DALL-E
This month we’re guiding you through the basic concepts of capital gains tax (“CGT”) using the example of an investment in a collection of paintings, although this could be applied to any other investment (but not your primary residence) bought on one specific date.
Setting the scene
John, a 55-year-old South African tax resident, buys a collection of paintings on 21 March 2003 from an art gallery in Johannesburg. As an art lover, John bought paintings for enjoyment and artistic value. He paid R200,000 for the collection and R20,500 to transport it to Cape Town. A year after purchasing the paintings, he paid a further R10,000 to a framer who repaired a broken frame on one of the paintings. Six years after the purchase, he sold the paintings for proceeds of R350,000.
Let’s go!
The Income Tax Act 58 of 1962 (“the Act”) includes rules for determining ‘base cost’ and ‘proceeds’ in CGT calculations. Broadly speaking, ‘base cost’ refers to the amount John paid to acquire the paintings while ‘proceeds’ is the amount he received when disposing of the paintings. Nevertheless, these concepts have very specific meanings in terms of the Act.
The price of the paintings and the cost of transporting them would constitute John’s base cost, which is R220,500. The costs of repairing the frame cannot be included in the base cost.
CGT is calculated as the difference between the proceeds (R350,000) and the base cost (R220,500). Therefore, the capital gain resulting from the sale of the paintings would be R129,500. However, this isn’t the amount on which John is taxed. The Act allows for an annual exclusion of R40,000 per year, provided the paintings were held in John’s name.
This exclusion also applies to capital losses. If John makes a capital loss of R40,000 (or less), he can’t carry that amount forward to off-set future capital gains. And the exclusion also isn’t applied ‘pro-rata’. So if John dies, or ceases to be a South African tax resident in half way through the year of assessment, the full R40, 000 exclusion still applies.
John’s capital gain of R129,500 is then reduced by R40,000, resulting in a taxable amount of R89,500. However, for individuals, only 40% of this taxable amount is added to John’s income. This is then taxed as normal income.
i.e. R89,500 x 40% = R35,800.
It’s worth noting that CGT is not separate from normal income tax. An amount (as determined above) gets added to your income and is taxed according to your relevant tax bracket. The R35,800 is, therefore, subject to income tax at John’s tax bracket. In effect, the highest tax rate for capital gains is 18% , because the highest tax bracket is 45%, and 40% of 45% = 18%.
Assets bought pre-1 October 2001
Let’s consider a scenario where John bought the paintings on 19 March 1996 i.e., before CGT came into effect. Our calculation would look a bit different as we need to determine the value of the paintings (or investment) on 1 October 2001. Taxpayers are not taxed on the growth of assets before 1 October 2001.
In this scenario, John may adopt one of the following alternatives as the valuation-date value:
- The market value of the painting collection on 1 October 2001, provided that the collection was valued by 30 September 2004 (i.e., within three years of the valuation date). Let’s assume a market value of R400,000 and allowable expenditure after the valuation date of R100,000.
Here John adopts the market value of the painting collection as the value on 1 October 2001, to the extent that the proceeds (R350,000) do not exceed its market value (R400,000). The evaluation-date value substitution would be calculated as follows: Proceeds (R350,000) less the allowable expenditure incurred after the valuation date (R100,000). - 20% of the proceeds (R350,000), after deducting from the proceeds the allowable expenditure incurred after valuation date (R100,000).
- The time-apportionment base cost of the asset.
Tax Tuesday
Being tax efficient is an important part of great financial management. In this blog, a group of South African tax experts at AJM Tax share their tips and explanations on tax issues. Learn everything you need to know about tax, from deductions you never knew about to retirement savings and capital gains. The first Tuesday of every month is Tax Tuesday.
