This article (number one of a series of articles) summarises some of the key aspects holders of shares need to be aware of in computing their liability for income tax and CGT. It is primarily aimed at resident individuals who own shares in their own names. However, many of the principles covered apply equally to companies and trusts, and when appropriate the more obvious differences in the treatment of these entities have been highlighted.
Source and relevant legislation
SARS Guide – 8th issue dated 18 October 2022 – Tax Guide for Share Owners
Income Tax Act 58 of 1962
Glossary
- “CFC” means “controlled foreign company” as defined in section 1(1);
- “CGT” means capital gains tax, being the portion of normal tax attributable to the inclusion in taxable income of a taxable capital gain;
- “CTC” means “contributed tax capital” as defined in section 1(1);
- “dividends tax” means dividends tax levied under section 64E(1);
- “income tax” means the portion of normal tax attributable to the inclusion in taxable income of income (that is, excluding any taxable capital gain);
- “JSE” means the securities exchange operated by JSE Ltd;
- “paragraph” means a paragraph of the Eighth Schedule;
- “Schedule” means a Schedule to the Act;
- “section” means a section of the Act;
- “the Act” means the Income Tax Act 58 of 1962;
- “year 1”, “year 2”, “year 3” and so on in any of the examples refer to calendar year 1, calendar year 2, and calendar year 3 respectively; and
- any other word or expression bears the meaning ascribed to it in the Act.
An increasing number of persons have become shareowners. Many investors have turned to participation in the stock exchange either directly through share ownership or indirectly through collective investment schemes in an attempt to derive a return that beats inflation. The proliferation of broad-based employee share incentive arrangements has also contributed to share ownership among South Africans.
Non-residents are subject to income tax in relation to their gross income on amounts from a source within South Africa. For example, a non-resident would potentially be subject to income tax on shares held as trading stock if such shares formed part of a branch in South Africa. In addition, equity shares in a land-rich company meeting the requirements set out in section 9J are deemed to be from a source within South Africa.
Paragraph 2(1)(b) provides that non-residents are subject to CGT on disposal of the following assets:
• Immovable property in South Africa or any interest or right of whatever nature to or in such property including rights to variable or fixed payments as consideration for the working of, or the right to work mineral deposits, sources, and other natural resources. Equity shares in a land-rich company meeting the requirements set out in paragraph 2(2) (see below) are deemed to comprise an interest in immovable property and are potentially subject to CGT.
• Any asset effectively connected with a permanent establishment in South Africa. A non-resident holding shares as capital assets forming part of a branch in South Africa would therefore potentially be subject to CGT on disposal of those shares.
Under section 9J(2) and paragraph 2(2) respectively, amounts derived from the disposal of equity shares held as trading stock are deemed to be from a source within South Africa, while for CGT purposes such shares are deemed to be an interest in immovable property if:
- 80% or more of the market value of those equity shares at the time of their disposal is attributable directly or indirectly to immovable property in South Africa; and
- the person (whether alone or together with any connected person in relation to that person), directly or indirectly, holds at least 20% of the equity shares in that company.
Income Tax vs Capital Gains Tax
Shares held as trading stock are bought for the main purpose of resale at a profit. Any gain or loss made on the disposal of a share held as trading stock will be of a revenue nature. Revenue gains of a natural person are subject to income tax at the marginal tax rate, which may vary between 18% (but effectively 0% if tax rebates are taken into account) and 45%, depending on the level of taxable income.
By contrast, if a share is held as a capital asset (that is, as a long-term dividend-producing investment), any gain or loss upon its disposal will be of a capital nature.
Capital gains are subject to tax at a lower effective rate than income gains.
2022 Tax Year example
For the 2022 year of assessment, a natural person must disregard the first R40 000 of the sum of capital gains and losses in the year of assessment for CGT purposes (2021: R40 000). This exclusion is known as the “annual exclusion”. For a natural person dying during the 2022 year of assessment, the annual exclusion is R300 000 (2021: R300 000). Of the balance remaining after applying the annual exclusion, and any assessed capital loss brought forward from the previous year of assessment, 40% is included in taxable income and taxed at the marginal tax rate in the same way as, for example, salary or pension income. This percentage is known as the inclusion rate.
The effective rate of tax on a natural person’s capital gain in a year of assessment can vary between 0% and 18%. The 0% rate would apply when:
- the sum of capital gains and losses does not exceed the annual exclusion;
- the sum of capital gains is less than or equal to the sum of capital losses; or
- taxable income falls below the level at which normal tax becomes payable.
The 18% rate would apply when a natural person’s marginal tax rate is 45% (that is, 45% (marginal rate) × 40% (inclusion rate) × R100 = 18%).
Companies and trusts, other than special trusts, pay CGT at a higher rate than natural persons. They do not qualify for the annual exclusion and must include 80% of any net capital gain in taxable income.
The effective tax rate on a capital gain for a company is 28% (tax rate) × 80% (inclusion rate) × R100 = 22,4% for years of assessment commencing on or after 1 March 2021 (unchanged since years of assessment commencing on or after 1 March 2016).
A trust that is not a special trust has an effective CGT rate of 45% (tax rate) × 80% (inclusion rate) × R100 = 36% for the 2022 year of assessment (2021: 36%).
A special trust is subject to the same marginal tax rates on a sliding scale, and inclusion rate (40%) as a natural person. A special trust created solely for the benefit of a person or persons having a “disability” as defined in section 6B(1) which incapacitates them from earning sufficient income for their maintenance, or from managing their own financial affairs, qualifies for the annual exclusion. A special trust created on death solely for the benefit of relatives of the deceased person, including a beneficiary under the age of 18 years does not qualify for the annual exclusion although it does qualify for the 40% inclusion rate.
Capital vs Revenue
The first step in computing a person’s tax liability on a disposal of shares is to determine whether the gain or loss is of a capital or revenue nature.
Apart from the three-year holding rule in section 9C, the Act does not provide objective rules to distinguish between amounts of capital and revenue nature. This task has been left to the South African courts, which over many years have laid down guidelines for making this distinction. A person will have to prove that a particular amount is of a capital or revenue nature; a case must be established on “a balance or a preponderance of probabilities” (CIR v Middelman court case).
A second article will discuss the criteria for distinguishing between revenue and capital profits and income tax implications.