How to work out the taxable capital gain when disposing of share investments.
One of the underlying principles of Capital Gains Tax (CGT) is that a capital gain is normally determined as being the difference between the proceeds on sale of an asset, less the so-called ‘base cost’. Calculating the base cost is therefore critical to ensure that your gain is calculated correctly.
If you purchased your shares on or after 1 October 2001, calculating the base cost is fairly straight-forward, starting with the actual purchase price of the shares. In addition, you are entitled to add certain costs, such as the dealing costs both when you purchased the shares, as well as when you sold them.
If you borrowed money for the specific purpose of acquiring the shares, Paragraph 20(1)(g) of the Eighth Schedule allows you to add one-third of the interest paid on the loan to the base cost, subject to certain conditions.
In the case of shares purchased before 1 October 2001, market value as at that date is normally used to determine the base cost. The reason for this is that capital profits accruing up to the introduction date for CGT remain tax-free. However, Paragraph 29 of the Eighth Schedule stipulates that the valuation for listed shares is to be based on the aggregate value of all transactions in that particular share during the five business days preceding the valuation date, divided by the total volume thereof during the same period.
In the case of unit trusts, the value is based on the average of the price at which a unit could be sold to the management company of the scheme for the last five trading days before valuation date. The reason for using these methods would be to iron out any attempts to manipulate the share price in anticipation of the introduction of CGT. These determined values have been published in the Government Gazette.
Bear in mind that you are not compelled to use market value as a method for determining the base cost of an asset, and there are other options (such as the time apportionment method or the 20% of proceeds method) that may be used. Taxpayers are entitled to use whichever method provides them with the best advantage (i.e., lowest taxable capital gain) provided that they can satisfy SARS as to the correctness of their calculations, and provide appropriate supporting documentation where applicable.
‘Free’ shares received from the demutualisation of Sanlam and Old Mutual
One of the questions frequently asked is what is the base cost of the ‘free’ shares received from the demutualisation of Sanlam and Old Mutual a few years back.
Because both of these demutualisations took place prior to 1 October 2001, the base cost will be the values published in the Government Gazette. For Sanlam, this value is R8.89 per share, and for Old Mutual, R13.63 per share.
It frequently happens that a group of companies chooses to unbundle its subsidiaries and list them separately, and shareholders in the holding company receive shares in the newly-listed entities as a result. For example, shareholders in Tongaat-Hulett would have received a number of Hulamin shares in June 2007 when the latter company was unbundled.
How does one calculate the base cost of the unbundled shares?
When a capital distribution of shares in an unbundled company is made as a result of an unbundling transaction contemplated in terms of Section 46(1) of the Income Tax Act, Section 46(3) stipulates that part of the base cost of the shares in the company should be allocated to the unbundled shares.
The apportionment of the base cost must be “in accordance with the ratio that the market value of the unbundled shares, as at the end of the day after that distribution, bears to the sum of the market value, as at the end of that day, of the unbundling shares and of the unbundled shares” (Section 46(3)(a) (v)).
When a company carries out an unbundling transaction, an announcement outlining the cost-apportionment ration is published on the Stock Exchange News Service (SENS). In this example, Tongaat-Hulett made such an announcement on 27 June 2007, giving the cost-apportionment ratio as allocating 73.61% of the original base cost of the Tongaat-Hulett shares to Tongaat-Hulett after the unbundling, with the remaining 26.39% being applied to Hulamin.
This means that, hypothetically, if the base cost of Tongaat-Hulett shares was R100.00 per share prior to the unbundling, the apportionment ratio would result in such base cost being reduced to R73.61 per share after the unbundling, while that of the newly-unbundled Hulamin shares would be R26.39 and not the zero value that would have been based on the consideration paid or, in this case, not paid.
Exception in the case of the Kumba unbundling from Iscor
There is however one exception to this general rule, which relates specifically to the unbundling of Kumba from what was then Iscor (later Mittal Steel, now ArcelorMittal South Africa). According to Issue 1 of the SARS Comprehensive Guide to Capital Gains Tax the 1 October 2001 value of Kumba shares is not reflected in the Government Gazette as it was only listed on 26 November 2001.
The following explanation is provided in Issue 9 of the Guide (pages 281-2):
Iscor distributed the Kumba shares to its shareholders as a dividend in specie under a pre-valuation date unbundling transaction. SARS and Iscor have agreed on a price for Kumba at 1 October 2001 of R28.04 (this agreement was advertised in Business Day on 29 January 2002) and it is suggested that taxpayers use this figure.
The price for Iscor is R25.22, as reflected in the Government Gazette.
For the purposes of Paragraph 76, the Kumba distribution constituted a dividend, and hence was not a capital distribution as then defined in Paragraph 74.
If the time-apportionment base cost method is adopted in valuing the Iscor shares on valuation date, there is no means by which the pre-CGT expenditure in respect of the Iscor shares can be proportionately reduced to account for the Kumba unbundling.
Although such a reduction must be made in respect of a post-valuation date unbundling transaction, no adjustment is required for a pre-CGT unbundling transaction.
The above extract from the Guide refers the reader to Paragraph 18.2 thereof, which deals with distributions in specie by a company. This topic will be dealt with in greater detail in a future article.
WRITTEN BY STEVEN JONES
Steven Jones is a registered SARS tax practitioner, a practicing member of the South African Institute of Professional Accountants, and the editor of Personal Finance and Tax Breaks.
This article is a general information sheet and should not be used or relied on as legal or other professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your adviser for specific and detailed advice. Errors and omissions excepted (E&OE).