Impact of tax incentives on the restriction of the set off of the balance of assessed losses

It is two years since amendments were made to section 20 of the Income Tax Act No.58 of 1962 (the Act), which limits the amount of an assessed tax loss that may be set off against taxable income. For companies affected by this amendment, tax incentives have become a more enticing proposition. They not only increase the assessed loss, but may be a way of reducing the tax burden resulting from these amendments.

Before 19 January 2022, in determining taxable income, section 20 of the Act allowed companies that carry on a trade to set off their balance of assessed losses carried forward from the previous year against the company’s income for the current year of assessment. Any unutilised portion of the assessed loss could be carried forward and set off against future income - provided the company continues to trade. Therefore, taxpayers would only pay income tax once their assessed loss balance had been fully utilised.

Currently, there is a restriction in terms of section 20(1)(a) of the Act on the offset of the balance of assessed losses carried forward for companies. The offset of the balance of assessed losses carried forward is limited to the higher of R1 million or 80% of taxable income. Provided that the continuous trade requirement is met, any unutilised assessed loss balance may continue to be carried forward for future set off, however limited to the higher of R1 million or 80% of taxable income. Therefore, the effect is that in cases where the assessed loss is brought forward and taxable income is above R1 million, and regardless of whether the actual assessed tax loss is much greater than the taxable income, the company is liable to pay income tax in the current year.

Impact of tax incentives

Companies that did not previously consider tax incentives due to having high assessed losses may now want to reconsider the impact tax incentives could have.

The following two main tax incentives are available:

• Research and development tax incentive: A company that conducts research and development (R&D) activities can reduce its tax liability if the R&D has been approved in terms of section 11D of the Act. Section 11D of the Act is offered by the Department of Science and Innovation and allows for a 150% tax deduction for qualifying R&D expenditure to the company incurring the R&D costs with no limit on the benefit which results in a cash benefit of 14%. The activities undertaken must occur in South Africa and the expenditure incurred must be directly linked to the R&D activities undertaken.
• Energy efficiency savings tax incentive: The government introduced environmental-related tax incentives such as section 12L of the Act to promote the efficient use of energy as a means to safeguard the security of supply and help combat greenhouse gas emissions. Section 12L came into operation on 1 November 2013 and allows taxpayers to claim a deduction for most forms of energy-efficiency savings that result from activities performed in the carrying on of any trade and in the production of income. Section 12L presents an income tax deduction of R0.95/kWh for quantified energy efficiency savings and is available until 31 December 2025.

Companies with an assessed loss, with a year of assessment commencing after 31 March 2023, that qualify for and claim tax incentives such as section 11D or section 12L of the Act have been able to reduce the impact of the restriction of assessed loss carried forward.  A deduction in terms of these tax incentives allows for a reduction in the taxable income and/or increase in the assessed loss carried forward in terms of section 20 of the Act.  

Conclusion

Tax incentives are a more attractive proposition for companies in an assessed loss position as they do not merely increase the assessed loss but assist in reducing taxable income due to the restriction of the set-off of the balance of assessed losses.