Weekend Argus (Saturday Edition)
Capital gains tax: when and how much do you pay?
THIS week I focus on capital gains tax (CGT), which was introduced in South Africa over 20 years ago and became effective on October 1, 2001. It operates in many other countries, including the United Kingdom, the United States and Canada.
To what does CGT apply?
This tax, which basically forms part of your income tax, applies to all types of property including immovable property (a house, apartment or plot) and equity in a business. It does not apply to interest-bearing investments, such as bank deposits and money-market funds, or to retirement fund investments. It also does not apply to what are termed “personal use items”, which include collectibles such as artworks, stamp collections and vintage cars. However, it does apply to bullion, in the form of gold coins such as Krugerrands, and foreign currencies, including cryptocurrency.
Practically, you will pay CGT on:
¡ Your profit on selling a property;
¡ Your profit on selling shares in a company, either as direct owner of the shares, or indirectly, as an owner of units in a unit trust or exchange traded fund;
¡ Your profit on selling a small business;
¡ Your profit on selling a bullion coin such as a Krugerrand (but not, according to one coin website, a proof Krugerrand, which is considered a collectible);
¡ Your profit in a currency transaction, including cryptocurrency.
These must be once-off-type transactions. As soon as you’re buying and selling these assets regularly, SARS regards you as a trader. Instead of paying CGT, your profits are fully subject to income tax.
How does CGT work for individuals?
CGT only applies on the sale of an asset – you do not pay CGT on assets you're currently invested in. If you do not cash in on your gain, there is nothing to pay.
If, on the sale of an asset, you make a loss instead of a gain, that loss may be offset against gains on other assets or may be rolled over to be offset against gains in the following tax year.
When CGT is triggered, the gain is calculated on the difference between the selling price and what is known as the base cost of the asset (the price you bought it for plus certain qualifying expenses). You then include 40% of your gain in your taxable income for the year, of which R40 000 is excluded. For example, the base cost of an asset is R100 000 and the selling price is R250 000. Of the gain of R150 000, 40% of it (R60 000) minus the exclusion of R40 000 is taxable. If your marginal rate is 39%, you will, at most, pay tax of 39% of R20 000, or R7 800 (5.2% of the gain).
Property
The only expenses you are allowed to add to the base cost are those incurred in improving or enhancing the property and those incurred in selling it, such as the estate agent’s commission. You are not allowed to add day-to-day running expenses such as rates, levies, maintenance, and interest on your mortgage bond.
Your primary property – the one you live in for most of the time and call home – is subject to a R2 million exclusion. But secondary properties, such as holiday homes, are not.
Collective investments
Did you know that each time you switch your money from one unit trust fund to another, you trigger a CGT event? This can have serious implications if you are nearing retirement and want to switch from higher-risk funds into lower-risk funds. The answer is to slowly move across funds over a number of years, trying to stay with the “exclusion zone” each time.
Because of the often differing durations that units are held, resulting in varying base costs, the unit trust industry uses a weighted average unit cost, which your unit trust provider will supply on your statements and which you can use to roughly calculate a capital gain.
Inflation
Inflation is the one big cost that CGT does not take into account. If you buy a property for R1 million and sell it 10 years later for R3 million, a large portion of your gain is pure inflation.
Is it not unfair to be taxed on this?
Dale Cridlan, director at Norton Rose Fulbright Tax Services, provides the reasoning behind the omission: "When CGT was originally introduced in 2001 the concept of explicit indexation (an adjustment to take into account inflation) was researched at length by National Treasury. A briefing by the National Treasury’s Tax Policy Chief Directorate, 2001 stated: ‘The capital gains will not be indexed for inflation.
The combined benefits of the ‘low inclusion rate’ and deferring accrued capital gains until realisation should more than compensate for the effects of inflation in a moderate-inflation environment.’
This briefing concluded that adjusting for inflation would only be necessary if anticipated inflation reached significant levels, in excess of 20%, over a prolonged period of time. As it turns out, the ‘inclusion rate’ for CGT has increased over time.
Although South Africa appears to be entering into a period of rising inflation, it does not appear from a policy perspective that the intention is to introduce any form of indexation into the CGT regime in a moderately inflationary environment.”