Capital gains tax may sound like bad news, but it is easy to manage once you understand it and less daunting when you know it is not designed to fleece taxpayers. There is one thing you have to do - keep good records.
1 What are capital gains and losses?
A capital gain is the profit you make when you dispose of an asset, such as shares, a property or unit trusts. Profitability takes into account the cost to you of the asset, plus the cost of anything you have done to make the asset more valuable. You will only be taxed on that part of the capital gain which accrues the day after the tax kicks in. For instance, the tax takes effect on October 1 this year. You bought shares in October 1980 and sell them in October 2003. You will pay tax only on the increase in the price of the shares between October 2001 and October 2003.
2 What is not affected by the tax?
* The property you live in, unless you make a gain of more than R1 million or unless it is bigger than two hectares;
* Your car, unless you use it for business purposes;
* Clothes, jewellery, stamps, art works, antiques,
collector's coins and other personal effects;
* Lump sums from your pension, provident or
retirement annuity funds;
* Lump sums from endowments; compensation for injury, illness or defamation;
* Winnings on the national lottery, the horses or
from a casino;
* Any gain you make when you exchange foreign currency for rands when you come back from an overseas trip; and
* A gain of up to R500 000 on the sale of the assets of your small business when you retire.
3 What is affected?
* Shares;
* Unit trusts;
* Land;
* Property you do not use as your primary residence (and that means rights to property as well);
* Large boats and aircraft;
* Plant and machinery;
* Kruger rands;
* Mineral rights; and
* All other assets except those specifically excluded.
4 What is the tax rate?
You will pay capital gains tax (CGT) as part of your normal income tax return. As an individual, you will be taxed on one quarter of your aggregate capital gains - the total of all the capital gains you make in a year, less any capital losses.
The first R10 000 of your aggregate capital gain or loss is disregarded. On the rest of your gain, you will be taxed at your marginal rate (the highest rate of tax you pay on your income). For example, if you are on the top marginal rate of 42 percent and make a capital gain of R20 000, your CGT would be calculated as follows: R20 000 less R10 000 = R10 000; divide by one quarter = R2 500; tax at 42 percent = R1 050.
You can offset capital losses against capital gains, but you cannot offset capital losses against income.
5 What is the object of the tax?
The main point of introducing CGT is not to raise money, the South African Revenue Service says. The tax is expected to bring relatively small amounts into the government's piggy-bank - R200 million in the first years and between R1 billion and R2 billion a year in time. Instead, the tax is designed to plug holes in the tax system. In the absence of a capital gains tax, sophisticated taxpayers can convert income (which is taxable) into capital gains (which are not) and this erodes the country's tax base. Many other countries have CGT.
6 What is base cost?
Capital gains are the difference between the base cost of the asset and the sum you get on sale or disposal.
Base cost includes:
* Acquisition costs - what you paid in order to acquire the asset;
* Costs associated with acquisition and disposal - for example, legal fees, agent's commission, stamp duty, advertising costs, broker's fees, transfer duty,
conveyancing;
* VAT;
* Improvement costs - what you spent on improving the value of the asset; and
* Any legal costs you incurred if you had to fight a court battle to maintain your right to an asset you already owned.
You are not allowed to claim current expenses, such as insurance, repairs, and interest on a loan, as base costs. For example, if you bought a second home and sold it at a profit, for the purposes of calculating a CGT liability you would be able to claim the price of the house, any improvements (not repairs) you made, and the estate agent's commission on the sale.
7 How do you value an asset before October 1?
If you buy and sell an asset after the tax kicks in on October 1, the capital gain or loss will, broadly speaking, be the difference between the price you paid for it and the price at which you sell it. (You must keep records of each.)
But it is more complex to calculate capital gains on assets bought before October 1 and sold after this date.
For shares, bonds and other securities that are traded on an open market, the base cost will be the average closing price of the asset for the five trading days before the day on which you acquired it. Since you will not be taxed on capital gains before October 1, the base cost is the average closing price of the shares on the JSE Securities Exchange over the five trading days before October 1. (It is as if you bought the shares on October 1.)
For other assets, you can choose either to have your assets valued at October 1 to establish the base cost, or use the time apportionment method. This involves looking at the total capital gain from the day you bought the asset until the day you sold it, and then working out how much of the gain took place after October 1. Again, you will only pay tax on this portion.
Say you bought a plot by the sea five years ago for R50 000. In 10 years' time you decide to sell and the plot fetches R260 000. In 15 years the plot has gained R210 000 in value. But you can only be taxed on the part of the capital gain that took place after October 1 this year:
Full capital gain = R210 000
Period = 15 years
of which 10 years fall after October 1 2001
Taxable portion of gain = 10/15
Taxable gain 2/3 of R210 000 = R140 000
8 What if the asset was an inheritance or part of a divorce settlement?
CGT is only triggered when an asset is sold or disposed of. The transfer of assets on divorce, and for that matter donations between spouses, do not count as disposal. So if you get the holiday house as part of the divorce settlement, you are considered to have acquired the asset at the original base cost - the cost at which you bought it when you were still married. When you sell it, you would calculate the capital gain on the difference between this base cost and the price at which you sold the house.
Inheritance is different. If a parent dies and leaves you a house, for instance, the capital gain on the value of the house will be taxed as part of your parent's estate, as if it had been sold to you. You will inherit the house at its current value. If one day you sell the house, you will be taxed on the difference between the value of the house when you inherited it and the price at which you sell it.
The tax authorities are looking into ways to mesh CGT and estate duty.
9 What records should you keep?
It is up to you to prove the base cost of your asset, whichever valuation method you use, so keeping good records is essential. If you have not kept records of assets you already own, you should be able to get copies from your stockbroker, unit trust company, attorney or estate agent. In the case of a house, keep copies of any invoices from builders. And make a point of keeping better records from now on.
Here is what you need to record:
* The date you acquired an asset;
* The price you paid for it;
* Any money you spent on the purchase (estate agent's fees and the like);
* Any money you spent improving the asset;
* The date you disposed of it; and
* The profit or loss you made from selling it.
Hold on to contracts of purchase and sale, market valuations, invoices and receipts for services.
If you inherit an asset, make sure you get copies of all the records relating to the value of the asset from the executor of the will that makes you an heir.
When you sell an asset, you will declare it in your income tax return and you must keep records relating to the asset for four years after the taxman acknowledges receipt of your tax return. If you do not submit tax returns and you sold an asset worth more than R10 000, you must keep records for five years from the date of sale.
10 The taxman is watching
Don't try to bump up the base costs of assets before October 1 next year; the taxman is introducing provisions to cover this. Nor will it help you to donate assets to your children rather than sell them, in the hope of dodging CGT. The taxman may consider this a disposal and attribute capital gains to you even if you have not sold the assets.
Nor will you be able to claim a capital loss if it arises from your own use of an asset. Wear and tear is not a capital loss. For instance, you cannot buy a boat, sail it for a few years, sell it at a loss and then try to claim the loss against your capital gains.
HOW CGT WORKS
A pensioner has an income of R42 510 a year and has invested the rest of her life savings in a unit trust. Every year she sells some of her unit trust investments to complement her pension. In 2002 she sells units which cost her R50 000 and gets R70 000 for them; in other words, she makes a R20 000 capital gain. The first R10 000 is excluded from tax. She pays tax on 25 percent of the rest. So she must include R2 500 in her taxable income for the year, raising her taxable income to R45 010. Her tax is calculated as follows:
On the first R35 000 of taxable income: 18 percent of R35 000 = R6 300
On the next R10 000 of taxable income: 26 percent of R10 000 = R2 600
On the next R10 of taxable income: 32 percent of R10 = R3.20.
So her total tax on income of R45 010 is R8 903. Of the R20 000 capital gain she made, only R2 500 entered her taxable income.
Only R10 fell into a higher tax bracket and was taxed at a higher rate.
And as a pensioner, this taxpayer is entitled to an additional tax reduction, reducing her tax liability by R6 700 to R2 303.
This article was first published in
the 2nd Quarter 2001 issue of Personal Finance magazine. See what's in our latest issue