1.OVERVIEW OF THE THIS SECTION - …



CHAPTER 52TAX IMPLICATIONS OF OWNING SHARES1.OVERVIEW OF THE THIS SECTIONThe next two chapters will explore the taxation legislation that relates to the calculation of taxable income for shares and share related transactions.This is split into two distinct sections, namely:Taxation implications for the taxpayer that owns the sharesTaxation implications for the issuer of the sharesWhen looking at the taxpayer that owns shares, separate consideration will be given to:Share dealers owning shares for speculative reasons andTaxpayers holding shares for investment purposesWhen looking at the taxation implications for the issuer of the shares, separate consideration will be given to:Taxation implications on issue of shares, andTaxation implications when the company makes distributions to shareholders2.GRAPHICAL REPRESENTATION OF THE OVERVIEWTAXATION RULES FOR SHARESTAXATION IMPLICATIONS FOR THE ISSUER OF SHARESTAXATION IMPLICATIONS FOR THE HOLDER OF SHARESTAXPAYERS HOLDING SHARES FOR SPECULATIVE REASONS SUCH AS SHAREDEALERSTAXPAYERS HOLDING SHARES AS AN INVESTMENTTAXATION IMPLICATIONS OF DISTRIBUTIONS TO SHAREHOLDERSTAXATION IMPLICATIONS ON THE ISSUE OF SHARESTHIS IS COVERED IN THE NEXT CHAPTERTHIS IS COVERED IN THIS CHAPTER3. REASONS FOR HOLDING SHARESTaxpayers hold shares for many possible reasons. These include:Speculative reasonsInvestment reasonsBusiness reasons2.1 Speculative reasonsShares may be owned for speculative reasons where a taxpayer believes that profit will be made through the trading of shares in the short term.This could be a taxpayer that carries on the trade of a share dealer. At the other extreme, it could be a taxpayer that buys shares in a scheme of profitmaking due to receiving a share stock tip that a share was about to increase in value substantially. Example of a share dealer/person buying shares in a scheme of profitmakingA person receives a stock tip, and buys shares in a company for R100,000. They then sell such shares for R180,000 3 months later at a substantial profit. Consider this – As this is a scheme of profitmaking, the proceeds on the disposal of shares should be included in gross income.2.2 Investment purposesCertain taxpayers may hold shares for investment purposes and believe that returns may be found through the long term holding of shares and the receipt of dividends over time.. Such taxpayers will obtain returns through the receipt of dividends and the capital appreciation made on the ultimate disposal of shares. Example of shares held for investment purposesA taxpayer buys shares for R100,000 with the intention of holding the shares for a substantial period of time. He believes that the accumulated dividends plus the eventual selling price of the shares will lead to an investment that will deliver an excellent investment return over the next 10 to 15 years.The taxpayer never changes his intention and upon retirement sells his shares. The taxpayer sells the shares in the current year for R450,000 (thus holding the shares for a long period of time). During the many years the shares were owned by the taxpayer, dividends of R80,000 were received from time to time. Consider this – The proceeds on disposal of the shares will be treated as proceeds for capital gains purposes.Business reasonsShares may also be held for a business purpose. Consider where shares may be bought for the following reasons:The company has a government license to do something that your company has no ability to receive a license for. Thus if you wanted a license to run a public TV service, you may consider buying ETV.The company is a supplier of yours and you want to secure a continuous supply of raw materials. The company is in the same industry as yours and you want to buy a competitor. (SA Breweries buying Miller) The above 3 situations are an example of many such types of transactions where shares are bought for a business purpose. The business purpose the shares are bought for is generally not speculative, and such shares will be held as investments. Each of the above will be discussed individually. 3. Deductibility of expenses in respect of share ownershipSection 23(f) states that an expense may not be claimed in instances where there is no underlying income. It is necessary to understand the term income. Income = Gross income minus Exempt Income.Consider the following:A taxpayer buys a share as an investment, and takes out a loan to buy the sharesInterest of R7,000 is paid in the current tax year on this loanA local dividend of R10,000 is earnedThe taxation implications will be as follows:R10,000 local dividend is gross incomeR10,000 local dividend is exemptIncome = R10,000 – R10,000 = R0.As income is R0, the deduction for the interest is not allowed as section 23(f) does not allow this deduction to be claimed.If the above example were changed by adding the following dynamic:The shares were acquired for speculative reasons for R100,000The shares were sold for R130,000The solution would change as follows:R10,000 local dividend is gross incomeR10,000 local dividend is exemptR100,000 purchase price of the shares will be allowed as a deduction of trading stockR130,000 selling price would be included in gross income as this is the amount collected on the sale of this trading stock.Interest of R7,000 would be allowed as a deduction, being an amount incurred in the production of income not of a capital nature.If shares are bought for business reasons, in most circumstances the interest will be deductible. This may occur in the following circumstances:Buying shares in a competitorBuying shares in a supplierBuying shares in a company that has a business license you want to useBuying shares in a company that owns a patent you want to use in your businessBuying shares in a company that owns a trade name you want to use in your businessThus if a small hotel chain bought “holiday inn” so that they could rename all their hotels holiday inn, the interest on the loan to acquire the shares would be deductible.Each case should however be assessed on its merits.ILLUSTRATION 3BFor each of the following indicate whether the expense is deductibleInvestor (not a share dealer)incurs interest of R10,000 for a loan used to specifically buy shares in B Ltd. B Ltd earned dividends of R15,000.Share dealer incurs interest of R10,000 for a loan used to specifically buy shares in B Ltd. B Ltd earned dividends of R15,000.Investor (not a share dealer)incurs interest of R10,000 for a loan used to specifically buy shares in B Ltd. B Ltd earned dividends of R15,000. The shares were bought in a competitor so that the company could obtain synergistic benefits in respect of cost cutting between the companies (1 debtors department not 2, 1 sales department not 2, etc.).SUGGESTED SOLUTION TO ILLUSTRATION 3BR15,000 dividend is gross income, but full R15,000 is an exempt local dividend. This income = R15,000 – R15,000 = 0. As there is no income, there is no deduction for the R10,000 interest incurred.R15,000 dividend is gross income, but full R15,000 is an exempt local dividend. This income = R15,000 – R15,000 = 0. However as a share dealer will include the proceeds on disposal of the shares into gross income, the R10,000 interest will be allowed as a deduction.R15,000 dividend is gross income, but full R15,000 is an exempt local dividend. This income = R15,000 – R15,000 = 0. However as the shares were acquired for business purposes (cost cutting synergistic benefits), the R10,000 interest will be allowed as a deduction.Other expenses related to ownership of shares would have similar rules. Consider brokers fees. For a share dealer, these brokers fees would be treated as a deduction for taxation purposes, whilst for a person holding shares as an investment, the brokers fees on sale would be added to the base cost. Selling expenses are added to the base cost for transactions that involve capital gains.There would have to be a link between the ownership of the shares and the expense incurred by the taxpayer.4.PRINCIPLES RELATING TO INCOME AND DEDUCTIONS FOR HOLDERS OF SHARES4.1SHARE DEALERSShare dealers acquire shares for speculative purposes. 4.1.1Gross income implications for share dealersSuch taxpayers receive various receipts from the company. These are:Dividends received on shares in the normal course of business, andThe proceeds on disposal of shares when shares are sold, and Amounts paid to the share dealer by the company that are not dividends in the normal course of business. Examples of this are share buybacks and amounts received on liquidation or deregistration of the company. DividendsDividends are included in gross income. Paragraph k of the gross income definitions specifically includes dividends into gross income. Proceeds on sale of sharesProceeds from the disposal of shares by a share dealer will also be gross income. This is due to the fact that shares owned for speculative purposesConsider the example where a share dealer buys shares with speculative intent for R100,000 He sells the share 3 months later for R180,000, This is paid to him by his broker in cash. The gross income definition includes the R180,000 amount into gross income if:Requirements of the gross income definitionDiscussion of whether the type of income is included in gross incomeThe total amountThere is an amount of value received for the share sale. It is R180,000In cash or otherwiseThe amount of R180,000 was received in cashReceived by or accrued to the taxpayerThe taxpayer has received an amount of R180,000 for his own benefit (Alternately the taxpayer is unconditionally entitled to receive R180,000)Not of a capital natureThe intention of the taxpayer was a scheme of profitmaking – holding the shares speculatively and selling them at a profit.Thus the R180,000 will be gross income.Summarising for share dealers, who have bought shares with speculative intentWhen local dividends are received, such dividends are included in gross income. Such dividends may also be exempt from income.Proceeds on the disposal of shares are included in gross income when the shares are sold.Liquidation and deregistration of an enterprise There is an amount that is payable to shareholders once a company has been liquidated or deregistered.Consider the following:The total amount distributed to shareholders is equal to all the reserves plus pure share capital once all assets have been paid and liabilities have been settled.Note that this is because of the accounting equation where OWNERS EQUITY = ASSETS - LIABILITIES How much has been received as a dividend and how much has been received from a return in capital will need to be determined to establish:How much dividends tax is payable,How much dividends has the owner of the shares received.How much return on capital has the owner of the shares received.4.2 Exempt income implications for share dealersLocal dividends received by sharedealers are exempt from dividends in most circumstances. An exception for this is that up till 1 April 2012, any dividends received by a share dealer on buyback of shares will not be exempt for tax purposes. 4.3 Deductibility of expensesAs share dealers are carrying on a trade to produce income, any expenses actually incurred not of a capital nature will be deductible.5.Shares held for investment purposes5.1 GeneralUnits help in equity unit trusts and property unit trusts will in most circumstances be held for investment purposes, rather than in a scheme of profitmaking.For shares owned by a taxpayer directly, one should consider the intention of the taxpayer upon buying the shares. This section covers the situation where shares were bought for investment purposes, where return is received in the form of dividends and long term capital appreciation.5.2 Gross income and exempt income tax implicationsLocal dividends are included in gross income, but are exempt in terms of section 10(1)(k) of the Act. Normal rules for unit trusts will apply. 5.3 Capital gains The proceeds on disposal of investment shares will be treated as proceeds for capital gainsThe base cost of shares will be the amount paid on acquisition of the shares. 1/3 (one third) of interest paid on the acquisition of listed shares may also be added to the base cost.5.4 Deductibility of expensesAs the investment produces dividend income that is exempt from income, the expenditure is not allowed as a deduction unless there is a business reason for the expense.See the section previously on deductibility of expenses.6. section 9cSection 9C deems the disposal of a share to be capital in nature if it has been held by the taxpayer for 3 years or more. The application of this section is not optional. Any share held for 3 years or more will automatically become capital. Shares are deemed to be held on a FIFO basis when determining the 3 year period.Even a share purchased for speculative reasons, that remains to be held speculatively, the disposal of the share will be treated as capital in nature by application of this section.Section 9C is activated on disposal of trading shares. Shares continue to be treated as speculative until actual disposal takes place. The disposal will then be treated as a disposal for capital gains purposes and the base cost of the share will be determined using the deductions that have now been reversed.ILLUSTRATION 6AA Ltd has a December year end. A Ltd bought 100,000 shares in B Ltd for speculative reasons on 1 November 2009 for R100,000. The shares were held for speculative purposes. The shares were sold as follows On 16 October 2011, 30,000 shares for R57,000On 12 December 2012, 50,000 shares for R88,000on 15 March 2013 20,000 shares for R42,000. What are the tax implications from 2009 to 2013 years of assessment?SUGGESTED SOLUTION TO ILLUSTRATION 6ACGTIncome/Expense2009Purchases deduction(100,000)Closing stock 100,0002010Opening stock deduction(100,000)Closing stock income 100,0002011Opening stock deduction(100,000)Gross income 57,000Closing stock income 70,0002012Opening stock deduction(70,000)Reversal stock deduction section 9C 50,000Proceeds CGT 88,000Base cost(50,000)Closing stock income 20,0002013Opening stock deduction(20,000)Reversal stock deduction section 9C 20,000Proceeds CGT 42,000Base cost(20,000)All deductions that have been claimed on the shares disposed will be reversed. Shares are deemed to be held on a FIFO basis when determining the 3 year period.If a listed share is owned, and interest has been incurred on this share, 1/3 (one third) of the interest may be capitalized into the base cost of the shares.ILLUSTRATION 6BMr Camel, a sharedealer, bought shares in Marlboro Limited, a company listed on the JSE. The shares were acquired as follows:10,000 shares were acquired for R50,000 on 1 February 200915,000 shares were acquired for R90,000 on 31 May 2010Sold 4,000 shares on 18 September 2010 for R90,000Sold 8,000 shares on 12 February 2012 for R160,000Mr Camel took out a loan to acquire the 1st tranche of shares. The loan was repaid on 25 July 2010 after R10,000 interest had been paid on the loan.Calculate the taxable income for the February 2012 year endSUGGESTED SOLUTION TO ILLUSTRATION 6B2012 tax yearOpening stock deduction tranche 1 6,000/10,000 X R50,000(30,000)Opening stock deduction tranche 2(90,000)Section 9C – Reversal of interest paid 6,000/10,000 X R10,000 6,000Section 9C – shares held over 3 years sold 30,000Proceeds 6,000/8,000 X R160,000120,000Base cost(30,000)Base cost 1/3 X 6,000 (interest on listed company) (2,000)Gross income 2,000/8,000 X R160,00040,000Closing stock 13,000/15,000 X R90,00078,000Note that shares transactions must use the first in first out (FIFO) basis for section 9C.ILLUSTRATION 6CMr Albertyn, a share dealer, had the following transactions for his shareholding in BHP Ltd, an unlisted company Billiton, a company listed on the JSE.He bought 7,000 shares were bought in BHP Ltd on 1 February 2010 for R70,000. Another 3,000 shares were purchased on 26 February 2010 for R45,000. A loan was taken out to buy the 7,000 shares and interest of R2,000 was claimed as a deduction in the 2010 tax year and R10,000 in the 2011 tax year when the loan was repaid. 2,500 shares were sold on 15 January 2013 for R74,000 and 5,500 shares were sold on 16 February 2013 for R125,000.What are the tax implications for the 2010 – 2013 tax years for the shareholding in B (Pty) LtdSUGGESTED SOLUTION TO ILLUSTRATION 6CCGTInc/Expense2010 tax yearPurchases deduction (70,000)Purchases deduction(45,000)Interest deduction( 2,000)Closing stock 115,000 2011 tax yearOpening stock deduction(115,000)Interest deduction 10,000Closing stock 115,0002012 tax yearOpening stock deduction(115,000)Closing stock 115,0002013 tax yearOpening stock (R115,000)Gross income on sale of the shares (held for less than 3 years) R 74,000Gross income R 22,727 only 1,000 out of 5,500 shares held for less than 3 years FIFO basis applies – 1,000/5,500 X 125,000 = 22,727Proceeds = 102,273 (4,500/5,500 X 125,000 102,273Base cost = 45,000 (4,500/7,000 X 70,000)(45,000)Reversal of opening stock deduction 45,000 treated as income (4,500/7,000 X 70,000) 45,000Reversal of interest deduction = 7,714 7,714(4,500/7,000 X 12,000) added to incomeClosing stock added to income 30,000 (2,000/3,000 X 45,000)Note that even though the closing stock has been held for more than 3 years, it will be treated as a trading share until disposal. The stock deduction is only reversed on disposal of the shares.Interest is not capitalised into base cost as the company that he invested in is not listed.7. COST OF A CAPITALISATION SHARE Capitalisation issues are not dividends as defined. As they are not treated as dividends, these shares have a nil cost. Also consider that shares are valued on a FIFO basis for section 9C.ILLUSTRATION 7AHorror Ltd own 1,000 shares in Suspense Ltd that cost R102,000. These shares were acquired on 12 January of the current year for R10,000. On 23 March, Suspense Ltd had a 1:1 capitalisation issue. On 29 July, 1,600 shares in Horror Ltd were sold for R90,000. At year end the shares were trading at R8 a share.Horror Ltd has an August year end. What are the tax implications of the above.SUGGESTED SOLUTION TO ILLUSTRATION 7APurchases deduction(102,000)Capitalisation issue (not a dividend) 0Sale of shares – Gross income 90.000Closing stock – 400 shares at R0 cost (FIFO used) 08.writedown of sharesShares are trading stock to a share dealer. Usually trading stock is valued at the lower of cost or net realisable value, but for shares, trading stock cannot be written down.ILLUSTRATION 8AHorror Ltd own 10,000 shares in Suspense Ltd that cost R102,000. These shares were acquired on 12 January of the current year for R102,000. On 23 March, Suspense Ltd had a 1:1 capitalisation issue. At year end, the shares were trading at R8 a share.Horror Ltd has an August year end. What are the tax implications of the above.SUGGESTED SOLUTION TO ILLUSTRATION 8APurchases deduction(102,000)Capitalisation issue (not a dividend) 0Closing stock 10,000 original shares cost R102,000 MV R80,000 no write-down 102,000 Closing stock – 10,000 cap issue shares at R0 cost 09. TEACHING EXAMPLEA Ltd is a share dealer that has a 30 June 2013 financial year end. The following details are relevant to A Ltd:Closing stock last yearShareDate acquiredCost on acquisitionMarket value beginning of year10,000 shares in B Ltd14 April 2011R100,000R160,0008,000 shares in C Ltd25 July 2009R40,000R30,00012,000 shares in C Ltd17 August 2011R75,000R45,00010,000 shares in E Ltd16 April 2005R300,000330,000The shares in E Ltd were bought after taking out a loan from the bank. Interest of R30,000 was paid on the loan in the 2005 – 2008 tax years. E Ltd is a listed company. In addition to the above, the company had a non trading share portfolio where shares were held for capital purposes as investments.Investment shareDate acquiredCost on acquisitionMarket value beginning of year5,000 shares in D Ltd15 January 2012R125,000R80,000Dividends of R23,000 was received was declared and paid by B Ltd to the company on 18 December 2012.Dividends of R10,000 were declared to the company by C Ltd on 17 June 2013 to shareholders registered on 2 July 2013, payable on 14 July 2013. On 17 September 2012, B Ltd bought back 2,000 shares in B Ltd for R35,000. Each share in B Ltd had a share capital of R2 and the directors decided to use R2 as the contributed tax capital per share.. Various shares in C Ltd were sold:2,000 shares in C Ltd were sold on 2 July 2012 for R38,000.7,000 shares in C Ltd were sold on 15 January 2013 for R140,000. In addition, 2,000 shares in D Ltd were sold for R83,000.Interest of 6,000 was paid this year on a loan taken out to buy shares in D Ltd.The whole shareholding in E Ltd was sold for R510,000 on 13 March of the current year.Shares acquired during the year3,000 shares were acquired for trading purposes in Z Ltd for R30,000. Z Ltd had a 1:1 capitalisation issue and thereafter the company sold 4,000 shares for R25,000. 2,000 shares were acquired in Y Ltd for share dealing purposes on 15 July 2012 for R39,000. Brokers fees of R1,000 were paid on acquisition. On 1 January, when the share price was R25 a share, A Ltd decided to move the shares from the trading portfolio to the investment portfolio. On 27 June 2013, 100 shares in Y Ltd were sold for R4,000.On 28 August, 5,000 shares in X Ltd were acquired for the investment portfolio at a cost of R50,000. On 1 January when the value of the shares was R72,000, the company decided that X Ltd should be part of the share dealing portfolio of shares.Calculate the taxable income of A Ltd.SUGGESTED SOLUTION TO TEACHING EXAMPLE - SHAREDEALERSCGTDeductionIncomeOpening stock B Ltd(100,000)Opening stock C LtdCompanies are not allowed to write down shares held as trading stock (115,000)Shares in D LtdThis is not treated as trading stock as it is part of the investment portfolio in the company and is not held for trading purposes.0Shares in E LtdUntil the date of sale, the 3 year rule is not applied. Thus even though these shares have been held for greater than 3 years, they are treated as trading stock till the date of sale(300,000)Dividend received B LtdLocal dividend exempt23,000(23,000)Dividend received C LtdNot included in the current year as the last date to register was after year end0Share buyback B LtdShares held less than 3 years thus 9C does not applyGross incomeReturn of share capital is R2 X 2,000 shares = 4,000. Dividend Dividend is total received of R35,000 less share capital of R4,000.Dividend exemptionThere is no dividend exemption for a share dealer where shares are bought back. It should be noted that if the shares had been held for more than 3 years, as per section 9C, the R31,000 be exempt as the share would be treated as capital. 4,00031,000(0)Closing stock B LtdB Ltd shares 6,000 left after 2,000 bought back8,000/ 10,000 X 100,00080,000Sale of shares in C Ltd on 2 July 2011Shares valued on FIFO basis for section 9C to apply. Thus first in is first out.Sale 2,000 shares Shares not yet held for 3 years thus gross income38,000Sale of shares in C Ltd on 15 January 2012Next 6,000 shares on FIFO basis were held for more than 3 years thus not gross income0C Ltd Section 9CReversal of opening stock deduction 6,000/8,000 X 40,000 = 30,00030,000C LtdProceeds on disposal 6,000/7,000 X 140,000 120,000C LtdBase cost(30,000)C LtdThe next 1,000 shares are from the next acquisition. These have not been held for 3 years and the sale is subject to gross income. 1,000/7,000 X 140,000 = 20,00020,000Closing stock C LtdC Ltd shares11,000 left after 1,000 shares sold11,00/12,000 X 75,00068,750Interest on loan D LtdD Ltd is part of the investment portfolio thus the interest on the loan is not tax deductible.(0)Sale of shares in D LtdCapital as shares formed part of an investment portfolioProceedsBase cost 2/5 X 125,00083,000(50,000)Closing stock D LtdInvestment shares not in closing stockE Ltd Section 9C Reverse stock deduction for E Ltd as shares now sold and held for greater than 3 years 300,000E Ltd Section 9C Reverse interest deduction for E Ltd shares as interest deduction cannot be claimed on capital shares30,000E Ltd Proceeds on sale510,000E Ltd Base costStock reversal(300,000)E Ltd Base cost interestCapitalise 1/3 of interest paid on listed shares thus 30,000 X 1/3(10,000)Sale of Z Ltd shares25,000Purchase of 3,000 Z Ltd sharesPurchase deduction(30,000)Closing stock Z LtdCapitalisation issue shares have a nil cost. Shares are treated on a FIFO basis.0Purchase Y Ltd sharesPurchase deductionPurchase deduction - Brokers fees(39,000)(1,000)Change intention Y Ltd sharesDeemed sold at market value of R2550,000Sale Y Ltd sharesProceedsBase cost 100 X 254,000(2,500)Closing stock Y LtdPart of the investment portfolio after change of intention thus not included in closing stock0Deemed disposal when intention changed – Shares in X LtdProceedsBase cost72,000(50,000)Change of intention X Ltd sharesDeemed acquisition at market value. Thus opening stock deduction(72,000)Closing stock X Ltd72,000355,500Capital gains inclusion X 66,6666%237,000Taxable incomeXXXXX ................
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