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Returns of capital The 1 April CGT Trigger

08 July 2012   (0 Comments)
Posted by: Author: Aneria Bouwer and Simone Esch
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Returns of capital - The 1 April CGT Trigger
 
1 April 2012 could have triggered a capital gains tax (CGT) liability for taxpayers holding shares, even if they did not receive any distributions and did not sell their shares during the tax year. And that’s no April Fool’s humour.
 
In addition, taxpayers may think that they are familiar with the return of capital rules that were originally introduced during 2007, but these rules were further amended and expanded during 2011. SARS first changed the capital distribution rules in 2007 with the introduction of paragraph 76A of the Eighth Schedule to the Income Tax Act, 1962 (the ITA). Paragraph 76A introduced new rules regarding the CGT treatment of returns of capital by a company, which included a deemed part-disposal of shares on 1 July 2011.

However, in 2011 the deemed disposal date was postponed from 1 July 2011 to 1 April 2012 and a new paragraph 76B was introduced. 2011 was a busy year with regard to amendments to the ITA and these changes may have passed unnoticed for many taxpayers.The CGT treatment of capital distributions has changed materially and taxpayers should thus consider the potential application of the applicable provisions before they complete their provisional tax returns for the relevant tax year (which for individuals would be the 2013 tax year). 

Until 2007, it was common practice for companies to make returns of capital (also referred to as capital distributions) to shareholders. A return of capital was not regarded as a dividend and was therefore not subject to secondary tax on companies (STC), nor did it trigger CGT at the time.CGT would only be triggered on the ultimate disposal of the share. If a share was never sold, the capital distributions would effectively remain untaxed. At the time of the ultimate disposal of the share, any returns of capital received over the years had to be included in the proceeds on disposal, which had the effect of gathering up the amounts received prior to disposal.
 
However, all that changed during 2007, when paragraph 76A was introduced. Paragraph 76A provides for three different potential scenarios:
•Scenario 1: Returns of capital received on or after 1 October 2007 but before 1 April 2012, triggered a deemed disposal of a part of the share on the date that the return of capital is received by or accrues to the shareholder. The shareholder would thus have to calculate the capital gain or loss on the disposal of part of the share and include it in their tax return for the relevant tax year. 
•Scenario 2: Where returns of capital were received on or after 1 October 2001 but before 1 October 2007 and the taxpayer disposed of the share before 1 April 2012, the loss or gain on the part disposal would have been triggered on the date of disposal of the share. 
•Scenario 3: Where returns of capital were received on or after 1 October 2001 but before 1 October 2007 and the taxpayer has not disposed of the shares by 1 April 2012 (referred to herein as untaxed returns of capital), the taxpayer must be deemed to have received a return of capital on 1 April 2012.
 
In the case of scenarios 1 and 2 (an actual disposal or deemed part-disposal of the share before 1 April 2012), the value of the return of capital must be treated as proceeds on disposal. In the case of a part-disposal,paragraph 33 of the Eighth Schedule prescribes how part of the base cost of the asset should be taken into account for purpose of calculating the capital gain or loss on disposal.However, in the case of scenario 3, the capital gain or loss must not be calculated in terms of paragraph 76A, but in terms of the new paragraph 76B, which applies to returns of capital received on or after 1 April 2012.

In short, while paragraph 76A provided for the value of the return of capital to be included in the proceeds on disposal, paragraph 76B provides that the value of the return of capital will reduce the shareholder’s base cost in the share.

If the return of capital exceeds the expenditure incurred in respect of the shares to which the return relates, the excess must be treated as a capital gain during the year of assessment in which the return of capital is received or accrued (whichever is earlier).

Where a return of capital is received and the shares in question were acquired before 1 October 2001, the calculation is complicated as the shareholder’s base cost in the shares is calculated by determining the market value of the share on the date of the return of capital and then deducting (or adding to it) the notional capital gain (or loss) which would have been realised if the share were disposed of on such date. The base cost is then reduced by the value of the return of capital. If the return of capital exceeds the expenditure, the excess must be treated as a capital gain.
 
Hence, any untaxed returns of capital received between 1 October 2001 and 1 October 2007 (in those instances where the underlying shares have not been disposed of by 31 March 2012) will potentially trigger tax in terms of paragraph 76B by virtue of the deemed return of capital provided for in paragraph 76A.

The new rules contained in paragraph 76B may be less negative for taxpayers than the deemed disposal rules in paragraph 76A, since the latter could trigger a capital gain each time a return of capital is received.However, in terms of paragraph 76B, a capital gain will only be triggered when and to the extent that the return of capital exceeds the base cost.

When paragraph 76A was first introduced during 2007, it was envisaged that a deemed disposal would take place on 1 July 2011 in the case of untaxed returns of capital.While it may seem like a reprieve that the deemed return of capital date was postponed to 1 April 2012 and that a potential gain would have to be calculated in terms of paragraph 76B rather than paragraph 76A, there is a sting in the tail.
 
The downside in those instances where a capital gain would in fact materialise is that such gain may be subject to the higher effective CGT rates as a result of the increased inclusion rates announced by the Minister of Finance in his February 2012 Budget Speech.While a company could still escape the higher effective CGT rates depending on when its financial year ends, a natural person would feel the pain of the higher CGT rate.Taxpayers owning shares should keep this in mind when completing their provisional and final tax returns to ensure that it is dealt with correctly.
 
Source: By Aneria Bouwer, Simone Esch (TaxTALK)
 


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