One of our readers is planning to sell his business and wants to know whether this would have any Capital Gains Tax (CGT) implications for him, says Pieter Willem Moolman.
CGT was introduced at the turn of the century and forms part of the provisions of the Income Tax Act. Income tax typically focuses on gains of a revenue nature, while CGT provisions target gains of a capital nature.
The first step in calculating a person’s tax liability is to determine whether a capital gain or loss has been made. The event that triggers CGT is the disposal of an asset and, unless such a disposal occurs, no gain or loss arises.
For the purposes of our discussion, the sale of a business crosses this first hurdle.
Where an asset is disposed of, the amount which is received by or which accrues to the seller of the asset, constitutes the proceeds from the disposal.
Another important building block in the calculation of a capital gain or loss is the base cost of an asset.
The base cost essentially consists of three broad components, namely costs incurred in respect of the: acquisition of an asset; improvement of an asset; and direct costs in respect of the acquisition and disposal of an asset.
CGT applies to all assets of a person which are disposed of on or after 1 October 2001 (valuation date), whether or not the asset was acquired before, on or after that date. However, only the gain accruing from the above date will be subject to tax.
Our reader therefore would have had to have had his business valued as at October 2001 to determine what his base cost is. If he acquired the business after this date, the purchase price and/or capital input will constitute the base cost.
The legislation also provides for formulas that can be used if no base cost was determined within the allowed time after October 2001.
Only a portion of the difference between the base cost and the proceeds (the taxable gain) will be included in the CGT calculation. In the case of natural persons, the inclusion rate is 25%.
Once a person’s taxable capital gain has been determined, it is included in his/her taxable income in terms of Section 26A of the Income Tax Act of 1962. Thereafter, the ordinary tax rates are applied to the person’s taxable income (which now includes taxable capital gains) to determine his/her normal income tax liability.
From the above it can also be seen that if our reader sells his business in August of one year, he will only have to account for capital gains, if any, at the end of the tax year in February of the following year.
On the other hand, it is also possible that if an asset is sold and ownership has been transferred in, say, February, but the seller only receives the purchase price some months later, for whatever reason, he will already be potentially liable for CGT after the end of February.
Since CGT could have such far-reaching effects, it is advisable to acquire sufficient information if any uncertainty exists.
Take note that CGT could also be an issue that affects the liquidity in a deceased estate, as there may be CGT payable in various instances as a result of death, which is seen as a disposal for CGT purposes.