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June 11, 2019
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Sale of shares: Income vs revenue – Back to first principles

The distinction between amounts of a capital nature as opposed to a revenue (or income) nature is essential, and over the years, few other topics have enjoyed so much attention in our tax courts. Although most taxpayers appreciate this distinction, it is essential to revisit the core principles from time to time, to ensure that taxpayers are not caught off-guard when accounting for the tax on the sale of shares.

Non-capital amounts are subject to tax at a higher effective rate compared to capital profits. The difference arises from the annual exclusion that applies to capital gains for natural persons, and the inclusion rate applied to it. In the case of natural persons, the maximum effective rate for capital gains is 18% (compared to 45% on revenue gains); companies are taxed at 22.4% (compared to 28%) and trusts at 36% (compared to 45%).

The departure point for the analysis is how long a person has held the shares. In terms of 9C of the Income Tax Act, 58 of 1962 (the Act), where shares have been held for a period of at least three years, the amount received in respect of the share sale will automatically be deemed to be of a capital nature. Consequently, any gain would constitute a capital gain. Section 9C does not require an election, and its application is automatic and compulsory. Importantly, profits on the disposal of shares held for less than three years is not automatically of a revenue nature. The nature of such profits must be determined using the general capital versus revenue principles. Apart from the three-year holding rule in section 9C, the Act does not provide objective factors to distinguish between capital and revenue gains on share disposals. General principles for making this distinction have been formulated in courts over many years.

A person’s intention (both at the stage of purchase and disposal) is the essential factor in determining the nature of profits. If shares were acquired with mixed intentions (bought partly to sell at a profit and partly to hold as an investment), the person’s intention would be determined by the dominant or main purpose. South African courts have held that a taxpayer’s evidence as to intention must be tested against the surrounding circumstances of the case, which include, amongst other things, the frequency of transactions, method of funding and reasons for selling.

Where shares have been purchased and sold as part of a profit-making scheme, gains will be regarded as revenue in nature. In this regard, although not conclusive, the frequency and scale of share transactions is an important consideration. Where shares are bought regularly for the main purpose of resale at a profit, it will be regarded as trading stock and profits will be revenue in nature. An occasional sale of shares yielding a profit suggests that a person is not a share trader engaged in a scheme of profit-making. Where profits have been made through the mere realisation of investment, there is no scheme of profit-making. Although it is possible that a once-off venture involving the acquisition of shares can comprise a venture resulting in the shares becoming trading stock, the “slightest contemplation of a profitable resale” is not necessarily determinative for a gain to be revenue in nature.

Profits on the disposal of shares acquired for long-term capital growth and dividend income will more likely be capital in nature. Shares sold for a profit very soon after the acquisition is, in most cases, an indication of the potential revenue nature of those profits. However, that measure loses a great deal of its importance when there has been some intervening act, for example, a forced sale of shares.

Taxpayers are encouraged to take careful note of the distinction between income and capital gains since a different interpretation by SARS could result in a lengthy (and costly) dispute.

This article is a general information sheet and should not be used or relied upon as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice.  Errors and omissions excepted (E&OE)

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