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Keep down share sales to avoid capital gains tax
Martin Spring
'The SA Revenue Service is now attacking share transactions by individuals with more vigour'
UNDOUBTEDLY the most widely used tax shelter is the equity portfolio.
Whether you invest directly in shares, or indirectly through unit trusts, most of your return comes in the form of capital gain, which is normally tax-free.
However, the risk that you may be classified as a trader in shares, and see the gains, less related expenses or losses, taxed accordingly as income, is increasing.
The only safe way to avoid income tax in this way is to take advantage of the five-year "safe haven" rule for shares (it's not available for unit trusts).
But once you've made that choice, you expose yourself to an increased risk of being taxed on profits made on any shares sold that you have held for less than five years.
'The risk that you may be classified as a trader, and see the gains taxed accordingly as income, is increasing'
If you don't opt for "safe haven" status, whether or not you're taxed will depend on whether the profit arose out of a scheme intended to make capital gains, or whether it was incidental.
It all turns on the SA Revenue Service and ultimately, if you dispute their decision, the courts determine your intention at the times of purchase, holding and sale.
The authorities don't give much weight to your stated intention, or even to what supporting documents may say about your intention. They look at all the circumstances surrounding the transaction.
Traditionally, tax consultants have advised their clients to combat the risk of being taxed on capital gains by approaches such as these:
Choose shares which are good dividend payers to support your argument of an intention to produce dividend income, not capital profits.
Sell as infrequently as possible, and then only in circumstances where there is strong supporting evidence of intent to finance some unforeseen expense such as surgery, to safeguard or improve dividend income, or to protect capital value.
If you have a portfolio manager, give him a written mandate emphasising security and growth of income and capital.
Avoid borrowing money, especially in the form of short-term loans, to finance share purchases.
If there are reasons why you have to do some trading, quarantine that activity in a specific portfolio separate from the one in which you hold your shares for long-term investment.
Even better, hold the portfolio in a separate entity, such as a close corporation.
But such advice is no longer convincing following the 1996 Nussbaum judgment.
The taxpayer argued that his share disposals, which generated profits of R1.1-million over three tax years, were a redeployment of capital after turning 60.
The intention was to take advantage of high interest rates in the money market, to escape anticipated dividend cuts in some of the stocks he held, and to generate cash to buy a house and to pay for future medical expenses.
Nevertheless, the court held that even though his primary purpose may have been to protect and enhance his income, he had a secondary, profit-making motive in selling the shares.
Key factors identified were the scale and frequency of his transactions (580 sales and purchases), and the assiduous attention the taxpayer gave to "farming" his portfolio.
The court decided that his profits were correctly subject to tax.
Attorneys Deneys Reitz say this judgment now "makes it very difficult to escape tax on share dealings".
And tax consultant Michael Brits says that, as a result of this judgment, the SARS is now "attacking share transactions by individuals with more vigour".
Apparently this is particularly so where large profits and frequent transactions are involved, and/or where capital gains exceed a taxpayer's normal taxable income.
If you are active in the stock market, you may need to adjust your strategy accordingly, especially in relation to the frequency of your transactions.
Unit trust profits have so far escaped tax. I can recall only one case that came to court based on such an attack by SARS, and that was many years ago.
However, Niel Raubenheimer of BOE Private Bank says there is now "a fairly significant risk" of such profits being attacked.
"It would be consistent with the kind of view Revenue is taking these days when people make full disclosure in their tax returns," he says.
Many taxpayers fail to give all the details of sales and purchases of units in their annual returns, though they are clearly required to do so.
These taxpayers evade the issue, and often seem to get away with it, by merely listing current holdings or saying something like "managed for me by "
Increasingly aggressive trading both by the funds themselves, and by individual investors through the now widespread use of low-cost switching services, raise the risk of SARS's hostile action.
For the moment, however, portfolios of equities, whether held directly or indirectly, remain the most attractive tax shelters.
The tax risk is low if you keep down the number of your transactions, particularly your share sales.
Martin Spring is editor of Personal Finance newsletter
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