FAQ - 25 September 2014
22 September 2014
Posted by: Author: SAIT Technical
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?
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
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
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 188.8.131.52 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.