Capital Gains Tax: briefing by SARS

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Finance Standing Committee

23 January 2001
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Meeting report

FINANCE PORTFOLIO AND SELECT COMMITTEE
24 January 2001
TAXATION LAWS AMENDMENT DRAFT BILL: BRIEFING BY SARS

Chairperson: Ms B Hogan (Portfolio Committee); Ms D Mahlangu (Select Committee)

Document handed out:
SARS Presentation Document

SUMMARY
The Ministry issued a statement that the extension on the implementation date of CGT is not definite. An appropriate period may be considered if it is necessary to do so. Those who request the extension period will have to prove their case to the Treasury.

SARS briefed the committee on the intricacies that are to found in the proposed Bill. Much of the explanation revolved around how CGT would affect the average citizen. Regarding the fact that owners of assets would be valuing their own assets, SARS pointed out that SARS reserves the right to reject a valuation if it is unreasonable. Some personal use assets are subject to CGT (example: boats and aeroplanes). It appears that if a capital gain arises from the sale of these assets, then it falls into the CGT system. However if a loss arises from the sale of these assets then this loss is not allowed as a deduction. The DP pointed out this disparity and noted that it seemed inequitable. SARS did not provide the rationale behind the rule responding simply that it was accepted international practice.

MINUTES
Statement by the Ministry
The media misinterpreted the Treasury's comments (made the day before) on the possible delay on the implementation of CGT. SARS and the Ministry issued a statement to clarify their position. The statement notes that the extension on the implementation date is not definite. An appropriate period may be considered if it is necessary. Those who request the extension period will have to prove their case to the Treasury.

Presentation by SARS (Mr Kosie Louw)
Introduction
There has been criticism that SARS released the draft Bill too late. Mr Louw explained that they released it as early as they could as they had many other budget proposals that they had to deal with last year. SARS also tried to consult on the Bill as widely as possible.

Many submissions have been received and they hope to develop a response document.

There have been many internal drafts of the Bill. In developing these SARS had international assistance. Professors from the UK, the US, and Australia assisted them. The IMF also played an extremely useful role when 3 members visited SA to evaluate CGT proposals. (Mr Andrew requested that the report of the IMF be made available to the commitTee).

The core reasons for introducing CGT are to bring about horizontal and vertical equity. One must not simply consider the direct revenue which will come from CGT. It is designed to supplement other taxes, example income tax.

An example of this is:
Transfer duty: houses are often held in trust and held by companies to avoid paying transfer duty on them when they are sold. However now CGT will apply to these circumstances.

CGT forms part of the tax systems of both developed and developing countries.

Mr Louw noted the difference between taper relief and indexation. Taper relief considers the length of time that the person held the asset. The longer the asset is held the smaller the portion of the gain included becomes.

In Canada for example there is no taper relief, they only include 60% of the gain. The UK includes the full gain with taper relief (a different percentage is used for business and private assets).

Various commissions have been established to give views on the implementation of CGT ranging from the Franszen Commission in 1969 to the Katz Commission in 1995. In its third report the Katz Commission acknowledged the case for CGT but felt that there was not sufficient administrative capacity at that time to deal with the complexity of the tax. In 1997 SARS became a separate organ of state. As a result of this SARS has been able to enhance its administrative capacity as recommended by the Katz Commission.

Intricacy of legislation - oversimplifying the fiscal legislation can result in a loss of precision. Therefore one must try to attain a balance between simplicity and precision.

The draft Taxation Laws Amendment Bill
CGT can be approached in various ways. In the UK it is a separate tax, in the USA and in Australia it is incorporated into the income tax system.

In South Africa CGT has been integrated with the income tax system. It is not handled separately like in the UK for example. Previously there was a big distinction between capital and revenue. This needs to change to a definition of income on a wider basis.

The tax will be residence based (therefore the resident will be taxed on gains made within and outside of SA).

Non-residents will be taxed on their gains in SA. There are some exemptions to this, for example, immovable property. Shares on the JSE do not form part of CGT (this applies only to non-residents).

Question: Mr Andrew (DP) asked SARS to explain the reasoning for this. Mr Louw replied that this is not unique to SA, it is the way international tax works. The reason is for administrative concerns. A foreigner has no link to the country therefore they cannot tax the shares. If a foreigner has a business then they can tax the assets. Sometimes the distinction between the two is artificial but the standard is used throughout the world.

Mr Louw explained the difference between inclusion rate and effective rate.
Inclusion rate: this is the portion of the gain that is going to be taxed (25% for individuals). The effective rate must then be applied to this.
Effective rate: Example: if there is a gain of R400 for an individual. 25% of this will be taxed. This equals R 100. The statutory rate is then applied to this amount (statutory rates have been set by the Minister). If there is a statutory rate of 42% then you say 42% of R100 = R42. R42 as a percentage of the full R400 gain = 4.5%.
This 4.5% is then the effective rate.

There are set statutory rates. Examples are: individuals (0 - 42%), unit trusts (30%), ordinary companies (30%) etc.

Eighth Schedule (Parts I - IV)
This is a new schedule which consists of XII parts.

Part I: Definitions
Two of the core definitions are:
Asset - they made the definition as wide as possible. It includes movables, immovables, tangibles and intangibles.

Disposal - this is a crucial definition because it is the event that will trigger CGT. They will not tax on an accrual basis but on a realisation (when the asset is sold) basis. The proceeds upon sale is taxed. The base cost (expenditure) is subtracted from the selling price and the result is the capital gain.

Part II: Taxable capital gains and assessed capital losses
Capital gain and loss (clauses 3 and 4)
The capital gain is added to the normal taxable income. It there is no gain then one must assess the capital loss. The assessed capital loss can be ringfenced (set off against capital gain). One can never set off capital loss against normal revenue BUT normal revenue loss can reduce capital gain. The revenue loss will shield the capital gain.They are only going to tax 25% of the capital gain.
Capital loss can set off capital gain. Revenue loss can set off capital gain. Capital loss can never set off normal revenue.

Annual exclusion (clause 5)
In terms of the CGT system all capital gains which are less than R10 000 are not going to be taxable. The reason why this annual gain has been taken out of the system is to reduce the administrative burden.
This also applies to losses under R10 000. This is to add simplicity to the system. Small losses cannot be carried forward because it is too much of an administrative burden.

Assets acquired before the implementation date are in the CGT system but they will only tax the gains which are realised after the implementation date.

Part III: Disposal and acquisition of assets
They tried to incorporate any event which causes the transfer or extinction of an asset as a disposal.

Part disposals (clause 12)
Part disposals of assets are also dealt with. Clause 12 deals with this and sets out the rules to apportion the base cost and proceeds in the case where only part of an asset has been disposed of.

Events treated as disposals and acquisitions (clause 13)
Certain events are also treated as disposals. This is referred to as deemed disposals. With such events they need rules to decide which base cost must apply. Examples of such events are:
1) Emigration. If one emigrates for example then this is considered a deemed sale. The market value of shares is deemed to be the price of the shares. If one emigrates certain assets will be excluded from the deeming rule example immovable property. This is because non-residents can be taxed on immovable property. Because this right is retained it is not necessary to charge them an exit fee through deeming that a sale has taken place.

Question: Mr Andrew (DP) referred to immovable property held by someone who is no longer a resident. An exit fee is not charged. In light of the coming change in exchange controls how will SA police the sale of this immovable property so that it can be taxed in SA?

Mr Louw replied that immovable property would be easy to monitor because when it is sold it must be registered in the deeds office. This is a formal legal process. There will be a link between the transfer duty system and the CGT system.

2) Where an asset was held as a capital asset and now becomes held as trading stock. When does this happen? If a builder builds houses to sell then this is part of his trading stock. He also has houses which he keeps for his own dwelling or for investment. He decides to include these in his trading stock.
In such instances the government has to lay an exit charge or they will lose the revenue off that asset forever.

Question: Mr Andrew asked how agricultural livestock is treated.
Mr Louw replied that the valuation is different from normal business assets where the closing values are applicable. With livestock there are standard values which are applicable to particular livestock. There is even depreciation of animals.

Time of disposal (clause 14)
Clause 14 sets out what time an asset is considered to be disposed of certain circumstances such ass a conditional agreement or when there has been the granting of an option.

Ms Fubbs (ANC,Gauteng) referred to clause 14 (time of disposal) and commented that an unconditional agreement is deemed to have gone through the date upon which the agreement is concluded. What about problems encountered in receiving funds? The money could possibly only be received in the following tax year. The money is not actually realised yet.

Mr Louw replied that this clause relates to time. The issue Ms Fubbs was raising was not related to CGT specifically but it was a normal tax principle. Money is taxed on receipt or accrual. This is not arising from CGT it is a principle of taxation. Accrual is an entrenched principle in tax.

Mr Andrew asked for clarity on the granting of an option as being a deemed disposal. Mr Louw replied that the deemed disposal of an asset is triggered by the granting of an option.

Part IV: Disregarded disposals and limitation of losses

Aircraft, boats and certain rights and interests (clause 17)
Personal use assets: these are for domestic and personal use and are therefore not subject to CGT. Things such as furniture and appliances are excluded. These assets are consumed over time so the value will just go down. It will just generate losses.
A number of personal use assets will be kept in the system. Examples are immovable property, shares, boats, aircraft, and major assets. These are the ones which can have an increase in the value.

Capital losses for assets set out in clause 17 will be disregarded. If however you make a gain then it will be in the system but the loss will not qualify. Examples of such assets are boats and aircraft.

Mr Andrew asked what would happen if a person owned a boat for example. Why is the tax gain in the system but not the loss. He asked where the equity in that was.
Mr Louw replied that personal use assets are not used to produce income. Therefore they do not allow the loss but they allow the gain. This is an international concept which is applied to personal use assets. ''There are not always clear principles for CGT''.

Professor Engel (from the United States; advisor to the National Treasury) added that most countries always tax the gain and never allow a deduction for the loss. with clothes for example one cannot claim a loss because this would mean that one is allowed to depreciate their clothes. The asset is consumed therefore it is devalued. No deduction for personal consumption is allowed. Technically all personal use items should be out but bigger objects like boats are included.

Mr Durr (ACDP) asked how personal use assets are valued.
Mr Louw replied that if those that are out of the system do not need a value.
If it is in the system then the owner has a choice of either a personal valuation or he could use the time-apportionment basis.
If the items are trading stock then CGT is not applicable.

Designated Intangible asset (clause 18)
On disposal of intangible assets, a loss realised prior to the valuation date will be disregarded. This is because it is easy to manufacture losses therefore these losses will be disregarded.

Forfeited deposits (clause 19)
Personal use assets: if a deposit has been paid and the deal falls through then one cannot claim the lost deposit as a loss.

Securities lending (clause 20)
These are big in the retirement industry (loan of consumption). Here ownership passes to the borrower when lent.

Straddle transactions (Clause 21)
Straddle transactions occur when people manufacture huge losses before the year end and they conceal other gains. It is a manipulation of the system. Therefore they have a rule on this. This clause sets out circumstances where losses will be disregarded.

Part V: Base cost and proceeds
Mr Louw listed the three components of base cost as the following:
· Acquisition cost
· Directly related to acquisition and disposal
· Improvements

Dr Conroy (NNP, Gauteng) asked whether maintenance costs would form part of base cost.

Mr Louw stated that the question would be answered in the section he was about to commence with. He explained that there were certain exclusions from base cost and they are the following:
Borrowing costs eg. Interest and finance charges. Mr Louw stated that only capital gains would be taxed and illustrated this by way of an example of a house. The purchase price and any improvements to the house would be taxed, whereas normal repairs to maintain the house would not be taxable. Mr Louw conceded that there was no hard and fast rule to make the aforementioned distinction, it would be done on a case by case basis. Expenses already deducted for income tax purposes.

Mr Louw stated that assets acquired before 1 April 2001 (commencement date of CGT) would be taxed according to their market value or a time apportionment schedule. Mr Louw explained that in the event that no records exist to pinpoint the time of acquisition of an asset, the 20 % rule would apply. He pointed out that the general principle to follow when making valuations, is the asset's market value. The onus is on the owner of the property to make the valuation or to pay an appraiser to do it. With listed shares, however, the valuation would be according to their value 5 days preceding 1 April 2001.

Deviation: When a person dies CGT is triggered. The property in the estate is valued at market value. Transfer of the property from the deceased to the estate encompasses a tax being levied on the estate. Similarly when the property is transferred from the estate to an heir a tax is also payable.

Mr Louw stated that CGT must not be seen as a complete substitute for estate duty. CGT only places a tax on a gain, whereas estate duty is a tax on the whole estate. He added as a matter of interest that they intend to decrease estate duty rates.

Questions:
Mr Andrew (DP) asked for clarity on raising fees and the 20% disposal of assets rule. He also asked whether all subjective valuations by owners of property are acceptable.

Mr Louw replied that if the raising fees are for private property then it would be excluded but if it were for trading property it would be taxed. He added that as far as valuations are concerned the general rule would be to use the market value or the time apportionment schedule. Only in the case where no records on the property exist would the 20% rule apply. Mr Louw explained that they have to be flexible on the issue of valuations, as the majority of the broader public would not be able to afford the of an appraiser. He did make the point that SARS has the right to reject a valuation if it is unreasonable.

Mr Fankomo (ANC) asked what would be deemed the value for tax purposes if a person sold a house with a market value of R200 000 to a family member for the mere sum of R10 000.

Mr Louw replied that it would be deemed to be sold for R200 000.

Mr Durr (ACDP, Western Cape) asked if either a husband or wife passes away would they have to pay CGT from the deceased estate.

Mr Louw answered that there are exclusions relating to spouses.

Ms Fubbs (ANC, Gauteng) asked what happens to the valuation of a property if it fluctuates from year to year due to external forces such as crime or squatters. Would the valuation be made on a year to year basis?

Mr Louw stated that the valuation issue is transitional and it only applies to property acquired before 1 April 2001. He added that it is only used in determining the base cost. Mr Louw however stressed the importance of knowing the market value, as it would be the guiding factor.

Part VI: Primary residence exclusion
Mr Louw explained that with primary residences the general principle is to disregard capital gain and capital loss. He added that they have included an occupation rule per person.
Mr Louw elaborated further on the exceptions to paying CGT as they relate to primary residences:
Apportionment in respect of periods of absence
He stated that where a person sells an interest in a primary residence and such person was not ordinarily resident in that residence throughout the period on or after the valuation date during which that person held the interest then that portion of the capital gain or loss to be disregarded shall be determined with reference to the portion of that period during which that person was so ordinarily resident.
Disposal and Acquisition of primary residence
Mr Louw stated that they have made provision for a 2-year rule in the Bill that enables a person who puts his residence up for sale to be deemed to be ordinarily resident in that residence for a continuous period not exceeding 2 years if in fact he is living somewhere else at the time.eg A person who gets a job offer in another city and has to put his house up for sale.
Rental periods
The Bill also provides for a person to treated as being ordinarily resident in a residence even if such person is letting the property for a continuous period of not exceeding 5 years provided that such person was ordinarily resident in such property for at least 1 year prior to this 5-year period.

Mr Louw emphasised that where a property is being used for both business and residential use the property needs to be apportioned for tax purposes.

Part VII: Other exclusions
The Bill lists assets to which CGT would apply. Those that are excluded are as follows:
· Personal use assets
Collectables like jewelry and paintings are regarded as personal use and excluded from CGT.
· Assurance and retirement benefits
Payouts from these types of schemes are exempt from CGT.
· Small Business exclusions
Small businesses are excluded on the assumption that in most cases small business owners have a little nest egg for retirement.
However there is a cap of R500 000 and one must have held the asset for 5 years. The exemptions apply to any small business whether it is a sole proprietor or a close corporation.
· Personal injury/defamation claims
· Prize monies won in South Africa
· Conversion of foreign currency if utilised for personal use
· Insurance proceeds so as to prevent double taxation

Questions:
Mr Andrew asked if a person winning the national lottery would be taxed. Also would bonuses for wins received by professional sportspeople be taxable?

Mr Louw answered that lottery wins would not be taxed but the bonuses received by sportspeople would be taxable as it forms part of the individual's income.

Dr Rabie (NNP) asked how gross asset value is determined.
Mr Louw replieded that it is the value before you have settled your liabilities.

Mr Rabie asked if this is in line with international best practice.
Mr Louw stated that it is a policy issue and that SARS does not necessarily have to follow international trends.

Part VIII: Roll-overs and Attribution rules
The instances where a roll-over would apply are:
Involuntary disposal - The theory is that if an asset is disposed of involuntarily the taxation of the gain would be delayed until the individual disposes of the replacement asset.
Reinvestment in similar asset - At the time of sale of an asset an individual would not be taxed as he purchases a similar asset. The individual's gain on both assets is therefore spread over a 5-year period. Example: sold Asset 1= R20; bought replacement asset 2 = R200. Thus total gain = R20+R200= R220
Spread over 5 years = R220/5 years=R44 per year is taxable

Mr Louw stated that they have listed the Attribution Rules in the Bill. He did however wish to point out that the burden is on the donor to pay the tax on the gains.

Question: Prof Turok asked if there is any provision in the Bill relating to disclosure of information for attribution rules such as for lawyers. Does the Act not rely on the co-operation of various professions?
Prof Keith Engel (US advisor to the National Treasury) stated that the provisions of the existing Act would still apply on these issues.

Part IX: Companies and shareholders
Mr Louw stated that this part of the Bill essentially sets out the anti-avoidance rules as they relate to the following:
· Dividends declared by non-listed company
· Dividends declared by listed company
· Reduction and redemption of share capital and share premium
· Liquidation or de-registration of companies

Part X: Trusts and Insolvent Estates
The general principle is that a beneficiary in a trust is deemed to have a vested right in the ownership of any trust property. Therefore in the event of any property being disposed of, the gain forms part of the income of the beneficiary. Mr Louw stressed that there are no exclusions that exist in this respect.

Mr Louw made the brief point that for tax purposes the insolvent and the estate is deemed to be one and the same person.

Part XI: Anti-avoidance
The criteria for anti-avoidance are set out in Clause 103(1) and that subsection (2) sets out how losses are to be assessed.
SARS are still working on value shifting.

Part XII: Miscellaneous
If an asset does not reflect the true market value, then SARS would be looking at the base value of the first person who sold it. This is only a transitional measure.

Specific Industries:
·
Unit Trusts - where unit trusts are sold, SARS will tax the unit holder. Foreign and local unit trusts are treated the same.
· Insurance Industry - The same rules applying to trusts also apply to the insurance industry. I.e. the insurance company pays the tax.

Mr Louw briefly stated that they are in the process of making amendments to the following:
· Estate Duty
· Donations tax
· Rationalisations and Unbundling

The meeting was adjourned.

______________________________________________________________

Capital Gains Tax in South Africa
Briefing by the National Treasury's Tax Policy Chief Directorate
to the Portfolio and Select Committees on Finance
Wednesday, 24 January 2001

1. Introduction
In the 2000 Budget, the Minister of Finance announced the introduction of a capital gains tax with effect from 1 April 2001 as part of a wider tax reform effort aimed at enhancing the integrity, efficiency and equity of the South African income tax regime. This seeks to address some of the existing avoidance opportunities such as recharacterising ordinary (taxable) revenue into capital revenue, thereby escaping the tax net. Hence, the introduction of a capital gains tax serves as a backstop to the income tax system, which enables the fiscus to broaden the tax base and ultimately reduce the rate structure, for a given revenue requirement.

The idea of taxing capital gains is not new in South Africa. In 1969, the Franzsen Commission proposed a limited form of capital gains tax on immovable property and marketable securities, while the Margo Commission in 1986 recommended that capital gains should not be taxed. Most recently, the Katz Commission considered the merits and demerits of a capital gains tax in South Africa. It declined to make firm recommendations in view of the complexity of its administration and the lack of capacity of the Inland Revenue at that time.

This submission seeks to place the capital gains tax in context. Many of the issues raised are the subject of ongoing policy analysis and difficult policy trade-offs as the capital gains tax legislation is being prepared.

2. Capital Gains Tax and the Fiscal Framework
Since 1994 the South African fiscal authorities embarked on systematic structural adjustments, thereby rectifying a series of macroeconomic imbalances. These fiscal reforms translated into a marked reduction of inflationary pressures and fiscal deficits. In line with the macroeconomic adjustments, real GDP growth improved to an average of 2.3 per cent per year over 1995 to 1999 as compared to 0.2 per cent over 1990 to 1994.

In future years, the main macroeconomic and fiscal challenge remains to increase economic growth in order to address the serious unemployment, poverty and related crime problem. Needless to say, robust growth needs to be underpinned by increases in savings and investments.

Fiscal restraint translated into National Government's systematic reduction of the deficit before borrowing from 5 per cent of GDP in 1994/95 to approximately 2 per cent for 1999/2000, and rising slightly to an estimated 2,5 per cent for 2001/02. This impressive improvement can largely be ascribed to strong revenue collection performance, which was backstopped by attractive and effective tax reform initiatives and improved tax administration. Indeed, the combination of these policy prompts was singularly aimed at improving the efficacy and efficiency of the South African tax system.

The tax reform agenda was initiated by the new Government and was executed under the able leadership and wisdom of the Katz Tax Commission. The Commission's work was largely informed by the global paradigm shift of eliminating tax incentives or preferences throughout the tax codes, thereby enabling tax base broadening that could finance a marked reduction of tax rates in the field of the personal and corporate income tax systems. The principle behind the attractiveness of a low rate tax system is that it makes tax-planning activities less lucrative, thereby freeing up scarce human resources in any economy. Moreover, an overall lower rate structure would address effectively distortions in the economy that result from certain sectors enjoying huge tax privileges, which per definition must lead to an over-investment in those sectors as investment risks are artificially being lowered.

2.1 Composition of national taxes
The standard corporate tax rate was reduced from 40 to 30 per cent (15 per cent for small and medium-sized enterprises, whilst personal income tax benefited from rate reductions, scrapping of tax brackets and by reducing the compression within the brackets.

Table 1 Composition of national tax revenue



Tax instrument

1983/84

1989/90

1994/95

1999/00 (preliminary actual)

2000/01 (revised)

2001/02 (revised)

Direct taxes

 

 

 

 

 

 

Persons and individuals

30,1

30,9

39,6

42,8

40,7

40,4

Gold mines

8,9

1,6

1,0

0,1

0,1

0,1

Other mines

1,0

2,8

0,4

0,3

0,4

0,4

Companies (other than mines)

17,1

17,0

10,5

10,2

10,7

10,9

Secondary tax on companies

0,0

0,0

1,1

1,3

1,4

1,4

Tax on retirement funds

0,0

0,0

0,0

2,9

3,0

3,0

Donations tax

0,0

0,0

0,1

0,0

0,0

0,0

Estate duty / inheritance tax

0,5

0,1

0,1

0,2

0,2

0,2

Other

1,7

0,9

1,0

0,3

1,2

1,9

Total - Direct taxes

59,3

53,3

53,9

58,1

57,7

58,3

Indirect taxes

 

 

 

 

 

 

Value-added tax / General sales tax1

20,5

25,9

25,8

24,0

24,6

24,9

Excise duties

9,3

4,4

5,1

4,7

4,5

4,5

Fuel levy

0,9

6,3

7,4

7,1

7,0

6,8

Customs duties and import surcharges

6,9

7,4

4,8

3,2

3,7

3,1

Marketable securities tax

0,2

0,4

0,4

0,5

0,6

0,6

Transfer duties

1,7

1,0

1,2

0,9

1,0

0,8

Stamp duties and fees

1,1

1,1

0,8

0,8

0,8

0,8

Other

0,2

0,1

0,6

0,7

0,1

0,2

Total - Indirect taxes

40,7

46,7

46,1

41,9

42,3

41,7

Total tax revenue

100,0

100,0

100,0

100,0

100,0

100,0

1. Value-added tax replaced the General Sales Tax in 1991.


The Fiscus realised its revenue targets with ease. National Government or Main Government Revenue is estimated to amount in 2000/01 to R216,4 billion or 24,1 per cent of GDP. Taxes on income and profit are responsible for almost 60 per cent of the total revenue take of which individual income tax contributes close to 41 per cent of total revenue, the single most important revenue source for Government. It is important to note that the revenue importance of corporate income tax in total tax revenue evidences a long-term decline to approximately 10 per cent in 2000/01, whereas it used to generate up to 17 per cent of total tax revenues in 1983/84.

The introduction of capital gains tax therefore will seek to adjust a fundamental weakness in the South African tax system as it will minimise the significant arbitrage opportunities that exist for avoiding tax through the recharacterisation of ordinary taxable income or revenue streams into untaxed capital gains. As corporations, especially the sophisticated players in the local financial markets, are commonly the well-advised taxpayers it is obvious that the introduction of capital gains tax will seek to reduce the high tax burden on individuals and to shift the tax burden more equitably across the different categories of taxpayers. As pointed out in the IMF Report, this is an additional, necessary and long overdue base-broadening exercise, which eliminates the current zero-rated income tax on capital gains income.

3. Rationale for taxing capital gains
Economic policy often involves important trade-offs. Tax policy is no exception. As Stiglitz (1988, pp 478-479) notes:
"The optimal tax structure is one that maximises social welfare, in which the choice between equity and efficiency best reflects society's attitude toward these competing goals."
The introduction of a capital gains tax is most often justified on fiscal equity grounds, but other criteria are also important. International best practice strongly suggests that capital gains should ideally attract the full income tax as other forms of income as the continued preferential treatment of capital gains will perpetuate avoidance and decline in tax morality by the low income taxpayer who cannot afford the use of tax advisers. It widens the income tax base, secures the existing base by limiting tax avoidance activities, improves equity and reduces investment distortions.

3.1 International trends and practice in applying the income tax on the basis of the comprehensive income concept
Many jurisdictions accept the soundness of the 'comprehensive income' concept as the ideal tax base. This approach was outlined by Haig and Simons and means that the total sum of all revenue streams over the tax period should be included in the income tax base as it constitutes increases in the purchasing power of a taxpayer. Capital gains represent one of these income streams and should attract the same income tax charge as all other revenue streams. Taxing capital gains is therefore relatively common internationally. In 1996, New Zealand was the only OECD country that did not tax capital gains explicitly, though as Oliver (2000: 2) notes:
"[I]t seems a bit simplistic to describe a tax system as one that does or does not tax capital gains. Any income tax that left all capital gains tax-free would be unworkable".
In reaction to the circulated Draft Taxation Law Amendment Bill on the introduction of capital gains tax provisions, the argument was put forward that the introduction of capital gains tax provisions would be impractical and inappropriate in the case of developing countries and went even further by suggesting that indeed many developed countries are in the process of phasing out capital gains tax. However, numerous cross-country comparative studies clearly refute these claims. Table 2 outlines the respective CGT regimes in both developed, middle income and developing countries. The analysis is based on the most recently published and comparable tax legislation information available.

Table 2: Cross-country review of CGT systems - AFRICA

Country

Max Corp CGT Rate

Max Corp Rate

Max Individ CGT Rate

Max Individ Rate

Comment on CGT
* In respect of individuals, for rates indicated in the format A/B, A is the rate for non-entrepreneurs and B is the rate for entrepreneurs.

Algeria

30

30

40

40

Some long-term capital gains are subject to 35% inclusion rate

Bênin

38

38

35/40

35/40

 

Botswana

15

15

25

25

Shares/debenture of public companies are exempt. 50% inclusion rate for property other than immovable property

Burkina Faso

40

40

15/40

30/40

CGT on real property is 15%

Burundi

45

45

60

60

 

Cameroon

38.5

38.5

25

Unclear

 

Central Africa Republic

46

46

65

65

 

Chad

45

45

65

65

Real property is taxes at 25%

Congo (Brazzaville)

45

45

50

50

 

Congo Dem. Rep

40

40

35/40

35/40

 

Egypt

40

40

2.5/40

32/40

Securities exempt. Individuals are only subjected to real estates at 2.5%

Eritrea

Unclear

35

Unclear

38

 

Ethopia

30

35

30

40

Limited to shares & bonds and urban houses

Gabon

35

35

55

55

 

Gambia

25

35

15

35

 

Ghana

5

35

5

35

 

Guinea

-

-

-

-

Information unavailable

Guinea - Bissau

-

-

-

-

Information unavailable

Cotê d'Ivoire

35

35

25

60

 

Kenya

n.a

32.5

n.a

32.5

CGT suspended on 14 June 1985

Lesotho

n.a

35

n.a

35

 

Libya

-

-

-

-

Information unavailable

Madagascar

30

35

30

35

 

Malawi

38

38

38

38

Listed shares are exempt

Mali

-

-

-

-

Information unavailable

Mauritania

40

40

40

55

 

Mauritius

n.a

35

n.a

28

 

Morocco

39.6

39.6

10

44

 

Namibia

n.a

35

n.a

36

 

Niger

45

45

30

52/30

 

Nigeria

10

30

10

25

Disposal of shares/stocks are exempt

Senegal

35

35

50

50

 

Seychelles

n.a

40

n.a

n.a

 

Sierra Leone

Unclear

40

Unclear

45

 

Somalia

-

-

-

-

Information unavailable

Sudan

10

45

10

30/45

Limited to real estate & motor vehicles

Swaziland

n.a

37.5

n.a

39

This information is in respect of 1996

Tanzania

n.a

30

n.a

35

Abolished in 1996. CGT was only on real estate.

Togo

40

40

55

55

 

Tunisia

n.a

35

15

35

Limited to shares in property companies and real estate.

Uganda

30

30

n.a

30

CGT is only on business assets

Zambia

35

35

30

30

 

Zimbabwe

20

35

20

40

Limited to immovable property & marketable securities. Listed securities taxable at 10%


Table 2 continued: ASIA

Country

Max Corp CGT Rate

Max Corp Rate

Max Individ CGT Rate

Max Individ Rate

Comment on CGT

American Samoa

U.S

35

U.S

39.6

CGT based on U.S federal system

Australia

36

36

47

47

 

Bangladesh

25

40

25

25

Listed shares and stocks are exempt

Belau

-

-

-

-

Information unavailable

Bhutan

Unclear

30

Unclear

30

 

Brunei

n.a

30

n.a

n.a

 

Cambodia

20

20

Unclear

20

 

China, Peoples' Rep.

20

30

20

45

Shares of listed companies exempt from individual income tax

Cook Islands

20

20

37

37

 

Fiji

n.a

35

n.a

35

 

French Polynesia

50

50

20

Unclear

Individuals limited to real property & CGT depends on asset holding period.

Guam

U.S.

46

US

50

CGT based on U.S federal system

Hong kong

n.a

16

n.a

17

 

India

20

35

20

30

 

Indonesia

30

30

30

30

Listed shares and real estate are exempt

Japan

30

30

37

37

For individuals securities are taxable at 20%. Inclusion rate for assets held for more than 5 years is 50%

Kiribat

n.a

35

n.a

35

 

Korea, North

-

-

-

-

Information unavailable

Korea, South

28

28

40

40

For individuals shares in listed Korean companies are exempt

Laos

40

45

Unclear

40

 

Macau

15

15

n.a

15

 

Malaysia

30

28

30

30

Limited to real property & shares thereon

Maldavis

n.a

20

n.a

n.a

Limited to commercial banks

Marshall Islands

n.a

12

n.a

12

 

Micronesia

n.a

3

n.a

10

 

Mangolia

Unclear

40

Unclear

40

 

Myanmar

30

30

30

30

 

Nohuru

n.a

n.a

n.a

n.a

 

Nepal

Unclear

30

Unclear

25

 

New Caledonia

25

30

25

40

 

New Zealand

n.a

33

n.a

39

 

Niue

30

30

50

50

 

Northern Mariana Islands

46

46

50

50

 

Pakistan

25

43

35

35

For individuals, there is 60% exclusion for long-term capital gains from listed shares.

Papua New Guinea

n.a

25

n.a

47

 

Phillipines

35

32

6

32

Listed shares are exempt

Singapore

n.a

26

n.a

28

 

Solomon Islands

n.a

35

n.a

47

 

Sri-Lanka

25

35

25

35

 

Tahiti

50

50

20

Unclear

Individuals limited to real property & CGT depends on holding period

Taiwan

25

25

40

40

Marketable securities & land are exempt

Thailand

30

30

37

37

Shares in listed companies and mutual funds are exempt

Tonga

n.a

30

n.a

10

 

Turalu

Unclear

40

Unclear

40

 

Wallis & Futuna

n.a

n.a

n.a

n.a

 

Western Samoa

-

-

-

-

Information unavailable


Table 2 continued: AMERICA

Country

Max Corp CGT Rate

Max Corp Rate

Max Individ CGT Rate

Max Individ Rate

Comment on CGT

Argentina

35

35

n.a/35

35

Shares, bonds & other securities by individuals are exempt

Bolivia

25

25

13/25

13/25

 

Brazil

15

15

15

15

Transactions through stock exchanges, taxed at 10%

Canada

29

29

29

29

CGT inclusion rate is 75%

Chile

15

15

45

45

 

Colombia

35

35

35

35

 

Costa Rica

n.a

30

n.a

35

 

Ecuador

n.a

Ftt

n.a

1

Has financial transactions tax (FTT) at 1%, except for oil income

El Salvator

25

25

30

30

 

Guatemala

10

30

10

25

 

Honduras

35

35

35

25

 

Mexico

40

35

40

40

Shares & other securities through stock exchange are exempt for individuals

Nicaragua

30

30

30

30

Gains from stock exchanges exempt

Panama

30

30

30

30

Gains on securities through official approved channels by individuals are exempt

Paraguay

30

30

0/30

0/30

 

Peru

30

30

0/30

30

 

Uraguay

30

30

0

0/30

 

U.S.A

35

35

18

39.6

 

Venezuela

34

34

34

34

Shares through stock are exchange


Table 2 continued: CARIBBEAN AND OTHER COUNTRIES IN ASIA (MIDDLE EAST
)

Country

Max Corp CGT Rate

Max Corp Rate

Max Individ CGT Rate

Max Individ Rate

Comment on CGT

 

Caribbean & Middle East

 

Bahamas

n.a

n.a

n.a

n.a

 

Bahrain

n.a

n.a

n.a

n.a

Taxes only on certain or companies

Barbados

n.a

40

n.a

40

 

British Virgin Isalands

n.a

15

n.a

20

 

Channel Islands (Guernsey)

n.a

20

n.a

20

 

Faroe Islands

27

27

37

37

 

Guatemala

10

25

10

25

 

Guyana

20

45

20

33.3

For individuals shares or stocks in listed companies are exempt

Iran

Unclear

54

Yes, rate unclear

54

 

Isle of man

n.a

20

n.a

20

 

Israel

36

36

50

50

 

Jamaica

n.a

33.3

n.a

25

 

Kazakhstan

Unclear

30

30

30

 

Kuwait

n.a

n.a

n.a

n.a

 

Netherlands Antilles

39

39

60

60

Personal assets not subject to CGT

Oman

25

25

n.a

n.a

 

Peurto Rico

25

20

33

33

The excess of net long-term capital gains over net short-term capital losses are taxed at a 20% rate

Qatar

n.a

n.a

n.a

n.a

 

St.Lucia

Unclear

33.3

n.a

30

 

Saudi Arabia

n.a

n.a

n.a

n.a

 

Trinidad and Tobago

n.a

35

n.a

35

 

United Arab Emirates

n.a

n.a

n.a

n.a

Corporate tax levied only in respect of oil companies.



Table 2 continued: EUROPE

Country

Max Corp CGT Rate

Max Corp Rate

Max Individ CGT Rate

Max Individ Rate

Comment on CGT

Austria

34.00

34.00

50.00

50.00

 

Belgium

40.17

40.17

55.00

55.00

 

Bulgaria

25.00

25.00

40.00

40.00

 

Canada

21.84

29.12

20.30

30.45

 

Cyprus

20.00

25.00

24.00

40.00

 

Czech Republic

31.00

31.00

32.00

32.00

 

Denmark

32.00

32.00

59.00

59.00

 

Estonia

26.00

26.00

26.00

26.00

 

Finland

29.00

29.00

28.00

38.00

 

France

20.90

36.66

33.33

54.00

 

*Germany

42.20

42.20

56.50

56.50

* Could not obtain recent information.

Greece

30.00

40.00

30.00

45.00

 

Hungary

18.00

18.00

20.00

40.00

 

Iceland

30.00

30.00

33.41

33.41

 

Ireland

20.00

20.00

20.00

46.00

 

Italy

37.00

37.00

45.50

45.50

 

Latvia

25.00

25.00

25.00

25.00

 

Luxembourg

31.20

31.20

47.15

47.15

 

Malta

35.00

35.00

35.00

35.00

 

Monaco

35.00

35.00

35.00

0.00

 

Netherlands

35.00

35.00

60.00

60.00

 

Norway

28.00

28.00

28.00

28.00

 

Poland

30.00

30.00

40.00

40.00

 

Portugal

32.00

32.00

40.00

40.00

 

Romania

25.00

25.00

0.00

40.00

 

Russia

30.00

30.00

30.00

30.00

 

Slovak Republic

29.00

29.00

42.00

42.00

 

Slovenia

25.00

25.00

50.00

50.00

 

Spain

35.00

35.00

48.00

48.00

 

Sweden

28.00

28.00

30.00

25.00

 

Turkey

33.00

33.00

45.00

45.00

 

United Kingdom

30.00

30.00

40.00

40.00

 

Sources:
PriceWaterhouseCoopers (1999) "Corporate Taxes: Worldwide Summaries1999-2000", John Wiley and Sons, Inc (USA)
PriceWaterhouseCoopers (1999) "Individual Taxes: Worldwide Summaries1999-2000", John Wiley and Sons, Inc (USA)
Kesti, J and Balle, C.H. eds (2000) European Tax Handbook, IBFD, Amsterdam
International Bureau for Fiscal Documentation, 1998-2000. African Tax Systems, IBFD, Amsterdam.
International Bureau for Fiscal Documentation, 1998-2000. Taxation in Latin America, IBFD, Amsterdam.
International Bureau for Fiscal Documentation, 1998-2000. Taxes and Investment in Asia and the Pacific, IBFD, Amsterdam.
International Bureau for Fiscal Documentation, 1998-2000. Taxation of Individuals in Europe, IBFD, Amsterdam.

In sum, and based on limited information available it would appear that -
i. In the case of Africa, 14 out of 43 jurisdictions have decided against the introduction of capital gains tax or data is simply not available, which is 32 per cent, whilst 68 per cent of the jurisdictions opted for some form of inclusion of capital gains.
ii In the case of Asia and the Asian Pacific region, 21 jurisdictions or 46 per cent decided against capital gains tax, 54 per cent elected to tax capital gains but sometimes on only a very limited asset class, such as real property. In some cases marketable securities or shares of listed companies are exempt at the level of natural persons.
iii. In the Americas, 2 out of 19 jurisdictions (Costa Rica and Ecuador) have excluded capital gains tax provisions from their respective income tax legislation (11 per cent) - the others all tax capital gains (89 per cent). However, it is interesting to note that Ecuador introduced a financial transaction tax of 1 per cent on turnover as a presumptive tax measure for the financial service sector. Argentina exempts gains realised by individuals on shares, bonds and other securities.

ii. 12 jurisdictions (55 per cent) in the Caribbean and the Middle East opted against the introduction of capital gains tax provisions. It needs to be noted that many of these are oil-producing countries saw hitherto no need to introduce an income tax system.
iii. In Europe 31 jurisdictions saw the need to include realised capital gains into the income tax system.

4. Capital gains tax and equity
Tax policy and tax reform are informed by the three central tenets of tax design - equity, efficiency (including inter-sectoral neutrality) and simplicity. It is against these standards that the capital gains tax should be evaluated, which is the focus of the remainder of this section.

According to the comprehensive income definition, capital gains should be treated no differently from other forms of income. Shome (1995: 7) defines comprehensive income as:
"… the sum of the market value of rights exercised in consumption and the change in the value of the store of property rights between the beginning and the end of the period in question. Thus, this definition of 'comprehensive' income equals consumption plus net wealth accumulated during the period".
Equity in taxation consists of both horizontal and vertical equity. Horizontal equity demands that individuals in similar economic circumstances should bear a similar tax burden, irrespective of the form the accretion of economic power takes. In other words, taxpayers should bear similar tax burdens, irrespective of whether their income is received in the form of wages, or capital gain. In this context, the exclusion of capital gains from the income tax base fundamentally undermines the horizontal equity of the tax system.

Vertical equity connotes that taxpayers with greater ability to pay taxes should bear a greater burden of taxation. It is common cause that capital gains accrue disproportionately to higher income individuals. Thus, including capital gains in taxable income contributes to the progressivity of the income tax system, while enabling government to pursue other tax policy objectives, premised on widening tax bases and reducing standard tax rates.

Furthermore, international experience indicates that the biggest share of capital gains tax revenues can be attributed to the wealthiest of individuals. As was indicated earlier, in Canada and the United States the top 1 per cent of taxpayers generate approximately 60 per cent of the capital gains. The high inequality in South Africa, with an income Gini coefficient of 0.61 as reported by Aron and Muellbauer (2000) makes it absolutely necessary to include capital gains.

For illustrative purposes Table 3 (Burman 1999:114) details the American experience that the distribution of capital gains tax liability is more heavily concentrated at the high income levels than the distribution of realised capital gains across the taxpayer population. Table 3 indicates that taxpayers who had incomes of more




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