CAPITAL GAINS TAX (CGT): SOME ASPECTS IN A NUTSHELL

Mr. Deon Nel, Reincor Investments CC

INTRODUCTION

CGT was introduced with effect from 01 October 2001 and is applicable to capital gains made after that date. CGT applies to assets acquired before and after the date of 01 October 2001 and that are disposed of after 01 October 2001. CGT is not a separate tax but forms part of the income Tax Act and applies to individuals, trusts and companies.

CGT is a tax on gains and not a tax on proceeds.

MEANING AND EXAMPLES OF THE WORDS NORMALLY USED FOR CGT DISPOSAL

A “disposal” might be the actual physical disposal of the capital asset by sale or it could be a “deemed disposal” of an asset. The disposal of an asset will either result in the application of the income tax rules (for example if the asset was held as trading stock) or CGT rules if the asset was held as a capital asset (for example fixed property).

Disposal is defined widely as any event, act, forbearance or operation of law which results in the creation, variation or extinction of an asset.

DEEMED DISPOSAL

When a person dies, that person is deemed to have disposed of their assets on the day before death. The deemed disposal is to their deceased estate.

The proceeds resulting from such deemed disposal are regarded as the market value of the assets. In turn the deceased estate will be treated as having acquired those assets for a base cost equal to that market value. When the estate assets are distributed to the heirs, legatees, and other beneficiaries or to the trustees of a trust, the deceased estate is deemed to have disposed of those assets for an amount equal to the base cost of that asset in the hands of the estate (in other words, at the market value taken into account on the deemed disposal of the asset by the deceased on the day before their death).

The person receiving the assets from the estate is deemed to have acquired the asset for the same amount. This will now be the base cost of the asset in the hands of the heir, legatee, beneficiary or trustee.

EXCEPTIONS TO THE DEEMED DISPOSAL RULE

Certain assets will not be deemed to have been disposed of on the death of a taxpayer. In other words, these assets will not attract CGT on the death of the deceased.

The following  are exceptions of deemed disposals:

Assets accruing to a surviving spouse

Assets bequeathed by the deceased to a public benefit organization

Long-term insurance policies

An interest in a pension, provident or retirement annuity fund.

CAPITAL ASSET

CGT can only arise in respect of “capital” assets. An asset is either trading stock or it is a capital asset. For example, if the taxpayer sells his primary house (the one he resides in), the house was clearly not acquired by the taxpayer as trading stock, and the proceeds from the sale of the residence are capital in nature. A capital asset can be any physical asset, and it can also be a right.

“Goodwill” will also be an asset for CGT purposes. Shares in companies that have been held for longer than three years will be regarded as “capital” assets, and will therefore be subjected to the CGT rules on its disposal. The only asset that falls outside of the ambit of CGT is cash (currency). The definition of “asset” is therefore very wide and includes property of whatever nature and any interest in such property.

It includes any coin made mainly of gold or platinum, but excludes cash as already mentioned. Examples of “assets” for CGT purposes could be buildings, trade marks, holiday homes, shares, unit trusts, gold coins and goodwill.

CAPITAL GAIN / LOSS

A capital gain arises when you dispose of a capital asset on or after 01 October 2001 for proceeds that exceed its base cost at the time and a loss arises when you dispose of a capital asset for proceeds less than its base cost.

BASE COST

The determination of the base cost of an asset is very important, since a capital gain or loss is determined by subtracting the base cost of a capital asset from its proceeds once a disposal took place or when there is a deemed disposal (example: the death of the owner).

Base cost of assets owned prior to 01 October 2001 CGT will only apply to the growth in the pre- 01 October 2001 asset that take place from 01 October 2001 to the date of disposal of the asset.

EXAMPLE

Dr. B.T. de Vet acquired a factory building in 1995 for R 500 000 and sold the property in 2008 for R 2000 000. The capital gain of R 1 500 000 is made. The full gain will not be subject to CGT because the property was acquired before 01 October 2001.

Assume the value of the property at 01 October 2001 is determined as R 1000 000. This value will be regarded as the base cost of the property and therefore, for CGT purposes the gain will be R 500 000. In the event of a gain as illustrated above, there is an annual exclusion of R 30 000 available for individuals only, and the net capital gain will be R 470 000.

Please take note that in the event of death (deemed disposal) the exclusion is R 300 000.

HOW TO DETERMINE THE VALUE OF AN ASSETS ACQUIRED BEFORE 01 OCTOBER 2001

A taxpayer will have a choice in determining the value of an asset as at 01 October 2001 (the taxpayer can chose the smallest capital gain):

Determine the value of the asset on 01 October 2001 (valuation obtained before to 30 September 2004)

Use the “time-apportionment” method (based on a formula)

20% of the proceeds from the sale of the asset (after deduction of any expenses incurred after 01 October 2001 i.e. capital improvements which increased he value of the property and NOT maintenance costs).

VALUE OF THE ASSET ON 01 OCTOBER 2001

CGT is calculated on the difference between the price for which the property is sold and a valid valuation of the property as at 01 October 2001 (assumed that a valid valuation was obtained prior to the 30th of September 2004).

Capital improvements prior to the 1st of October 2001 cannot be deducted as they have already been taken into account in the valuation of the property as at the 1st of October 2001.

TIME  – APPORTIONMENT METHOD

The best way to explain this method is by example:

Dr. B.T. de Vet acquired a capital asset on 01 October 1998 and paid R 250 000 for the asset. Dr. Joe de Vet sold the asset on 01 October 2010 to Mr. Keen Buyer for R 450 000.

Dr. de Vet had the asset for exactly 12 years – 3 year before 01 October 2001 and 9 years after 01 October 2001.

Profit from the sale: R 200 000

Profit attributable to the period before 01 October 2001: R 200 000 x 3 years / 12 years = R 50 000.

The value of the asset on 01 October 2001 is calculated as follows: R 250 000 (original cost) plus R 50 000 (profit attributable to period before 01 October 2001) giving a value (base cost) of R 300 000.

This method becomes complicated if some expenses incurred before the valuation date or after the valuation date. In this instance, a professional qualified person needs to assist with the calculations as there are two formulas to be used in these calculations, therefor the reason of using exact time periods in the example above.

THE 20% RULE

Dr. B.T de Vet acquired an asset many years ago, long before 01 October 2001 and paid R 15 000 for improvements after 01 October 2001.

He sold the asset in 2013 for R 115 000. (We ignore the annual exclusion for example purposes)

Determine the value at 01 October 2001: 20% x R 100 000 (proceeds of R 115 000 minus expenditure of R 15 000).

Thus: Value at 01 October 2001 = R 20 000. Base cost when asset is sold: R 20 000 plus R 15 000 = R 35 000.

Capital gain: R 115 000 less base cost of R 35 000 = R 80 000 capital gain. Base cost of assets acquired after 01 October 2001. There are specific rules in the Income Tax Act specifying what must be included and excluded from base costs.

For example, costs of acquisition and of disposal of the asset form part of the base cost of the asset. On the other hand, the base cost must be reduced by any tax allowances allowed in respect of the asset.

The following amounts incurred as expenditure directly related to the creation, variation, acquisition or disposal form part of the base cost of the asset:

  • Advertising costs to find a buyer or seller
  • Agent’s commission
  • Transfer costs
  • Accountant costs
  • Transfer duty
  • Stamp duty
  • Costs of moving asset to another location
  • Installation costs
  • Legal costs in maintaining, establishing or defending title
  • VAT paid and not claimed or refunded
  • One third of the borrowing costs in the case of listed shares
  • The following examples of expenditure must be excluded in determining the base cost of an asset:
  • Expenditure on repairs, insurance, rates and taxes, repairs, maintenance or similar related to non-business assets
  • Costs of borrowing including interest or raising fees (except for listed shares or expenses which is 100% used for business purposes and which have not already qualified as a deduction for tax purposes)

PRIMARY RESIDENCE

A primary residence is a residence in which a natural person or special trust has an interest and ordinarily resides in as their main residence and uses it mainly for domestic purposes.

SPECIAL TRUSTS

Special Type A – a trust created only for the benefit of a person(s) with a “disability”, where the disability makes it impossible for the person(s) from earning enough money for their care or from managing their own financial matters.

Special Type B – a trust created only for the benefit of a person(s) who are relatives of the person who died and who are alive on the date of death of that deceased person (including those conceived but not yet born), and the youngest of the beneficiaries are younger than 18 years on the last day of the year of assessment.

PERSONAL-USE ASSETS

A capital gain or capital loss in respect of a natural person or special trust must be disregarded to the extent that the asset is not used for the purposes of carrying on a trade.

Examples of personal-use assets:

  • Motor vehicles
  • Artwork
  • Caravans
  • Furniture
  • Household appliances
  • Boats not exceeding 10 meters in length
  • Aircraft with an empty mass of less than 450kg which are personal-use assets
  • Other assets used mainly (more than 50%) for non-trade purposes

LONG-TERM INSURANCE AND RETIREMENT BENEFITS

Lump sums from a pension, provident or retirement annuity funds are free from CGT. Where a long-term insurance policy issued by a South African Insurer matures, surrendered or pays out, it will not attract CGT, as long it is not a secondhand policy or a foreign policy.

INCLUSION RATES OF CGT

Individuals and special trusts 33,3%

Companies and close corporations 66.6%

Ordinary trusts 66,6%

We need to take note that if there is a net loss, that loss is not included in a taxpayer’s taxable income, but carried forward to the next tax year and may only be set off against future capital gains.

CGT AND ESTATE DUTY

Once any CGT liability has been ascertained, then any estate duty must be determined. Any CGT liability will reduce the net value of the deceased estate for estate duty purposes.

LIQUIDITY

There could be a CGT liability on the death of a person and as a result place a higher burden on the liquidity of a person’s estate. There is a need for cash to settle liabilities, CGT and estate duty plus other expenses such as Master fees and executor fees. It is very important to assess the liquidity of an estate to determine the sufficiency (available cash) of the estate in the event of the death.

The discussion above is a summary of certain aspects of CGT and the effect it can have on liquidity of our wealth and estates. We need to make sure that CGT is correctly calculated and should be included when we do our contingency and succession planning in our practices.

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