NEW RULES REGARDING RETURNS OF CAPITAL BY COMPANIES
1 April 2012 has come and gone, and by now all April fools' joke should be forgotten. However, 1 April 2012 could still have some significance for taxpayers, as it could have triggered a capital gains tax (CGT) liability for taxpayers holding shares, even if they did not receive any distributions and did not dispose of their shares.
Taxpayers would thus be well advised to consider the potential application of these provisions before they complete their provisional tax returns for the relevant tax year (which for individuals would be the 2013 tax year).
Paragraph 76A of the Eighth Schedule to the ITA - part-disposal of shares
In the past, it was common practice for companies to make returns of capital (also referred to as capital distributions) to shareholders. A return of capital was not regarded as a dividend and was therefore not subject to secondary tax on companies ("STC"), nor did it trigger CGT at the time. CGT would only be triggered on the ultimate disposal of the share. If a share was never disposed of, the capital distributions would effectively remain untaxed. At the time of the ultimate disposal of the share, any returns of capital received over the years had to be included in the proceeds on disposal, which had the effect of 'gathering up' the amounts received prior to disposal.
However, all that changed during 2007, when paragraph 76A was introduced in the Eighth Schedule. Paragraph 76A now provides for three different potential scenarios:
- Scenario 1: Returns of capital received on or after 1 October 2007 but before 1 April 2012, triggered a deemed disposal of a part of that share on the date that the return of capital is received by or accrues to the shareholder. The shareholder would thus have to calculate the capital gain or loss on the disposal of part of the share and include it in his/her tax return for the relevant tax year.
- Scenario 2: Where returns of capital were received on or after 1 October 2001 but before 1 October 2007 and the taxpayer disposed of the share before 1 April 2012, the loss or gain on the part disposal would have been triggered on the date of disposal of the share.
- Scenario 3: Where returns of capital were received on or after 1 October 2001 but before 1 October 2007 and the taxpayer has not disposed of the shares by 1 April 2012 ("untaxed returns of capital), the taxpayer must be deemed to have received a return of capital on 1 April 2012.
In the case of scenarios 1 and 2, (an actual disposal or deemed part-disposal of the share before 1 April 2012) the value of the return of capital must be treated as proceeds on disposal. In the case of a part-disposal, paragraph 33 of the Eighth Schedule prescribes how part of the base cost of the asset should be taken into account for purpose of calculating the capital gain or loss on disposal.
However, in the case of scenario 3, the capital gain or loss must be calculated in terms of the new rules in terms of paragraph 76B.
Paragraph 76B - reduction in base cost of shares as result of distributions
The above rules regarding part-disposal only apply to returns of capital between 1 October 2001 and 31 March 2012. The 2011 Taxation Laws Amendment Act No 24 of 2011 introduced paragraph 76B which sets out new rules regarding returns of capital. These rules apply to returns of capital received on or after 1 April 2012.
Briefly summarised, while paragraph 76A provided for the value of the return of capital to be included in the proceeds on disposal, paragraph 76B provides that the value of the return of capital will reduce the shareholder's base cost in the share.
If the return of capital exceeds the expenditure in respect of the shares to which the return relates, the excess must be treated as a capital gain during the year of assessment in which the return of capital is received or accrued (whichever is earlier).
If the shares in question were acquired before 1 October 2001, the calculation is complicated somewhat as the shareholder's base cost in the shares is calculated by determining the market value of the share on the date of the return of capital and then deducting (or adding to it) the notional capital gain (or loss) which would have been realised if the share was disposed of on such date. The same principle as set out in the previous paragraph still applies, i.e. where a return of capital is received, the base cost in the share would then be reduced by the value of such return of capital and if the return of capital exceeds the expenditure, the excess must be treated as a capital gain.
Any "untaxed" returns of capital received between 1 October 2001 and 1 October 2007, in those instances where the underlying shares have not been disposed of by 31 March 2012, will potentially trigger tax in terms of paragraph 76B, by virtue of the deemed return of capital provided for in paragraph 76A.
The new rules contained in paragraph 76B may be less negative for taxpayers than the deemed disposal rules in paragraph 76A: In terms of paragraph 76A a capital gain could be triggered each time that a return of capital is received. However, in terms of paragraph 76B, a capital gain will only be triggered when and to the extent that the return of capital exceeds the base cost.
When paragraph 76A was first introduced during 2007, it was envisaged that a deemed disposal would take place on 1 July 2011 in the case of "untaxed" returns of capital. While it may seem like a reprieve that the deemed return of capital date was postponed to 1 April 2012 and that a potential gain would have to be calculated in terms of paragraph 76B rather than paragraph 76A, there is a sting in the tail. The downside in those instances where a capital gain would in fact materialise, is that such gain may be subject to the higher effective CGT rates as a result of the increased inclusion rates announced by the Minister of Finance in his February 2012 Budget Speech. While a company could still "escape" the higher effective CGT rates depending on when its financial year ends, a natural person would feel the pain of the higher CGT rate.
Taxpayers owning shares would thus have to keep this in mind when completing their provisional and final tax returns, to ensure that it is dealt with correctly.