In this article we will discuss the basics of Capital Gains Tax and in subsequent articles provide examples of capital gains tax for businesses.
Capital gains tax (CGT) was introduced in South Africa with effect from 1 October 2001 and applies to the disposal of an asset on or after that date.
Internationally, the idea of such a tax is not uncommon, with many of South Africa’s trading partners having implemented CGT decades ago. All capital gains and losses made on the disposal of assets are subject to CGT unless specifically excluded.
The CGT provisions are mostly contained in the Eighth Schedule to the Income Tax Act 58 of 1962 (the Act), although some are in the main body of the Act, such as those dealing with change of residence, ceasing to be a controlled foreign company or becoming a headquarter company (section 9H), government grants (section 12P), international shipping (section 12Q) and the corporate restructuring rules (sections 41 to 47). The Eighth Schedule determines a taxable capital gain or assessed capital loss and section 26A of the Act provides that the taxable capital gain must be included in taxable income.
SARS developed a flowchart explaining the main aspects in determining a taxable capital gain to be included in taxable income or an assessed capital loss to be carried forward to a subsequent year of assessment.
How do you determine a capital gain or loss?
The Eighth Schedule of the Act contains four key definitions: Asset, Disposal, Proceeds and Base Cost. These form the basic criteria in determining a capital gain or loss. Below is information per definition.
An asset is widely defined and includes property of whatever nature and any right to, or interest in, such property.
CGT applies to all assets disposed of on or after 01 October 2001 (valuation date), regardless of whether the asset was acquired before, on, or after that date and only the capital gain or capital loss attributable to the period on or after 01 October 2001 must be brought to account for CGT purposes.
A disposal covers any event, act, forbearance or operation of law which results in the creation, variation, transfer or extinction of an asset.
It also includes specified events treated as disposals, such as the change in the use of an asset, the commencement or cessation of residence, a company ceasing to be a controlled foreign company and a company becoming a headquarter company.
The amount received by or accrued to the seller on disposal of the asset is known as the proceeds.
Assets disposed of by donation, for a consideration not measurable in money, or to a connected person at a non-arm’s-length price are treated as being disposed of for an amount received or accrued equal to the market value of the asset.
Proceeds are treated as being at market value when specified deemed disposal events occur, such as cessation of residence, company ceasing to be a controlled foreign company, company becoming a headquarter company and conversion of a capital asset to trading stock or distribution of an asset in specie (specie refers to the process of distributing an asset in its physical form rather than selling it and then distributing the proceeds). Amounts included in income such as a recoupment of capital allowances are excluded from proceeds.
The determination of the base cost of an asset depends on whether it was acquired as follows:
- On or after 01 October 2001;
- Before 1 October 2001;
- By donation, for a consideration not measurable in money or from a connected person at a non-arm’s length price or
- In consequence of a deemed disposal event such as a distribution in specie, cessation of residence, company ceasing to be a controlled foreign company, company becoming a headquarter company or conversion of a capital asset to trading stock.
The assets described in the last two bullet points are generally treated as having been acquired at a cost equal to their market value.
Assets acquired on or after 1 October 2001
The base cost of an asset acquired on or after 1 October 2001 generally comprises the actual expenditure incurred on the asset.
To qualify for inclusion in base cost, the relevant expenditure must appear on the list of qualifying expenditure in paragraph 20 of the Eighth Schedule. Some of the main costs that qualify to be part of the base cost of an asset include:
- the costs of acquisition or creation of the asset;
- the cost of valuing the asset for the purpose of determining a capital gain or loss;
- the following amounts actually incurred as expenditure directly related to the acquisition or disposal of the asset, namely:
- • the remuneration of a surveyor, valuer, auctioneer, accountant, broker, agent, consultant or legal advisor, for services rendered;
- • transfer costs;
- • securities transfer tax, transfer duty or similar tax or duty;
- • advertising costs to find a seller or to find a buyer;
- • moving costs;
- • installation costs including foundations and supporting structures;
- • donations tax limited by a formula;
- • cost of an option used to acquire or dispose of the asset;
- cost of establishing, maintaining or defending a legal title to or right in the asset;
- cost of effecting an improvement to or enhancement of the value of the asset; and
- value-added tax incurred on an asset and not claimed as an input tax credit for value-added tax purposes.
Holding costs generally do not form part of the base cost of an asset. Expenditure on repairs, maintenance, protection, insurance, rates and taxes, or similar expenditure is specifically excluded.
Borrowing costs (including bond registration costs, bond cancellation costs and raising fees) are also generally excluded with one exception. Under that exception a person is entitled to add to base cost one-third of the interest incurred on borrowings used to acquire listed shares and participatory interests in collective investment schemes. One-third of the interest incurred on borrowings used to refinance such investments may also be included. However, interest on borrowings used to finance the acquisition of shares in an operating company contemplated in section 24O may not be included in the base cost of those shares since such interest would be deductible against the borrowing company’s income under that section.
Reduction of base cost
Any expenditure referred to above which is allowable against a company’s income must be reduced in arriving at the base cost of an asset. For example, capital allowances will
reduce the expenditure incurred in acquiring an asset.
Collectively, SARS has issued four guides to Capital Gains Tax and amounts to more than 1000 pages of information. In determining Capital Gains Tax outcomes it is advisable that companies and individuals utilise the services of professionally qualified tax practitioners to deal with such complex matters.
Author Craig Tonkin