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FASSET
CAPITAL GAINS TAX SEMINARS – SUPPLEMENTARY NOTES
INTRODUCTION
During the capital gains tax seminars presented by me around the country during October and
November 2001 a number of questions arose which were not covered in the notes made available by me to
seminar delegates. In these notes I seek to address the most important questions raised in the seminars
presented at the various locations around the country namely, Pretoria, Durban, Bloemfontein,
Johannesburg, Port Elizabeth, Cape Town, Potchefstroom and Nelspruit.
DONATIONS TO TRUSTS
Many trusts have been formed such that the founder of the trust disposed of assets to the trust on loan
account. Invariably the loan account is reduced each year to take advantage of the R25 000,00 exemption
available under the donations tax rules. In the event the donor or founder of the trust waives repayment of
the loan due to them at a rate that does not exceed R25 000,00 per year, such amount will be exempt from
donations tax. The question that arises in this regard is whether or not the trust will become liable to CGT
thereon by virtue of the fact that it no longer has to pay the amount due to the donor or founder of the trust.
It is therefore necessary to consider the CGT implications facing the founder or creditor as well as the trust
itself.
Paragraph 12(5) of the Eighth Schedule of the Income Tax Act, Act 58 of 1962, as amended specifically
provides that where a debt owed by a person to a creditor has been reduced or discharged by the creditor
without full consideration for that reduction or discharge, the debtor will be regarded as having realised a
capital gain equal to the amount of the reduction or discharge of the loan in question. If for example, Mr X
had previously sold assets to a trust on loan account for R500 000,00 and chooses to reduce the loan
account by R25 000,00 per year the CGT consequences thereof will be that the trust will be regarded as
having realised a capital gain in each tax year in an amount of R25 000,00. Such gain will fall to be taxed in
the hands of the trust at the rate of the tax applicable to the trust, that is an effective rate of either 16% or
21% depending upon the level of income derived by the trust itself.
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The further question to consider is the CGT implications facing the creditor, that is the founder of the trust.
The founder has effectively relinquished the right to claim payment of an amount of R25 000,00 and has thus
realised a loss for CGT purposes.
Paragraph 56 of the Eighth Schedule regulates the position and provides that the creditor is required to
disregard any capital loss as a result of the waiver of the debt due. The provision, however, does not apply
in respect of any capital loss determined in consequence of a donation by a creditor of a loan due by the
debtor to the extent that the amount of the loan in question, in this case R25 000,00, represents a capital
gain which is included in the aggregate capital gain of the debtor or which falls to be taxed in accordance
with Paragraph 12(5) of the Eighth Schedule.
Regard must also be had to Paragraph 39 of the Eighth Schedule which effectively provides that the capital
loss can only be used to reduce capital gains derived from transactions concluded with the same person in
the future. The loss of R25 000.00 can therefore not reduce CGT on gains realised on the disposal of other
assets. The trust will thus become liable to CGT on an amount of R25 000.00 and the creditor (that is the
donor or the founder of the trust) will have a capital loss that will be capable of being utilised only against
capital gains realised either in that tax year or subsequent tax year but only against gains realised from
transactions concluded by the founder or donor with the particular trust in question.
In the event that the donation does not take the form of a loan account but is structured such that cash is
donated to the trust, not exceeding R25 000.00 per year, no donations tax will become payable thereon.
More importantly no CGT will be payable thereon by virtue of the fact that cash or currency is specifically
excluded from the definition of an asset as contained in Paragraph 1 of Eighth Schedule. If it is at all
possible the donor or founder of the trust should donate amounts of cash to the trust thereby ensuring that
no CGT exposure will arise. This clearly would be the preferred route to adopt in that CGT becomes payable
in the event that a portion of the loan account is donated in favour of the trust.
A further advantage of donating assets to a trust either by way of cash or a reduction of the loan account is
that the estate of the person in question will be reduced insofar as estate duty is concerned. The loan
account due by the trust to the founder or donor will constitute an asset at the time of death fully liable to
estate duty. Therefore it does make sense, if it is possible, to reduce the amount owed by the trust to the
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founder thereof, thereby ultimately reducing the estate duty payable. What must not be overlooked though
are the CGT consequences thereof which have been discussed above.
CAPITAL GAINS TAX AND DEDUCTIONS
It must be remembered that the deduction available in respect of contributions to a retirement annuity fund
will not be increased in the event that a person realises a taxable capital gain in a particular year of
assessment. This is by virtue of the fact that taxable capital gains are included in taxable income whereas
the 15% deduction available in respect of retirement annuity fund contributions is based on 15% of the
taxpayer’s income remaining after the deduction of certain deductions and after excluding therefrom income
derived from retirement funding employment. Currently, therefore the fact that a taxpayer realises a capital
gain will not mean that they can contribute, on a tax effective basis, additional amounts to a retirement
annuity fund.
The one deduction that will be capable of being increased is that of donations made to qualifying public
benefit organisation in accordance with section 18A of the Act.
The deduction of donations made to
approved public benefit organisations is limited to 5% of the taxpayer’s taxable income. By virtue of the fact
that a taxable capital gain is regarded as part of taxable income, the taxpayer can increase donations to
approved entities and obtain the tax relief thereon, so long as the total deduction sought does not exceed 5%
of taxable income.
The deduction available for medical expenditure will effectively be reduced for taxpayers not over the age of
65 years. In the event that a taxpayer is over the age of 65 all medical expenses incurred, so long as they
comply with the statutory provisions, can be claimed against taxable income. In all other cases the medical
deduction is effectively limited to that amount of expenditure that exceeds 5% of the taxpayers taxable
income. By virtue of the fact that the taxable capital gain increases the taxable income of the taxpayer the
deduction for medical expenditure will be reduced.
PRIMARY RESIDENCE
In the event that a taxpayer personally owns a home in which they live and realises a gain on the disposal of
such property the first R1 000 000,00 will be exempt from CGT so long as the property does not exceed an
area of 2 hectares. It is also necessary that the dwelling is not used partly for business purposes otherwise it
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will be necessary to undertake an apportionment of the gain realised on the disposal of the property. In the
event that the taxpayer’s home cost R2 000 000,00 and is subsequently disposed of for a consideration of
R3 500 000,00, R500 000,00 of the total gain realised will be subject to CGT. The first R1 000 000,00 gain
is exempt as a result of the specific concession contained in the Eighth Schedule. It must be remembered
that the concession of R1 000 000,00 of gain applies in respect of each disposal of the primary residence
and is not a once per life time concession. It is possible therefore that a taxpayer may be able to utilise the
R1 000 000,00 exemption on more than one occasion.
In the event that a person utilises a portion of their home for business purposes CGT will be payable to the
extent that the home is used for business purposes. In many cases the deduction available in respect of the
home office or premises utilised at home for business purposes is relatively small. With the introduction of
CGT the taxpayer should decide whether or not to continue claiming the expenses in relation to the home
office with effect from 1 March 2001. The CGT provisions require that regard must be had to the use of the
dwelling in respect of the period on or after 1 October 2001. In the event that the decision is made to
continue claiming home office expenditure for income tax purposes, CGT will become payable on that
portion of the property utilised for the purposes of the home office. In such a case it would also be necessary
to value the dwelling so that the taxpayer can rely upon such valuation in determining the capital gain liable
to CGT when the home is finally sold.
It often happens that the primary residence is owned by a parent together with their children and the
question that arises in this regard is the manner in which the capital gain realised upon the disposal of such
a property will be dealt with.
In the event that a parent and their child jointly owns the primary residence and the dwelling is disposed of as
such and a capital gain is realised thereon , it is necessary that the R1 000 000 exemption be apportioned
between the natural persons by having regard to their interest in the fixed property. If, for example, the
parent owns 60% of the house and the child owns 40% the R1 000 000 exemption would have to be split on
the basis that R600 000 is attributable to the parent and R400 000 to the child.
It will often happen that a taxpayer lives in one place and upon retirement chooses to dispose of their first
home and to relocate and permanently reside in the home that was originally acquired for holiday purposes.
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Clearly the first R1 000 000 of capital gain realised on the disposal of the first property will be exempt from
capital gains tax. In the event that the second property, that is the former holiday home, is finally disposed of
it would be necessary to apportion the gain realised on the disposal as to that portion attributable to the time
that it was occupied as a primary residence and that attributable to the period that it was not so occupied.
The gain attributable to the period that the property was owned as a holiday home will be fully liable to CGT.
To the extent that the capital gain attributable to the period during which the home was occupied as the
primary residence will be excluded from CGT purposes so long as such gain does not exceed R1 000 000.
It must be remembered that in the event of death a taxpayer is deemed to have disposed of their assets at
market value. Where the assets are bequeathed to the surviving spouse, no estate duty is payable thereon
nor will CGT be payable thereon. This is by virtue of the fact that the surviving spouse is deemed to have
acquired the assets at the deceased’s original cost. Once the surviving spouse finally disposes of the assets
in question CGT will become payable on the gain realised by having regard to the proceeds received at the
time of disposal and deducting therefrom the historical cost of the asset to the deceased taxpayer.
Where the executor disposes of the primary residence within a period of 2 years of the date of death of the
deceased the first million Rand of gain will be excluded for CGT purposes. In the event that the home is not
disposed of within 2 years the property rather will no longer be regarded as the primary residence and will
thus not qualify for the R1 000 000 exemption available on the primary residence.
In the event that a taxpayer is married according to customary law and has more than 1 wife and thus owns
more than 1 residence, the taxpayer will have to choose which home will be treated as the primary residence
for the purposes of the exemption available. It is not possible to claim the primary residence exclusion for
more than 1 residence at a time. In the event that a taxpayer has say 3 wives only 1 property will qualify for
the primary residence exclusion.
In the event that the different homes are owned by the spouses it may be possible for the respective spouses
to argue that the home that they reside in qualifies as a primary residence for the purposes of R1 000 000
exclusion.
PROVISIONAL TAX
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It must be remembered that a provisional taxpayer is only obliged to account for the income tax on capital
gains realised in their third provisional tax payment, that is the third or topping up payment due by natural
persons at the end of September of each tax year.
It is not necessary to increase the estimates of taxable income for the purposes of first and second
provisional tax payments when capital gains are realised.
In the event that a salary taxpayer realises a capital gain the fact that a capital gain is realised will not result
in such person having to register for provisional tax purposes. In such a case the tax due on a capital gain
will be payable only once the taxpayer is assessed.
PERSONS NOT REGISTERED FOR TAX OR SUBJECT TO SITE
In the event that a person who is not registered for income tax purposes disposes of an asset and realises a
taxable gain in excess of R10 000 they will be required to register for income tax purposes for that year of
assessment only. In the event that the person is earning a salary and is subject to SITE only because they
are earning less than R60 000 per tax year they will be obliged to register in the year in which their taxable
capital gains exceed R10 000. The tax due on the capital gain will be payable only once the assessment is
issued to the taxpayer in question. The realisation of the capital gain will not result in the taxpayer becoming
a provisional taxpayer. A person who is not registered for tax purposes and who realises a capital gain in
excess of R10 000 would have to register for tax purposes so that the income tax due on the capital gains
can be paid over. Once the assessment has been issued they would, so long as they do not exceed the
SITE threshold R60 000 per annum be taken off the tax system.
DISPOSAL OF SMALL BUSINESS ASSETS
In the event that a taxpayer disposes of a small business is defined, that is a business of which the market
value of all assets at the date of disposal does not exceed R5 000 000 they can qualify for an exemption so
long as certain specified criteria are complied with.
A question arose as to a farming business and whether one should have regard to the standard value for tax
purposes of the livestock or the market value thereof. Paragraph 57 of the Eighth Schedule specifies that
one must have regard to the market value of all of the business assets as at the date of disposal. It is
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therefore not possible to have regard to the standard value of the livestock for the purposes of exemption
contained in the Eighth Schedule.
SALE OF DEPRECIABLE ASSETS
It must be noted that an amount received by a taxpayer will either constitute income liable to normal income
tax or will be regarded as a capital gain liable to CGT. It is not possible that an amount received by a
taxpayer will be liable to both income tax and CGT.
In the event that a taxpayer disposes of an item of plant on which wear and tear has been claimed the
proceeds received from the disposal of the asset must be reduced to the extent that the wear and tear is
recovered or recouped.
If one assumes that an item of plant costs R100 000 and wear and tear was claimed thereon of R75 000 and
that the asset is disposed of for R128 000, the R75 000 wear and tear claimed in the past will be regarded as
recovered or recouped. The amount received by the taxpayer in excess of the original cost of the asset will
be liable to capital gins tax, that is the proceeds of R128 000 less the original cost thereof being R100 000
giving rise to the taxable capital gain of R28 000.
PEOPERTY FINANCED BY LOAN ACCOUNT
A question arose regarding the issue of interest payable on the financing of a fixed property in South Africa
as well as the foreign exchange losses that may arise particularly, where the loan is made available from
abroad.
Where the property is utilised for trade purposes any interest incurred in relation to the construction of the
building will be deductible for income tax purposes in the year in which the building is brought into use trade
purposes. This is in accordance with section 11(bA) of the Act. To the extent that the interest relates to the
financing of the land no deduction of the interest is permitted in accordance with the section and in
accordance with judicial precedent. In such a case the interest paid will be regarded as part of the base cost
in determining the capital gain finally liable to CGT when the property is disposed of.
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In the event that the property constitutes a holiday home owned by a non-resident of South Africa and no
income is derived therefrom, no relief will be granted for the interest paid on the property either for income
tax purposes or indeed for CGT purposes.
In the event that the property is owned for trade purposes any foreign exchange losses realised thereon will
be deductible for income tax purposes in accordance with section 24(I) of the Act.
SPOUSES
It must be remembered that the fiscal legislation has been amended to expand the meaning of the term
“spouse”, such that it no longer means only persons who are formally married but includes those persons
who are married formally or in accordance with a customary union recognised in accordance with the laws of
the country or constitutes a union that is recognised as a marriage in accordance with the tenets of any
religion. More importantly, it must be noted that the definition of spouse includes spouses of partners of the
same sex or a heterosexual union which the Commissioner: SARS is satisfied is intended to be permanent.
In the event that assets are disposed of by one spouse to another no CGT will arise thereon as the historic
cost of the donor will be taken over by the spouse receiving the assets. The spouse receiving the assets will
be liable to CGT on the proceeds finally realised on the disposal of the assets less the historic cost thereof to
the first spouse.
In the event that spouses are divorced and assets are awarded pursuant to a divorce order no CGT will arise
therefrom. Once again the CGT consequences are postponed until the spouse receiving the assets finally
disposes of the assets to a third person.
In the event that the spouses own the primary residence jointly the R1 000 000 exemption must be attributed
to the spouses in proportion to their ownership of the property.
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Where spouses are married in community of property the R1 000 000 exclusion will be split equally between
the two spouses.
Beric Croome
Director: EDWARD NATHAN & FRIEDLAND (PROPRIETARY) LIMITED