Tag Archives: CGT

“Booking” capital losses on shares is not that easy

There is a number of techniques that taxpayers use to reduce their capital gains tax (CGT) exposure on long-term share investments. A common practice is to utilise the annual exclusion of R40 000 provided for in paragraph 5 of the Eighth Schedule of the Income Tax Act[1] by selling shares that have been bought at a low base cost, at a higher market value and then immediately reacquiring those shares at the same higher value, thereby ensuring that the investments’ base cost is increased by as much as R40 000 per year. If the gain on those shares is managed and kept below the annual R40 000 exclusion, taxpayers receive the benefit of a ‘step-up’ in the base cost of the shares to the higher value for future CGT purposes, without having incurred any tax cost.

A reverse scenario is to build up capital losses for off-set against any future capital gains and taxpayers are often advised, especially during times of market volatility, to ‘lock-in’ capital losses created by the expected temporary reduction in share prices. This involves selling shares at a loss and then immediately reacquiring the same shares at the lower base cost, but with the advantage of having created a capital loss – a technique known as ‘bed-and-breakfasting’.

Without placing an absolute restriction on ‘bed-and-breakfasting’, paragraph 42 of the Eighth Schedule limits the benefit that could have been obtained from the ‘locked-in’ capital loss. The limitations of paragraph 42 apply if, during a 45-day period either before or after the sale of the shares, a taxpayer acquires shares (or enters into a contract to acquire shares) of the same kind and of the same or equivalent quality. ‘Same kind’ and ‘same or equivalent quality’ includes the company in which the shares are held, the nature of the shares (ordinary shares vs preference shares) and the rights attached thereto.

The effect of paragraph 42 is twofold. Firstly, the seller is treated as having sold the shares at the same amount as its base cost, effectively disregarding any loss that it would otherwise have been able to book on the sale of the shares and utilise against other capital gains. Secondly, the purchaser must add the seller’s realised capital loss to the purchase price of the reacquired shares. The loss is therefore not totally foregone, but the benefit thereof (being an increased base cost of the shares acquired) is postponed to a future date when paragraph 42-time limitations do not apply.

Unfortunately, taxpayers do not receive guidance on complex matters such as these on yearly IT3C certificates or broker notes, since these are generally very generic. Therefore, taxpayers wishing to fully capitalise CGT exposure on market fluctuations are advised to consult with their tax practitioners prior to the sale of shares.

[1] No. 58 of 1962

This article is a general information sheet and should not be used or relied upon as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice. Errors and omissions excepted (E&OE)

Treasury moves to close CGT avoidance loophole through share buybacks

Where one company previously sought to dispose of its shares in another company, it was able to do so without incurring an exposure for capital gains tax (“CGT”) or dividends tax, if that disposal were structured as an issue of shares by the target company to the “purchaser”, followed by a corresponding buyback of shares by the target company from the “seller”. For example: Company A holds 50% of the shares in Company X (which stake is worth R500,000). A had acquired the 50% interest for R50. B approached A with an offer to purchase the 50% for R500,000. A straight sale of the 50% would give rise to a tax effect of little less than R112,000 for A (being R499,950 x 80% x 28%). To ensure that the aforementioned tax charge does not arise, A agrees with B that the effective transfer of the 50% interest will be structured by B subscribing for shares in X for R500,000. B will now have effectively acquired a 33% interest in X. X will utilise that R500,000 to buy back the shares that are already in issue to A. When A’s shares are cancelled therefore, it will have received the R500,000 contributed by B, while B will have 50% in X by virtue of A’s interest being cancelled. From a tax perspective, the buyback of shares is treated as a dividend, which is both income tax and dividends tax exempt for A. The result: A effectively disposed of its shares in X for R500,000 without incurring any attendant tax cost.

The use of linked share issue and buyback transactions to avoid CGT has been on SARS’ radar for quite some time already, yet without any meaningful remedy to counter such (we would argue, legitimate avoidance) transactions. Where such transactions were in excess of R10 million, those transaction had to be reported to SARS though in terms of section 35(2) of the Tax Administration Act, 28 of 2011.

National Treasury has now moved to close this “loophole” through the proposed introduction of paragraph 43A in the Eighth Schedule to the Income Tax Act, 58 of 1962. The proposed amendments to paragraph 43A are contained in the draft Taxation Laws Amendment Bill, and if accepted by Parliament in its current form, will become operational with effect from 19 July 2017 (being the date of publication of the draft Bill).

In terms of the proposed amendments, tax exempt dividends declared to shareholders (which could hold as little as 20% in the declaring company with the dividends being declared either 18 months prior to the disposal of those shares, or in anticipation of their disposal) will be treated as a capital gain in the hands of the shareholder and taxed accordingly when the shares held are disposed of. In our example above therefore, the share buyback of R500,000 will be taxed as a capital gain.

As noted above, the current draft legislation has not yet been enacted, and we will closely monitor developments to consider implications of the final version of the legislation ultimately introduced.

This article is a general information sheet and should not be used or relied upon as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice.  Errors and omissions excepted (E&OE)

The link between CGT and Income Tax

A7The name “Capital Gains Tax” (CGT) can create the impression that CGT stands on its own as a seperate tax from the rest of the taxes but this is not the case. CGT forms part of the Income Tax system and capital gains and capital losses must be declared in the annual Income Tax return of a taxpayer.

If a taxpayer is not registered for Income Tax

If a natural person is not registered for Income Tax and his/her taxable income consists only of a taxable capital gain or a deductible capital loss, the amount of which is more than R30 000, the person will have to register as a taxpayer with SARS. In addition, the new taxpayer will have to submit an Income Tax return for that tax year.

If a taxpayer is already registered for Income Tax, they don’t have to register for CGT seperately as CGT forms part of Income Tax.

Tax treatment of capital gains in three steps

The first step is to calculate the capital gain according to the provisions of the CGT Act. A discussion of the formulas to calculate the amount of capital gains and capital losses fall outside the scope of this article.

The second step is to reduce the capital gain with any exclusions which might be applicable. Please contact your tax advisor to find out if you qualify for any CGT exclusions.

Step three will be to include the taxable amount of the capital gain in the taxable income of the taxpayer. There are different inclusion rates for the following categories of taxpayers:

  • For natural persons, deceased or insolvent estates, and special trusts the taxable inclusion rate is 33,3%. In other words, 33,3% of the capital gain will be added to the taxable income of the taxpayer and the taxpayer will have to pay more income tax.
  • Companies, close corporations and trusts (excluding special trusts) have a taxable inclusion rate of 66,6%. This means that 66,6% of the capital gain will be added to the taxable income and taxed at the normal income tax rate of the taxpayer.

As a taxable capital gain will be added to the taxable income of a taxpayer, it will have an effect on certain deductions in the income tax calculation while other deductions will not be affected.

The following tax deductions for individual taxpayers will not be affected by the inclusion of a taxable capital gain in the taxable income of the taxpayer:

  • Pension fund contributions
  • Retirement annuity fund contributions

Tax deductions that will be affected by the inclusion of a taxable capital gain in an income tax calculation are the following:

  • Medical expenses (only applicable to individual taxpayers)

If a taxpayer’s medical deduction is subject to the 7,5% of taxable income-limitation, the deductible amount for medical expenses will become smaller if a taxable capital gain is included in the taxable income.

  • Section 18(A) donations

A taxpayer can include the taxable capital gain in taxable income before calculating the 10%-limit for the tax deduction of Section 18(A) donations. The allowable tax deduction of these donations will then increase by 10% of the amount of the taxable capital gain.

Tax treatment of capital losses

Capital losses may not be deducted from taxable income but must be set off against current or future capital gains. If there is insufficient capital gains to offset the full capital loss in the current tax year, the unclaimed balance of the capital loss is carried forward to the next tax year(s) until it has been fully offset against future capital gains.

As a capital gain/loss can have a material effect on a taxpayer’s liability for Income Tax, it is crucial to calculate these amounts accurately and take advantage of all the exclusions that might be applicable to the taxpayer. For further assistance regarding any aspect of capital gains/losses, please contact your tax advisor.

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This article is a general information sheet and should not be used or relied upon as professional advice. No liability can be accepted for any errors or ommissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice.