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Treasury clarifies the clogged-loss rules
- 19 December 2019
- Individuals Tax
- Jessica Carr
Monday, 20 August 2018
Important:
This article is based on tax law for the tax year ending 28 February 2019.
Author: Jessica Carr (Cliffe Dekker Hofmeyr)
Amendments to paragraph 39 of the Eighth Schedule to the Income Tax Act, No 58 of 1962 (Act) have been proposed in National Treasury’s draft Taxation Laws Amendment Bill (draft TLAB), as published in July 2018 for public comment. Per the Explanatory Memorandum on the draft TLAB, the proposed amendment seeks to clarify that capital losses between connected persons will be ring-fenced, where a person redeems its interest in the other person (such as a company) and the two persons are connected persons, in relation to each other.
The clogged-loss rule
Paragraph 39 of the Eighth Schedule to the Act is a capital gains tax (CGT) anti-avoidance provision which requires a capital loss to be treated as a “clogged loss” where a person disposes of an asset to a connected person and incurs a capital loss. The clogged-loss rule comes into play when determining the disposer’s aggregate capital gain or aggregate capital loss and requires that the loss be entirely disregarded. In this way, the capital loss is ring-fenced and may be set off only against capital gains arising from disposals to the same connected person.
Restrictions in the rules
The clogged-loss rule restricts the deduction of capital losses if the asset in question is disposed of to a person who was a connected person in relation to the disposer of the asset immediately prior to the disposal, or if the asset is disposed of to a person which, immediately after the disposal of the asset, is a member of the same ‘group of companies’ as the disposer or is a trust with a company beneficiary that is a member of the same group of companies as the disposer.
The ring-fencing restrictions are extended so that the capital losses, in addition to only being permissibly deducted from capital gains arising from disposals of assets to the same connected person, may only be deducted from the arising capital gains during the same or a subsequent year of assessment.
The timing of the disposal is governed by a further restriction, in that the disregarded capital loss may be deducted only if the other person to whom the subsequent disposals are made, is still a connected person in relation to the disposer at the time when the disposer makes the disposals.
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This article first appeared on cliffedekkerhofmeyr.com.