The tough economic environment is taking a toll on most businesses albeit revelations that at least one company liquidates each day. Some are warming up for closure whilst others continuously post losses. Losses are not bad for tax purposes but what is key is for a business to stay afloat and hoping that one day fortunes will turn. The tax law recognises that loss represents an expenditure that can be used to reduce one’s future taxable income and consequently the tax bill. In the taxman’s language such loss is referred to as assessed loss and refers to a situation where one’s deductible expenditure exceeds income. It can be carried forward to be deducted against taxable income in any subsequent year of assessment. Hence creating a tax holiday for the business until the assessed loss is fully utilised. It is this turn of fortune that many struggling are hoping for. A loss making business is often a target for acquisition by a prospering business. Getting to utilise assessed loss is however not easy, there are conditions stipulated within the law that must be met.
Limitation on carry forward of assessed loss
Our law provides for separate taxation of “persons” namely a “person” with a separate legal entity is separately taxed. That is, assessed loss is ring fenced to a taxpayer. It permits assessed loss to be carried forward and deductible against future taxable income of the same taxpayer for a maximum period of six years from end of year of assessment in which the assessed loss first occurred. Assessed loss incurred first is claimed first, i.e. on first in first out basis. A much better olive branch is extended to taxpayers engaged in mining operations as these are allowed to carry forward their assessed losses indefinitely. However there no provisions for carry back of an assessed loss; namely assessed loss cannot be used to reduce taxable income of earlier years.
Buying companies with assessed loss
Assessed loss is taxpayer specific but in rare circumstances the tax code has allowed assessed loss to be shared within a group of companies if it is as a result of a scheme of reconstruction. It provides that where there is a change in the shareholding of a company with assessed loss or which directly or indirectly controls any company with an assessed loss and the Commissioner is of the opinion that such change has been effected solely or mainly in pursuance of or in connection with any scheme for taking advantage of such assessed loss, no assessed loss incurred prior to that change shall be deductible. In other words, the taxman can sanction inheritance of assessed loss of one company by another as long as they are in the same group unless the takeover or scheme’s main objective was to take advantage of assessed loss (see: CIR v Ocean Manufacturing Ltd 1990 (3) SA 610 (A), 52 SATC 15). A taxpayer must prove that the change in shareholding was not influenced by existence of assessed loss. In ITC 983, 25 SATC 55, a company engaged in clothing manufacture bought shares in a company also engaged in clothing manufacture got its inheritance of assessed loss approved after it was proved that the main purpose of buying the shares was to enable the purchasing company to obtain a productive manufacturing unit for purposes of supplementing its productive capacity. The story was different in New Urban Properties Ltd v SIR, 27 SATC 175 where shareholders in successful land dealing companies bought the shares of another land dealing company but which was hopelessly insolvent but with an enormous deficit and assessed loss. It was held that the obvious intention was to channel profits of the successful companies to the unsuccessful one and, thereby, take advantage of the assessed loss.
Assessed loss of a localised foreign company
Companies often set up a branch or permanent establishment (PE) when entering foreign markets. A branch or a PE is considered to be a taxpayer in Zimbabwe. A PE is an international term that refers to a fixed place of business or dependent agent of a foreign business situated in the host country. If such a business decides to incorporate under the Zimbabwean laws i.e. to become a Zimbabwean company it is permitted to inherit assessed loss of such a branch or PE. Thus the law sanctions inheritance of assessed loss where a company formally incorporated outside Zimbabwe (non-resident company) and was carrying on its principal business within Zimbabwe is about to be wound up voluntarily in its country of incorporation for the purpose of the transfer of the whole of its business and property wherever situate to its successor, a Zimbabwean incorporated company. The new company should however have the same shareholders in the same proportion as the old company if the inheritance is to be sanctioned by the taxman.
A company converting into public business corporation or vice versa
A company incorporated under the Companies Act (Chapter 24:03) which is converted into a Private Business Corporation (PBC) or vice versa is permitted to carry forward assessed loss into the new entity unless the conversion has been motivated solely or mainly by the existence of an assessed loss.
Insolvent and assigned estates
A rehabilitated person and his/her insolvent estate are two different persons in the eyes of tax law. Therefore a person that has been declared insolvent or had his property or estate assigned for the benefit of creditors cannot carry forward his/her assessed loss.
Ring fencing of assessed loss
Our law operates separate capital gains tax and income tax systems .In other words capital loss is ring fenced to capital gains tax, meaning it cannot be set off against other tax heads. The same applies to assessed loss emanating from business, it can be offset against income from business of the taxpayer subject to the limitations stated above. Similarly a person in employment is prohibited from setting off his/her employment against business income or vice versa.
Your assessed loss today represents a tax treasure to be used in days of plenty. It’s important however to have in place plans for harvesting assessed loss such as new businesses initiatives that brings in income, deferring deductible expenditure, avoiding tax yields investment etc, bearing in mind that your assessed loss has 6 year life span. However, perpetual losses often get the taxman talking “why should a taxpayer remain in business when he continues making losses”. This often invites a tax audit for purposes of scrutinizing whether the assessed loss is genuine and not a result a tax avoidance scheme or operation. Judge Kudya in CRS (PVT) LTD v the ZIMRA HH-728-17, FA 20/2014 said that the main objective of a private company is to make profit and when content with the untenable situation and continues to make losses with no prospects of profit this an indication the company is engaged tax avoidance scheme or operation.