Member Article

Given the difference between the effective rate of tax on capital gains and the highest marginal rate of tax imposed on income, in particular for individuals, it is important to determine whether the proceeds from the disposal of an asset are subject to capital gains tax or to income tax.

In the Pick ‘n Pay case, the proceeds from the sale of certain shares were found to be capital in nature. The court held that the test for distinguishing between capital and revenue accruals is the enquiry as to whether the taxpayer was engaged in a scheme of profit-making. The majority of the court reached its decision by first asking whether the taxpayer objectively conducted a business and secondly whether it was the objective of the taxpayer to conduct a business. The court further held that that any receipts or accruals bear the imprint of revenue if they are not fortuitous but designedly sought and worked for.

The dominant test in relation to determining whether capital has been productively employed in order to earn profits, is the intention of the taxpayer. The test of intention is subjective and its application involves consideration of all the circumstances surrounding the acquisition of and method of dealing with an asset.

When a taxpayer sells an asset and has claimed capital allowances in respect thereof, then, to the extent that the purchase price exceeds the tax value of the asset, the taxpayer may have a recoupment of such allowances in which case the portion of the proceeds equal to the allowances recouped will be included in the taxpayer’s income and subject to income tax.

When the relevant asset is held by a trust and is vested in a beneficiary then the capital gain is allocated to the beneficiary if such beneficiary is a resident of South Africa. If such beneficiary is not a resident then, in SARS’ view, the capital gain is taxed in the hands of the trust.

In this regard, the vesting of an asset by a trust in the beneficiary is viewed as a disposal for capital gains tax purposes. Although no proceeds are derived from this vesting, the capital gains tax provisions deem the asset to be disposed of at its market value.

Given the high effective capital gains tax rate for a trust (36% at time of writing) it is generally beneficial for a trust either to vest the relevant asset in a resident beneficiary after which it can be sold by the beneficiary. Alternatively, the trust could sell the asset and vest the capital gain in the beneficiary in which case it will be taxed at the effective capital gains tax rate for an individual (18% at time of writing).