In the final report on the recent Personal Finance/Investec Asset Management World Investment Seminar, Matthew Lester (right), professor in charge of taxation studies at Rhodes University, discusses capital gains tax. Lester is a chartered accountant and one of the country's leading tax experts. His department at Rhodes is conducting an intensive investigation into capital gains tax.
The introduction of capital gains tax (CGT) requires you to take a hard look at how you structure and manage your investments, Matthew Lester, professor in charge of taxation studies at Rhodes University, says. He says you can properly manage the impact of CGT by asking the following questions:
Question One: Has there been a 'CGT event'?
A "CGT event" normally occurs when an asset is sold. However, emigration is considered to be a "CGT event" whether or not you sell assets: You will be taxed on any capital gains made up to that date.
Question Two: Has there been a capital gain or a revenue gain?
It is crucial to establish that a gain is not revenue (income) in nature. If it is, then the entire gain will be subject to taxation at the higher maximum marginal rate of income tax (top rate of 42 percent), against the lower effective rate of CGT. For many years, taxpayers have been passing off what are essentially revenue gains - that should be subject to income tax - as non-taxable capital gains.
"CGT flushes out capital gains that are in fact revenue. CGT is going to force you to disclose all capital gains. The taxman will examine all gains, and may well attempt to classify some as being revenue in nature and subject to income tax. Watch out that you don't get caught in the revenue net," Lester says.
Issues to take into account in deciding whether you are dealing with income or a capital gain are:
* Gross income as defined in income tax legislation. The legislation sets out the types of revenue that are subject to income tax;
* The golden rule in deciding what is a capital or a revenue gain is "intention" - your original intention. Your original intention when acquiring a capital asset must be "to keep your asset for better or worse only to be disposed of if some unexpected or unusual circumstances intervene".
The onus is on you to prove your original intention was to make a capital gain and not a revenue gain. To prove this, you need to record your original intentions when you purchase an investment.
Two examples of intention:
Fixed property transactions. Say you go to Kenton-On-Sea and buy a repossessed property from a bank for R200 000 with the intention of selling it. You spend R100 000 on improvements and sell it in December to a Johannesburg yuppie for R600 000. This will be regarded as revenue of R300 000 and will be subject to income tax at the full marginal rate.
On the other hand, you may buy the property with the intention of renting it out for an income. In December, the Johannesburg yuppie comes along and offers you double what you paid. This would be a capital gain. But to prove this, you must have documented all events surrounding the transaction.
Share dealings. If the South African Revenue Service (SARS) decides that you are actively trading shares, the gains will be subject to taxation at the full marginal rate. If you hold shares for less than five years, then you will be considered a trader and subject to income tax rather than CGT. Say you buy shares in Amplats because you believe the share price will rise over the long term. But six months later you read an article saying the price of platinum is expected to drop and decide to sell. Cut out and keep the article. You will be subject to CGT and not income tax if you show that your intention was to hold on to the investment, and that the decision to sell was a result of the unexpected market adjustment.
From the point of view of tax, if you speculate in shares and are subjected to income tax on any profits, it may be more tax-efficient to put your money in a money market investment. With the introduction of CGT you will also need returns of at least 1.3 percent above the inflation rate to ensure you get a real return on your investment.
Question Three: Has there been a loss or a gain?
If you incur a loss on a capital investment, that assessed loss can be carried forward until you make a capital gain and the loss can be deducted from the capital gain. Again, you need to keep accurate records to ensure that losses are properly recorded. Losses incurred in what SARS considers to be an investment subject to income tax can also be deducted against revenue gains.
Question Four: Are there any exemptions?
Exemptions from CGT are few and far between. They include:
* Your primary property (the dwelling you live in). Properties held in trusts are currently not considered as primary properties for CGT purposes. Lester says this is unfair, but it will be difficult to allow for a property held in a trust to be considered a primary property. You should also be wary of removing a property from a trust as you will pay transfer duties;
* Private motor vehicles. Gains from the sale of private motor vehicles are not subject to CGT. Boats and caravans are excluded from this exemption;
* Personal effects. This could include such items as jewellery and carpets. Lester warns that you should not rush out and buy Persian carpets and diamonds as you could lose more in the sale than you will save in CGT;
* Retirement fund investments (which are already subject to tax);
* Gambling winnings based on chance, such as the national lottery;
* The sale of small businesses for less than R500 000, if the taxpayer is older than 65; and
* The sale of assets by exempt institutions, such as charities.
Question Five: Can the tax be rolled over (deferred)?
CGT can be delayed until a second disposal. For example, if an asset is sold to a spouse there is no "CGT event". The "CGT event" occurs only when the asset is sold to a third party. This affects all inter-spouse tax transfers and also people in same gender, long-term relationships. The legislation does not say what happens in the case of an unmarried heterosexual couple in a long-term relationship.
Question Six: What costs can be deducted from a capital gain?
You can claim costs, such as improvements to a property and purchasing costs. There are no deductions for the upkeep of an asset or for inflation. Lester says this is the most unfair aspect of CGT because you could pay CGT on the sale of an asset which in real terms (the price less the inflation rate) has not increased in value. You could be paying the tax on inflationary growth alone. In the United Kingdom, the longer you an hold asset, the lower the CGT. This is called tampering to take account of inflation. This principle has not yet been accepted in South Africa.
Question Seven: When do you value the assets?
CGT will only apply to gains or losses made from the date on which the tax is scheduled to be implemented: April 1 2001. There are two ways in which you can value your assets:
* Actual values. You can have an appraiser value the property. However, the cost of obtaining a sworn appraisal could be more than the actual tax you will pay. On a share portfolio, you must take the price over a five-day average from the effective date of CGT; or
* A simple pro rating formula may be used instead of appraisal:
Taxable portion of gain =Period after 1/04/2001 x gain
Total period (max 20 years)
Do not fall for the temptation of over-valuing your assets when CGT is implemented in an attempt to minimise the declared capital gain. Firstly, SARS will look at your balance sheet and ask where the money came from to buy the assets. Secondly, when you die, you will have to pay estate duty at 25 percent on the value you have set for CGT.
Question Eight: Are you entitled to any tax-free allowances?
It is proposed that you will be allowed R1 000 for every "CGT event". Lester says the figure is very low and should be higher so that the processing of small capital gains does not clog up the tax system.
Question Nine: Amount you pay
The amount of CGT you pay depends on your marginal rate of tax and the periods you owned the asset before and after the effective implementation date of CGT on April 1 2001. You are only scheduled to be taxed on the capital gains made after April 1 2001. If the asset is held in your own name, 25 percent of the gain made after April 1 2001 will be taxed at your marginal rate of income tax. If the asset is held in the name of a close corporation, a trust, or a com-pany, 50 percent of the gain will be taxed.
DEFINITION
A capital gain is an improvement in value of anything (an asset) you own. For example, if you bought a house for R100 000 two years ago and you sell it today for R150 000, then you will make a capital gain of R50 000. A capital gain is not an earning on an asset. For example, interest on a fixed deposit or rent from a house is not a capital gain.