Capital versus revenue: Part 1

2008-01-24 00:00

"Capital vs revenue", the saga continues! For many years, the capital vs revenue issue has been a "contentious area" in the tax legislation. Tax professionals and officials from the South African Revenue Service (SARS) have presented numerous cases before the tax court in order to determine whether the transaction is of a capital nature or a revenue nature. These reported tax cases have since been used by tax professionals and SARS to ascertain whether the transaction in question is capital or revenue in nature. It is imperative that the issue, in each situation, is resolved, as the two regimes are taxed at different rates.

In the Revenue Laws Amendment Act No. 36 of 2007, which was promulgated on January 8 2008, the capital vs revenue issue has come to light once more. In this instance, the proposed legislation seeks to provide guidance with respect to shares. In terms of section 9B of the Income Tax Act No. 58 of 1962, as amended "the Act", the disposal of listed company shares will attract capital gains tax if the shares were held for a period of five years and the seller elects for the provision to apply. The fiscus have identified that section 9B relates primarily to listed shares and does not provide guidance on other shares. It is for this reason that a new section 9C has been proposed.

The proposed legislation states that section 9C will be effective from October 1 2007, and it will apply to all shares that have been held for a continuous period of three years (previously five years). This legislation will effectively replace section 9B. For the purposes of this proposal, the definition of "shares" includes the following:

o Domestic and foreign shares listed on the JSE.

o Private company shares.

o Interest in close corporations.

o Certain collective investment schemes.

The following are excluded from the definition:

o Hybrid instruments.

o Shares in former section 24A roll - over schemes.

o Interest in share block companies.

o Unlisted foreign companies.

The general rule contained in the new legislation is that the disposal of shares, which have been held for a three-year period, will be deemed to be capital in nature and will be subject to capital gains tax. A fundamental point is that the 3-year rule is mandatory, unlike section 9B which was elective.

The fiscus has also expressed concerns that the proposed section may create possible avoidance where shares are held in companies, which mainly hold real estate. In essence, the term "mainly" means more than 50%. One of the proposed preventative measures is that section 9C will not apply to equity shares in a company where more than 50% of the total value of the company consists of immovable property acquired less than three years before disposal of the shares. Where the taxpayer fails to prove "the more than 50% test",

the transaction may be revenue in nature and will be taxed accordingly.

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