Bal­anc­ing act seen in CGT tweak

Gord­han weighs op­tions, and so should pub­lic when faced with SARS as­sess­ment

Business Day - Business Law and Tax Review - - FRONT PAGE - EVAN PICK­WORTH

FINANCE Min­is­ter Pravin Gord­han needs to be lauded for his ef­forts to meet with the busi­ness sec­tor and col­lab­o­rate more to spur growth. I was for­tu­nate enough to be in at­ten­dance at one of these charm of­fen­sives soon af­ter the bud­get and was left most im­pressed with the healthy re­spect top pro­fes­sion­als and busi­ness­men had for the min­is­ter.

Where else in the world could you see a finance min­is­ter get an au­di­ence of straight-laced pro­fes­sion­als and profit-driven busi­ness­men to stand as one to re­cite Nel­son Man­dela’s pow­er­ful “I am fun­da­men­tally an op­ti­mist … Part of be­ing op­ti­mistic is keep­ing one’s head pointed to­wards the sun, one’s feet mov­ing for­ward …” re­frain from his Long Walk to Free­dom?

Well it hap­pened at this event, spon­sored by Deloitte, and I have no doubt the busi­ness­men walked out of that room with a spring in their steps to go out and drive pro­duc­tiv­ity and sell SA in a more op­ti­mistic fash­ion.

How­ever, it’s all well and good talk­ing the talk. Ev­ery­one knows the rat­ings agen­cies can be seen off at the pass only if broad pol­icy de­ci­sions are in ac­cor­dance with busi­ness im­per­a­tives. Thank­fully, Gord­han speaks quite openly about gov­ern­ment short­com­ings and how he in­tends plug­ging these gaps. He is equally good at throw­ing the ball into busi­ness’s court to help come up with the an­swers in a prac­ti­cal way.

In these dis­cus­sions, tax pol­icy is of­ten seen as a key en­abler of bring­ing about change, bal­anc­ing the in­ter­ests of the tax­payer with those of a state seek­ing more streams of rev­enue from its tax base. How­ever, it is not the only one and it is pos­i­tive that the re­cent meet­ings with CEOs gen­er­ated a num­ber of work group ideas across a broad front.

Yet that does not dis­count the ma­jor role tax pol­icy can play as a fab­u­lous fa­cil­i­ta­tor of value-cre­ation ac­tiv­i­ties in the econ­omy. We are nowhere near achiev­ing har­mony yet, or ex­pand­ing an al­ready stretched tax base, but the Fe­bru­ary bud­get at­tempted to bal­ance the need for rev­enue gen­er­a­tion with cutting ex­pen­di­ture, with tak­ing more from wealth­ier tax­pay­ers. The cap­i­tal gains tax (CGT) in­clu­sion rate is an ex­am­ple of how this bal­anc­ing act is play­ing out. As op­posed to a “su­per­tax” on the wealthy, in­creases are in­cre­men­tally hap­pen­ing across the taxes most of­ten paid by wealth­ier peo­ple and com­pa­nies.

Ac­cord­ing to ENSafrica’s tax depart­ment, the CGT in­clu­sion rate for com­pa­nies will in­crease from 66.6% to 80%, in­creas­ing the max­i­mum ef­fec­tive rate for com­pa­nies from 18.6% to 22.4%. These new rates be­came ef­fec­tive for years of as­sess­ment be­gin­ning on or af­ter March 1 this year.

It is quite nor­mal for com­pa­nies to go to the courts when a dis­pute arises about whether in­come is of a cap­i­tal or in­come na­ture be­cause the dif­fer­ence in mone­tary terms is usu­ally enor­mous, notwith­stand­ing lit­i­ga­tion costs. Will the new tax amend­ments change this be­hav­iour if CGT is so high? Time will tell but in a re­cent case, Com­mis­sioner for the South African Rev­enue Ser­vice v Cap­stone 556, the Supreme Court of Ap­peal (SCA) had to deal with the im­por­tant in­come ver­sus rev­enue distinc­tion. It had to de­cide two ques­tions: Whether the share sale of the tax­payer, Cap­stone, of about 17.5-mil­lion shares in JD Group, through which it made a profit of R400m, con­sti­tuted rev­enue or was cap­i­tal in na­ture; and

Whether an in­dem­nity set­tle­ment paid by the tax­payer af­ter it sold the shares formed part of the base cost of the shares for CGT pur­poses.

In essence, s1 of the In­come Tax Act de­fines “gross in­come” as the to­tal amount re­ceived by or ac­crued to a per­son, ex­clud­ing re­ceipts or ac­cru­als of a cap­i­tal na­ture.

When deal­ing with an in­vest­ment, the na­ture of the risk un­der­taken has a bear­ing on whether the trans­ac­tion is aimed at build­ing up the value of the tax­payer’s cap­i­tal or is di­rected at gen­er­at­ing rev­enue and profit.

In many com­mer­cial sit­u­a­tions there may be no clear in­ten­tion at the out­set and it may then be ac­cepted that the tax­payer’s fu­ture in­ten­tions were in­de­ter­mi­nate.

The SCA re­jected the ar­gu­ment by the South African Rev­enue Ser­vice (SARS) that the tax­payer’s in­ten­tion be­came one of profit mak­ing when he de­cided to sell some of the shares to Stein­hoff as part of a book-build­ing ex­er­cise Stein­hoff had un­der­taken. The tax­payer tes­ti­fied he de­cided to sell only af­ter dis­cussing it and af­ter his wife had con­vinced him he was over­ex­posed in SA. Stein­hoff’s of­fer to sell pur­suant to the book-build­ing ex­er­cise was thus merely for­tu­itous. The SCA re­jected SARS’s ar­gu­ment that the short-term na­ture of a loan and the na­ture of the eq­uity kicker in­di­cated an in­ten­tion to fund the loan re­pay­ments by sell­ing the shares.

The SCA held that SARS had to pay all the tax­payer’s costs in op­pos­ing the ap­peal and the costs in­curred by the tax­payer in the cross-ap­peal, in­clud­ing the costs of two coun­sel.

Ac­cord­ing to Cliffe Dekker Hofmeyr’s tax and ex­change con­trol depart­ment, this case con­firms the prin­ci­ple that to de­ter­mine whether an amount con­sti­tutes cap­i­tal or rev­enue will al­ways be a ques­tion of fact and that courts will not fol­low a one-size-fits-all ap­proach.

In light of the in­crease in the CGT rate to 80%, as op­posed to 50% at the time the shares were sold, the case raises an in­ter­est­ing prac­ti­cal is­sue, es­pe­cially for com­pa­nies that em­bark on lit­i­ga­tion of this na­ture.

Ac­cord­ing to Cliffe Dekker Hofmeyr and based on the facts in this case, had the shares been dis­posed of af­ter March 1 this year, the tax­payer would have paid tax on the sale at an ef­fec­tive rate of 22.4%. On an amount of R400m, this would trig­ger a tax li­a­bil­ity of R89.6m. Had the amount been clas­si­fied as in­come in terms of s1, the tax­payer would have been li­able to pay tax at the rate of 28%, which would amount to R112m and amounts to a dif­fer­ence of R22.4m.

The SCA’s find­ing that the obli­ga­tion to pay the in­dem­nity set­tle­ment formed part of base cost would have re­duced the tax­payer’s tax li­a­bil­ity by a fur­ther amount of R12.32m. On the same facts, the suc­cess­ful lit­i­ga­tion would have re­duced the tax­payer’s tax li­a­bil­ity by about R34.72m and would most likely have been worth the tax­payer’s while, from a busi­ness and fi­nan­cial per­spec­tive.

Con­sid­er­ing the high cost of and risks at­tached to lit­i­ga­tion, com­pa­nies would be well ad­vised to do the maths and count the pos­si­ble lit­i­ga­tion costs be­fore they de­cide to chal­lenge SARS’s as­sess­ment on whether an amount is cap­i­tal or rev­enue.

This type of out­come may not have been the in­ten­tion of the Trea­sury when mak­ing the changes to CGT in the bud­get. But it is a good ex­am­ple of how a tax change may change be­hav­iours and why bal­anc­ing the in­ter­ests of tax­pay­ers needs to be care­fully con­sid­ered in fu­ture.

See also Page 12

Pic­ture: TREVOR SAM­SON

Newspapers in English

Newspapers from South Africa

© PressReader. All rights reserved.