Capital vs revenue — part 1

2007-12-13 00:00

Capital versus revenue — the saga continues! For many years the issue has been a contentious area in tax legislation.

Tax professionals and South African Revenue Service (SARS) officials have presented numerous cases before the tax court in order to determine whether a transaction is of a capital nature or a revenue nature.

The outcomes of these reported tax cases have since come to be used as precedents to ascertain whether the transaction in question is capital- or revenue-based. It is imperative that the issue in each situation is resolved because the two regimes are taxed at different rates.

In the Revenue Laws Amendment Bill, which is being promulgated, the issue has come to light once again. 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 disposal of listed company shares attracts 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 has ruled 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.

Section 9C will be effective from October 1, 2007 and it will apply to all shares which 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:

• Domestic and foreign shares listed on the JSE;

• Private company shares;

• Interest in close corporations;

• Certain collective investment schemes.

The following are excluded from the definition:

• Hybrid instruments;

• Shares in former Section 24A roll- over schemes;

• Interest in share block companies;

• Unlisted foreign companies.

The general rule contained in the new legislation is that the disposal of shares that have been held for a three-year period will be deemed to be capital in nature and will be subject to capital gains tax. An important point is that the three-year rule is mandatory, unlike with 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 that 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 will be revenue in nature and will be taxed accordingly.

Nolan Daniels

Senior Tax Consultant

083 776 2271

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