NEWSLETTER 2 OF 2004

The reasons for this introduction was as follows:-

1.1 INTERNATIONAL BENCHMARKING

Capital gains tax was introduced by South Africa’s trading partners many years ago.

USA	–	1913
UK	–	1965
Canada	–	1971
Australia	–	1985

Many African countries also introduced CGT, though often in a more limited form, e.g. Botswana, Egypt, Nigeria and Zimbabwe. Some of these countries limit their CGT for administrative reasons to share and property transactions only.

1.2 HORIZONTAL EQUITY

Horizontal equity demands that individuals in similar economic circumstances should bear a similar tax burden, irrespective of the form the accretion of economic power takes. Therefore taxpayers should bear similar tax burdens, irrespective of whether their income is received in the form of wages or capital gains.

1.3 VERTICAL EQUITY

Vertical equity connotes that taxpayers with greater ability to pay taxes should bear a great burden of taxation. International experience indicates that the biggest share of capita gains tax revenues can be attributed to the wealthiest individuals. Including capital gains in taxable income contributes to the progressively of the income tax system, while enabling government to pursue other tax policy objectives, premised on widening the tax bases and reducing standard tax rates.

1.4 REDUCING THE SHIFT FROM INCOME TO CAPITAL

When capital gains are not taxed taxpayers have an incentive to re-characterise income as capital. Taxpayers are also encouraged to shift from income bearing investments to those that produce capital gains. This erodes the tax base and results in an artificial allocation of resources.

1.5 ECONOMIC EFFICIENCY

The efficiency case for introducing a capital gains tax is particularly strong if one considers the impact on the allocation of investment funds. If capital gains go untaxed, individuals are encouraged to invest their savings in assets that provide returns in the form of capital gains, rather than in income producing assets. CGT will narrow the gap in the tax treatment of different assets, reducing these distortions in individual portfolio decisions. CGT applies only to disposals that take place on or after the valuation date, which is 1 October 2001. The dates (time rules) on which disposals are treated as having taken place are set out in Para 13 and are of importance in deciding whether disposals fall within the CGT net.

Paragraph 2 draws a distinction between a resident, which is a defined word in s 1, and a non-resident.

• A resident is subject to CGT on the disposal of any asset whether in the Republic or outside,
• A non-resident is subject to CGT on the disposal of ¾
  • any immovable property or any interest or right in immovable property situated in the Republic,
  • any asset of a permanent establishment of the non-resident.

The term ‘an interest in immovable property situated in the Republic’ which is held by a non-resident, is broad. It includes a direct or indirect interest of at least 20% held by a person in the equity share capital of a company or other entity, where 80% or more of the net asset value (determined on the market value basis) of the company or other entity at the time of disposal is attributable directly or indirectly to immovable property situated in the Republic. The 80% excludes immovable property held as trading stock.

FORMULA TO DETERMINE TAXABLE CAPITAL GAIN

Proceeds	Rxxxxxxxxxxxxxxx
– Base Cost	Rxxxxxxxxxxxxxxx
= Capital Gain	Rxxxxxxxxxxxxxxx
– Annual Exclusions	Rxxxxxxxxxxxxxxx
= Aggregate capital gain/loss	Rxxxxxxxxxxxxxx
– b/f capital losses	Rxxxxxxxxxxxxxx
= Nett capital gain/loss	Rxxxxxxxxxxxxxx
x Inclusion rate%	_______%
= Taxable Capital Gain	Rxxxxxxxxxxxxxx

• Capital gain

A capital gain is determined for each asset disposed of during a year of assessment by deducting the base cost of the asset from the proceeds, where the proceeds exceed the base cost.

• Capital loss

A capital loss is determined for each asset disposed of during a year of assessment by deducting the proceeds ‘in respect of’ the disposal of that asset.

• Annual exclusion

Although gains or losses in respect of most personal use assets are excluded from the CGT system, an annual exclusion is provided to exclude the total of smaller gains and losses from CGT.

Person	Annual Exclusions
Natural persons	R10 000
Natural persons in year of death	R50 000
Special trust	R10 000
Deceased estate	R10 000
Insolvent estate	R10 000

• The exclusion does not apply to companies/CC/ Other trusts
• Reduces both gains and losses
• Annual exclusion is not apportioned
• Not cumulative
• The exclusion does not apply to companies/CC/ Other trusts
• Reduces both gains and losses
• Annual exclusion is not apportioned
• Not cumulative

• Aggregate capital gain or loss

All capital gains and losses for a year of assessment are aggregated and the resultant gain or loss in the case of a natural person and special trust is reduced by the amount of the annual exclusion in order to arrive at a person’s aggregate capital gain or aggregate capital loss. Capital gains required to be taken into account in the determination of the aggregate capital gain or aggregate capital loss of a person must also be included, for example, a capital gain of another person which is attributed to that person.

• Nett capital gain or loss

Only assessed capital losses brought forward from previous years are taken into account to determine the net capital gain/assessed capital loss for the current year of assessment. An assessed capital loss will not be allowed against revenue income.

• Taxable capital gain or loss

Where a person has arrived at a net capital gain for the current year of assessment this is multiplied by the inclusion rate applicable to that person to arrive at a taxable capital gain. This amount is then included in the taxable income of the person in terms of s 26A for the year of assessment.

inclusion rate:-

Type of person	Inclusion rate %
Natural person	25%
Insolvent estate	25%
Deceased estate	25%
Special trust	25%
Insurer – individual policy holder	25%
Insurer – untaxed policy holder fund	0%
Company / close corporation	50%
Company policyholder fund of an insurer	50%
Corporate funds of an insurer	50%
Other Trusts	50%
Permanent establishment	50%

CGT is imposed on the disposal of an asset. Disposal of an asset can be any of the following events:-

• Sale, donation, expropriation, conversion, grant, cession, exchange or transfer of ownership
• Forfeiture, termination, redemption, cancellation, surrender, discharge, relinquishment, release, waiver, renunciation, expiry or abandonment
• Scrapping, loss or destruction
• Vesting of an interest in an asset of a trust in a beneficiary
• Distribution of an asset by a company to a shareholder
• Granting, renewal, extention or exercise of an option
• Decrease in value of a persons interest in a company, trust or partnership as a result of value shifting arrangement
• Sale, donation, expropriation, conversion, grant, cession, exchange or transfer of ownership
• Forfeiture, termination, redemption, cancellation, surrender, discharge, relinquishment, release, waiver, renunciation, expiry or abandonment
• Scrapping, loss or destruction
• Vesting of an interest in an asset of a trust in a beneficiary
• Distribution of an asset by a company to a shareholder
• Granting, renewal, extention or exercise of an option
• Decrease in value of a persons interest in a company, trust or partnership as a result of value shifting arrangement

• Assets that are excluded from CGT
  
  • Sale of primary residential property up to 2 hectares and R1 000 000 profit
  • Sale of personal vehicle
  • Sale of clothes, jewellery, stamps, art works, antiques, collectible coins and other personal effects
  • Lump sums from pension, provident and annuity funds
  • Proceeds from endowment policies, or life insurance policies (excluding second hand policies)
  • Lottery winnings; race winnings; casino winnings (only local winnings not foreign winnings)
  • Compensation for injury; illness or defamation
  • Gains on foreign currency for rands after returning from an overseas trip (private trip)
  • Sale of assets of small business on retirement only upto R500 000 if requirements are met
    
• Assets that are included:-
  • Shares
  • Unit Trusts
  • Land
  • Property not used for residential purposes
  • Large boats exceeding 10m in length
  • Aircraft, of which empty mass exceeds 450 kg
  • Financial instruments
  • Plant and machinery (holdover relief applicable in many cases)
  • Mineral rights
  • Coins made mainly from gold or platinum
    
• WHAT IS THE IMPLICATION OF CGT WHEN A PERSON DIES?
  • the first R 50 000 of the gain is exempted
  • A deceased person must be treated as having disposed of the assets to the estate for proceeds equal to market value
  • If the spouse is the heir, there is no CGT implication, as there was no disposal
  • The deceased person is taxed in his/her final assessment on CGT, on the deemed market value on day of death less the base cost
  • If there is a capital gain in an estate, that has not been finalised yet, the gain made will be taxed in the hands of the heir, who will qualify for the R10 000
    exemption (for example selling a asset to a 3rd party in making the gain – base cost will be the market value on day of death)
  • Estate duty have been reduced from 25% to 20% after 1/10/2001
    
• WHAT IF ASSET WAS AN INHERITANCE OR PART OF DIVORCE SETTLEMENT?
  • Transfer of assets on divorce, and donations between spouses, is not regarded as a disposal
  • If asset is received as part of a divorce settlement, the base cost will be the cost at which it was bought, when still married
  • On sale of asset, CGT will be calculated on selling price less base cost
  • On inheritance the CGT will be calculated on the selling price less the value of asset when it was inherit
    
• WHAT IS INCLUDED IN THE BASE COST OF AN ASSET?
  • Acquisition Cost – this is the cost actually incurred in acquiring an asset, to the extent that the expenditure has not been claimed for normal income tax purposes
  • Incidental Cost – directly related cost to the acquisition of disposal of an asset, it includes:
    • fees paid to a surveyor, auctioneer, accountant, broker, agent, consultant or legal advisor for services rendered
    • Transfer cost
    • Stamp Duty
    • Advertising cost
    • VAT paid and not claimed or refunded on asset
    • Cost of establishing, maintaining or defending a legal title or right in that asset
    • Cost of moving the asset from one location to another
    • Capital cost of maintaining title or rights to an asset
    • Improvements, on improving the value of the asset

** Current expenses such as repairs, insurance, interest on a loan can not be claimed as base cost, as they are domestic or private expenses connected with the use and enjoyment of the property. Had the property been rented, the rentals would not have been deducted for the same reason.

• HOW SHOULD THE BASE COST BE DETERMINED, IF THE ASSET WAS ACQUIRED BEFORE 1 OCTOBER 2001, AND NO RECORDS WAS KEPT?

Any one of the next 3 options can be used to determine the base cost + after 1/10/01 expenditure incurred:

• MARKET VALUE as at 1 October 2001. The valuation must be done before or on 30 September 2004 , OR
• 20% of the proceeds upon realisation can be deemed to be the base cost, OR
• TIME APPORTIONMENT METHOD. This is calculated as follows:

THE NORMAL TAB METHOD

Y = B +	[(P – B) x N]
T + N,

where-

(a) ‘Y’ = time apportionment base cost (TAB)

(b) ‘B’ = pre-1.10.2001 admissible expenditure, excluding any capital allowances.

‘P’ = proceeds on disposal of the asset

• In the case of assets subject to capital allowances proceeds must be reduced by any recoupments included in gross income
• P must be determined in accordance with the proceeds formula below where improvements occur before and after valuation date.

(c) ‘N’ = number of years determined from the date that the asset was acquired to the day before valuation date.

• ‘N’ is limited to a maximum of 20 where improvements have occurred prior to valuation date
• A part of a year is treated as a full year.

(d) ‘T’ = number of years determined from valuation date until the date the asset was disposed of after valuation date. Again, a part of a year is treated as a full year.

The twenty year limit

Where improvements to an asset take place before valuation date, they are ‘thrown back’ to the date of acquisition.

Where no improvements occur prior to valuation date there is no limit.

The 20 year limit will also not be triggered where improvements take place after valuation date, though in this case a portion of the proceeds will be allocated to the post-CGT period.

The normal proceeds formula (para 30(2))

The symbol ‘P’ in the above TAB formula must be determined in accordance with the following formula where expenditure is incurred both before and on or after valuation date.

P =	R x B
(A + B),

where-

(a) ‘P’ = proceeds to be used in the TAB formula

(b) ‘R’ = proceeds

(c) ‘A’ = admissible expenditure incurred on or after 1.10.2001.

(d) ‘B’ = pre-1.10.2001 admissible expenditure

Note: ‘A’ and ‘B’ exclude any capital allowances and ‘T’ excludes any recoupments included in gross income.

• HOW WILL THE SALE OF SHARES ACQUIRED BEFORE 1 OCTOBER 2001, BE AFFECTED BY CGT?
  • Disposal price less the average closing price for buying and selling for the last 5 trading days BEFORE VALUATION DATE, which is 1 October 2001 (26/9/01 – 30/9/01)
  • If it is foreign shares, the base cost will be the average price of the buying and selling closing price of the last trading day, prior to valuation date – the currency will be converted to our currency (this method will apply for shares acquired before and after valuation date) + any expenditure directly related to the acquisition of the shares
    If shares were purchased after 1/10/01, the base cost will be the average of the buying and selling closing price of the last 5 trading days, prior to the day on which it was acquired + any expenditure directly related to the acquisition of the share
• WHAT RECORDS MUST BE KEPT? (SEC. 73B)

The onus will rest upon the taxpayer, of proving the base cost claimed.

Records that needs to be kept:

• date asset was acquired
• price that was paid for asset
• any money spent on the purchase (e.g. estate agent fees)
• any money spent on improving the asset
• the date of disposal of asset
• profit or loss made from selling it
• contracts on purchase and sale, market valuations, invoices and receipts for services
• where an asset was inherit, get copies of all the records, relating to the value of the asset at death, from the executor of the will which makes the person an heir When the asset is sold, it must be declare in the tax return for year of assessment, in which transaction took place.
• Details of any asset transferred into a trust
• Copies of valuations used in the determination of taxable gain or assessed capital loss
• Details supporting the proportional use of an asset for both private and business purposes
• Details of any continuous absence of more than 6 months from a primary residence

• HOW LONG SHOULD RECORDS BE KEPT AFTER DISPOSAL OF AN ASSET?
  • 4 Years from date of acknowledgement of receipt of income tax return reflecting the disposal of the asset
  • If a person is not required to render a return, and an asset was disposed, records should be kept for 5 years from date of disposal.

RESIDENTIAL PROPERTIES

• WILL THE SALE OF A PRIVATE RESIDENCE BE SUBJECT TO CGT?

The existence of the primary exclusion means that most capital gains on the sale of a home will not be subject to CGT

• WHAT IS A PRIMARY RESIDENCE?

the requirements ot have your house regaded as a primary residence is:

1. it must be owned by a natural person or a special trust; and
2. the owner, beneficiary of the special trust, or spouse of the owner or beneficiary must ordinarily reside in the home and must also use the home for domestic or private residential purposes.

On certain occassion the sale of your home will have CGT on it. This will only happen where:-

• the capital gain or assessed loss, on the sale of the residence, exceeds R 1 million, the portion that exceeds R 1 million, will be subject to CGT
• the property is larger than 2 hectars, the portion that exceeds the 2 hectares will be subjected to CGT
• The exclusion will not be allowed in respect of that part of a residence, that has been used for the carrying on of a trade, after the valuation date (1/10/01) – e.g. use of a study

the primary residence exclusion is limited to one residence at a time

• WHAT HAPPENS IF A PERSON DOES NOT ORDINARILY RESIDE IN THE HOME, AS HE HAS MOVED, BEFORE SELLING IT, OR AM STILL BUILDING A HOME ON A NEW PROPERTY, OR FOR SOME OTHER REASON?

You can be treated as having been ordinary resident in your house for up to 2 years in respect of the following reasons only:-

• your old home was in the process of being sold, whilst a new primary residence was acquired or was in the process of being acquired;
• your new home was undergoing renovation or improvement prior to him taking up residence;
• your new home was being built on land for the purpose of being his primary residence;
• The primary residence had been accidentally rendered uninhabitable

IN WHICH OTHER CASES WILL A PERSON BE REGARDED AS ORDINARILY RESIDENT IN A PROPERTY?

• Where a natural person:
  • Are absent from his primary residence, and rent it out for a continuous period of up to 5 years;
  • Resided in the residence for a period of at least one year prior to and after the period of absence; and
  • Treated no other residence as a primary residence during their absence; and
  • Were temporarily absent from the Republic, or employed or carrying on business in the Republic at a location further than 250km from that residence
    
• TRANSFER OF PROPERTY FROM COMPANY/CC/TRUST TO BENEFICIARY

Sec 9 of the Transfer Duty Act, has been amended to make provision for the following:

NO DUTY will be payable in respect of the acquisition by a NATURAL PERSON, of a RESIDENCE, that will constitute the PRIMARY RESIDENCE, as defined in paragraph 44 of the 8th Schedule to the Income Tax Act, from a COMPANY/CC/ TRUST, where –

• acquisition takes place, before 30 September 2002;
• the natural person, and his or her spouse, directly held ALL THE EQUITY SHARE CAPITAL, or MEMBERS’ INTEREST IN THAT COMPANY/CC, from 5 APRIL 2001, to the date of registration in the deeds registry of the residence in the name of the natural person or jointly in the name of that person and his/her spouse;
• that natural person or his/her spouse ordinarily resided in that residence, and used it mainly for domestic or private residential purposes as his/her ordinary residence from 5 APRIL 2001 to the date of that registration; AND
• the registration in the deeds registry of the acquisition of that residence in the name of that natural person, or jointly in the name of that person and his/her spouse, takes place not later than 31 MARCH 2003
• In the case of a trust the same rules apply, where the natural person is the SETTLOR of that trust, and that residence was disposed of to that trust by that SETTLOR

THIS EXEMPTION WILL ONLY APPLY:

• To the part of the residential portion that does not exceed 2 hectares;
• If it is used for domestic or private purposes in association with that residence; and
• Is disposed of at the same time and to the same person as that residence

All valuation to all assets/property has to be done by 30 September 2004.

Should you have any enquiries don’t hesitate to contact me. Also is you have any comments or wish to receive information on a specific topic you can email teresa@worldwidetax.co.za or craig@worldwidetax.co.za

Regards

Teresa Louw