Understanding Recoupment and Capital Gains Tax in South Africa: Calculations, Exclusions, and Tax Implications

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Understanding Recoupment and Capital Gains Tax in South Africa: Calculations, Exclusions, and Tax Implications

• 03 April 2024
• Tax
• Zuva Financial Services

Introduction

Capital Gains and Recoupment are two concepts that are important to understand in the income tax space. They are similar and have overlaps but are not the same thing. For that reason, it is important to understand their individual nuances so that they can be treated correctly in accordance with the tax laws of the country.

• South African tax law allows for various deductions and allowances to be included in determining the taxable income of a taxpayer and, where some of these deductions and allowances are in respect of a certain asset, ultimately, they reduce the tax value of the asset.
• Where a taxpayer disposes of an asset and receives proceeds from the sale of that asset, recoupment and / or capital gains tax consequences might follow.
• Let us look further into what recoupment and capital gains are, how they are calculated, and the tax consequences thereof.

Recoupment

• In terms of Section 8(4)(a) of the Income Tax Act, an amount that has been previously allowed as a deduction must be included in a taxpayer’s gross income if it has been recovered or recouped during the year of assessment.
• Although the Income Tax Act does not provide a definition of the word “recoup” or “recover”, it has been considered in several court cases. One of the popular court cases is Omina Fertiliser Ltd v C:SARS, where the court held that to recover or recoup means to return to the taxpayer’s pocket something which has previously been allowed as an expense. Taking into consideration this principle, it can be concluded that the word “recoupment” means all amounts as referred to under section 8(4)(a) which have been allowed as a deduction and have been regained, compensated for, or repossessed, and must be included in a taxpayer’s income.
• Recoupment is calculated as selling price, which is limited to the cost price, minus the tax value where the tax value figure is the cost price of the asset minus all wear and tear.
• The final amount of recoupment is, therefore, limited to the allowances that have been previously allowed.

Capital Gains Tax

According to the South African Revenue Service (SARS), a capital gain refers to the profit realized from the sale of a capital asset, such as property, shares, or other investments, that exceeds the original purchase price or cost base of the asset.

This is the distinguishing feature between recoupment and a capital gain. Recoupment is calculated as selling price, which is limited to the cost price, minus the tax value, whereas a capital gain refers to the profit realized from the sale that exceeds the original purchase price or cost base of the asset.

• Before calculating the taxable capital gain, the following four elements must be determined:
  • there must be an asset (as defined in Section 1 of the Act),
  • There must be a disposal of an asset (eg a sale/donation/exchange/transfer),
  • There must be a base cost of the asset, determined according to:
    • Market Value at Valuation Date – which determines the base cost of the asset as the market value of the asset at a specific valuation date. The valuation date is typically the date when the asset was acquired or when it first became subject to capital gains tax. Market value refers to the price that the asset would fetch in an open market between a willing buyer and a willing seller.
    • 20% of Proceeds Less Expenditure Incurred On/After Valuation Date: Under this method, the base cost of the asset is calculated as 20% of the proceeds from the disposal of the asset, minus any expenditure incurred on or after the valuation date. This method is often used when the exact historical cost of the asset is not available, or when it is impractical to determine it accurately.
    • Time-Apportionment Base Cost: This method is applicable when an asset was acquired before 1 October 2001, and it involves adjusting the base cost of the asset based on the period of ownership after that date. The base cost is apportioned over the period of ownership from 1 October 2001 to the date of disposal, considering any improvements, additions, or enhancements made to the asset during that period.
  • There must also be proceeds from the sale of an asset – which is is the total amount received or accrued due to the disposal of an asset.
• Once the four elements have been determined, a taxpayer must further determine whether the proceeds are revenue or capital in nature, because the tax treatment would be different in either case.
• Where the proceeds are revenue in nature; the full amount of capital gain will be included in the taxpayer’s taxable income. Where the proceeds are capital in nature; the amount to be included in taxable income is the capital gain portion that is capital in nature multiplied by the inclusion rate of 80%, in the case of a company, or 40% in the case of an individual.
• Below is an example involving both recoupment and a taxable capital gain:

Question: a client purchases a car for the value of R200,000. R80,000 is claimed as Wear & Tear over two years. After two years, the vehicle is sold.

There are two scenarios:

Scenario 1: Vehicle sold for R180,000

Cost	W&T	Tax Base	Proceeds	Recouplment	Capital Gain
200,000.00	80,000.00	120,000.00	180,000.00	60,000.00

OR - Scenario 2: Vehicle sold for R220,000

Cost	W&T	Tax Base	Proceeds	Recouplment	Capital Gain
200,000.00	80,000.00	120,000.00	220,000.00	80,000.00	20,000.00

In both instances, Wear and Tear of R80,000 is claimed in terms of s11(e) of the Income Tax Act, per paragraph (20) (3) (a), Eighth Schedule. When the asset is disposed, the amount by which the proceeds exceed base cost (cost less W&T), is recouped as per section 8(4)(a) of the Income Tax Act. The recouped amount will also not form part of the proceeds on disposal since it has been included in income.

In scenario 1, a recoupment of R60,000 will be included in income as an amount recovered of a previous allowance in terms of section 8(4)(a) of the Income Tax Act. That same R60,000 will also be deducted off the proceeds which makes the proceeds (R180,000 less R60000 = R120,000). Since this result is the same as base cost, there is therefore no capital gain in this scenario.

In scenario 2, where the car is sold for R220,000, then recoupment of (R200,000 - R120,000 = R80000) would be included in taxable income and the proceeds would be reduced by R80,000. (Proceeds would be R220,000 less R80,000 = R140,000). Therefore a capital gain of (R140,000 - R120,000 = R20,000) would be realised.

How would we differentiate between the two? There are a few indicators one can use, such as:

Nature of Transaction: Does the transaction involve the sale of a capital asset, such as property, shares, or machinery, (likely to be of a capital nature), or does it involve the sale of trading stock or inventory in the ordinary course of business, (more likely to be revenue in nature).

Intention of the Taxpayer: If the taxpayer's intention was to make a profit from the sale of the asset as part of their regular business operations, the proceeds are more likely to be considered revenue in nature, but if the intention was to invest in the asset for the long term with the expectation of capital appreciation, the proceeds are more likely to be considered capital in nature.

Frequency and Regularity: If the taxpayer engages in similar transactions frequently and regularly as part of their business activities, the proceeds are more likely to be considered revenue in nature. However, if the transaction is isolated or infrequent, it may be more likely to be considered capital in nature.

Use of Proceeds:  If the proceeds are reinvested in similar assets or used to generate further income in the ordinary course of business, they are more likely to be considered revenue in nature, but if the proceeds are used for non-business purposes or invested in assets for long-term growth or preservation of capital, they are more likely to be considered capital in nature.

Legal and Accounting Treatment: If the transaction is treated as a capital asset on the taxpayer's balance sheet and in their financial statements, it is more likely to be considered capital in nature for tax purposes.

Capital Gain exclusions

• A R40 000 annual exclusion is available for an individual taxpayer to deduct from the amount of capital gain.
• Furthermore, in cases where an individual disposes of their primary residence, R2 000 000 of the capital gain can be disregarded from the taxable capital gain. If the total capital gain realized from the disposal of qualifying capital assets during the tax year is R2 million or less, the taxpayer can exclude the entire amount from CGT.

Hopefully this gives you enough of a broad understanding of the topic of recoupment and capital gains taxation to be able to identify situations where either one or both of these might apply. If, however, you need to ensure that affected transactions are treated correctly in accordance with the tax laws of the country, feel free to contact the author.

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Published by SA Accounting Academy (SAAA). Keep up to date with the latest accountancy, audit and tax news here.

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Written by: Zuva Financial Services is a team of accountants, tax practitioners and other professionals helping businesses in South Africa with a variety of financial services including, but not limited to, accounting, tax, payroll, secretarial, business valuations, audit, advisory, business cultivation, coaching, business turnaround, and wealth management. For more information on their services or to discuss your specific needs, visit their website at www.zuvafs.co.za or call them directly on 011 886 1062.

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