Balancing act seen in CGT tweak
Gordhan weighs options, and so should public when faced with SARS assessment
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