Adjusting capital gains tax (CGT) for inflation would only be necessary if inflation topped 20 percent for a long time, the National Treasury's Tax Policy Directorate says.
In a recent submission to Parliament's finance committees, the Treasury sets out in detail the reasons why indexation of capital gains against inflation will not be introduced in the CGT system, due to kick in on April 1.
Many commentators have argued that it is not fair to ignore inflation when taxing capital gains. They have suggested that the part of capital gains which is due to inflation alone should not be taxed and only real (after-inflation) capital gains should attract the taxman's attention because only real capital gains add to people's wealth.
But although it would be theoretically correct to include only real capital gains, the Treasury says, this is difficult to implement.
A survey of 40 countries showed that of the 37 which had capital gains tax, 21 had no indexation system. Five others had since removed inflation indexing from the tax. By far the majority of countries which indexed capital gains taxes for inflation are countries with huge inflation rates such as Brazil, where average inflation between 1970 and 1999 was 612 percent, and Argentina, where the average was 317 percent - and once inflation was under control, both these countries scrapped the indexing system.
At moderate rates of inflation, the fact that only 25 percent of capital gains is to be taxed in the hands of individuals, coupled with the fact that the tax is only paid when the asset is sold, more than compensates for the effects of inflation, the Treasury says.
Taxing capital gains on realisation - when the asset is disposed of - is already a departure from economic theory, the document points out. Theoretically, capital gains should be taxed on accrual - in other words, you should be taxed each year on the improvement in value in your asset, whether or not you have sold it. But some taxpayers might not have the money to pay these annual taxes without selling the asset, so almost all countries have opted for the realisation system.
Italy is an exception - in Italy most capital gains on unit trusts, for instance, are taxed on an accrual basis.
Using the realisation basis for tax means the effective tax rate on capital gains declines the longer you hold the asset, so you get a tax deferral benefit. Rent and interest on the other hand are taxed at full rates every year.
This tax deferral reduces the effect of inflation, the Treasury document says.
Arguments against indexing capital gains include:
* Indexing one part of the tax system only would distort the level and patterns of investment, the Treasury says;
* If only capital gains are indexed, people who make capital gains would have an advantage over those who receive interest income or other fixed income streams. "An investor receiving income in the form of capital gains would only be taxed on the real growth in the asset's value, while a person who placed his or her funds in a fixed deposit would be taxed on the full - nominal - value of the interest received."
This would go against the equity principle, the Treasury says. It would mean that wealthier taxpayers receiving capital gains would be favoured over other taxpayers who receive income which is fully taxable regardless of the inflation rate;
* Indexation would be very difficult to administer and would place a heavy burden both on the tax services and taxpayers. The more accurate the indexing system is, the more complex it becomes.
If monthly index adjustment tables are used, for instance, as was the case in the United Kingdom and Australia (both of which have since scrapped this method), the cost of all assets acquired over a period longer than a month has to be separated out into a monthly amount.
Someone with a monthly unit trust debit order who reinvests dividends twice a year, over a period of 15 years would have 210 separate base costs to track. And each acquired asset would have an original cost, for the purposes of ordinary tax, and an indexed cost, for the purposes of capital gains tax, doubling the number of costs to be accounted for.
"In the final analysis, adjusting for inflation is only necessary if anticipated inflation reaches significant levels, for example in excess of 20 percent, over a prolonged period of time. Given South Africa's inflation outlook, it is not necessary to contemplate indexing the capital gains tax for inflation at this juncture," the Treasury concludes.
WHAT IS A CAPITAL GAIN
A capital gain takes place when you buy an asset and dispose of it at a higher price.
At present these gains are not taxed in South Africa, although many other countries have a capital gains tax. The government is planning to tax capital gains this year in order to put an end to tax dodging by investors who hide income (which is taxable) by claiming that it is a capital gain (which at the moment is not taxable).
The Government's proposal is to tax 25 percent of an individual's capital gain.
Only gains made after the day the tax kicks in will be taxed. In other words, if you bought a holiday house 20 years ago and sell it in two years time, only the increase in price in the last two years will be taxable.
The tax is due to kick in on April 1.
Capital gains on the house in which you live (unless you make a profit of more than R1 million on its sale), on your furniture and personal effects, lump sums from your life assurance policies, lottery winnings and a few other assets are exempt from the tax. But capital gains on your holiday house, shares, unit trusts, Kruger rands and most other assets will be subject to capital gains tax.
You can deduct the cost of improvements made to an asset from the selling price before calculating the gain made. You can also offset capital losses against capital gains.
Capital gains tax will be paid as part of income tax. One quarter of your total capital gain, less any capital losses, will be added to your income and you will be taxed at your usual income tax rate.