Investors: Be Careful When Buying Into A Business With An Assessed Loss
The economic difficulties seen over the past couple of years will certainly have led to many businesses incurring losses. This creates an opportunity for investors to acquire either the whole or part of the equity of a business at a discount.
Many if not most of these businesses will also have run up tax losses.
Investors need to be extra careful as our tax law aggressively tries to prevent tax losses being used in these circumstances. In essence, they should discount getting any benefit from using tax losses in the loss-making entity they buy (or buy a stake in).
What does the anti-avoidance legislation say?
Anti-avoidance tax legislation regarding the use of assessed losses has been around for a long time. The assessed loss avoidance clauses are triggered by a business, which has an assessed loss, either entering into an agreement or acquiring new shareholders whereby new income is injected into the entity which is offset against the assessed loss. This results in no or reduced tax being paid by the loss-making organisation.
Note it is wider than equity changing hands – an agreement between two parties can also invoke the legislation. For example, company A has an assessed loss and manufactures toys. Company B does a deal with company A whereby Company B’s toys are manufactured by Company A.
Company A cannot realistically expect that the additional sales from manufacturing Company B’s toys can be set-off against its tax loss.
What would trigger SARS invoking these anti-avoidance clauses?
Businesses affected are trusts, close corporations and companies.
Should a business as above enter into an agreement or have a change of shareholding and both -
- As a “direct or indirect result of” the agreement or change of shareholding, income is received or accrued by the entity, and
- The “sole or main purpose” of the receipt of injected income (trading or capital) is to reduce the tax liability of the entity; then
SARS will disallow the set-off of the income against the organisation’s assessed loss.
The onus lies with the assessed loss entity to prove that the “sole or main purpose” was not to use the assessed loss.
The Bottom line
It is foolhardy to enter into a deal and expect to be able to use an assessed loss. It only makes sense if there is a compelling business rationale for the deal.
No one wants to enter into an argument with SARS which you are not likely to win. Seek expert advice.