Generally, these losses realised by individuals can be offset against other income in later years and irrespective of the source of that revenue. Said differently, an individual could make a loss in respect of one trade and offset that loss against income from another trade. However, there are certain limitations, exceptions and exclusions to that general rule.

Section 20A of the ITA is one of those rules. It comes into play when assessed losses from a trade were allowed in earlier years of assessment and determines whether or not a trade loss should be set off against other income, thereby reducing taxable income. In other words, it “ring-fences” certain losses from specific trades in that those losses can then only be offset against income from that same trade. Importantly, a “ring-fenced” loss is not “lost” or “disallowed”, but merely carried forward to the next year of assessment and is available for set-off against any income derived from that specific trade in that year.

When does the ring-fencing of losses under section 20A apply?

Firstly and importantly, section 20A only applies to natural persons (i.e. individuals) and not companies, trusts or other juristic persons, which is somewhat ironic because it is quite a complex and intricate section. The South African Revenue Service’s (SARS) Guide on the Ring-Fencing of Assessed Losses Arising from Certain Trades Conducted by Individuals (SARS Guide), lists four factors that need to be determined when considering if the section is triggered, namely:

1. The “maximum marginal rate of tax requirement”.
2. The “three-out-of-five” years requirement or alternatively, the “suspect trade requirement”.
3. The “facts and circumstances” test (the escape clause).
4. The “six-out-of-ten-years” requirement (the “catch all” provision).

Step 1 was the subject of Government’s displeasure in the recent tax policy pronouncements in the 2025 Budget. Before considering that, it is worth looking at other requirements first.

In this context, step 2 enquires into whether the taxpayer has made a loss from a specific trade in three out of the last five years or, alternatively, if the trade is a “suspect trade”. The suspect trade list contains eight different trades including:

• sport practised by taxpayers;
• dealing in collectibles (e.g. art or coins or wine);
• renting of residential accommodation where 80% of the accommodation is used by relatives of the taxpayer who occupy the residence for at least half the year;
• rental of movables such as aircraft, boats or vehicles where 80% of the use is by relatives of the taxpayer who use the asset for at least half the year;
• animal showing;
• part-time farming;
• creative arts performances; and
• crypto-asset trading.

Step 3 of the test allows a taxpayer to not be caught by the provisions where, for example, they can show that there is at least a reasonable prospect of earning a profit within a reasonable period. This test is not always easy to apply as it’s a “facts and circumstances” based test and even if a taxpayer believes it may make a profit, SARS does not always necessarily agree. The SARS Guide provides a list of factors to consider and apply when considering this leg of the test and this is indicative of the fact that its not simple. In this context, this step is often the subject of much debate between taxpayers and SARS.

Step 4 then provides that one cannot escape the claws of section 20A (i.e. the losses must be ring-fenced) if there has been a loss in at least six out of the last ten years. The assessed loss will be permanently ring-fenced in the year of assessment in which the rule applies. Said differently, one does not consider the “facts and circumstances” based test (step 3) if there have been losses in the past six out of ten years.

Government’s proposal to remove the marginal income tax rate carve out

Notably, as already mentioned, the section does not come into play at all if the natural person in question is not taxed at the highest marginal income tax bracket. Moreover, if a person’s taxable income is below the threshold for the highest marginal income tax bracket (currently R1,817,000 per annum), the assessed loss may not be ring-fenced under section 20A. This is irrespective of the number of years in which losses have been incurred and the nature of the trade being carried on.

However, the Minister of Finance recently announced in the Budget Review Documents 2025 that the current application of section 20A of the ITA enables taxpayers below the maximum marginal rate threshold to allegedly exploit the tax system by continuously offsetting losses from certain trades against other sources of income.

According to Government, this creates a loophole that leads to substantial revenue losses for the fiscus, as taxpayers receive full refunds of their employees’ tax when those losses are allowed. It has therefore been proposed that the threshold at which ring-fencing rules apply be reviewed and amended.

Observations

It is interesting to note Government’s proposal and it is expected that there will be a robust public consultation process on this proposed change. This is especially against the background of Government also proposing not to adjust the personal marginal income tax brackets. In other words, given Government lessened its stance on the 2% value-added tax (VAT) increase (now a proposed staggered 1% increase over two years), it needed to find the money elsewhere (instead of cutting costs) and has chosen instead to target individuals through an indirect personal income tax increase by not adjusting the personal income tax brackets (for a second year running) and targeting amendments to section 20A.

It is further noticeable that the proposed amendments to section 20A stand at odds with the initial rationale behind the introduction of section 20A in its current form back in 2004. In the explanatory memorandum on the Revenue Laws Amendment Bill, 2003 (which introduced the current section 20A in its current form), Government was at pains to state that:

“…private consumption can be masqueraded as a trade (i.e. a hobby) so that individuals can set-off these expenditures and losses against other income (usually salary or professional income). This attempt to deduct hobby-like expenses undermines the ability to pay principle of the income tax system because wealthier individuals have more means to disguise hobby expenses as a trade. Hence, a more stringent “facts and circumstances” test will be introduced as a means to uncover these artificially labelled trades.” [Our emphasis]

The explanatory memorandum states further that limiting the ring-fencing rule to high earners was important because “this aspect of the threshold ensures that section 20A ring-fencing is targeted solely at higher income individuals who have the means for disguising hobbies as trades”.

It is accepted that 2004 is now over 20 years ago and “facts and circumstances” change. However, it is expected that there will be public pushback on this in the absence of evidence that supports Government’s intentions. The reality is that many of these trades conducted by individuals are making losses because the South African economy is not growing. Hitting those taxpayers with an indirect “additional tax” may accelerate the economy’s demise further.