Understanding Capital Gains Tax
Many individuals and businesses focus primarily on income and transactional taxes, often overlooking the implications of Capital Gains Tax (CGT). This tax becomes relevant when a capital asset is disposed of for a profit. Understanding why CGT is charged, how it operates within tax legislation, and the key factors to consider can help taxpayers make informed financial and investment decisions. Let us break it down in this week’s article.
Why is Capital Gains Tax payable?
CGT is based on the principle that profits derived from the sale or disposal of assets and therefore it represents a form of wealth increase that should be subject to tax, just like other types of income or profit. The tax ensures fairness within the system by including these gains in the taxable income base, thereby contributing to national revenue for public services and infrastructure.
How does Capital Gains Tax work?
CGT is not a standalone tax but forms part of the normal income tax calculation. When a taxable event occurs, typically through the sale, donation, exchange, or disposal of an asset, any capital gain or loss must be declared in the taxpayer’s annual income tax return.
A capital gain is determined by subtracting the base cost of the asset from the proceeds received on disposal. The base cost includes the original purchase price along with certain allowable expenses incurred in acquiring, improving, or disposing of the asset.
Example:
If a property is purchased for R800,000 and later sold for R1,200,000, the capital gain would be:
R1,200,000 (proceeds) – R800,000 (base cost) = R400,000
This R400,000 would be subject to CGT, after taking applicable exclusions into account.
Key Factors to Consider
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Annual exclusion
Natural persons are entitled to an annual capital gains exclusion. For the current tax year, the exclusion is R40,000. This means the first R40,000 of total capital gains realised within a tax year is exempt from CGT.
In the event of death, the annual exclusion increases to R300,000 for the year of death.
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Inclusion rate
After applying any exclusions, a portion of the remaining capital gain, known as the inclusion amount, is added to taxable income, according to specific inclusion rates:
- Individuals and special trusts: 40%
- Companies: 80%
- Other trusts: 80%
This inclusion amount is then taxed at the applicable marginal income tax rate.
Example:
Using the earlier property sale example:
- Capital gain: R400,000
- Less annual exclusion: R40,000
- Net capital gain: R360,000
At a 40% inclusion rate for an individual:
R360,000 × 40% = R144,000
This R144,000 is then included in taxable income and taxed at the individual’s marginal rate. If the marginal rate is 31%, the tax payable would be:
R144,000 × 31% = R44,640
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Primary residence exclusion
Where a property qualifies as a primary residence, the first R2 million of the capital gain is excluded from CGT, provided certain criteria are met. These include that the property must have been used predominantly for domestic purposes and personally occupied by the taxpayer.
Example:
If a primary residence is sold with a capital gain of R2.5 million:
- Less primary residence exclusion: R2,000,000
- Taxable capital gain: R500,000
- Less annual exclusion: R40,000
- Net capital gain: R460,000
At a 40% inclusion rate:
R460,000 × 40% = R184,000
This amount would then be included in taxable income for that year.
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Assets subject to CGT
CGT applies to a wide range of assets, including:
- Fixed property (subject to primary residence provisions)
- Shares and unit trusts
- Cryptocurrency
- Business assets
- Certain personal-use items (though some personal-use assets like motor vehicles used privately are typically exempt)
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Timing of disposal
CGT is triggered at the point of disposal, which occurs when ownership changes hands or a legally binding agreement is signed, not necessarily when payment is received.
CGT plays a critical role in ensuring a balanced and equitable tax system by including profits from the disposal of assets within taxable income. Understanding how CGT is calculated, what exclusions apply, and how it integrates with other tax obligations can assist taxpayers in managing their financial affairs more effectively.
Proper planning, awareness of applicable exclusions, and careful timing of disposals can help minimise CGT liabilities. It is advisable to seek guidance from a qualified tax practitioner or financial adviser for advice tailored to individual circumstances.