as a so-called ‘deferred tax asset’) as a secondary benefit when a company with an assessed loss is sold. However, it may happen that a potential purchaser of the shares in a company does so with the sole or main purpose to acquire the underlying assessed loss, and not necessarily the other assets that the company may own. For example, if a natural person were to incorporate his or her profitable business, it would be preferable to make use of a dormant company with a historic assessed loss, rather than incorporating a new company or make use of a shelf company. The established assessed loss can then be used to negate the income tax consequences that would otherwise have arisen from the business.
Section 103(2) of the Income Tax Act, 58 of 1962 (‘Income Tax Act’) has been designed to counter exactly this form of abuse if the utilization of an assessed loss is the sole or main purpose of a specific transaction. The provision applies whenever the South African Revenue Service (‘SARS’) is satisfied that any agreement affecting, or any change in the shareholding in, any company has been effected solely or mainly for purposes of utilizing an assessed loss of a company in order to avoid an income tax liability. Should these prerequisites be met, SARS has the power to disallow the setoff of any such assessed loss against any such income generated by the company.
Section 103(2) moreover does not only apply to taxable trading profits, but also where an assessed loss is used to negate capital gains tax exposure, or even where capital losses (as opposed to assessed income tax losses) are at stake. The provision also applies to trusts with assessed losses as much as it does to companies.
Finally, it is worth noting that section 103(2) may be used in the alternative to the general anti-avoidance rules (the so-called GAAR) contained in sections 80A to 80L of the Income Tax Act, and vice versa. It is arguable rather that the provisions of section 103(2) would be more difficult for the taxpayer to escape from, as (unlike the GAAR) it is not a prerequisite of this anti-avoidance measure that an element of ‘abnormality’ linked to the transaction in question also need to be illustrated for section 103(2) to apply.
This article is a general information sheet and should not be used or relied upon as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice. Errors and omissions excepted (E&OE)