Three strikes, you’re out

Rev­enue takes its cut­ters to ring-fenc­ing

Finweek English Edition - - Creating Wealth - RUAN JOOSTE ru­anj@fin­

FIVE TAX YEARS have now elapsed since the South African Rev­enue Ser­vice in­tro­duced its ring-fenc­ing pro­vi­sions, and the tax­man is wast­ing no time in send­ing as­sess­ments to tax­pay­ers en­gaged in loss-mak­ing secondary trades, par­tic­u­larly those it con­sid­ers “sus­pect”, says Bernard Sacks, tax part­ner at tax, au­dit and ad­vi­sory firm Mazars Moores Row­land.

Ring-fenc­ing pro­vi­sions were in­tro­duced into SA’s In­come Tax Act with ef­fect from the 2005 tax year. It ring-fences as­sessed losses of in­di­vid­u­als in the high­est tax bracket in cer­tain cir­cum­stances. Those pro­vi­sions were in­tro­duced in or­der to pre­vent the per­ceived abuse by tax­pay­ers re­duc­ing their tax­able in­come by claim­ing losses from hob­bies dis­guised as secondary trades, such as farm­ing.

To pro­vide af­fected in­di­vid­u­als with a bet­ter un­der­stand­ing of what ring-fenc­ing is, and also to en­able them to de­ter­mine how and to what ex­tent the pro­vi­sions may af­fect their per­sonal in­come tax li­a­bil­ity, Rev­enue pub­lished a guide on its web­site that sets out how it in­ter­prets the leg­is­la­tion and pro­vides some prac­ti­cal ex­am­ples and re­sponses to fre­quently asked ques­tions.

In deal­ing with the is­sue of what con­sti­tutes ring-fenc­ing, Rev­enue refers to it as “an anti-avoid­ance mea­sure, in terms of which the ex­pen­di­ture in­curred in con­duct­ing a trade is lim­ited to the in­come from that spe­cific trade. Any ex­cess ex­pen­di­ture (loss) is then car­ried for­ward and is set off against any in­come de­rived from that trade in a sub­se­quent year of as­sess­ment”.

The ring-fenc­ing pro­vi­sions are ap­pli­ca­ble to nat­u­ral per­sons only. It there­fore in­cludes nat­u­ral per­sons trad­ing in a part­ner­ship. As­sessed losses in­curred by com­pa­nies, close cor­po­ra­tions and trusts aren’t sub­ject to those ring-fenc­ing pro­vi­sions.

“As a gen­eral rule losses from one trade can be set off against prof­its in an­other, un­less that trade makes a loss three years out of five or is con­sid­ered ‘sus­pect’ by Rev­enue,” says Sacks.

Sus­pect trades in­clude any sport prac­tised by the tax­payer or a rel­a­tive; deal­ings in collectibles; an­i­mal show­ing; any form of per­form­ing or creative arts; any form of gam­bling or bet­ting; and the rental of res­i­den­tial ac­com­mo­da­tion, ve­hi­cles, air­craft or boats as de­fined in the In­come Tax Act (un­less at least 80% of the res­i­den­tial ac­com­mo­da­tion, ve­hi­cles, air­craft or boats are used by per­sons who aren’t rel­a­tives of that per­son for at least half of the year of as­sess­ment).

If the op­er­a­tion makes a loss three years out of five, Rev­enue will ring-fence the third year’s loss and only al­low it to be set off against tax­able in­come from that spe­cific trade. It will not set it off against the tax­payer’s in­come from other trades.

Sacks says the onus is on the tax­payer to ob­ject to an as­sess­ment from Rev­enue ringfenc­ing a loss. The leg­is­la­tion al­lows for ringfenc­ing to be waived if the tax­payer can show the en­ter­prise has a “rea­son­able prospect” of mak­ing a profit within a rea­son­able time pe­riod. “How­ever, if the trade is con­sid­ered ‘sus­pect’ and losses have been in­curred in six years out of 10, the rea­son­able prospect rule can’t ap­ply to the ben­e­fit of the tax­payer.” The ex­cep­tion to that rule is farm­ing.

In mak­ing a “rea­son­able prospect” case, Rev­enue would want to see proof of things such as the gross in­come from the trade, the na­ture of the busi­ness, the level of ac­tiv­ity car­ried on, busi­ness plans, de­tails of em­ploy­ees, un­ex­pected events giv­ing rise to losses and de­tails of ad­ver­tis­ing, pro­mo­tion and sell­ing ex­penses.

“In other words, Rev­enue wants to see whether the trade is car­ried on in a com­mer­cial man­ner,” says Sacks. Where an as­sess­ment that ring-fences an as­sessed loss is is­sued to a per­son, that per­son has a right to ob­ject to the rel­e­vant as­sess­ment if he isn’t sat­is­fied with the de­ci­sion made by Rev­enue.

If the ob­jec­tion is dis­al­lowed or par­tially dis­al­lowed that per­son has the right to lodge an ap­peal against such dis­al­lowance or par­tial dis­al­lowance. In­for­ma­tion re­gard­ing the ob­jec­tion and ap­peal pro­ce­dures is avail­able on Rev­enue’s web­site un­der “dis­pute res­o­lu­tion” or can be ob­tained from any Rev­enue branch of­fice.

Onus on tax­payer to ob­ject to an as­sess­ment. Bernard Sacks

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