1.Introduction



TAXATION RULES – SHARES AND SHARE RELATED TRANSACTIONSTable of Contents TOC \o "1-3" \h \z \u 1.INTRODUCTION PAGEREF _Toc326010142 \h 22.TAX EFFECTS ON ISSUE AND CANCELLATION OF SHARES IN A COMPANY AND THE GRANTING OF OPTIONS TO ACQUIRE SHARES AND DEBENTURES PAGEREF _Toc326010143 \h 23.EXCHANGE OF SHARES OR ASSETS FOR SHARES (SECTION 24B (1) OF THE ACT) PAGEREF _Toc326010144 \h 34.HYBRID INSTRUMENTS PAGEREF _Toc326010145 \h 45. LIMITATION OF LOSSES ON CERTAIN SHARES PAGEREF _Toc326010146 \h 56. SHORT-TERM DISPOSALS AND ACQUISITIONS OF IDENTICAL FINANCIAL INSTRUMENTS PAGEREF _Toc326010147 \h 67. ASSETS OF TRUST AND COMPANY PAGEREF _Toc326010148 \h 71.IntroductionThis chapter discusses various tax effects when shares are either held as an investment or for speculation purposes. After completing this chapter, the following should be understood:Tax effects on the issue and cancellation of shares by a companyTax effects when shares are issued in exchange for assets and sharesHybrid instrumentsPara 19 of 8th schedulePara 42 of 8th schedulePara 37 of 8th schedule2.Tax effects on issue and cancellation of shares in a company AND THE GRANTING OF OPTIONS TO ACQUIRE SHARES AND DEBENTURESAs per paragraph 11(2)(b) of the 8th schedule, there is no disposal of an asset by a company in respect ofthe issue or cancellation of a share or member’s interest in the company, or by a company in respect of the granting of an option to acquire a share, member’s interest or debenture in that company;There will thus be no CGT on these transactions.ILLUSTRATION 2AA company had the following transactions as regards its share capital:issued 10,000 shares for R100,000cancelled 4,000 of its own shares held by a subsidiary in terms of JSE listing requirementsissued 2,000 options to acquire 5,000 shares at a price of R8 a share.Are there any tax effects for these transactionsSUGGESTED SOLUTION TO ILLUSTRATION 2AThere is no vat as all these transactions are regarded as financial services which is exempt from VATThe amounts do not constitute dividends, nor are there any capital gains calculated as the issue or cancellation of shares as well as the granting of options to buy shares are excluded from the term disposal in paragraph 11(2)(b) of the 8th schedule.3.EXCHANGE OF SHARES OR ASSETS FOR SHARES (SECTION 24B (1) OF THE ACT)Consider the following situation:You own a piece of land worth R2,000,000 that cost R1,600,000You are approached by a developer who wishes to buy the land, but does not have the cash to pay for the landHe instead offers you shares in his company that will develop the land and sell off townhouses and clusters built on the land. You are reluctant to receive shares, but eventually decide to as you believe the shares he is offering you are worth R2,100,000 after the land is acquired by the company.The question arises:At what value must the land be recorded in the books of the buyer andWhat are the tax effects to the sellerPer section 24B(1), when assets or shares are exchanged for shares, the company is deemed to have acquired the assets or shares at the lesser ofThe market value of the assets or shares so received orThe market value of the shares issued after the transaction has taken place.Thus the company will be deemed to acquire the land for R2,000,000. This will be shown as a purchases deduction as land acquired by a property developer is the purchase of trading stock by that developer.Per section 24B(1), the selling taxpayer who has disposed of the asset or shares is deemed to have sold the assets or shares at the market value of the shares so received.Thus the taxpayer will be deemed to have sold the land for R2,100,000. If the seller held the land for investment purposes, proceeds on disposal would be R2,000,000 and the base cost R1,600,000.If the seller held the land speculatively, R2,000,000 would be included in gross income and R1,600,000 would be classified as an opening stock deduction. ILLUSTRATION 3AMr A entered into a transaction with A Ltd, a property developer. The property developer issued 60,000 shares to Mr A in return for Mr A giving a property (that originally cost R120,000 in 2004) to the company. Mr A had used the property as his holiday home, before subdividing the property as he considered the property too big to maintain. The market value of the land given by Mr A to the company is R500,000 and the shares were worth R530,000. What are the tax implications of the above for the buyer and for the seller of the property.SUGGESTED SOLUTION TO ILLUSTRATION 3AMr AThe property was not held for speculative purposes.Proceeds on disposal of the property is R530,000Base cost is R120,000A LtdTrading stock purchases deduction may be claimed of the lesser of R530,000 (value of shares issued) and R500,000 (the value of the property.) Thus a purchases deduction of R400,000 may be claimed.4.hybrid instrumentsSpecial taxation treatment exists for hybrid instruments.Hybrid instruments show elements of debt and equity within the same instrument. For tax purposes, rules exist if they are redeemed or convertible within 3 years.Consider the following two financial instruments:A redeemable preference share shows a debt element and an equity elementThe preference share is an equity instrumentIts limited life span and fixed rate of annual payment mimics debtA convertible debenture shows a debt element and an equity elementDebentures are debt instrumentsThe conversion to equity at a future stage shows an equity component. TAX TREATMENT SECTION 8E AND 8F HYBRID INSTRUMENTSTAX IMPLICATIONSISSUERTAX IMPLICATIONS HOLDERSECTION 8EREDEEMABALE PREFERENCE SHARES ISSUIED FOR 3 YEARS OR LESSPREFERENCE DIVIDEND PAID WHICH IS NOT DEDUCTIBLE FOR TAXATION.DIVIDENDS TAX ON THE PREFERENCE DIVIDENDHOLDER DEEMED TO RECEIVE INTEREST AND NOT A DIVIDEND.INTEREST IS INCLUDED IN GROSS INCOME.SECTION 8FCONVERTIBLE DEBENTURES WITHIN 3 YEARSCOMPANY DEEMED TO PAY A DIVIDEND AND NOT INTERESTDIVIDEND TAX PAID ON DEEMED DIVIDENDHOLDER RECEIVES INTEREST WHICH IS INCLUDED INTO THE GROSS INCOME OF THE HOLDER OF THE SHARES5. Limitation of losses on certain sharesParagraph 19 limits the losses that may be claimed on the disposal of certain shares. 'extraordinary dividends' means so much of any dividends received or accrued within the period of two years contemplated in subparagraph (1), as exceed 15 percent of the proceeds received or accrued from the disposal of the share; andThe amount of extraordinary dividends is taken off the capital loss.Illustration Mr A, not a sharedealer, buys 10 shares in B Ltd for R100 each. The shares declare a dividend of R25 a share in year 1 and 15 a share in year 2. The shares are sold for R70 a share in year 2. What are the CGT implications.Suggested solutionCapital loss on the sale of shares is R30 X 10 shares = R300.The extraordinary dividend is calculated using the following 3 steps:Calculate the amount of the dividend declared in the 2 year periodDividend declared is R25 + R15 = R40 per share.Calculate 15% of the proceedsProceeds are R70. Therefore 15% X 70 = R10.50.Extraordinary dividends = dividends declared – 15% of proceedsR40 – 10.50 = 29.50Thus R29.50 per share X 10 shares = R295 capital loss would be disallowed. Thus the capital loss allowed to Mr A will be R300 – R295 = R5.6. Short-term disposals and acquisitions of identical financial instrumentsThere is a possibility that a person owning shares sell shares for a small profit prior to year end to recognise small capital gains or large capital losses and then buy back the same shares shortly after year end. Paragraph 42 of the 8th schedule deals with such share transactions.IllustrationMr A has a large capital gain of R300,000 in the current year. He owns a share portfolio. One the shares in the portfolio has a base cost of R300,000 and a current market value of R20,000. He sells the shares for R20,000 shortly before year end and buys back the shares shortly after year end for R21,000.What are the CGT implications ignoring any potential application of paragraph 42 of the 8th schedule.Suggested solutionThe capital gain is R300,000.There is a capital loss of R280,000 made on the sale of shares.The net capital profit is R20,000. A R30,000 annual exclusion is taken off the profits no capital gain is included into Mr A’s taxable income.Note: This solution ignores the application of paragraph 42 of the 8th schedule.Paragraph 42 of the 8th schedule discusses that where a capital loss is determined in respect of the disposal by a person of a financial instrument and within a period beginning 45 days before the date of disposal and ending 45 days after that date, that person or a connected person in relation to that person, (connected person meaning for a natural person only a parent, child, stepchild, brother, sister, grandchild or grandparent of that person and for a fund of an insurer contemplated in section 29A does not include another such fund of that insurer in respect of the disposal of an asset in terms of section 29A(6) or (7).) acquires or has entered into a contract to acquire a financial instrument of the same kind and of the same or equivalent quality:the person who disposed of the financial instrument must be treated as having disposed thereof for proceeds equal to the base cost thereof; andthe person who acquired the financial instrument of the same kind and of the same or equivalent quality must be treated as having acquired that financial instrument at a cost equal to the amount spent plus any capital loss that the seller tried to claim.IllustrationUsing the same facts as the previous illustration, what are the effects of paragraph 42?Suggested solutionThe capital loss of R280,000 is ignored as the same shares are bought back within 45 days of the date of sale. The shares are deemed to be disposed of at their base cost of R300,000 and their loss of R280,000 is ignored.The new shares are deemed to have a base cost of R21,000 plus the capital loss of R280,000 = R301,000. 7. Assets of trust and companyParagraph 37 of the 8th schedule discusses the treatment of certain assets held by trusts and companies that would be classified as personal use assets if they were held by natural persons.Where a personal use asset (if it were held by a natural person) is held by a company or trust which is not used for purposes of carrying on a tradeany interest in which or any shares of which are held directly or indirectly by a natural person;there is a decrease in the market value of that asset while held by that trust or company after that person acquired an interest in that trust or company; andany interest in that trust or that company is thereafter disposed of by a person,that person must be treated as having disposed of that interest for proceeds equal to the market value of that interest, determined on the date of disposal, as if the market value of that asset had not decreased.This does not apply where more than 50 per cent of the assets of the trust or company consist of assets used wholly and exclusively for trading purposes.Illustration Mr A wants to buy a 8 metre boat for R1,000,000. He anticipates that he will use the asset for 5 years in a private capacity and then sell the asset for R300,000.He knows that capital losses are not allowed on personal use assets held in an individual capacity.He thus proposes that the asset be held by a company for him. He will own all the shares in the company. He will invest R1,000,000 in the company. The company will buy the boat for R1,000,000. The company will sell the boat for R300,000 at the end of the 5 year period. He will then sell the shares in the company for R300,000.The company will then make a capital loss of R700,000 on the sale and he as an individual when selling the company will in turn make a R700,000 capital loss. (R1,000,000 paid for the shares vs R300,000 received for selling the shares)He wants to know whether this can circumvent the law which states that he cannot claim a capital loss for personal use assets.Discuss the proposal made by Mr A.Suggested solutionIf the person owned the boat in his own private capacity, the boat would be classified as a personal use asset and any capital losses would be denied.By putting the boat into a company that is 100% owned by him, the boat would not be a personal use asset as personal use assets are owned by natural persons.Thus capital gains and losses could be calculated on the asset. However the provisions of paragraph 37 to the 8th schedule need to be taken into account.Paragraph 37 applies whenan asset is held by a company or trust that would be a personal use asset if it were held by a natural personthe asset is a 8 metre long boat that would be a personal use asset if held by a natural personthe asset is not used for the purposes of carrying on a tradethe boat is not used for the purposes of carrying on a tradeany interest is held directly or indirectly by a natural personthe company is owned directly 100% by Mr Athere is a decrease in the market value of that asset while held by that trust or company after that person acquired an interest in that trust or company; andthe value of the company decreases as the value of the boat has decreased over timeany interest in that trust or that company is thereafter disposed of by a person,the person intends to dispose of the asset at the end.Thus paragraph 37 applies. Paragraph 37 then deems that that person must be treated as having disposed of that interest for proceeds equal to the market value of that interest, determined on the date of disposal, as if the market value of that asset had not decreased.Thus if the shares in the company are sold for R300,000 (being the cash left after the boat is sold), Mr A will be deemed to have disposed of the shares for R1,000,000 which is the amount that the shares would be disposed for had the loss not taken place.Thus proceeds will be R1,000,000.Base cost will be R1,000,000There will be no capital gain or loss. ................
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