Capital vs revenue: Part 2

2008-01-30 00:00

In Capital versus Revenue Part 1, I discussed the first part of the amendments with regard to shares. In this week’s article, I examine other relevant issues relating to the proposed amendment.

If a taxpayer acquires identical shares on different dates, he must ascertain which shares were actually sold at the point of disposal for the purposes of the three-year rule under Section 9C. In this regard, the fifo (first in, first out) method is applied. This treatment is synonymous with that prescribed in Section 9B.

Section 9C may also have the effect of "converting" shares previously held as trading stock into a capital asset at the point of disposal. It is possible that the taxpayer may have claimed interest deductions in respect of shares claimed to be trading stock up until the point of disposal. In the event that this has occurred, all interest must be recouped at the point of the Section 9C capital disposal.

The deemed capital disposals under Section 9C must work in combination with the deemed disposal of trading stock in terms of the provisions of Section 22(8) of the Income Tax Act No. 58 of 1962, as amended. In the absence of special rules, the deemed disposal would trigger an ordinary gain upon the deemed capital conversion at the time of disposal. There are certain issues in place that prevent the provisions of Section 22(8) of the Act from undermining the benefits of Section 9C. Therefore, taxpayers must recoup only the Section 11(a) cost upon the Section 9C disposal. This implies that no market value recoupment as set out in Section 22(8) is applicable.

The three-year period as proposed in Section 9C will usually take into account various rollover provisions set out in various sections of the Act. However, the rollover provisions will not apply in the situation of asset-for-share transactions. The legislation clarifies the impact of other rollover regimes. As an example, securities lending transactions should provide a date rollover.

Section 9B will be applicable only until September 30, 2007; thereafter; section 9C will apply. The fiscus has noticed that a number of private equity deals entail management "carried interests". These "carried interests" are characterised by a form of service which should be taxed at ordinary rates. However, the carried interests are arranged so that they are taxed as a capital gain.

One method for disguising these interests may be through the use of shares. Should this be the case, it has been proposed that the three-year deemed capital rule may be amended at a later stage to eliminate this potential loophole.

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