Capital Gains Tax: report-back on amendments by SARS

Meeting report

FINANCE PORTFOLIO COMMITTEE
9 March 2001
TAXATION LAWS AMENDMENT DRAFT BILL: REPORT-BACK ON AMENDMENTS

Chairperson: Ms B Hogan

Documents handed out
SARS Summary of Comments on First Draft of the Capital Gains Tax Bill (12 December 2000) and SARS and the National Treasury's Response (90 pages)

National Treasury's Summary Outline of Major Policy Changes with Respect to the Proposed Capital Gains Tax Legislation

SUMMARY
National Treasury said that they have made many accommodations throughout the Bill. SARS noted that they have been involved in discussions with various industries in an attempt to resolve differences of opinion. SARS said that while they entertained discussions with an open mind one had to accept that SARS would not be able to please everybody.

Some amendments made to the Bill include:
- a definition of ''value-shifting arrangements'' so that such transactions can be identified to address avoision.
- a formula for the time apportionment base cost has been incorporated into the legislation. The revised CGT draft does not resolve the complications which result from multiple adjustments. Instead the revised draft contains three options:
1) retain the multiple calculations in full, or
2) eliminate these multiple calculations by assuming all adjustments occur upon initial acquisition, or
3) a combination of the two methods, such as applying multiple calculations except for financial instruments.

SARS also replied to a question regarding the sale of tribal trust land and CGT.

MINUTES
SARS discussions with stakeholders
Mr Kosie Louw (SARS) noted that SARS has been involved in discussions with various industries regarding certain issues in the Bill. SARS had a meeting scheduled with the Life Offices Association that afternoon to discuss points in the draft bill that the LOA did not agree on. He pointed out that while they entertained discussions with an open mind, one had to accept that SARS would not be able to please everybody.

Some organisations that SARS has had discussions with are:
SACOB: This organisation raised a number of issues. One of these was that capital losses are not allowed to be offset against ordinary income. SACOB argued that the Bill was weighted too much in favour of revenue. Mr Louw pointed out that one must take a balanced view. There are various points upon which SARS has taken a favourable stance to the taxpayer. For example there is a low inclusion rate, and various concessions were made to SMMEs.

Agricultural Union of SA: SARS had discussions with them and SARS conceded that they can use the Land Bank valuation. However there is a condition attached to this. The condition is that the same value that is used for the opening value must also be used for the closing value.

Mr Louw said that SARS would continue to meet with industries to try to resolve differences of opinion as far as they could.

Professor Engel (National Treasury) added that they have made many accommodations throughout the Bill. He reiterated that the bulk of Capital Gains Tax is going to be primarily in the upper income levels. ''The middle and lower class is pretty much out of the Bill''. For example, personal use assets are out as are homes valued at less than one million rand. The Bill is targeted in the direction of high income earners.

Taxation Laws Amendment Draft Bill: Report-Back On Amendments
Mr Louw noted that of the 27 million people who pay taxes in the UK, only 207 000 of these pay CGT. Thus, even though the SA context is different, by analogy a relatively low percentage of people are affected by CGT.

He noted that the amendments prior to the Eighth Schedule of the Bill are consequential changes. Some amendments noted were:

Clause 2 - The definition of spouse has been inserted. It extends the term to same-sex relationships. This theme exists throughout the Bill.

Clause 3 - It provides for a window period for people to transfer a house back into their own name from a trust or a close corporation without paying a transfer cost.

Clause 7 - There is a reduction in the estate duty rate from 25% to 20%.

Clause 12 – To explain this, reference was made to a court case where a parent made a loan to a company in which the minor child was a shareholder and from which the minor child received dividends. The court held that the amount which must get taxed in the parents hands is not the amount of the dividend but rather the amount of the interest free loan that the parent made to the child. This means that the value of this loan must be determined.

Clause 12 deals with a similar issue. It concerns loans made to connected persons at low interest rate or with no interest attached to the loan. SARS will have to devise a method to determine the value of the interest free loan. An interest free loan is essentially a benefit which is transferred.

Clause 13 - This deals with Controlled Foreign Entities (CFEs). Three rules are introduced in clauses 13(d), (e), and (f):
13(d): If a CFE makes a foreign capital gain then the gain will be determined in the foreign currency and then converted into the South African currency.
13(e): Provides that valuations according to the time-based apportionment method must be used except for specifically listed assets. This is for administrative reasons.
13(f): If a company becomes a CFE after the 1 October 2001 implementation date then the base value will be determined according to the date the company becomes a CFE. Thus they will not be taxing ''historical value''.

Clause 19 - It sets out the amendments to the formula for the long-term insurance industry. This is still under discussion with the industry.

Clause 23 - This is a new provision which deals with returns submitted electronically. The problem is that taxpayers need to sign their returns. This clause regulates the legal status of an electronic signature. It allows the Minister to make rules on procedures for accepting an electronic signature.

Determination Of Taxable Capital Gains And Assessed Capital Losses:
Eighth Schedule
Some of the amendments noted were:

General: Part 1
Definitions: Clause 1
- The ambit of the definition of ''financial instrument'' has been extended.
- The same applies for ''natural person''. This definition now includes the deceased or insolvent estate of a person.
- A definition of ''value shifting arrangement'' has been inserted. There are now new references to ''value shifting arrangements'' throughout the Act. The concept of a value shifting arrangement is explained as follows:
A father owns 100 shares in a company and his son also owns 100 shares in the company. The father then issues another (extra) shares to the son at nominal value. By doing this the father has reduced his own amount of the shares and increased the son's amount of the shares. Thus, value shifting occurs when a person has an interest in an entity and because of an arrangement there is a reduction of the persons interest and an increase in the other person’s interest.

With value shifting arrangements one is issuing shares at below the fair market value rate. Inserting this definition is to identify such arrangements and thus prevent avoision.

Application - clause 2(2)
A non-resident is only taxed on immovable gains in SA and on permanent business establishment assets. SARS has introduced a de minimus rule so that now the foreign interest held must be at least 20%.

Taxable Capital Gains and Assessed Capital Losses: Part II
Annual exclusion - clause 5
Death is dealt with as a deemed disposal. There was a complaint that with estate duty and CGT on death there would be double taxation. Estate duty was reduced to 20% and the amount of the annual exclusion has been increased to R50 000.

Taxable Capital Gain - clause 10
In subclause (a) ''natural person'' includes an insolvent. In subclause (ii) ''untaxed policyholder fund'' has been inserted.

Disposal and Acquisition of Assets: Part iii
Disposals - clause 11
Subclause (2) deals with those events which are not considered to be a disposal of an asset. Subparagraph (g) has been added so that a disposal made to correct a registration error with immovable property in someone's name is not considered a disposal because the intent was not to trigger a tax event.

Disregarded Disposals and Limitation of Losses: Part IV
Forfeited Deposits - clause 17
Deposits for personal use assets are forfeited. The loss will be allowed in certain circumstances (example with coins made mainly from gold or platinum).

Exercise of options - clause 18
This is a new rule. A capital loss of a person will be disregarded if the person was exercising an option.

Securities lending - clause 20
Where a marketable security was lent by a lender to a borrower in terms of a lending arrangement and another marketable security has been returned by the borrower to the lender within the 12 month period then the instrument does not have to be registered again in the hands of the lender. This is a temporary concession.

Pre-acquisition dividends - clause 21
With pre-acquisition dividends a taxpayer can generate artificial losses by buying shares with immediately expected dividends which they receive tax-free and then sell the share at a loss. Clause 21 is an anti-avoidance rule which addresses this.

Debt substitution - clause 22
This clause regulates the value the asset is being disposed of in the case where an asset is disposed of to someone to discharge or to reduce a debt to that person. Example: if person A owes person B one thousand rand. A owns shares worth eight hundred rand. B is prepared to take that shares as payment of the debt. In terms of CGT person A has made a profit while person B has made a loss. The value at which the asset is sold is regulated here to prevent mismatches.

Base Cost and Proceeds: Part V
Base cost of asset: clause 23
Clause (f) has been added. This clause deals with recurring costs. In the initial draft this was excluded. They have now agreed that for business assets and shares (not necessarily held in a business or trade environment) one third of the business or finance charges will be allowed.

Clause 23(6) is a new provision. It deals with donations tax. Usually liability for donations tax falls on the donor. The formula calculates donations tax but it is limited to donations tax attributable to the gain.

Valuation date value of an instrument - Clause 28
This is a new clause.

Valuation date market value - clause 29
Clause 29(1) - A financial instrument for which a price was quoted before and after the valuation date the value used is:
- Where the instrument is listed on an exchange in SA one must use the average of each of the 5 days trading preceding the valuation date.
- If it is not listed on an exchange in SA then use the value of the last trading day preceding the valuation date.

Clause 29(2) - If one holds more than 50% in an entity then that is a controlling interest. One must use the same ratio to determine the premium at the time of selling the controlling interest as the ratio that was used to determine the premium at the time of buying the controlling interest.

Clause 29(4) - this is a new rule. SARS has built in a de minimus rule for the valuation of certain assets. The onus is on the taxpayer to do the valuation.

Clause 29(6) - the Commissioner can challenge the valuation.

Time apportionment base cost - clause 30
Professor Engel went through thisThe time-apportionment method determines post-October 1 gains by assuming that all gains accrue evenly over time. The purpose of this rule is to reduce the need for the appraised valuation of all pre-effective date assets. They have incorporated the formula into the legislation.

Although the time-apportionment rule can be simple in theory complications arise when pre-effective date assets are subject to multiple base cost adjustments. These adjustments may come in various forms, such as improvements, depreciation, and share capital distributions. Multiple base cost adjustments require separate calculations because the gain/loss attributable to each adjustment must be distinguished from the gain/loss attributable to the initial acquisition.
Subsequent adjustments add significant complexity to the time-apportionment calculation.

The revised CGT draft does not resolve the complications resulting from any of these multiple adjustments. The revised CGT instead contains three options:
- retain the multiple calculations in full, or
- eliminate these multiple calculations by assuming all adjustments occur upon initial acquisition, or
- a combination of the two methods, such as applying multiple calculations except for financial instruments.

Determination of market value - clause 31
This clause is a general rule on market value. Market value will be necessary for events such as death for example. There are some new rules in this clause. These include:
Subclause 31(1)(b) has changed slightly. The market value of a long term insurance policy is either the surrender value or the fair market value of the policy, whichever is the greater.
In subclauses 31(d) and (e) there are two new sub-rules to value a fiduciary or usufructuary instrument.

Determination of base cost of financial instruments - Clause 32
This is a new clause. It applies to the disposal of financial instruments which form part of a holding of identical assets. The taxpayer has a choice of methods to value a financial instrument. However once the taxpayer has made the election it is binding for that class of instruments.

Tax payable by heir of a deceased estate - clause 40
Where CGT on an estate exceeds fifty percent of the net value of the estate, payment of CGT can be deferred for a maximum of three years (subject to an interest charge).
Mr Lermer (a representative from PriceWaterhouseCoopers) was present. He said that no relief is given to an insolvent estate. Capital gains tax in this instance is not taking into account liabilities and in this way it can be punitive. One should try to avoid tax in circumstances where there is no net value to the estate.

Professor Engel replied that the payment of the CGT is deferred for three years. Thus they are giving them time to work with the assets. He added that it would be quite uncommon for an estate to have high amounts of gain and high amounts of debt.

Companies and Shareholders: Part IX
Professor Engel said that they would deal with the companies restructure over the next few months leading up to October. Part IX sets up the foundation for this. The interim period is not a worry because they will only start taxing gains in October.

Trusts, Trust Beneficiaries and Insolvent Estates: Part X
Capital gain attributed to a beneficiary - clause 76
The old paragraph 67 (which said that where a beneficiary has a vested right that is considered to be ownership) has been removed. This rule was removed because in terms of trust law it is already the case. To codify it is redundant.
The old paragraph 68 said that where there was a gain the gain is used to determine CGT for the trust in the hands of the beneficiary. This rule has been kept and is reflected in the new clause 76.

Base cost of interest in a discretionary trust - clause 77
This is a new paragraph.

Miscellaneous - Part XI
Electronic filing of Statement - Clause 54
A clause on the electronic filing of a statement (Clause 54) has been added. It provides that the Commissioner may accept electronic signatures and that the Minister may prescribe regulations for the way this must be done for it to be acceptable.

Tribal Trust Land question
The Chairperson asked a question on behalf of Dr Koornhof (UDM) who was unable to attend the meeting: How would the uncertainty over the ownership of tribal trust land affect the application of CGT to the sale of such land.

Mr Louw replied that they have been involved in discussions with the Department of Provincial and Local Government and the Department of Land Affairs. Land Affairs has put together a team to determine where ownership around this land lies. They are bringing out legislation to regulate it.

He continued that the chief is considered to be the owner of the tribal land and people in the tribe have the right of use over that land. This is not regulated properly in the Deeds Office. SARS will follow up the issue. In the interim the core rules will apply. The definition of asset is very wide in the core rules: it does not refer only to property but also the right to property. The right of use to property is a right over property. Therefore use of property falls into the definition of an asset. Thus if such an asset is sold and one gets a base cost then the normal calculations will follow.

The meeting was adjourned.