SARS to take its share, but by way of capital or revenue?

BY DE WET DE VILLIERS Director: Private Clients, AJM Tax

& HERNA-DETTE VAN DER ZANDEN Junior Associate, AJM Tax

As the 2021 tax year ended at the end of February and with the filing season to open soon, we need to revisit old favourites in the everchanging world of tax.

A paramount distinction needs to be drawn between amounts of a capital nature as opposed to a revenue (or income) nature. The reason is non-capital amounts are subject to tax at a higher effective rate compared to capital profits. In the case of natural persons, the maximum effective rate for capital gains is 18% (compared to 45% on revenue gains), companies are taxed at 22.4% (compared to 28%) and trusts at 36% (compared to 45%).

By virtue of the above, a taxpayer would undoubtedly want its share profits classified as to that of a capital nature. It therefore comes as no surprise that section 9C of the Income Tax Act No. 58 of 1962 (‘the Act’) is often referred to as a safe harbour rule, and rightfully so, as it states that where equity shares (i.e. typically listed shares) have been held for a period of at least three continuous years, any amounts received in respect of a share sale must be deemed to be of a capital nature. Consequently, any gain would constitute a capital gain. Favourably welcomed, section 9C does not require an election and its application is automatic and compulsory.

And much to the taxpayer’s relief, the converse cannot be stated with regards to shares held for less than three years – therefore, not automatically of a revenue nature.

To much dismay, this is how far the Act goes in terms of clarification, and the default capital versus revenue guidelines needs to be carefully thought through to ascertain the nature of the shares held for less than three years. By relying on principles sprouting from courts, the taxpayer bears the onus to prove that the sale is capital of nature.

A taxpayer’s intention, both at the stage of purchase and disposal, is the most important factor as can be derived from case law. However, the subjectivity of people lead them to perhaps acquire shares with mixed intentions (bought partly to sell at a profit and partly to hold as an investment); or they can even change their rationale for the purchase. The dominant or main purpose is to be established in these instances. Evidence relating to intention must be tested against the circumstances of each case, which include, among other things, the frequency of transactions, method of funding and reasons for selling.

An applicable example, with COVID-19 and the undesired consequences such as job-loss, which necessitates selling, it is more often than not shares that are the first to leave the asset portfolio.

As a point of departure, where shares have been purchased and sold as part of a scheme for profit-making, gains will be regarded as revenue in nature. Juxtaposed thereto, an occasional sale of shares yielding a profit suggests that a person is not a share trader engaged in a scheme of profitmaking. The “slightest contemplation of a profitable resale” is also not necessarily determinative, but shares sold for a profit very soon after the acquisition is an indication of the potential revenue nature of those profits. However, that measure loses a great deal of its importance when there has been some intervening act, for example a forced sale of shares.

Whether COVID-19 can constitute such a forced sale will have to be individually evaluated with reference to each taxpayer’s purpose and their circumstances.

Yes, dear taxpayer, the goal box for shares, at least, has been established – it is entirely possible for you to hold your shares for less than three years, yet for the sale to be taxed on capital account.