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FAQ - 25 September 2014

22 September 2014   (1 Comments)
Posted by: Author: SAIT Technical
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Author: SAIT Technical

1. Spouses trading together – when do sections 24H and 7(2) of the Income Tax Act apply?

Q: If spouses trade in partnership, and the agreed profit sharing ratio is 50/50, but the extent of work done and responsibility borne by each partner is not necessarily 50/50, does one automatically have to take section 7(2) into account when determining the amount to be taxed in each spouse’s hands?

I understand that 24H of the Income Tax Act is the default section under which the taxable income of the partners is determined, but then when is S7(2) applied? Do you apply it automatically if the partners are also spouses?

If one has to apportion the taxable income of each Partner taking 7(2) into account, are there any objective tests to determine the % on which each partner should be taxed?

 In this case the agreed profit sharing ratio for accounting purposes was 50/50, and the partners had signed annual financial statements as 50/50 partners. However, the parties are now getting a divorce and the tax liability of each partner is likely to be an issue during the divorce proceedings. The husband’s income tax return was never submitted, and it appears the annual financial statements were incorrectly prepared, potentially increasing taxable income by over R1 million for each of several years of assessments, which will result in the taxable income of the wife for previous years of assessment being understated as well. We would like to submit the husband’s outstanding tax returns, but are not sure of the income tax consequences.

A: You are correct that the standard position for the tax treatment of partners in a partnership is s24H of the Income Tax Act, therefore each partner will accrue the income per the partnership agreement [see s24H(5)(a)].  

The first enquiry, like any other agreement, is that the form of agreement will apply unless the substance can be shown to be something different i.e. the partners actually agreed to a different ratio than what is written. In such instance the substance will supersede the form and the partners will be held to the substance of the agreement. For example, if the written agreement and documents show a ratio of 50/50 but the partners actually applied and intended to apply a ratio of 60/40, then 60/40 is what is applicable for section 24H purposes. This would apply even before applying s7(2), but such factor may be relevant in also applying s7(2). 

Section 7(2) represents a deeming provision as an anti-avoidance measure. Therefore, notwithstanding the valid partnership ratio (i.e. form = substance) for the purposes of s24H, in certain circumstances the amounts will be deemed to accrue other than in accordance with the partnership agreement or substance of the agreement. This is set out in s7(2)(a) and (b). 

The first provision applies if:

  • Income is derived as a result of donation, settlement or other disposition by one spouse to -another;
  • The sole or main purpose of a transaction was the avoidance, postponed or reduction of the "donating” spouse’s tax liability; and 
  • Such tax liability would have become payable by the donor spouse but for the donation, settlement or disposition.

A main or sole purpose of tax avoidance must therefore first be established before it applies and secondly the income must be derived from a transaction that was a result of a donation, settlement or other disposition by the donor spouse. These are factual questions.

The second provision requires:

  • That the income is received from a trade carried on in partnership or is associated with the donor spouse or a company that such spouse effectively controls; and 
  • Such income represents an amount in excess to which the recipient spouse would have received with regard to the nature of the trade, the recipient’s participation, services rendered or any other relevant factor.

Your concern seems to relate more to the second provision. This is however also a question of fact as to whether the recipient spouse’s input reasonably results in the income received from the partnership compared to the other partner spouse. 

Thus you need to address two questions. (1) Was the profit sharing ratio what the partners intended to agree to (form = substance) for the purposes of s24H? If not, then it needs to be adjusted to what they actually intended. If it was, then (2) would the one spouse reasonably have received his or her share of the profits based on his or her input? If yes, then there’s no s7(2)(b) adjustment [assuming s7(2)(a) does not apply]. Otherwise if no, then there must be a s7(2)(b) adjustment to what should reasonably have been the income accrued. In the case of the latter, the agreed amount is accrued in terms of s24H and then adjusted in terms of s7(2).

2. CGT on the deemed disposal of a share portfolio for which there are no records of the base cost

Q: A client of ours recently passed away and we are battling with the capital gains tax calculation. The client had a portfolio of shares which was held for many years. There are no records of the purchases of those shares. We are unable to determine which shares were held prior to 1st October 2001 (when CGT was introduced in RSA). The current company managing the share portfolio cannot find records more than 5 years old. How do we calculate the CGT on the share portfolio in the event of death?

A: In the SARS guide to CGT it is stated in paragraph that "taxpayers should keep records of costs and valuations performed in order to enable their executors to properly determine capital gains and losses.”  We submit that this is in terms of section 73B that required of the taxpayer (until 1 October 2012 when section 73B was replaced by the Tax Administration Act) to keep records in relation to taxable capital gain or assessed capital loss.  It specifically included "invoices or other evidence of payment records such as bank statements and paid cheques relating to any costs claimed in respect of the acquisition, improvement or disposal of any asset”. 

These records must then be kept for 5 years after the disposal event (death in this case). 

The duty was therefore on the taxpayer to keep the detail and not on the company managing the portfolio.  If the information can’t be obtained it would mean that the executor will not be able to submit an accurate return.  It would enable SARS to issue an (estimated) assessment – see section 95 of the Tax Administration Act. 

Section 95(3) allows that "a senior SARS official may agree in writing with the taxpayer as to the amount of tax chargeable and issue an assessment accordingly”. If the information can’t be obtained it may well be the only option available to the executor. In this regard SARS may probably settle using the 20% of proceeds method for all the assets for which no records are available, which could probably lead to a lot of CGT but would still be a better result than if the base cost was nil, which is what would legally apply if there are no records to prove base cost.


Lynette J. Androliakos (Lamprecht) says...
Posted 25 September 2014
What costs can be taken into account to calculate base cost? The actual cost of the share, brokers fees and admin fees?


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