Amanda Warner, International Tax Director, Ernst & Young, explains a recently introduced rule to establish if company shares are held as a revenue or capital asset for TAXtalk, South Africa's leading tax publication. 

Introduction 

Capitals gains and income are taxed at different rates. Whether or not one crosses the Rubicon from holding an asset as a capital asset or to holding it on revenue account, has long been subject to the scrutiny of our court. These cases generally focused on the intention of the holder in acquiring it and, where the asset was acquired in order to earn income, for example rental, the asset was held to be on capital account, whereas if it was acquired in order to make a profit on subsequent resale, it was held to be on revenue account.

Listed company shares

Of particular interest to many has been how one holds shares. Prior to 2007 section 9B treated shareholders of listed company shares as having a capital intent if the shares where held longer than 5 years and the shareholder had elected to apply section 9B.

This section did not provide enough certainty for taxpayers in more generalised situations and the reliance on case law has resulted in unintended differences in application. SARS therefore decided to introduce more objective rules of application in order to give certainty for a wider set of shareholders and to ensure all taxpayers are treated equally.

New Section 9C

Section 9B was therefore replaced with a new Section 9C which applies to all disposals, liquidations etc, on or after 1 October 2007. The new section effectively deems certain holders of shares to be holding on capital account if they have held the shares for longer than 3 years. The new section is mandatory and no election needs to take place as was the situation with section 9B.

Section 9C will apply to all listed shares on the JSE, private company shares, interests in close corporations and certain collective investment schemes (unit trusts). Certain deemed disposals or deemed part-disposals will also be recognised as disposals for section 9C purposes. Some hybrid instruments (where debt and equity features are present), interests in share block companies and unlisted foreign company shares are excluded from the ambit of Section 9C.

Anti-avoidance

Anti-avoidance provisions have been included to cover specific situations which are excluded from the ambit of the deeming provision in Section 9C. For example where:

• more than 50% of the value of shares in the company relates directly or indirectly to immovable property acquired within three years before the disposal of the shares, or
• any asset was acquired by the company within the three years and encumbered by a lease or licence under which the payments are partly or wholly received by someone other than that company within the same three year period.

These restrictions only apply if the shareholder has a meaningful interest in the company ie is a “connected person” to that company. The definition of connected person has a slightly lower threshold in Section 9C and includes a shareholder with only twenty per cent of the shares, even if another shareholder holds the majority.

The three year rule will generally take into account the rollover regimes in the Act. However it will not apply to asset-for-share transactions or unbundling transactions, as it would otherwise be possible to convert non-three year assets into three year assets.

The effect of the anti-avoidance provision applying does not deem the share to be held on revenue account but rather the normal rules of capital vs revenue will apply in determining the nature of any gain made on disposal, liquidation etc..

Practical application

Where section 9C applies to shares which prior to the three year period were treated as being held on revenue account and expenses were claimed in respect of those shares, a recoupment of such expenses will occur when the section 9C disposal occurs. The section 11(a) cost of the shares (opening trading stock deduction in the year of disposal) will also be effectively recouped upon the section 9C disposal.

The FIFO method (first in first out) will apply to determine the period of holding when a taxpayer has acquired shares at various dates. This will not affect the calculation of the base cost.

Effectively the new section 9C automatically deems shares held for longer than 3 years to be on capital account regardless of the intention with which you acquired that share. Even where the shares were acquired on capital account and a change in intention occurs so that you now hold with a profit motive, both the deemed disposal on the date you change your intention and the final disposal if the three year period is realised, will be on capital account.

The above article was produced by Amanda Warner, International Tax Director at Ernst & Young in South Africa, and is reproduced with the kind permission of TAXtalk, South Africa's leading tax publication (www.taxtalk.co.za).

Article Added Friday, 29 August 2008 | 1085 Hits

Your attention is drawn to the disclaimer on this site, which applies to the content in this section.