CGT - Capital Gains Tax

Capital Gains Tax with special reference to Immovable Property.
Updated at 1st March 2006

Quick Summary
A.        Capital Gains Tax came into effect on the 1st October 2001.
B.        Take Disposal Consideration (e.g. Net sale price after deducting agent’s commission, borer and electrical inspection and remedial costs, but ignore amount required to discharge bond).
C.        LESS Base Cost
Properties acquired (e.g. bought) before 1/10/2001 are valued at 1/10/2001
Properties acquired after 1/10/2001 are valued at date of acquisition or on date Suspensive Conditions are fulfilled, whichever is the later.
In both cases add cost of acquisition and improvements.
Known as Base Cost.
D.        B less C is the Capital Gain or loss.
E.        LESS Primary Exclusion of R17 500.00 for Natural Persons, per year.
F.         D less E is multiplied by the inclusion rate, which is 25% for Natural Persons and 50% for Companies, CCs and Trusts.
G.        F must be included in taxpayer’s income for income tax purposes.
H.        Maximum Income Tax marginal rate for Natural Persons is 40%.
Therefore Natural Persons will in effect pay no more than 40 x 25% = 10% of the amount referred to in G.  (less if the taxpayer’s marginal rate is less).
Companies and Close Corporations pay 14% of Capital Gain.  Trusts pay 20% of Capital Gain.
I.          The first R1.5 million Capital Gain of a Natural Person’s Primary Residence is exempt from Capital Gains Tax.  Companies, CCs and Trusts do not qualify for this benefit. there used to be a window of opportunity to transfer the Primary Residence to a Natural Person/s without incurring CGT, Transfer Duty or Stamp Duty.  This has now fallen away.  The disposal of a Primary Residence for a purchase price of R2 million or less is exempt from CGT.
 
The above is a summary only.  If you want to learn more read on.  There will be some duplication.
A more detailed analysis of Capital Gains Tax with reference to Immovable Property.
Capital vs Revenue.

• A capital asset is one, which is bought or acquired with the intention that it will be kept for an extended period.
• A Revenue receipt occurs where assets are bought with the intention of resale.
• Therefore a developer purchasing property for development and resale uses that property as part of his stock-in-trade and pays income tax on any profit made.  He does not intend to keep the property but to develop it and sell it.  A person buying a property as his holiday home with the intention of keeping it for an extended period will pay CGT on any capital gain (as defined) on the disposal of the property.
• Payment of CGT is preferable to paying income tax due to the lower rate usually applicable to CGT as compared to income tax.

Determination of Capital Gain or Loss

• To determine the person’s capital gain or loss, the Eighth Schedule of the Income Tax Act provides for four key definitions, which form the basic building blocks in determining a capital gain or loss.

Asset
Is defined as widely as possible and includes any property not of a Revenue nature, and any interest therein.  CGT applies to all assets of a person disposed of on or after the 1st October 2001 (valuation date), whether or not it was acquired before or after that date.  However only the gain from 1st October 2001 will be subject to tax.

Exclude:

• Except for Immovable Property situate in the Republic of South Africa, assets of non-residents are excluded.
• Personal use assets, retirement benefits, long term insurance, first R500 000 capital gain on disposal (generally on retirement) of Small business assets, involuntary disposals where for example assets are destroyed in a fire, provided they are replaced, reinvestment in replacement assets, transfer of assets between spouses (the details of all these exclusions and others not mentioned are beyond the scope of this Newsletter and are not dealt with fully).  

Base Cost Calculation

Methods of Calculating Base Cost.

• A distinction is made between assets acquired before 1st October 2001 (valuation date) and those acquired after.
• Pre-valuation date assets.  There are three ways you can work this out:

1.         Market value of the Asset as at the 1st October 2001.  You can use a professional valuer or an experienced person such as an Estate Agent with knowledge of the property in the area.  You must be able to justify the valuation and it is suggested that full reasons should be given for arriving at such market value.  There is an SARS form, which should be completed by the person doing the valuation.
2.         You can deem 20% of the proceeds of the disposal of the asset to be the base cost as at 1st October 2001.  This method is useful if you don’t have any records indicating what you paid for the asset originally, but should be avoided as the result will usually not be favourable.
3.      Time apportionment method.  This is often the most favourable method. 
Briefly, the formula can be expressed as follows:
 
Y =       Amount to be determined.
A =      Original Purchase Price + allowable costs.
B =         Proceeds on disposal. (for simplicity Sale Price less Commission)
C =      Number of years from acquisition to 1/10/2001.
D =      Number of years from 1/10/2001 to disposal.
Formula:  Y = ((B – A) x (C ÷ (C + D))) + A

Using the above formula and rough figures, the approximation would be as follows:

A =      R240 000-00. (original Purchase Price)
B =      R1 600 000-00 less commission R127 680-00 (7% + VAT)
= R1 472 320-00
C =      6 years (1995 to 2001)
D =      4 years (2001 to 2005)
Y = ((B – A) x (C ÷ (C + D))) + A
B – A = R1 232 320-00
C ÷ (C + D) =  0.6
R1 232 320-00 x 0.6 = R739 392-00. + R240 000-00 = R979 392-00.
The base cost is therefore R979 392-00.
Capital Gain = R1 472 320-00 – R979 392-00 = R492 928-00.
If a natural person is the owner,(and assuming the property is not a Primary Residence) the Primary Exclusion of R17 500.00 would be deducted ie R492 928-00 – R17 500-00) = R475 428-00 x10% = R47 542-80 would be the maximum amount payable – less if the owner does not pay tax at the highest margin.
The effective rate payable by a Company or CC is 14%.  Therefore Capital Gain Tax payable is
R492 928-00 x 14% = R69 009.92.

Other considerations:
In calculating the capital gain, certain allowable expenditure (which amount forms part of the base cost) is deducted from the net proceeds:

• Costs of acquisition or creation of the asset.  e.g. surveyor, valuer, auctioneer etc.
• valuation costs for CGT.
• Transfer costs including Transfer Duty.
• Improvement or enhancement costs if still inherent in the asset when disposed of.

Specifically excluded from base costs are:

• Borrowing costs including interest on bond and raising fees.
• Expenditure on repairs, maintenance, rates, levies and insurance or similar costs which are not of a capital nature. 

Disposal

CGT is levied on the disposal of an affected asset.  Disposal occurs when

• The asset is sold.
• The asset is donated, scrapped, exchanged, cancelled, lost, destroyed or redeemed.
• An interest in a Trust is vested in a beneficiary.
• A Company distributes an asset or grants an option to a shareholder.
• A disposal is deemed to take place when a person emigrates or otherwise ceases to be a resident.

Proceeds on Disposal

The actual proceeds (there are provisions to ensure that they are market
related) less expenses directly related to the disposal of the asset, such as Agent’s Commission, costs of obtaining borer and electrical certificates, etc, but excluding Bond Interest or bond raising fees.

How does one determine the Capital Gain?

A capital gain or loss is the difference between the base cost of the effected asset and the proceeds realized or deemed to have been realized upon the disposal of the same asset.
Capital Gains Tax can be calculated by using the following formula: 
Proceeds on disposal          _______________________
Less Base Cost        _______________________
Capital Gain (or loss) equals           _______________________
LESS primary exclusion (see below)         R17 500.00
(primary exclusion only in the case of a natural person)
Amount subject to CGT        _______________________
MULTIPLIED by Inclusion rate (see below) 25% or 50% etc
Amount of the capital gain to be included in the taxpayer’s income for income tax purposes.            _______________________
 

Primary exclusion

Every year individuals are entitled to make a gain of up to R17 500.00 tax free.  It also refers to losses, so that if you make a loss of less than R17 500.00 it will also be excluded for CGT purposes.  In the year in which you die, your annual exclusion increases to R120 000.00.  There is no Primary exclusion for Companies, CCs and Trusts.

Inclusion rate

Individuals and Special Trusts (generally where the beneficiary is mentally or physically challenged and unable to earn a living) include in their taxable income 25% of the Capital Gain, whereas companies, close corporations and Trusts include 50% of the Capital Gain.

• Maximum Income Tax marginal rate for Natural Persons is 40%.
  Therefore Natural Persons will in effect pay no more than 40 x 25% = 10%, after the R17 500.00 (Primary Exclusion) is deducted.  (less if the taxpayer’s marginal rate is less).
  Companies and Close Corporations pay 14% of Capital Gain.  They do not enjoy a Primary Exclusion.

Spouses married in Community of Property.
Where the property falls within the Joint Estate, the disposal is treated as having been made in equal shares by each spouse.
Where the property is excluded from the Joint Estate (e.g. bequeathed to one spouse only with a condition of the bequest excluding it from the Joint Estate) the disposal will be treated as having been made solely by that spouse.

Deceased Estates
The deceased is treated as having disposed of his or her assets at market value on the date of death.  If during the winding up of the Estate, assets are disposed of other than to heirs, legatees and Trustees, the deceased is treated in the same way as the deceased would have been treated if alive.
In certain circumstances the heir can elect to pay a portion of the CGT within three years.
CGT is payable on any gain arising on the day prior to death.  Estate Duty is levied on the net value of the Estate.  There is a primary Estate Duty rebate of R3.5 million, and the Estate Duty in excess of R3.5 million is 20%.  Changes to Estate Duty are being considered.
No further CGT is payable on final distribution to the heirs and legatees.
Window of Opportunity
If your primary residence is registered in the name of a Company, Close Corporation or Trust, you now have a window of opportunity to transfer that property into your own name and save big.  See next item : Capital Gains Tax – Window of Opportunity.

Note - Disclaimer
This Newsletter is a summary of some of the Legislation.  The issues are sometimes complicated and we strongly recommend you seek professional advice when dealing with any CGT matter.
While every care has been taken in the drafting of this Newsletter, no liability is accepted for any errors, omissions or inaccuracies contained herein.