CGT guide - Part 1 (The basics of CGT)
The ABC of CGT for companies
Capital gains tax for companies, close corporations and partnerships has numerous permutations. This guide provides the basis of how the tax is implemented. You can expect tax advisers to take different views and legislation to be further amended. It is important that you obtain proper tax advice from qualified tax advisers to structure your company's capital gains tax affairs efficiently.
STEP 1: DETERMINING A CAPITAL GAIN OR LOSS
There are four key definitions which form the basic building blocks in determining a capital gain or loss. These four definitions are "asset", "disposal", "proceeds" and "base cost".
A capital gains tax (CGT) event is triggered by the disposal of an asset. Unless such a disposal occurs, no gain or loss arises.
Asset
An asset is defined as widely as possible and includes any property and any interest therein. CGT applies to all assets disposed of on or after October 1, 2001 (the valuation date), whether or not the asset was acquired before, on or after that date.
However, only the gain accruing from October 1, 2001 will be subject to CGT.
Disposal
The concept of disposal covers any event, act, forbearance or operation of law which results in a creation, variation, transfer or extinction of an asset. It also includes certain events treated as disposals, such as the change in the use of an asset.
Once an asset is disposed of the amount which is received by, or which accrues to the seller of the asset, constitutes the proceeds from the disposal.
Base cost
The base cost of an asset is generally the expenditure actually incurred in acquiring the asset, together with expenditure directly related to its improvement and direct costs, including its acquisition and disposal and certain holding costs. The base cost does not include any amounts otherwise allowed as a deduction for income tax purposes. Some of the main costs that may form part of the base cost of an asset are:
Direct costs of acquisition and disposal
This is any expenditure directly related to the cost of acquisition, creation or disposal of an asset, including:
- The cost of acquisition;
- The cost of creating an asset;
- The cost of obtaining a valuation for CGT purposes;
- Remuneration paid to a surveyor, valuer, auctioneer, accountant, broker, agent, consultant or legal adviser;
- Transfer costs;
- Stamp duty, transfer duty or any similar duty;
- Advertising costs to find a seller or to find a buyer;
- Moving costs - but only in acquiring or disposing of an asset;
- Installation costs, including foundations and supporting structures;
- The cost of an option to acquire or dispose of an asset; and
- VAT paid and not claimed or refunded in respect of an asset.
The costs of establishing, maintaining or defending a legal title or right in an asset
The cost of improvements or enhancements
The improvement or enhancement must, however, be reflected in the state or nature of the asset at the time of disposal.
Holding costs
These costs must be wholly and exclusively incurred for business purposes and include:
- Repairs and maintenance, insurance and rotection;
- Rates and taxes on immovable property;
- Interest on loans used to directly finance the cost of acquiring an asset and any improvements thereto;
- Interest on amounts used to repay existing loans; and
- One-third of such interest in respect of listed shares and unit trusts.
What is the base cost of an asset held on October 1, 2001?
In order to exclude the portion of the gain, or the loss, relating to the period before October 1, 2001, any one of the following methods may be used:
- The 20 percent rule which states that 20 percent of the proceeds upon realisation can be deemed to be the base cost (this method is useful if you have no records or the market value cannot be determined);
- The market value of the asset at October 1, 2001 (the "valuation date") can be taken to be the base cost; or
- The time apportionment method can be used to determine the base value.
The market value method
The law lays down various requirements that apply when the market value method is used:
- Time limit for performing valuations
All valuations must be done by September 30, 2003. Failure to do so will mean that this method cannot be used. Valuations must be performed as if done on October 1, 2001.
- Who may perform valuations?
The law does not prescribe who may perform valuations. This is the responsibility of the company and the onus of substantiating a valuation rests with the company.
- What methods must be adopted in valuing certain assets?
In general, the law does not specify the methods to be used in performing valuations, though there are some exceptions, as summarised in the table below.
- What are the submission requirements?
Copies of valuations must generally be lodged with the relevant return of income when the asset is disposed of. However, certain valuations must be lodged sooner, with the first return of income required to be submitted after September 30, 2003.
These categories of assets are set out in the table below.
- Loss and gain limitation rules
Certain rules are in place to limit losses and gains when the market value method is used. These rules prevent the creation of fictitious losses from inflated valuations and prevent hardship when assets are sold above market value on October 1, 2001 but below the original cost.
Guidelines for determining market value on Oct. 1, 2001
General rule
The market value equals the price based on willing buyer, willing seller at arm's length in an open market
SA listed securities
The volume weighted average price for the last five business days preceding October 1, 2001
Foreign listed securities
Depending on method used by the exchange to quote prices, either the "ruling price" or last quoted price on the last business day before October 1, 2001
SA unit trusts and property unit trusts
Average "sell to management company" price for the property unit trusts last five trading days before October 1, 2001
Foreign unit trusts
Same as for SA unit trusts, except based on the last trading day before Oct. 1, 2001
Controlling interest listed company
Control premium determined on disposal and listed company applied to listed price at October 1, 2001
SA secondhand endowment policiesGreater of: The surrender value; or Insurer's market value (assume policy runs to maturity).
Farm landLand Bank value or market value based on general rule
Categories of assets that require submission of valuations
Type of asset
Applies
Where market value exceeds
Intangible assetsPer assetR1million
Unlisted sharesAll shares held by the shareholder in the companyR10 million
All other assetsPer assetR10million
The time apportionment method
This method may be used when a company has records of the date of acquisition and cost of an asset. The following formula is used to determine the time apportionment base cost of an asset:
ORIGINAL COST + GAIN X PERIOD HELD BEFORE OCTOBER 1 DIVIDED BY PERIOD HELD BEFORE AND AFTER OCTOBER 1
For the purposes of this formula:
- Improvements or additions made in years after acquisition but before October 1 2001 are assumed to have taken place when the asset was acquired.
- The period before October 1, 2001 is limited to 20 years where:
* Improvements have been made to an asset in years after acquisition but before October 1, 2001; and
* The asset was acquired more than 20 years ago, before October 1, 1981.
- Where no additions or improvements have taken place prior to valuation date, the 20-year limit does not apply.
- Where capital allowances have been claimed on an asset for normal tax purposes:
* The proceeds must be reduced by the amount of any recoupments; and
* The base cost must be reduced by the amount of any capital allowances that have been allowed.
- Additions to an asset after valuation date are added to the base cost (not apportioned).
Similar rules apply in respect of losses.
Examples of time apportionment base cost calculations
XYZ (Pty) Limited purchased a machine for R100 000 on October 1, 2000, and sold it for R150 000 on October 1, 2003. At the date of sale capital allowances of R60 000 had been claimed on the machine. Calculate the capital gain.
1. Remove recoupments from proceeds and capital allowances from cost:
Proceeds
R150000
Less: Recoupment R60000
Proceeds for CGT purposesR90000
CostR100000
Less: Capital allowancesR60000
Cost for CGT purposesR40000
3: Determine portion of gain relating to period to October 1:
Period before: 1.10.2000 - 30.9.2001 = 1 year
Period after: 1.10.2001 - 1.10.2003 = 2 years
Total period = 3 years
R50 000 (gain) divided by 3 (total years) x 1 (period before) = R16 667
4: Determine time apportionment base cost (TAB)
TAB = R40 000 (cost) + R16 667 (gain) = R56 667
5: Determine capital gain or loss
Capital gain = Proceeds - base cost (TAB)
= R90 000 - R56 667 = R33 333
Now assume the same facts as above but that the machine was upgraded on July 1, 2002 at a cost of R10 000 and that allowances of R2 000 were claimed on these improvements. Calculate the capital gain.
1. Remove recoupments from proceeds
ProceedsR150000
Less: Recoupment(R62000)
R88000
2. Remove capital allowances from cost
Before 1/10/2001After 1/10/2001Total
CostR100000R10000R110000
Less: Allowances(R60000)(R2000)(R62000)
Cost for CGT purposesR40000R8000R48000
3. Determine portion of proceeds relating to period before October 1, 2001
= R88 000 x R40 000 divided by R48 000
= R73 333
4. Determine portion of gain relating to period before
October 1
Period before: 1.10.2000 - 30.9.2001 = 1 year
Period after: 1.10.2001 - 1.10.2003 = 2 years
Total period = 3 years
= (R73 333 - R40 000) gain x 1 divided by 3 = R11 111
5. Determine time apportionment base cost (TAB)
TAB = R40 000 + R11 111 = R51 111
6. Determine capital gain or loss
Capital gain = proceeds - TAB - cost after valuation date
= R88 000 - R51 111 - R8 000
= R28 889
STEP 2: Determine the aggregate capital gain or loss
This is determined by adding the capital gains and losses on individual assets together.
STEP 3: Deduct any capital loss from previous years
Any capital loss from previous years, may be deducted from the current year's gain or added to the current year's loss.
STEP 4: Apply the inclusion rate
While individuals only include 25 percent of the gain, in the case of a company 50 percent of the net gain is included in taxable income. Individuals are entitled to a R10 000 exemption every year, but no such exemption applies for companies.
Example of inclusion rate
XYZ (Pty) Limited has sold the following assets during the tax year:
Capital gain or loss
Vacant landR50000
Trade markR5000
Truck(R5000)
Machine(R10000)
R40000
As this is the first year that CGT has been introduced, XYZ (Pty) Limited does not have an assessed capital loss from the previous year. Note that an assessed capital loss may only be deducted from capital gains and added to capital losses. It may not reduce ordinary income.
Aggregate capital gainR40000
Assessed capital gain b/f-
Net capital gainR40000
Inclusion rate 50 percent
Taxable capital gain
(R40000 x 50%)R20000
The taxable capital gain will be included in the company's taxable income and taxed at the rate of 30 percent, that is R20 000 x 30 percent = R6 000. The effective rate of tax on the sum of all the gains and losses is R6 000 O R40 000
x 100 = 15 percent.
Effective rates of CGT
Type of company
Inclusion rate %
Statutory rate %
Effective rate %
Companies & close corporations503015
Small business corporations5015-3015
Employment companies503517.5
Permanent establishments (branches)503517.5
Tax holiday companies5000
How will CGT affect small businesses?
Owners of small businesses have been given a special dispensation when they sell their businesses to retire. This is because many small business owners build up retirement capital in their businesses.
It does not matter whether the small business is held directly or whether it is a company, close corporation or partnership. The gain or loss on the business is disregarded under the following conditions:
- The market value of the assets of the business does not exceed R5 million;
- You hold at least 10 percent of the share capital;
- You have been involved in the operations of the business;
- You have held ownership or shares for at least five years;
- When you sell, you are at least 55 years old or in ill-health and unable to continue with the business;
- Your estate receives the benefit if you die;
- Your total exemption under this dispensation does not exceed R500 000 in your life time. The dispensation can expire if you buy and sell a number of businesses;
- All such gains must be realised within two years of the first disposal; and
- If you are selling more than one business, the total amount cannot exceed R5 million.
FOR MORE INFORMATION
SARS has set up a call centre to handle queries about the new tax. If staff at the centre are not able to give you an answer immediately they will take your details and call you when they have an answer. The number to call is 0860 12 12 15.
Alternatively you can email your query to: [email protected]
Further information is also available on the SARS website: www.sars.gov.za