Capital gains Tax - 2001 amendments

Posted On Saturday, 01 January 2000 03:01 Published by
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The previous 2000/2001 National Budget introduced significant tax reforms, including Capital Gains Tax (CGT),

The previous 2000/2001 National Budget introduced significant tax reforms, including Capital Gains Tax (CGT), for which legislation has been released. Some of the more relevant issues raised in an explanatory memorandum and for inclusion in the Income Tax Act, as well as reference to the CGT guideline published in February 2000, form the basis of this analysis.
The reforms include measures to close perceived 'tax loopholes', with CGT designed to tax capital accruals that presently escape income tax. (Both resident's worldwide assets and non-resident's assets in South Africa, will be considered, and events that are to be treated as disposals and acquisitions of assets include the commencement and cessation of residence). The logic is based on the premise that when only income and not capital is taxed, the temptation is there to convert otherwise taxable income into tax-free capital gains. As such the notion of 'double taxation and 'wealth taxation' has been leveled, by the market in general, at CGT proponents. On the other hand, it has been argued that the wealthy can afford to have their wealth work for them without necessarily realising gains whereas the reverse holds true for the less wealthy.
Where records exist, there are essentially two methods for calculating CGT; the first is based on a market valuation and the second is on a time-based apportionment basis. Purchase price, time frames, sector performance and locality are all key issues having an influence on property performance, and in determining therefore what method to employ. The valuation method has been extended from 6 months to two years (30 September 2003) from effective date of CGT implementation with this period further extendable at the Minister of Finance's discretion - failure of which will automatically bring in the time-based method. In general terms, the shorter one's property holding time-frame horizon and/or the longer the historic holding period, the more important it becomes to have a thorough valuation conducted. Valuations must reflect market value at 1 October 2001.The extension to the original time-frame is partially as a result of market capacity (volume of valuations and small number of suitably qualified valuers available) and the fact that little CGT valuation activity has occurred in 2000/2001. Furthermore, sections of the Income Tax Act dealing with 'anti-avoidance' are to be amended to cover CGT and prevent the 'stepping-up' of base costs of assets during the period from the announcement of CGT to date of valuation. Proposals have also been formulated to ensure that CGT prevents certain hardships. As such, it is not levied where a market value is adopted below original cost and where the asset is sold for a price falling between market value and original cost - an issue or relevance to commercial property in the Johannesburg and Durban CBD's in particular.

CGT occurs at the point of Disposal (broadly defined as selling, giving away, scrapping, exchanging, losing, redeeming or cancelling of taxable assets). In the case of primary or principle and owner-occupied residences of natural persons, these are exempt from CGT - up to a R1 million gain and where the property is less than two hectares in extent. CGT is payable on the difference between the disposal proceeds and the base cost (expenses incurred). This base cost includes:
· Acquisition costs, incidental acquisition and disposal costs - including legal fees, agent's commission, stamp duty, transfer duty, conveyancing costs, advertising costs, broker's fees and valuation costs;
· Capital maintenance costs (but not operational or current costs such as interest, repairs, insurance, rates and taxes); improvement or enhancement costs; and
· VAT not claimed for income tax or refunded or credited for VAT.
· Wear and tear or capital allowances permitted for income tax purposes
No specific provision has yet been made in respect of automatic relief for inter-group disposals due to the potential for abuse and the lack of a group tax system in South Africa. Any group of companies considering a rationalisation or unbundling exercise will now have to reconsider the transaction in the light of the CGT legislation and evaluate whether such is worthwhile and cost effective.

Property-related Implications:
· With some uncertainty still prevailing regarding certain CGT details and procedures, markets may adopt asset-holding strategies until more clarity is obtained. Ahead of implementation though, some asset rationalisationan and changes to the composition of funds will have been occurring - how much as a direct result of future CGT implementation - perhaps somewhat debatable
· Furthermore, since CGT losses may not be offset against anything other than CGT gains, and bearing in mind some uncertainty regarding inter-group disposals noted above, property holders with assets located in various companies or entities are probably well advised to consolidate the properties into a single company.
· Since capital gain is to some extent a function of inflation, there is argument for discounting - but the principle, let alone inflation yardstick, has not been confirmed. In the UK, a system of indexation of capital gains was introduced in 1981 but amended in 1998 to reflect variable exclusion percentages (reducing rate commensurate with the length of time the asset is held). The Receiver cites international research, which reveals that ultimately the benefits of deferred gains payment at the point of disposal, outweighs detrimental bunching and inflationary impacts. Furthermore they argue that a systematic inflation index is administratively complex, and to reduce distortions and equity, would need to be applied within the total tax system - only Italy has such a system in place.
· Property developers and traders will continue to be taxed on the proceeds of disposal under the normal tax regime whereby revenue is recognised and profit is taxed. In some instances, as in the case of subdividing and developing land, debate may arise as to what activities are construed as profit based and which are viewed as capital gains based.
· Under the current tax regime, the interest on purchase price and rates payable by manufacturers purchasing land in order to erect a new factory, is not deductible as the property is not yet in use. Under CGT, these costs will now be allowed to form part of the base costs.
· The requirements for regular and fair valuations is a factor that will stand to benefit the listed property sector by virtue of the fact that they are already required to exercise these measures in compliance with regulations. These funds will also have established a market related base for the October 1 CGT implementation. For Property Unit Trusts and Property Loan Stock, the applicable market value will be the average five-day buying and selling price at close of business, will apply.
· Property yields could come down further as higher-end valuations are adopted.
· There is uncertainty regarding how valuers will derive their findings given the new property ratings system premised on market pricing and the old system currently in place. In general, the professional integrity of valuers will be brought more to the fore. However, the Act does not prescribe who may perform valuations - the onus and responsibility lies with the taxpayer. If valuations either under or overstate the capital gain or loss when compared to the time-based apportionment, penalties may be imposed. For property owners and individuals, any disputed market valuations of fixed property is likely to realise costly and time-consuming dealings with the Receiver. In disposing of assets, including fixed property where market value exceeds R10 million, copies of valuations must be submitted.
. Government's prudent fiscal policies have been very well received both locally and internationally - monetary and fiscal austerity including a reduction in debt, relaxation of exchange controls, reducing interest rates and moves toward privatisation of assets - among others. This has however not attracted the levels of fixed investments, including Foreign Direct Investment, required for stimulating the economy. CGT is regarded as a disincentive to investment and therefore somewhat contrary to macro economic objectives; particularly where capital is increasingly mobile and where the fine print of tax regimes are emerging into ever-bolder relief. Apart from concerns around deferred investment decisions that could arise and the suspect equity objective that the CGT is associated with, both government and business administrative resources required to comply, are regarded as costly. So, while some maintain that it makes political sense to have CGT, others argue that it may not make financial and economic sense.

CGT Effective Rates. Source: SARS Guide to Capital Gains Tax and amendments to Inclusion Rate as included in Memorandum

 

7,5

15,0

15,0

 

-

-

Taxpayer Inclusion rate % Statutory tax rate % Effective tax rate %
Individuals 25 0-10,5
Retirement Funds N/A - -

Unit Trusts (Resident Funds)

·Unit

·Special

·Other

N/A (payable by unitholder)

25

50

 

-

30

30

 

-

7.5

15

Life Assurers

·Individual policyholder fund

·Company policyholder fund

·Corporate policyholder fund

·>Untaxed policyholder fund

·Retirement fund business

·Other exempt business

 

25

50

50

 

N/A at this stage

N/A

 

30

30

30

 

-

-

Companies (standard)

Small business corporations

50

50

30

15-30

15,0

7.5-15


Marc Schneider


Publisher: Marc Schneider
Source: Marc Schneider

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