Deemed Disposals and Tax Residency

Section 9H of the Income Tax Act deals with matters relating to the cessation of residency in South Africa.

This section essentially states that where a person that is a resident ceases to be a resident during any year of assessment, that person must be treated as having disposed of his assets on the date immediately prior to ceasing his residency, and re-acquiring the same assets on a date immediately thereafter. This is referred to as a “deemed disposal”. Similarly, the year of assessment will be deemed to have ended immediately prior to the cessation and to have started on the next day.

Such a “deemed disposal” does not relate to the immovable property that such a person may hold in South Africa.

As a result of his ceasing to be a South African tax resident (an event simply declared by ticking a box on the annual income tax return when submitted), a so-called “deemed disposal” (also sometimes referred to as an “exit charge”) will be activated in terms whereof all the individual’s assets will be deemed to have been disposed of, at market value, on the day before he ceased to be a South African tax resident.

This event, therefore, potentially gives rise to capital gains tax incurred on the deemed disposal. Excluded from this regime, as stated above, is South African immovable property, cash and (although not explicitly stated, though included on a very technical basis) accumulated retirement-related funds. Apart from these assets, all remaining South African and other worldwide assets are included in the “deemed disposal” regime.

Before a taxpayer decides on cessation of tax residency, an investigation should be done into possible tax treaty relief the individual may qualify for. SARS has stated that “an individual who is deemed to be exclusively a resident of another country for purposes of a tax treaty is excluded from the definition of “resident”. It follows that while an individual may qualify as a resident under the ordinarily resident or physical presence tests, that individual will not be regarded as a resident for South African tax purposes if that person is a resident of another country when applying for a tax treaty.”

Based on this, it is clear that section 9H of the Income Tax Act immediately becomes applicable to a taxpayer in the case of financial emigration or the cessation of tax residency, for whatever reason, and may increase tax liability in the current year of assessment in which the cessation of residency occurs. One must, however, always remember the exemptions described above, and in the event that emigration and/or ceasing to be a tax resident is considered, pre-emigration planning is of utmost importance to ensure that a smooth and fluid transition plan is formulated.

This article is a general information sheet and should not be used or relied on as legal or other professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice. Errors and omissions excepted (E&OE)

Are my donations being taxed?

BPR 338 deals with the tax treatment of payments made to a Public Benefit Organisation (PBO) at a fundraising event, under section 30 of the Income Tax Act. The ruling is essentially an interpretation of section 18A of the Act and seeks to clarify the situation for PBOs and funders.

In terms of the transaction, the Applicant (a resident company registered as a PBO) will host an event for the explicit purpose of fundraising, but this event will be managed by a third-party events management company.

As is commonplace, persons attending the events will make payments to participate in activities taking place at the event, as well as make donations. The events management company manages an electronic system that will enable funders and donors to make payments at the event. This system is accessible through various roaming electronic touchscreen devices, developed for the distinct purpose of distinguishing between donations and payments for activities.

By the end of the evening, each attendee is required to settle their required payments in respect of the relevant transactions they entered into, with one single card payment. The system then determines which attendee is entitled to a section 18A certificate, as well as the amount to be reflected on the receipt. Only donations made by attendees are reflected on the section 18A receipt.

One condition and assumption of this ruling is that the payment tracking system must, as closely as practicable, conform to the one proposed and its intended function, accounting for the donations of money separately from payments, must be easily verifiable.

The ruling made by SARS is that donations made and identified as such by the applicant’s payment tracking system at the fundraising event will constitute bona fide donations made to a PBO under section 18A of the Act, and as such, the applicant may issue the donors with section 18A receipts in respect thereof.

This article is a general information sheet and should not be used or relied on as legal or other professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice. Errors and omissions excepted (E&OE)

Section 7C of The Income Tax Act

What is section 7C?
This section of the Income Tax Act is an anti-avoidance measure aimed at transactions between connected persons and trusts, where a trust is funded by low interest or interest-free loans. This is usually done to ensure that assets form part of the trust’s capital, and the funder (who is usually a trustee or founder of the trust) allows for the transfer of ownership of the assets, and the creation of a loan account in said person’s favour.

The sections allow for any loan, advance or credit by a connected person, directly or indirectly to a trust, and this loan, advance or credit incurs no interest, on the loan, advance or credit, or incurs interest at a rate lower than the official rate, an amount equal to the difference between the amount of interest incurred, and the amount it would have incurred had an acceptable interest rate (official rate) been used, will be deemed as a donation in the hands of the lender. For purposes of this section, the same principle applies where a company who is owned by trust loans on terms that are not regarded as commercial or market-related and no interest is charged.

What is the reasoning behind section 7C?
Trusts have traditionally been a very popular estate planning tool. In the past, the practice was to sell growth assets to a trust and to then extend an interest-free loan to the trust for that sale price. That would mean that the estate of the seller would be pegged at that value because the loan would not increase in value as time goes by while the assets would grow in the trust. Section 7C seeks to address this practice, as it is argued such a transaction should be seen as having no commercial sense, as only the trust benefits. The seller earns no interest on the loan and hence derives no value or benefit.

How does section 7C work?
Section 7C deems the interest that is not levied or charged on an interest-free loan, as a deemed donation on the last day of each tax year for a loan that was outstanding for any period during that preceding tax year.

The interest forgone is calculated by using the official interest rate in the 7th Schedule to the Income Tax Act, currently being 7.25%. This would be regarded as a deemed donation on the last day of the tax year and as a consequence donations tax would be levied on that donation.

Where there is a low interest-bearing agreement, the difference of the official interest rate and the lower interest rate will determine the deemed donation.

Trusts and loan accounts

Should I be charging interest on a loan, advance or credit to a Trust?

Making section 7C practical will require the use of a few examples to illustrate its effect.

Example 1

A loan in the amount of R10 million is advanced by an individual to a trust with no interest charged by the lender. The individual will choose to apply his annual donations tax exemption of R100,000.00 to the deemed donation.

The deemed donation will be R725,000 (R10 million x 7.25%). The individual then applies his annual exemption of R100,000.

The donations tax liability will be calculated as follows: R625,000 x 20% = R125,000 which the individual will be required to pay.

Example 2

A loan in the amount of R10 million is advanced by an individual to a trust with an annual interest charge of 5% by the lender. For this example, we will ignore the lenders annual donations tax exemption.

The deemed donation will be calculated as follows: R10 million less x 2.25% (the difference between interest levied and the official rate or 7.25% – 5%). The deemed donation will be R225,000.

The actual donations tax liability is then R225,000 x 20% = R55,000. The lender may now apply his annual R100,000 donations tax exemption.

It is clear that the non-charging of interest, or charging at a lower rate, may result in an increase in personal tax liability for the lender.

This article is a general information sheet and should not be used or relied on as legal or other professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice. Errors and omissions excepted (E&OE)

Valuation of trading stock for tax purposes

On 27 September 2019, just over a year since delivering judgement in another matter with very similar facts, the Supreme Court of Appeal in CSARS v Atlas Copco South Africa (Pty) Ltd (834/2018) [2019] ZASCA 124 gave a judgement on the valuation of trading stock for income tax purposes.

The general (and oversimplified) principle is that taxpayers are allowed, as a deduction, the value of opening trading stock during a year of assessment, while the value of the closing trading stock is required to be included in taxable income. From a tax perspective, the higher the value attributed to closing stock at the end of a tax year, the lower the cost of sales for that year will be and the greater the taxable income of the taxpayer. Conversely, the lower the value attributed to closing stock, the higher the cost of sales and the lower the taxable income for that year. The value of the trading stock is generally the cost thereof, less an amount which SARS may think is just and reasonable as representing a diminishing in that value due to damage, deterioration, change of fashion, decrease in the market value or for any other reason.

Taxpayers often use accounting (or IFRS) values for the determination of stock values. These valuation methods usually involve a time-based approach. I.e. a write-down of stock if it has not been sold for several months. The more the number of months since the stock was last sold, the higher the write down. This approach is often based on internal policies. The court notes (in the previous judgement) that:

“If taxpayers had a free hand in determining the value of trading stock at year-end it would open the way for them to obtain a timing advantage in regard to the payment of tax, by adjusting the value of closing stock downwards. They could by adjusting these values manipulate their overall liability for tax in the light of their anticipations in regard to future rates of tax, future trading results, the need to incur significant expenses in the future and the like.”

The Court finds that IFRS values, based on “net realisable value” are explicitly forward-looking and that using this value for tax purposes, has the effect that expenses incurred in a future tax year in the production of income accruing to or received by the taxpayer in that future tax year, become deductible in a prior year. Whether IFRS values was a sensible and business-like manner of valuing trading stock from an accounting perspective was neither here nor there for tax purposes. The concern was whether it accurately reflected the diminution in value of trading stock. For income tax purposes, the exercise is thus one of looking back at what happened during the tax year in question.

SARS may only grant a just and reasonable allowance in respect of a diminution in value of trading stock in two circumstances. The first is where some event has occurred in the tax year in question causing the value of the trading stock to diminish. The second is where it is known with reasonable certainty that an event will occur in the following tax year that will cause the value of the trading stock to diminish.

It may, therefore, be necessary that taxpayers keep to sets of trading stock valuations: one for accounting purposes and one for tax purposes.

Although often only a timing issue between opening stock (for which a deduction is allowed) and closing stock (which is taxable), it could happen that the assessment in respect of the year during which the deduction applies, may have prescribed by the time the dispute relating to the closing stock matter has been finalised. In such an instance, any difference becomes permanent, and not merely a timing difference. It is therefore advisable that any disputes relating to trading stock be dealt with by taxpayers as a matter of urgency.

This article is a general information sheet and should not be used or relied on as legal or other professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice. Errors and omissions excepted (E&OE)

Capital gain: Calculating your foreign currency

With the fast approaching 2019 tax season, taxpayers who have realised a capital gain in a foreign currency should take note of the special rules that apply to the translation of those gains to Rand.

 

Generally, there are two ways of translating a capital gain or loss into Rand – a “simple method” and a more “comprehensive method”. Under the simple method, the capital gain or loss is determined in the foreign currency and then translated to Rand at the time of disposal. Under the comprehensive method, the expenditure (when acquiring the assets) is converted to Rand at the time it is incurred while the proceeds are translated to Rand at the time the asset is disposed of. The comprehensive method picks up the effect of currency appreciation or depreciation on the cost of the asset.

 

Paragraph 43(1) of the Eighth Schedule to the Income Tax Act applies when an individual disposes of an asset for proceeds in foreign currency after having incurred expenditure in respect of the asset in the same foreign currency. In these circumstances, the individual must translate the capital gain or loss into the local currency by applying the average exchange rate for the year of assessment in which the asset was disposed of or by using the spot rate on the date of disposal of the asset.

 

An individual that buys an asset in one foreign currency and disposes of it in another foreign currency must use paragraph 43(1A) to translate the proceeds and expenditure to the local currency as follows:

 

  • the proceeds into the local currency at the average exchange rate for the year of assessment in which that asset was disposed of or at the spot rate on the date of disposal of that asset; and
  • the expenditure incurred in respect of that asset into the local currency at the average exchange rate for the year of assessment during which that expenditure was incurred or at the spot rate on the date on which that expenditure was incurred.

 

The term “average exchange rate” (in relation to a year of assessment) is defined in the Income Tax Act as the average exchange rate determined by using the closing spot rates at the end of daily or monthly intervals during a year of assessment. This rate must be applied consistently within that year of assessment.

 

For ease of reference (although the use of these exchange rates are not compulsory) SARS provides average exchange rates for years of assessment ending on each month since December 2003 for the following currencies: Australian Dollar, Canadian Dollar; Euro, Hong Kong Dollar, Indian Rupee, Japanse Yen, Swiss Franc, UK Pound and US Dollar. (you can get these at the following link:  https://www.sars.gov.za/Legal/Legal-Publications/Pages/Average-Exchange-Rates.aspx).

 

“Spot rate”, in turn, is defined as the appropriate quoted exchange rate at a specific time by any authorised dealer in foreign exchange for the delivery of currency. For spot rates, as well, SARS has a handy tool for rate conversions: https://tools.sars.gov.za/rex/rates/MultipleDefault.aspx.

 

The conversion of foreign currency gains and losses (primarily when incurred in different currencies), can present a practical difficulty, especially given the volatility of the Rand. Taxpayers are advised to consult with their tax practitioners on the conversion of gains and losses in foreign currency, particularly where these gains and losses are material. Making errors in this regard could lead to substantial penalties.

 

This article is a general information sheet and should not be used or relied on as legal or other professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice. Errors and omissions excepted (E&OE)

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