Capital Gains Tax
After much debate, Capital Gains Tax finally kicked in on 1 October 2001. it has been in place for some time now, but individuals are still struggling to understand its implications, so here’s a simple explanation of how it will affect you as a property owner.
What is Capital Gains Tax?
This is the tax on any capital gain, and it is applicable when you dispose of an asset such as an investment or property. A capital gain is the growth after subtracting the cost of the asset, plus everything you’ve done to make the asset more valuable, e.g. additions to your house. You’ll only be taxed on that part of the capital gain that has taken place and only if this gain was realised after October 1, 2001
Who Will Be Taxed?
South African Residents will be taxed on realised capital gains on assets held inside South Africa, as well as anywhere else in the world. For non-residents, CGT will occur only in respect of immovable property or interest in immovable property situated in South Africa, or assets of a permanent establishment, branch, fixed base or agency in South Africa through which trade, profession or vocation is carried out.
How It Works
You will declare capital gains as part of your nominal income tax return and you’ll be taxed at your marginal tax rate. A CGT event takes place when a disposal or deemed disposal of an asset takes place. As a general rule, an asset is acquired or disposed of whenever there is a change of ownership of the asset. The capital gain or loss is the difference between the base cost of the affected asset ant the money received when selling it. The base cost includes: what you paid in order to acquire the asset, plus any other cost relating to the acquisition and disposal of that asset e.g. lawyers fees, stamp duty, agent’s commission, plus VAT, plus improvement costs, plus any other legal costs involved.
As individuals, the first R10 000 of your total capital gain will be disregarded. 25% of the rest of your gain – which is the total of your capital gains made in a year, less your capital losses – will be included in your taxable income. A capital gain by somebody other than a natural person will be taxed on 50% of that person’s net capital gain for that year of assessment. For example, Albert purchased a house in order o derive rental income from the property (therefore his property will not be his primary residential property). He bought the house on 1 October 2001 for a total cost of R1, 25 million. 2 years later Albert sold the property for R1, 5 million. Assuming Albert pays income tax at the maximum marginal rate of 40%, and that he has no other capital gains or losses in the specific tax year, his additional income tax liability as a result of the released capital gain will be determined as follows:
Proceeds: R1, 5 million
Base Cost: R1, 25 million
Capital Gain: R 250 000
Annual exclusion: R 10 000 = R240 000
Taxable capital gain (R240k x 25%) R 60 000
Therefore R 60 000 will be included in Albert’s taxable income for the year.
Tax payable (R 60 000 x 40%) R 24 000
What Is Not Included In CGT?
All capital assets are considered affected assets and are therefore potentially subject to CGT. Some of the assets that are excluded from CGT include:
- A primary, owner-occupied residence up to a maximum of R1 million
- All private motor vehicles, and personal belongings and effects
- Retirement benefits, most first-hand policies such as long term insurance, endowments, and retirement annuities.
- Small business assets, compensation for personal loss and winnings from gambling, games and competitions, provided that you are a natural person and the winnings are from within the SA.
What Is Included In CGT?
Investments, such as shares and unit trusts, second-hand policies, any profit resulting from the sale of a property that you don’t use as a primary residence, coins, certain aircraft, boats and land. As with other capital gains, in the case of individuals, the first R10 000 of gain will be disregarded and 25% of the gain is included as if it is income. You would declare these investment gains annually and the R10 000 exclusion would apply annually.
How Do You Value Your Property In Respect Of CGT?
You can evaluate the base cost of your home by using one of two methods: the valuation method, or the tome apportioned method. If you use the valuation method, you should work on the value of your property as at October 1, 2001. This involves getting a valuation for the property as at 1 October 2001.
The time apportioned method involves that the total capital gain from he day you bought it to the day you sold the property, less any gain that took place before 1 October 2001. This is calculated by assuming a steady increase in the capital gain. For example, if you bought a property 2 years before CGT came into effect and then sold it again 2 years after the effective date, your capital gain would be calculated as follows: Tome period before CGT divided by the total length of ownership until sale. Here it would be 2 years divided by 4 (length of total ownership), and the CGT calculation would therefore be worked out on 2 divided by 4 or ½ the profit you realize.
What About Inheritance?
CGT is levied on all deceased estates and all donations. However, the transfer of assets that take place as a result of a divorce, and donation between spouses will not be subject to CGT. To compensate for the impact of Capital Gains Tax, estate duty and donation tax were reduced from 25% to 20% on the 1 October 2001.
What Records should You Keep?
It is up to you to prove the base cost, so keeping accurate records is essential. If you haven’t kept records, you can obtain copies of the relevant documentation from your financial adviser, estate agent or attorney. These records should include all details in respect of acquiring and disposing of the asset, such as the date you acquired the asset, the price you paid for it, and any additional money you spent on improvements, the date on which you disposed of the asset, It is advisable to keep these records for at least 4 years after the transactions have taken place.
A final word of advice: remember you cannot claim a capital loss if it arises from your use of the asset; for example, you cannot get tax back if the value of your car depreciated as a result of general wear and tear.
Capital Or Revenue?
The law is somewhat complex, making it difficult to determine whether or not the receipts or accruals in question are of a capital (tax-free) or revenue (taxable) nature. Our courts have grappled with the intention of the taxpayer in circumstances such as those set out above, given that it is tricky to assess whether the gain is a once-off realization of a capital asset, or whether the taxpayer embarked on a grand scheme of profiteering. In other words, there’s always a fine line between the two.
Simplistically speaking, the answer is as follows: if the homeowner realizes his capital asset and only subdivides and sells off subdivided stands, he will be found to have realized his capital asset to his best advantage, which will not attract tax.
However, if he takes active, premeditated steps to develop the property, whether by way of the installation of core services, and/or building a show house, and/or marketing the property with a clear and explicit intention to make a profit, he is likely to be found to be dealing (or trading) in the land for profit, the proceeds of which will be subject to tax (at the rate of 40%, in the case of individuals). The Rubicon would have indeed been crossed, from which there is no return.
The tax principle can be summarized as follows: once an asset is revenue in nature, it is always revenue in nature. The motives and activities of the taxpayer, perhaps in respect of a Phase 2 or Phase 3 subdivision, may be tainted forever more.
Homeowners are consequently advised to consider their motives carefully before subdividing large properties – they may inadvertently be redefining themselves as property developers, with all the adverse 9and possibly unintended) tax consequences.