Changes to the safe-haven tax provisions applicable to the sale of shares

The legal principles governing the taxability of profits from the disposal of shares have always been complex.

Prior to the introduction of capital gains tax (CGT) in 2001, profits from the sale of shares were subject to income tax if the taxpayer was a share-dealer or disposed of the shares in a scheme of profit making. But if the profits were of a capital nature, they were not taxed at all.

Since the introduction of CGT, the profits from the disposal of shares are subject either to income tax or to CGT.

Gerald Seegers, tax partner at PricewaterhouseCoopers SA, says that as the rate of CGT is lower than income tax, most taxpayers would prefer, if it is possible, to arrange their affairs so that their profits are subject to CGT, rather than to income tax.

The “old section 9B of the Income Tax Act

In terms of section 9B of the Income Tax Act, where the shares in question were listed on the JSE and the taxpayer had held them for a continuous period of at least five years, the taxpayer could elect, at the end of the tax year in which he sold them that the profits be subject to CGT. By making such an election, the taxpayer avoided the risk that SARS might take the view that he was a share-dealer or engaged in a scheme of profit making and might levy income tax on the profit.

Seegers says that the availability of this election was particularly beneficial to taxpayers who were indisputably share-dealers, and who would therefore normally have been subject to income tax on the profit from the sale of shares. Such taxpayers could also elect, in terms of section 9B, to be assessed to CGT on the profit from the sale of the shares – but only if the shares were listed on the JSE and if the taxpayer had held them for five years or longer.

The downside to such an election was that it bound the taxpayer permanently in relation to all JSE-listed shares that he held for five years or longer. The election offered by section 9B did not apply to shares in non-listed companies or to other types of equity interests.

Moreover, says Seegers, the election was available to a taxpayer only once – namely, on the first occasion that he sold JSE-listed shares he had held for five years or longer. Once made, the election bound the taxpayer for all future tax years in respect of the sale of such shares.

If the taxpayer failed to make the election, offered by section 9B, on the first sale of JSE-listed shares held for five years or longer, he would, for all time, forfeit the right to make any such election in the future in relation to JSE-listed shares held for five years or longer. Consequently, if a taxpayer who did not avail himself of the election wished to contend vis-à-vis later transactions that his profit on the sale of such shares was of a capital nature, and therefore subject to CGT rather than income tax, he would bear the onus of proof in this regard, and might find himself in a dispute with SARS which could only be resolved by the tax court.

In short, therefore, the section 9B provision was available in respect of JSE-listed shares held for a minimum of five years, and the taxpayer was given the choice of electing to be assessed to CGT on the disposal of such shares.

In terms of the Revenue Laws Amendment Act 35 of 2007, promulgated on 8 January 2008, section 9B is henceforth to apply only to shares, which were disposed of before 1 October 2007. In relation to shares disposed of on or after that date, a new section 9C, summarised below, will apply.

The new tax rules under section 9C

A new section 9C of the Income Tax Act will apply where shares are disposed of on or after 1 October 2007, and will determine the tax consequences of such a disposal.

In terms of section 9C, the disposal of shares on or after 1 October 2007 will be governed by the following rules–

• the new rules will apply to “qualifying shares” which the taxpayer has held for a continuous period of at least three years prior to disposal;
• “qualifying shares” means all equity shares except shares in a share block company, shares in a non-resident company (unless it was a listed company) and hybrid equity instruments;
• as an anti-avoidance measure, the new provisions will not apply to qualifying shares where, at the time of disposal, the taxpayer was a “connected person” in relation to the issuing company and certain further defined circumstances were present;
• the new provisions will apply automatically, and no election will be available to the taxpayer as was the case under the old section 9B;
• any amount received by or accruing to a taxpayer as a result of the disposal of qualifying shares will be deemed to be of a capital nature and will thus be subject to CGT;
• in the tax year when a qualifying share is disposed of by the taxpayer, any expenditure or losses incurred in respect of such share and allowed as a deduction in that tax year or any previous year will be included in the taxpayer’s income.

The main features of the new section 9C are therefore that it is to apply to all shares (including shares in private companies and members’ interests in close corporations) other than the stipulated excepted categories of shares, which were disposed of on or after 1 October 2007 and which were held for a continuous period of at least three years prior to disposal. Any amount received by or accruing to a taxpayer as a result of the disposal of qualifying shares will automatically be deemed to be of a capital nature and thus be subject to CGT.