TAXES ON CAPITAL GAINS

(a) Basic rule

South Africa imposes a tax on capital gains (CGT) on assets disposed of on or after 1 October 2001 (known as the valuation date). A portion of a taxable gain accruing to a person (including a company, trust or individual) is added to other taxable income and normal income tax applies to the total. There is no separate capital gains tax.

A resident of South Africa is subject to CGT on the post-30 September 2001 disposal of virtually all assets worldwide. A non-resident is subject only on the disposal of real estate in South Africa (owned directly or indirectly) and assets of a permanent establishment through which it carries on trade in South Africa. A capital gain or loss is determined separately for each asset disposed of by deducting the asset’s base cost from the proceeds of the disposal. Capital gains and losses are then aggregated and, after an annual exemption of R17,500 (not available to companies or most trusts), 50% (or 25% for individuals) of the total is added to other taxable income. As the company rate of income tax is currently 28%, the effective rate of tax on company capital gains is 14% (excluding STC). For individuals at the highest marginal rate of tax of 40%, the effective rate of tax on capital gains is 10%. For trusts at the flat tax rate of 40%, the effective rate of tax on capital gains is 20%. There is no adjustment for the effects of inflation.

Ref: ITA Sch 8

On a non-resident company’s disposal of immovable property after 1 September 2007, the purchaser must withhold 7.5% of the amount payable (5% if the seller is a natural person and 10% if the seller is a trust) from the purchase price and pay this amount to the SARS. The seller receives credit for this amount against its ultimate liability for capital gains tax. The seller can apply to SARS for a directive to withhold a lesser amount if its liability is likely to be less than the standard withholding rate. The terms of applicable tax treaties may lower these rates of tax.

Ref: ITA s 35A

No South African taxes can be set off against CGT. Foreign taxes paid in respect of capital gains may be credited against the South African capital gains tax liability.

If a resident disposes of assets situated outside South Africa and a foreign country levies taxes on the gain realised, South Africa provides a credit for the foreign taxes paid up to the amount of applicable South African CGT.

Ref: ITA s 6quat

Subject to certain rules, the capital gains of a controlled foreign entity are deemed subject to South African CGT.

Recoupment of capital allowances previously granted is included in gross income for normal tax purposes on the disposal of the asset. Such amounts are excluded for CGT purposes.

Ref: ITA s 8(4)(a) and Sch 8 para 35

If a taxpayer purchases an asset (eg real estate) for the purposes of resale at a profit, the sale price is not of a capital nature for CGT purposes. The sale price instead forms part of gross income.

(b) Disposals

Disposals include sales, donations, expropriation, exchanges and scrapping. Certain other events are deemed disposals. For example, if a person or entity ceases to be a resident of South Africa for tax purposes or becomes a tax resident, a deemed disposal occurs. The purpose of these deeming provisions is to eliminate gains in the period before a person or entity becomes a resident or after they cease to be a resident.

Ref: ITA Sch 8 para 11 and 12

Capital gains and losses upon the disposal of assets for personal use are disregarded.

Ref: ITA Sch 8 para 15

As non-residents are subject to CGT only upon the disposal of South African real estate and business assets (see (a) above), for CGT purposes a resident who becomes a non-resident is deemed to have disposed of all their worldwide assets (except those stated above) at the date they become a non-resident. This also applies to non-resident companies or trusts which cease to be non-residents for tax purposes. Similarly, a non-resident who becomes a resident is deemed to have disposed of and reacquired all their worldwide assets. Gains prior to becoming a resident are ignored.

Ref: ITA Sch 8 para 12

If a capital loss occurs on the disposal of an asset to a connected person, the loss is disregarded and can only offset capital gains upon subsequent asset disposal to the same person.

Ref: ITA Sch 8 para 39

A deceased person is treated as disposing of all their assets to their estate at market value at the date of death. CGT is payable on any capital gains and becomes a liability of the estate and thus a deduction for estate duty purposes. When the heirs of the estate receive the assets, the estate incurs no further gain. Bequests to a surviving spouse or to tax exempt organisations and the proceeds of certain life insurance policies are not subject to CGT. In the year of death, the annual exemption allowance of R17,500 increases to R120,000.

Ref: ITA Sch 8 para 5 and 40

A natural person’s realisation of a capital gain or loss on disposal of that person’s primary residence is disregarded to the extent that the gain does not exceed R1.5m or the gross proceeds do not exceed R2m. This concession does not extend to company-owned residences or non-resident individuals if they own primary residences elsewhere in the world.

Ref: ITA Sch 8 para 44 and 45

Gains from disposal of the active business assets of a small business are disregarded up to a cumulative maximum of R750,000.

Ref: ITA Sch 8 para 57

The proceeds of disposal of an asset include the arm’s length market value of assets donated, but exclude amounts taken into account in computing income for normal tax purposes.

Ref: ITA Sch 8 para 38

A company’s distribution of assets to its shareholders (i.e. dividend in specie) is treated as a disposal by the company at market value.

Previously, if a shareholder received a capital distribution of cash or assets, the base cost of the shares was reduced by the value of the capital distribution in the hands of the shareholder. If the capital distribution exceeded the base cost, the excess was added to the proceeds on the subsequent disposal of the shares. In other words, CGT on the gain was deferred until disposal of the shares. With effect from 1 October 2007, capital distributions are treated as part disposals. Prior capital distributions from 1 October 2001 to 1 October 2007 will be treated as capital disposals and taxable in 2011. Since 1 October 2001, such capital distributions are treated as part disposals with CGT computed and payable in that year and not deferred. Capitalisation or bonus shares have no base cost. Shares or other assets received as dividends in specie, have a base cost of their market value upon receipt.

Capital losses resulting from the disposal of company shares are disregarded to the extent that extraordinary dividends (i.e. dividends exceeding 15% of disposal proceeds) are received during the period of two years prior to disposal. A disposal also includes a value shifting arrangement which involves the effective transfer of value to another without constituting an ordinary disposal.

Ref: ITA Sch 8 para 19

Often the beneficiary, founder or funder of a trust rather than the trust itself will be taxed on capital gains.

If assets located outside South Africa are disposed of and foreign taxes apply to the gain realised, South Africa will give credit for foreign taxes paid up to the amount of the applicable South African tax on the capital gain.

(c) Base cost

The base cost of an asset includes expenditures actually incurred for the acquisition of the asset, including related costs but excluding those costs deductible for normal tax purposes. One third of interest paid to acquire South African listed shares can be added to the base cost.

Ref: ITA Sch 8 para 20

The base cost of assets acquired before 1 October 2001 is the value at valuation date plus any expenditure incurred after that date. The objective is elimination of capital gains before the valuation date when CGT was introduced. The taxpayer can choose the valuation date value of these assets from the following:

• the market value as established at that date (as long as the valuation was undertaken before 30 September 2004)

• 20% of the disposal proceeds, as reduced by base cost type expenditure incurred after valuation date, or

• the time apportionment base cost.

Ref: ITA Sch 8 para 26

The time apportionment base cost uses a formula to add to the costs before valuation date a portion of the eventual profit computed, on the assumption that the gain accrues evenly over the ownership period.

The formula for determining the time apportionment base cost is complex. In its most simplified form, the formula is as follows:

Y = Time apportionment base cost

B = Base cost type expenditure (costs of acquisition and improvements)

P = Proceeds on disposal

N = Number of years (or part years) from date of acquisition to valuation date of 1 October 2001

T = Number of years (or part years) from 1 October 2001 to date of disposal.

Ref: ITA Sch 8 para 30

(d) Rollovers

Certain capital gains are disregarded when they arise but are taxed later. A capital gain resulting from a disposal or bequest to a spouse rolls over until the surviving spouse disposes of the asset. Capital gains arising from the destruction of an asset can also be deferred if a replacement asset is acquired within a short period thereafter.

Ref: ITA Sch 8 para 65 and 67

(e) Losses

In general, the net capital gain or assessed capital loss for a year is the aggregate capital gain or loss reduced by the assessed capital loss brought forward from the previous year of assessment. A taxpayer can carry forward capital losses indefinitely but only to offset future capital gains. On the other hand, losses for normal tax purposes can offset capital gains.

Ref: ITA Sch 8 para 4

(f) Corporate reorganisations

Special rules apply to defer capital gains in certain company transactions. No system of group taxation exists in South Africa. The following rules apply to corporate reorganisations:

• In company formation transactions where a person (other than a trust) transfers an asset to a resident company in exchange for shares, any resulting capital gain can be disregarded. Instead the acquired shares are deemed to have a base cost equal to the base cost of the asset transferred to the company. The effect of this rule is that assets are transferred at their income tax and base cost values. Thus, the seller is not taxed on any recoupment of depreciation and does not owe capital gains tax even if the market value of the asset exceeds the tax value. The purchaser is deemed to have acquired the asset at the tax value to the seller.

Example

An asset has a cost to the seller of R1,000. Depreciation of R100 has been written-off to leave a tax value of R900. The asset is deemed to have been transferred at R900 even though the market value (and transaction value) is R1,200. When the purchaser sells the asset later, for R1,400, the purchaser will pay tax on the depreciation recoupment of R100 and the capital gain of R400.

• In an amalgamation transaction where a company disposes of all its assets to another resident company and, as a result, the first company terminates, the consequences are similar to those in company formations.

• In an intra-group transaction where a company disposes of an asset to another company, the consequences are similar to those in company formations. An intra-group transaction means any transaction in terms of which an asset is disposed of by one company to another company (that is tax resident) and both companies form part of the same group. A group of companies means two or more companies in which one company directly or indirectly holds shares in at least one other company to the extent that at least 70% of the equity shares of each controlled company are directly held by the controlling company, one or more other controlled companies or any combination thereof and the controlling group company directly holds at least 70% of the equity shares in at least one controlled group company.

• In an unbundling transaction where an unbundling company disposes of distributable shares to its shareholders or to its holding company, the unbundling company is treated as disposing of those shares for proceeds equal to the base cost of the shares. It realises no capital gain, but the shareholder or holding company is treated as having acquired the shares held in the unbundling company as well as the distributable shares at the original base cost of those shares to the unbundling company.

• In liquidation or deregistration transactions where the liquidating company distributes a capital asset to its holding company, the liquidating company is treated as having disposed of the asset at its base cost. No CGT is payable. The base cost of the asset will be carried forward to the holding company. Other consequences described above for a company formation also apply.

Ref: ITA s 1 definition of “group of companies”, 42, 44, 45, 46 and 47

(g) Anti-avoidance provisions

South Africa has enacted a number of anti-avoidance provisions, particularly in relation to connected persons. Regarding sales of fixed assets between connected persons, the purchaser must base the calculation of its allowances upon either the cost to the seller or the market value at date of sale (whichever is less). This rule prevents transfers between connected persons at enhanced prices, giving rise to a capital gain to the seller and a large depreciable tax cost to the purchaser.

Ref: ITA s 23J

Similarly, to avoid sale and leaseback transactions entered into for the same purpose, thereby allowing the seller to enjoy a large capital gain but then claim a deduction for the lease instalments based on the higher cost, the lessor/financier must claim its allowance on the smaller of the seller/lessee’s cost or the market value at the date of sale. This rule discourages banks and other financiers from entering into these transactions. A transaction is treated as a loan where either the lessor or the lessee is a tax-exempt body (e.g. a charity).

Ref: ITA s 23G

If a tax avoidance scheme exists to use an assessed capital loss to shelter a capital gain, the capital losses may not offset such capital gain and must be carried forward to offset future capital gains not part of a tax avoidance scheme.

Ref: ITA s 103(2)

With permission from the Worldwide Business Tax Guide published by CCH Australia Limited.