Difference between revenue and capital



The concept of capital gains, although usually understood by businesspeople and individuals with substantial assets, remains a mystery to the average South African homeowner, says Bill Rawson, President of the Institute of Estate Agents. The first point to grasp, he says, is that the gain only applies once the asset has been disposed of – or on the death of the asset owner. Many people seem to have the idea that they will be assessed or re-assessed once every two or three years. This is not the case. A clear distinction must be drawn between revenue and capital – but the difference is still hotly debated by tax officials and companies. Rent from a property, for example, or interest from a bank account would be counted as revenue – but the sale of other assets producing income might well be regarded as capital. If the asset was acquired with the intention of making a profit at a later date then the proceeds would be revenue. If, on the other hand, the asset was acquired with the long-term prospect of providing accommodation or as a financial investment, such as shares, it would be counted as capital. Rawson says the onus of proving that any amount is capital in nature lies with the taxpayer but is definitely worth doing because capital gains tax profits are generally taxed at a much lower rate than revenue profits. “In the circumstances the declared intention of the taxpayer at acquisition is always important. In some cases it could be acceptable that there are mixed intentions.” Rawson warns that taxpayers who regularly buy or sell property will almost certainly have profits taxed as revenue. If, however, the owner can show his intention is to hold on to the property as an asset for long-term growth, the eventual sale can be deemed to be a capital gain. Also important is the manner in which the asset was financed. If short-term borrowings were used to finance the purchase, the South African Revenue Services (Sars) will usually take the view that the buyer has no intention of holding on for a long-term capital gain. The main exception to capital gains tax, says Rawson, is where the asset was genuinely acquired “for what purpose”. Assets such as primary home, furniture, appliances, computers and motor cars as, therefore, usually exempt from capital gains tax, but assets such as shares, gold coins and boats (more than 10 metres in length) are taxable. Also exempt from capital gains tax are lump sum payments from retirement benefit funds, long-term insurance policies, compensation for injury and proceeds from gambling and competitions. The average homeowner will only face the possibility of being confronted with capital gains tax when he sells his holiday home. The primary residence exclusion, says Rawson, means that the capital gains tax is not payable on the proceeds of selling a private home, unless the capital gain is more thanR1 million or the property is larger than 2 ha, in which case capital gains tax is payable on the excess. The exclusion applies only to people who own their homes in their own names or through special trusts which have been set up for the benefit of disabled people. Rawson says homeowners have been surprisingly lax about getting their homes valued for capital gains tax purposes and warns that it is important because after September 30 it will no longer be possible to use the convenient method of base cost determination of a property’s value. Sars has not yet specifies exactly who should do the valuation – but it seems that an estate agent with a knowledge of the market is acceptable to it, says Rawson. However even is a professional is used, Sars reserves the right to audit and amend the valuation by its own criteria, leaving it up to the asset owner (taxpayer) to appeal against its decision if he wishes. Owners thinking of reducing their capital gains by bumping up their valuations, or getting inflated valuations should note that Sars has inserted loss limitation clauses into the rulings which will make “phantom losses” impossible. Rawson says some people believe a valuation is unnecessary because their homes have low value. They think they will not have to pay capital gains tax when they sell because their capital gain will be less that R1 m. However, they will still have to provide figures on their tax return to show that they qualify for the exemption. The alternative to a valuation are to use the time-based apportionment method, or a formula which deems the base cost of the property to have been 20% of the proceeds. As capital gains tax is calculated on the period of ownership between October 1, 2001 and the date of sale, using this formula could prove “very expensive” if that period is less than 80% of the full period of ownership. Article: Sarah-Jane Bosch first appeared in Cape Times, Property Times Friday January 23, 2004.