How to use Assessed Losses to Pay Less Tax
An assessed loss is when a company has more expenses than income during a financial year. This creates a loss that can be deducted from future taxable profits. Assessed Losses accumulate every year, increasing whenever you make a loss in another tax year. Once your company begins making taxable profits, the assessed loss accumulated so far will be used to decrease those profits.
How to use assessed losses as a new company
Once you understand the concept of assessed losses, you can see how useful this can be for new companies. New companies often have low sales at first and large start-up costs which means that they often run at a loss for the first couple of years. This means that if they submit tax returns for these years they are likely to create assessed losses, which they can use against future taxable profits.
There is a belief that new companies do not have to submit tax returns for the first few years of running a company because there is no tax payable. Apart from the fact that this can lead to non-compliance at SARS and penalties, they also miss the opportunity to build up an assessed loss tax asset. It is important to remember that SARS only allows companies to claim deductions in the year they occur so it is not possible to deduct expenses from prior years when your company starts making money. Only building up an assessed loss allows you to utilize your prior year's expenses.
How to use an assessed loss
Like all tax benefits SARS has certain requirements in place to make use of an assessed loss for a company and the most important one is the “trade” requirement. Before a company can carry forward its assessed loss from the previous tax year, it must have carried on a trade during the current tax year as well. If it fails to do so, it will forfeit the right to carry forward its assessed loss.
What is defined as a “trading company''?
Trade has a very wide definition and includes most business activities. However, once you stop business activities for an extended time, SARS may have grounds to determine that your company has not been trading. Your company must still be actively pursuing your trade and not merely keeping itself incorporated by maintaining a bank account, paying its annual duty, and complying with the Companies Act and Income Tax Act. Also, some passive activities like those that produce interest, dividends, annuities, or pensions are not considered trading by SARS.
If a company stops trading (for whatever reason) the assessed loss from the previous years will be lost even if the company starts trading again. So be very careful when submitting a dormant tax return to SARS as this would automatically have the effect of eliminating assessed losses from prior years.
Another requirement is that a company cannot merely be trading but must also receive income from that trade to make use of an assessed loss. In practice, however, SARS will accept that as long as the company has proved that a trade has been carried on during the current year of assessment, the company can use its assessed loss from the preceding year, even though no income is earned in that year. But if no income is recorded year after year, SARS may inquire to determine if the company really is trading at all and not simply intending to trade or just preparing to trade.