Tax Tuesday: Ring-fencing losses

Let’s start this conversation by looking at what it means to ring-fence a tax loss. A tax loss from one source of income (like rental property) is ring-fenced if SARS does not allow you to offset that tax loss against income from another source of income (like your salary). The two sources of income are then effectively taxed separately. Individuals are generally allowed to offset tax losses from one source of income against income received from another source. This reduces the individual’s overall tax liability.

Let’s consider the following example: You’re employed full-time and earn a salary. However, you also lease out some properties. Let’s assume you made a tax loss of R7,500 from renting out the properties. Would you be able to offset the tax loss from your rental business against your salaried income?

As always, there are some requirements involved for this to happen. Before we start with the more technical requirements below, it should be noted that this only applies to individuals trading in their own name.

First requirement

You must fall within the highest income tax bracket, which currently means you need to earn taxable income of more than R1.5m.

Second requirement (also known as the “suspect trade” requirement)

The trade which created the tax loss should be one of the following:

(i) The practising of any sporting activity

(ii) Any dealing in collectibles

(iii) Any animal showing

(iv) Any form of performing or creative arts

(v) Any form of gambling or betting performed

(vi) Rental of residential accommodation or vehicles, aircraft or boats

(vii) Farming or animal breeding.

SARS is trying to prevent individuals from claiming expenses related to hobbies for tax purposes.

For the last two suspect trades (rental business and farming) further requirements exist. For a rental business to not be a suspect trade, at least 80% of the accommodation must be rented to persons who aren’t relatives of the individual running the rental business. Furthermore, farming is also excluded from the suspect trade list if it’s your full-time job.

Third requirement

The individual must have incurred a tax loss in respect of the suspect trade in question in at least three of the preceding five tax years.

Under certain circumstances, irrespective of the three requirements being met, the tax loss in question will not be ring-fenced. This will be the case if the individual can prove to SARS that the trade constitutes a business with a reasonable prospect of deriving taxable income (other than a taxable capital gain) within a reasonable period.

Some practical issues

In completing your tax returns, you will be required to answer whether the tax loss in question should be ring-fenced or not. When answering this question, the rules outlined above and the specific facts of the matter must be taken into account, but ultimately, the decision rests with SARS.

When making provisional tax payments, it’s important to keep the ring-fencing provisions in mind (so your provisional tax should not be reduced by a tax loss that needs to be ring-fenced).

You can become liable for tax penalties if you have reduced your taxable income with a tax loss that needed to be ring-fenced.

Being tax efficient is an important part of great financial management. In this blog, a group of South African tax experts share their tips and explanations on tax issues. Learn everything you need to know about tax, from deductions you never knew about to retirement savings and capital gains. The first Tuesday of every month is Tax Tuesday. Don’t miss it!