Rental losses - carried forward if absent from SA?

[wiehahn]

I purchased an investment property in South Africa a number of years ago, while I was still working in South Africa. Every year, when submitting my personal tax return, I claimed the rental loss on the property as a deduction from my normal taxable income. The rental loss was calculated by subtracting the mortgage interest from my rental income. This used to result in me receiving a tax refund every year.

I have been working in the UK for the last 2 years, and therefore had no taxable income in South Africa for the last 2 years. I still have the investment property and continued to incur a net loss (rental income less mortgage interest), but I have not been able to claim this against anything due to not having taxable income in SA.

My question is, when I return to South Africa next year, will I be able to set off all the losses on this property for the past 2 or 3 years against my taxable income when I start working again in South Africa? In essence, if the losses are not used in a particular year, are they carried forward?

[Dave A]

By my understanding, you can't carry over accumulated tax losses into the subsequent tax year as an individual. However, you can as a company.

[wiehahn]

SARS gave me this exensive reply. It appears that they look at every case on its merits. The question of whether the loss is carried forward in an individual's name was not addressed, but from the previous reply on this thread it appears not.

Deduction of rental expenses:

In all instances, rental income will fall into gross income and then will be subject to taxation. However, this does not mean that rental expenses will be allowed in the computation of taxable income.



In this instance, one would have to revisit the Act in order to establish whether or not the specific expenses could be allowed.



Depending on the type of expense incurred by the taxpayer, the following sections of the Act would likely apply:



* Section 11(a), read in conjunction with section 23; and
* Sections 11 (c) to 19



Section 11 (a) of the Act provides for the general deduction formula and it states that:



For the purpose of determining the taxable income derived by any person from carrying on any trade, there shall be allowed as deductions from income of such person so derived-



a) expenditure and losses actually incurred in the production of the income, provided such expenditure and losses are not of a capital nature;



The components of section 11 (a) are not actually defined by the Act. We therefore have to look at case law for interpretation regarding the relevant components. Very important, all of these components must be met before a deduction can be allowed.



Carrying on of a trade:



For rental expenses to be allowed as a deduction, it must be clear that the taxpayer is carrying on a trade. The word “trade� is defined in the Act.



Trading commences once the property is actively made available for letting, provided that the property is in a “lettable condition�. A mere intention to let the property without any concrete attempt to do would not constitute a trade. This was extracted from the case of ITC1475; 52 SATC 135.



A reading of the definition of trade in section 1 of the Income Tax Act shows that trade covers a wide spectrum of activities. It is thus subject to different interpretations. In addition, a number of court cases have given us widely accepted interpretations of what trade means.



According to case law, “trade� involves an active occupation (i.e. physical involvement) as opposed to a passive occupation (i.e. no physical involvement). A passive occupation would include the earning or dividend income, for example.



One might argue that rental earned from the letting of property might not require any active involvement on the part of the lessor. However, the definition of trade specifically includes the letting of any property.



A “trade� is widely defined and specifically includes a business. The courts, however, have referred to these terms synonymously. To understand these terms one needs to look at different tests that have been used by the courts over the years. These tests, while used by the South African courts, are merely guidelines. A summary thereof is as follows:



1. Intention:



One needs to assess a case meticulously to ascertain intention of the taxpayer when he purchased the property. In verifying the intention of the taxpayer, it is important to look at all the circumstances surrounding the taxpayer’s decision to purchase the property; e.g. the mode of acquisition, arrangements for repayments, etc.



In ITC 1653 (61SATC 120) the taxpayer bought the property as a long term investment. She had been unaware that there was a rent order in force in respect of the property which severely limited the rental received and she declared a significant loss ‘on property rent’. The issue before court was whether there was no hope of a profit being realised on the income from rent after taking into account the expenditure on repayment of the loan taken out to finance the purchase and other expenses.

The court held that when the taxpayer bought the property her main purpose or motivation was not to embark on or carry on the trade of leasing it and therefore the expenditure incurred by her in respect of the property was not wholly and exclusively incurred for the purposes of trade.

Accordingly, the expenditure in issue was not deductible to the extent that it exceeded the income from rent.



2. Business-like System or Method:



A trade must have a business-like system in order for it to function soundly. A good example is the planning and organisation involved at the beginning and during the life of an undertaking. In these cases one can clearly establish via the actions of the taxpayers that a “trade� is being carried out.



3. The intention to Make profit



“Trade� must involve an element of profit. There must at the very least be an expectation or hope of profit. This expectation or hope of profit must also be reasonable.

As Myburgh J, quoted in Income Tax Case 1292



“if the possibility to earn a profit is excluded then such expenses are not deductible. The test is the real hope to make profit. Such hope must not be based on fanciful expectations but on reasonable possibility�



This is very important when establishing the existence of a trade. A trade is only in existence when the expectation or hope to earn a profit is present, and the expectation is based on a reasonable possibility.



This does not mean that the absence of a profit will exclude a transaction concluded for the purpose of trade.



A trader may, for some commercial advantage, trade at a loss for a period. The reason could for instance be to secure a market. This is illustrated in the case of Burgess v CIR which stated that:

If the taxpayer pursues a course of conduct which standing on its own, it constitutes the carrying on of a trade. He would not cease to be carrying of a trade merely because one of his purposes, or even his main purpose, in doing what he did was to obtain a tax advantage. If he carries on a trade, his motive for doing so is irrelevant.

Further, the definition of trade should be given a wide interpretation and should, for example, include the term “venture�. A venture is defined as “transaction in which a person risks something with the object of making a profit�. Venture is sometimes referred to as a ‘business venture’.



Two important principals arise from the above:

· Trade involves an element of profit;

· The taxpayer’s motive for carrying on a “trade� is irrelevant.



The question which arises when assessing a claim for rental expenses (and the subsequent loss incurred) is whether or not there was an intention to make profit. The method which the taxpayer employs to commence this “trade�, would serve to indicate his intention. This is illustrated in Special Board Decision No. 43. The facts of this case are as follows:



Mr. A purchased a property in X to provide accommodation for his family. However, A and his family were forced to move to C when he accepted an offer to work in another town. He then decided to let his property in X and rent a property when he accepted an offer to work I another town.



He then decided to let his property in X and rent a property for his family at his new place of employment. The rental he collected from the property X amounted to R1100. the interest on the bond over his property in X was in the region of R1700



Mr. A claimed a rental loss of R13 416.00 for the 1993-year of assessment, which he had suffered as a result of the poor economic conditions.



The Judge, in dismissing the expenses, had the following comment



“, , , I cannot agree that the losses were incurred for purposes of trade, as the letting of the property was clearly not commercially expedient. I cannot see how the rent paid would have assisted the appellant in paying the bond off. . .�



It is clear in this case, that the expectation of a profit was not a reasonable one.



Prohibited deduction (Section 23(g) of the Income Tax Act)



Section 11(a) is regarded as the Positive Test; i.e. once all of its components have been met, the deduction will be allowed in the computation of taxable income.



Once the positive test has been passed, it does not mean that the expense will be automatically allowed. Section 23 of the Income Tax Act, which is regarded as the Negative Test, must also be passed in order for the deduction to be allowed.



Section 23 (g) reads as follows:



“No deductions shall in any case be made in respect of the following matters, namely-

(g) Any moneys, claimed as a deduction from income derived from trade, to the extent to which such moneys were not laid out or expended for the purposes of trade:

The single most important limiting factor in the general deduction formula is section 23(g), which prohibits the deduction of any moneys claimed as a deduction from income derived from trade, to the extent that they are not laid out or expended for purposes of trade. This provision enables the disallowance of expenditure which has been incurred in the carrying on a trade, but has not been expended exclusively for the purposes of that trade.



In summary the purpose of the taxpayer in expending an amount is a matter of fact (SIR v Ineson; 42 SATC 125)

The first test to be applied in determining whether expenditure passes the test posed by section 23(g) is whether a profit motive is necessary before a taxpayer is entitled to claim that expenditure is to some extent laid out for the purposes of trade. This question falls to be addressed here, and not in relation to whether the taxpayer is carrying on a trade. The question, therefore is, whether, in absence of a profit motive, giving rise to an interference that trade is not the only activity of the taxpayer.

Once this profitability test has been

In ITC 777 (19 SATC 320) the Court held that although the mere intention to let property would not amount to the carrying on of trade, there did not have to be actual letting. The fact that the taxpayer had endeavoured to let its property during the year of assessment was sufficient to constitute the carrying on of a trade during that year.



The following facts pertained to ITC 1592 (57 SATC 247): The issue in this case was the deductibility of certain rental losses incurred by the taxpayer in the 1987 and 1988 years of assessment.

The taxpayer had purchased a house in Somerset West in 1983 for R66 000 and took out a bond of R50 000 for this purpose. He argued that the purpose of the purchase was to make a bona fide investment with a view to letting the property profitably.

The Commissioner for Inland Revenue contended that the taxpayer had had a “dual intention� in purchasing the house – partly to make a profit and partly to provide for a future private residence. He relied on the taxpayer’s 1984 income tax return in which he described the purpose for which he had acquired the property in question as being “for letting/future private use�.

The Commissioner argued that because of the private purpose, the deductibility of the loss was prohibited by section 23(g) of the Income Tax Act 58 of 1962 which, at the time, provided:

“No deductions shall in any case be made in respect of the following matters, namely –

(g) any moneys claimed as a deduction from income derived from trade, which are not wholly or exclusively laid out or expended for the purposes of trade�.

The court found in the taxpayer’s favour. It held that there had been no “dual intention� in regard to the property and that even if the taxpayer had had such an intention at some stage, he clearly did not have it at the relevant time. An amendment to section 23(g) of the Act may render this judgment inapplicable.



In ITC 1593 (57 SATC 251) the taxpayer, a clerk of works of a large corporation, sought property which could provide accommodation in the event of retrenchment or retirement and which could also provide him with an investment that would cope with inflation.

The property acquired was in a very dilapidated state and he decided to renovate it and rent it until he needed it. The renovations took two and a half years to complete due to a number of factors, including a cash flow problem and the fact that the taxpayer and his wife undertook various repairs themselves. The property was first let only from 1 March 1990. It was clear that the house was not rentable prior to 1 March 1990 as it was too dangerous and also because no attempt had been made to let it during that period.

For the years of assessment 1988, 1989 and 1990 the taxpayer sought to deduct his expenditure on repairing the house. This was disallowed. The taxpayer accordingly approached the Special Court.

The Court found against the taxpayer and disallowed the deduction of the expenditure. It held that the expenditure was not deductible for two reasons. Firstly, it was of a capital nature and accordingly not deductible in terms of section 11(a) of the Income Tax Act 58 of 1962, which disallows the deductibility of capital expenditure. Secondly, because the sole and exclusive intention of the taxpayer in relation to the property was not to use it for the purpose of trade, the deduction of the expenditure was prohibited by section 23(g) of the Act.

[Dave A]

There may be value in paying attention to the difference between capital expenditure and normal deductible expenditure for income tax purposes. Capital expenditure will come into reckoning in the calculation of CGT should you sell the property one day, regardless of the financal year in which it was incurred.