With the help of the South African Revenue Service we have put down all the basics you need to know about capital gains tax.
What is capital gains tax (CGT)?
Capital gains tax is a tax you pay on the profits you make on your assets. You only become liable for it when you sell or otherwise dispose of your asset. It is important to remember that you will only pay tax on the profit you make, not on all the money you make from the sale. This means you can deduct the cost of the asset from the amount you realise at the sale. Then, if you had the asset before the tax was implemented on October 1 2001, you must also exclude the profit that accumulated until then. Lastly, remember that you will only pay tax on a quarter of this gain.
Why is CGT being introduced?
The absence of a CGT creates many distortions in the economy, as it encourages taxpayers to convert otherwise taxable income into tax-free capital gains. The South African Revenue Service (SARS) has noticed that sophisticated taxpayers have engaged in these conversion transactions, thereby eroding the income tax base. This reduces the efficiency and equity of the overall tax system. Capital gains tax, SARS says, is, therefore, a critical element of any income tax system as it protects the integrity of the income tax base and can materially assist in improving tax morality.
When does CGT come into effect?
CGT came into effect on Monday October 1, 2001. Only gains made after this date will be taxed. That is why it is often important to know the value of an asset on October 1, 2001.
Do you have to register as a capital gains taxpayer?
No, you will only need to pay CGT if you sell or otherwise dispose of an asset. You will then need to calculate what gain or loss you made on that asset less any exclusions, and then a quarter of this amount must be added to the amount of taxable income you record on income tax return for the year of assessment in which the disposal occurred. However, if you are not registered for income tax purposes (for example, if you are a SITE taxpayer only) and you dispose of an asset and the proceeds are above a certain amount as determined by the Commissioner of Inland Revenue, you will have to register. If this could apply to you, contact your local Receiver of Revenue Office or the SARS call centre (see below).
What assets are excluded from CGT?
Certain assets are excluded from CGT. Some important exclusions are:
* Your primary residence unless you make a gain or loss on it of more than R1 million (see below);
* The gains you make on most of your personal belongings and effects such as motor vehicles, furniture, collectibles, etc, but excluding gold and platinum coins;
* The proceeds from an endowment policy or life insurance policy (the exception to this is a secondhand policy, which is subject to CGT).
* Your retirement savings - there is a three-year moratorium on CGT on lump sums for pension, provident and preservation funds as well as retirement annuities, while the government reviews taxation of retirement savings.
* Any compensation you receive for personal injury or illness.
* Prizes or winnings from any South African competition such as the National Lottery.
* The loss or gain you make on any foreign currency you obtained for your personal use on an trip abroad, that you did not spend and have brought back home with you to convert back into rands;
* Small-business assets, under
R5 million, where the proceeds will be used for your retirement. The small business owner must be over the age of 55 or retiring due to ill-health or infirmity and he or she must have held at least a 10 percent share of the business for five years. The exemption is also limited to a gain of R500 000 in your lifetime.
What is meant by primary residence?
There are two basic requirements, which must be met before a home may be
considered a primary residence:
* An individual or a special trust (not a company, ordinary trust or closed corporation) must own or have an interest in the home and;
* The owner, or the spouse of the owner, must ordinarily reside in the home and must use the home for domestic or private residential purposes.
If a portion of the residence is used for business purposes, this portion will not form part of a primary residence and any gains or losses made on it must be included for CGT purposes.
If you transfer property to your spouse, will you be liable for CGT?
No, this is also referred to as a rollover of assets. When this happens, your CGT liability is deferred until your spouse disposes of the asset. The base cost you had for the asset is rolled over to your spouse.
This also applies to the transfer of property as a result of a divorce order, a donation of property and the transfer of property from a deceased estate to an heir.
If the disposal of your property is involuntary, for example, if your house burnt down, was expropriated or a sold in execution, you can also apply the rollover rule, as long as you replace the asset within three years.
What happens if you do not live in your home?
In four cases you will be treated as still being
resident in your home for a continuous period of up to two years, even though you have moved out. These cases are:
* If your old home is in the process of being sold, while you acquire a new primary residence;
* If your home is in the process of being built on land you acquired for the purpose of using it as your primary residence;
* If your primary residence has been accidentally rendered uninhabitable; and
* If you die.
What is the amount of the annual exclusion?
Every year individuals are entitled to make a gain of up to R10 000 tax free. This is referred to as the annual exclusion and it also applies to losses. In other words, if you make a loss of less than R10 000, it will also be excluded for CGT purposes.
In the year in which you die, your annual exclusion increases to R50 000, which means your estate can dispose of your assets without incurring tax, unless there is a gain or loss of more than R50 000.
How are capital gains and losses calculated?
The gain you have made is the amount by which the proceeds exceed the the base cost of the asset. A capital loss is equal to the amount by which the base cost of the asset exceeds the proceeds.
What is the inclusion rate?
Individuals only need to include 25 percent of the net gain when calculating the tax payable. For other entities, such as companies / close corporations and trusts, 50 percent of the net gain is included when calculating the tax payable. It is because of this inclusion rate, that the effective rate of capital gains tax is in fact lower than your income tax rate.
What is the base cost?
The base cost of an asset is generally what you actually spent on acquiring an asset, together with expenditure directly related to the acquisition or disposal that an asset. It also includes any costs you incurred on improving the asset, so long as those improvements still exist when you dispose of the asset and you haven't claimed these expenses against your income tax. Some of the main costs that may form part of the base cost of an asset are:
* The original cost of acquisition;
* Transfer costs, stamp duty, and VAT paid, and not claimed or refunded on the asset;
* Advertising costs to find a buyer or seller;
* The cost of improvements to an asset;
* The cost of the valuation of the asset for purposes of determining a capital gain or loss;
* The costs directly related to the acquisition, creation or disposal of that asset, for example professional fees paid to a surveyor, broker, agent, consultant, etc for services rendered;
* The cost of establishing, maintaining or defending a legal title or right in the asset;
n The cost of moving the asset from one location to another; and
* The cost of the installation of the asset, including the cost of foundations and supporting structures.
How do you calculate the base cost of an asset held before October 2001?
Because capital gains tax only applies to gains made after October 1 2001, you need to exclude any gains made before then.
There are three ways in which you can work this out:
* You can take the market value of the asset as at October 1. With most assets you have some choice as to how to do this. For example with property, you can make use of a professional valuer or a knowledgeable person, or you can collect advertisements of property sales of similar properties. However, you should be aware that SARS can question your valuation and if you cannot prove it, the value may be adjusted. The valuation of property must be done before September 30 2003. If you don't want to bother with this method you can use one of the two other methods;
* You can deem 20 percent of the proceeds of the disposal of the asset to be the base cost as at October 1. This method is useful if you don't have any records indicating what you paid for the asset originally; or
* Time apportionment method. You take the gain you have made between the time you acquired the asset and the time you disposed of it and divide it by the number of years you have owned the asset. Then multiply this annual gain by the number of years you have owned the asset before October 1 2001. This amount must be added to the original cost of the asset to give you your base cost. The calculation must be according to the formula below.
ORIGINAL COST + ((GAIN X PERIOD HELD BEFORE VALUATION DATE) DIVIDED BY PERIOD HELD BEFORE AND AFTER VALUATION DATE))
A basic example of how CGT works in the case of an individual with regards to the annual exclusion, carry over of losses and the inclusion rate:
Year 2:Loss on sale of land-30 000Gain on sale of shares10 000Sum of gains and losses-20 000Less: annual exclusion10 000Aggregate capital loss-10 000Assessed capital loss from year 1-5 000Total capital loss carried to year 3-15 000
Year 3:Gain on sale of shares100 000Less: annual exclusion-10 000Aggregate capital gain90 000Assessed capital loss from year 2-15 000Net capital gain75 000Apply inclusion rate of 25%18 750
The amount of R18 750 must be included in taxable income for year 3.
How will CGT affect your listed shares?
Shares pay dividends and also show capital growth. Dividends are free of CGT, but any capital gains made on shares after October 1, 2001 will be subject to CGT. You have a choice of three ways to value your investments and you can choose which one suits you best. The choices are:
* Average price on October 1
The base value of shares listed on the JSE Securities Exchange is the weighted average closing price for the last five trading days before October 1. SARS will publish these prices in the Government Gazette. We will publish these figures in the next issue of Personal Finance magazine which is due out later this month. You will need to keep these prices handy to be able to calculate your capital gains for future declarations to the taxman.
If you have made a real loss on your shares, in others words you have sold them for less than what you paid for them, regardless of when in fact that was, you will be covered by the limitation of loss rule, and the capital gain or loss will be nil.
* The proportional calculation
If you bought a share before October 1 and sell it after this date, work out the capital gain over the full period, and divide this by the number of years you have owned the shares for.Then take the amount of this annual gain and multiply it by the number of years you have owned the share since October 1, 2001.
* The 20 percent calculation
If you have no records of the original price of the share, you can declare 20 percent of the proceeds of the disposal as the base cost.
On foreign securities not listed on the JSE, you will have to obtain the last selling price quoted on the relevant foreign exchange on the last trading day before October 1 2001.
How will CGT be calculated on your unit trust investments?
You will pay CGT on unit trust funds and property unit trusts, but only when you sell them or switch between funds. Your unit trust management company will inform you every year what capital gains or losses you have made on the unit trusts you have traded. You will have to declare these amounts in your annual income tax return.
The figures you get from your unit trust company will be the weighted average values. If you prefer you can use other methods, but the collection of data, such as the base cost of your units and the repurchase price, and the calculations will then be your problem. If you have bought and/or sold units in the same fund at different times, you can then decide in what order you sell your unit trusts. You could, for example, use what is called the first in, first out (FIFO) method. This means selling the units you bought in the order you bought them, subtracting the price you paid for each set of units from the price you receive from each sale until all the units have been accounted for.
If you want to sell your unit trusts now, you may want to know what tax you will have to pay without waiting for a statement from your unit trust company. Then you need to work out the difference between what you will be able to cash your units in for and, if you bought them after October 1 2001, what you paid for your units, or, if you bought them before October 1, the base value for those units on October 1.
SARS is planning to publish a list of unit trust base values shortly - you will find these in the Fourth Quarter 2001 issue of Personal Finance magazine which will be available at CNA and Exclusive books later this month.
Take the published value and multiply it by the number of units you plan to sell to find out the value as at October 1. If you have invested in a foreign mutual (unit trust) fund using your R750 000 offshore allowance, the value of those units on October 1, 2001 is the last published price at which a unit sold before that date. You will need to arrange to get a letter from the mutual fund manager confirming the price at the end of trading on
Friday, September 28, 2001.
All capital gain or loss calculations for a mutual fund are done in rands. You need to use the ruling exchange rate on the day of purchase or sale, even though you may not be transferring the assets back to South Africa.
Many foreign unit trust funds do not declare either a dividend or interest but use the money that comes into the fund to issue you with further units. The extra units you receive will be regarded as a capital gain on disposal and will be subject to CGT.
If you re-invest, or buy extra units, with interest payments from your fund on which you have already paid income tax, these units will have their own base costs determined by the price you paid for them.