In last year’s budget speech the Minister of Finance, Enoch Gondwana, announced a reduction in the corporate income tax rate from 28% to 27%. The Minister also announced there would be a limitation on the use of assessed losses as defined in the Income Tax Act.
In the past, corporate taxpayers were, in most instances, able to deduct 100% of assessed losses carried over from a past financial year against taxable income from a current year. The amendment to the rules, which was implemented last year but will be effective for companies with years of assessment ending on or after March 31 this year, will limit the offsetting of assessed losses for companies to the higher of R1 million or 80% of taxable income.
An assessed loss is defined as the loss that arises when tax-deductible expenses exceed gross income for tax purposes.
Catherine Arbuthnot, senior tax manager at BDO, says this means that a company seeking to use an assessed loss from a preceding year will be liable for tax on at least 20% of its current-year taxable income.
However, the portion of the assessed loss not allowed to be offset may be carried forward to the following year of assessment, so it will not be lost to the company, provided the company earns income from trade in the succeeding year of assessment, she says.
Sharon Bensch, a partner PKF South Africa, says the impact is illustrated in the following example:
- Assessed loss carried forward from previous year: R3m
- Taxable income for current year: R2m
- R2m x 80% = R 1.6m (higher than R1m)
- The company will be able to use the R1.6m of the previous year’s assessed loss against the current financial year’s taxable income (meaning it will pay tax on R400 000), and the remaining assessed loss of R1.4m will be carried forward to the following year.
“The 80% limitation is only applicable where a taxable profit was made during the year, Bensch says, “and smaller companies that earn a taxable income of less than R1m will also not be affected by the change.”
National Treasury said the purpose of the deductibility of assessed losses has been to “smooth the tax burden” for companies whose primary business is cyclical in nature and not in line with a standard tax year, and for start-up companies that are not profitable in the early years of trading. There has been a global trend to restrict the use of assessed losses carried forward, according to the Organisation for Economic Co-operation and Development, of which South Africa is a member.
Treasury also argued that the change is mitigated by the cut in the corporate income tax rate.
But certain life insurance investment products have also been caught up in this tax net, at significant cost to members or beneficiaries.
Life insurers use what are known as policyholder funds as investment vehicles for their policyholders, as opposed to asset managers, which manage collective investment schemes. Unlike collective investment schemes, policyholder funds are treated as companies and subject to company tax. If the policyholder fund can offset assessed losses against only 80% of its taxable income, this naturally places a bigger tax burden on the fund, which, in turn, eats into investment returns and creates uncertainty for current and future beneficiaries of life insurance products.
Annalise de Meillon-Muller, manager of distribution and sales support at Glacier by Sanlam, says that such uncertainty can either prove a cost of opportunity or capital.
She uses Mrs X as an example, a 42-year-old schoolteacher who was involved in a serious car accident (in which her husband tragically died) at the beginning of 2021, which left her permanently disabled and unable to work. Mrs X was left to raise their 13-year-old twins by herself. Before the accident she earned a gross income of R23 000 a month. She received disability and life insurance lump-sum payouts relating to the accident and death of her husband totalling R8.2m. She opted for:
- A voluntary life annuity to fund her medical aid premiums. The amount allocated for this was R1.25m.
- An income plan that included a capital preservation option, which replaced her teacher’s income. This plan also provides a guaranteed payout at death of R1m to each of her children. The amount allocated was R5.4m.
- A unit trust investment of R550 000 to provide for unforeseen medical aid expenses or funding for emergencies.
- A fixed-return plan with a fixed maturity value after five years to fund her children’s university fees. The amount allocated was R1m.
Emily spent all her available funds on crafting a sustainable solution for the future, says De Meillon-Muller. The rate she received on the fixed-return plan in December 2021 was 6.11% with a projected maturity value of R1 344 988 in 2026.
However, in January 2022, when the legislative tax amendment on assessed losses came into play, Mrs X’s rate on her fixed-return plan fell from 6.11% to 5.80%, leaving her with a deficit of R14 351 on the amount needed for her children’s tertiary education.
Needing certainty to help plan for the unforeseen changes that can happen is a somewhat difficult task if you consider the philosophical question as to whether you can ever really be certain of anything, said De Meillon-Muller. “If certainty is relative to an individual and what they know, see, understand and act upon, then it really does leave us with trusting our instincts when choosing financial partners and products.”
Note: All monetary values in this article are assumptions for illustrative purposes only. As markets fluctuate and every client is different, values, rates and incomes will vary.