Capital gains tax (CGT), introduced on 1 October 2001 as part of the Eighth Schedule to the Income Tax Act, is a cornerstone of the SA tax system.
CGT applies to individuals, companies, and trusts and is levied on the profit from the sale of certain capital assets. It is NOT a separate tax; it is integrated with income tax, meaning that the capital gains made during a tax year are added to the taxpayer’s income. In this summary, we outline the key aspects of CGT in SA, including its applicability, the calculation of capital gains, methods to determine the base cost of assets, exemptions, and rollover relief.
The basics of CGT
What assets are subject to CGT?
Assets subject to CGT can be broadly categorised into tangible and intangible assets. Tangible assets include property, shares, and business assets, while intangible assets include intellectual property rights or licenses.
Who is liable for CGT?
South African residents are taxed on capital gains made on their worldwide assets. In contrast, non-residents are taxed only on profits from the disposal of immovable property in SA or any rights in such property.
What constitutes capital disposal?
Capital disposal occurs when there is a sale, transfer, donation, or any event where the ownership of an asset changes. The most common disposals include selling or transferring an asset, donating an asset and even deemed disposals, such as becoming a South African resident or when a company ceases to be a controlled foreign company (CFC). Even if no actual transaction occurs, specific actions, such as expropriation or the destruction of an asset, can also be treated as disposals.
These events trigger a CGT liability to be included in the taxpayer’s annual tax return.
Capital gain or loss calculation
The calculation of a capital gain or loss involves three key components:
- Proceeds: The amount received or accrued from the sale or transfer of an asset.
- Base cost: The cost of acquiring, improving, or disposing of an asset, including associated costs such as legal fees and transfer taxes.
- Capital gain or loss: The difference between the proceeds and the base cost.
A capital gain occurs when the proceeds exceed the base cost, while a capital loss occurs when the proceeds are less than the base cost. Capital gains are taxable, while capital losses can be used to offset future gains.
Determining the base cost
The base cost is subject to different calculation methods depending on whether it was purchased before 1 October 2001 or after this date. For assets acquired before 1 October 2001, the following special calculation methods are used:
- 20% of proceeds: This method is used if no records or valuation are available for the asset’s value as of 1 October 2001.
- Market value on 1 October 2001: This can be used if the asset was valued before 30 September 2004.
- Time apportionment base cost (TAB): This method calculates the base cost by apportioning the asset’s value over the period of ownership before and after 1 October 2001. This method is suitable for long-held assets where accurate records of the purchase price exist.
If purchased after 1 October 2001, the base cost is the purchase price plus improvements, which may include certain other costs and fees.
Inclusion rates and effective tax rates
There is often a misconception that CGT for individuals is 18% of the gain, BUT this is incorrect. CGT is integrated with income tax, meaning a portion of the capital gain is added to the taxpayer’s taxable income. The portion of the gain included is determined by the inclusion rate, which differs by taxpayer type:
- Individuals and special trusts: 40% of the capital gain is included in taxable income.
- Companies and other trusts: 80% of the capital gain is included in taxable income.
The effective tax rates based on the inclusion rate are as follows:
- Individuals: Up to 18% (calculated as 40% of the capital gain taxed at a maximum marginal rate of 45%. If the individual is NOT subject to the top marginal tax rate of 45%, the tax paid is lower than 18% of the gain).
- Companies: 21.6% (80% inclusion rate taxed at 27%).
- Trusts: 36% (80% inclusion rate taxed at 45%).
Annual exclusions and primary residence exemption
Certain exemptions and exclusions help to reduce the CGT liability. These include:
- Annual exclusion: Individuals and special trusts are entitled to an annual exclusion of R40,000 from capital gains. In the year of death, this exclusion increases to R300,000.
- Primary residence exemption: For individuals, the first R2mn of the capital gain made from the sale of a primary residence is exempt from CGT. This applies only if the residence has been used for personal purposes and not for trade or rental. If the residence is jointly owned, each owner can claim up to R1mn of the exemption.
Rollover relief and clogged losses
In certain circumstances, CGT liability can be deferred through rollover relief:
- Involuntary disposals: When an asset is destroyed or expropriated, and the proceeds are reinvested in a replacement asset, the capital gain can be deferred.
- Transfers between spouses: No CGT is payable when an asset is transferred between spouses. The acquiring spouse takes on the original base cost, and gains or losses are deferred until the recipient spouse disposes of the asset.
- The clogged loss rule disallows capital losses in transactions between connected persons, such as family members or associated companies. However, these losses can be used to offset future gains on transactions with the same person or entity.
Capital gains for small business assets
Special provisions apply to small businesses. Based on specific provisions, if a person aged 55 or older disposes of an active business asset, they may disregard up to R1.8mn of the capital gain.
Record keeping and compliance
Taxpayers must maintain detailed records of all capital transactions, including:
- The original purchase price.
- Transaction and improvement costs.
- Any valuations done for CGT purposes.
Accurate record-keeping is essential to ensure capital gains tax is calculated correctly. A lack of records may mean the SA Revenue Service (SARS) charges CGT on the total sales proceeds!
Conclusion
CGT in SA is a critical aspect of the tax system, affecting a wide range of taxpayers. Being familiar with the basic principles, such as calculating gains, determining base costs, and available exemptions, is essential for effective planning.
If you have any questions or need further explanation and understanding of CGT and its possible financial implications, please contact Di Haiden or Aarthi Bikram for assistance.
