Date: 23 April 1993

1. Introduction

The distinction between capital and income is fundamental to the tax system, but neither concept has proved of a satisfactory definition in the Act. Despite guidelines laid down by South African case law, the test which must be applied to the merits of each case remains a subjective one. The Tax Advisory Committee (TAC) investigated these problems and recommended the introduction of what is, in essence, a so-called "safe-haven" for shares listed on the Johannesburg Stock Exchange (JSE), which have been held for a period exceeding 10 years. (The period has since been reduced to five years). These recommendations were accepted by the Government, subject to certain conditions, and led to the insertion of the provisions of section 98 of the Act by section 9 of the Income Tax Act, 1990.

2. The Effect of the Provisions

In terms of the provisions of section 98(2) of the Act, as originally inserted, a taxpayer may elect that any amount which is received by or accrues to him as a result of the disposal of an affected share on or after 14 March 1990, be treated as being of a capital nature in the application of the definition of "gross income" in section 1 of the Act. Should a taxpayer thus exercise his election positively and the provisions of the relevant section are made applicable to him, the effect thereof is that any profit made on the disposal of an affected share will not be subject to tax.

As far as the word "disposal" is concerned, the ordinary meaning of the word must apply and will include various forms of change in ownership, such as the sale, cession and exchange of shares. Furthermore, paragraph (c) of the proviso to section 98 (1) provides that where a share held by a taxpayer is cancelled or withdrawn or if the relevant company wherein the share is held is liquidated or deregistered, such share is deemed to be disposed of by the taxpayer.

3. The Meaning of an "Affected Share"

An affected share is defined in section 98(1) as "... a share listed on a licensed stock exchange as defined in the Stock Exchanges Control Act, 1985 (Act No. 1 of 1985), which has been disposed of by the taxpayer and of which he immediately prior to such disposal had been the owner for a continuous period of at least five years ...". A licensed stock exchange, in turn, is a stock exchange to which a stock exchange licence is issued in terms of section 9 of the last-mentioned Act and is, at present, limited to the JSE.

In respect of shares disposed of prior to 18 March 1992, the qualifying period for which a share must have been held was 10 years. As a result of the amendment introduced by section 9 of the Income Tax Act, 1992, the period has been reduced to five years.

In so far as the expression "share" is concerned, it is not defined in section 1 of the Act and the ordinary meaning thereof will apply and therefore does not include instruments such as debentures, stock, bonds and units in a unit portfolio as contemplated in the Unit Trusts Control Act, 1981.

Provision is also made in section 98(1) to ensure continuous ownership of an affected share under certain circumstances, for example—

The period of ownership of shares which are acquired in terms of a rights-issue does not, therefore, automatically follow the period of ownership of the underlying shares which gave rise to the rights issue, because the recipient of the shares in terms of a rights issue normally pays a consideration for the shares acquired thereunder.

Where a beneficiary acquires shares resulting from the distribution of the assets of a trust, the ownership of the shares by the trustee and thereafter by the beneficiary is not considered to be continuous in determining whether a share is an affected share. Where, however, the ownership of the shares already vested in the beneficiary since the creation of the trust (as in the case of a "bewind trust") and the trustee was responsible only for the administration of the assets (shares), the ownership will be considered to be continuous.

4. The Election in terms of Section 9B(2)

As already mentioned in paragraph 2 above, the taxpayer exercises his election in terms of the provisions of subsection (2) of section 9B of the Act. The proviso to that subsection also provides that where the taxpayer died or has no capacity to act, the election may be exercised by the executor of his deceased estate or the curator of his insolvent estate (the liquidator in the case of a company in liquidation), as the case may be.

Section 9B(3) provides that a taxpayer must exercise his election in terms of section 9B(2) when he disposes of his first affected share on or after 14 March 1990. The exercise of the election is thus compulsory and it is exercised by the taxpayer in his return of income in respect of the year of assessment in which he disposes of his first affected share. The annual return of income also contains an appropriate question in this regard, where the taxpayer must indicate whether he wishes the provisions of section 98 to be applicable to him or not.

In terms of the provisions of section 9B(4), the election exercised in terms of section 9B(2) is binding in respect of every subsequent affected share which is disposed of by the taxpayer in the relevant and every subsequent year of assessment. Despite the fact that every annual return of income contains a standard question with regard to the section 9B(2) election, the election is exercised only once i.e. when the first affected share is disposed of by the taxpayer. It is also important to note that the election is binding in respect of all affected shares disposed of by the taxpayer and not only with regard to the taxpayer's shareholding in the relevant listed company in respect of which he disposed of his first share. For example, where a taxpayer holds 1 000 shares in company A and 2 000 shares in company B for longer than five years and disposes of 500 A shares in year 1, he must exercise his election in year 1 and that election is not only binding in respect of company A, but also in respect of the shares held in company B.

Where a taxpayer disposes of an affected share but fails to exercise his election in his return of income, the provisions of section 98 will not apply to him.

5. Substitution of Section 9B(2) Election in terms of Section 9B(3a)

As already mentioned in paragraph 4 above, the election in terms of section 9B(2) is final and binding. By reason of the reduction in the period of ownership from 10 years to five years in respect of shares disposed of on or after 18 March 1992, taxpayers are, however, afforded the opportunity to alter their election in terms of section 9B(2).

The provisions of section 9B(3A) of the Act, which were inserted by section 9 of the Income Tax Act, 1992, therefore, now affords the taxpayer the opportunity to alter the otherwise binding election in terms of section 9B(2). The new election exercised in terms of section 9B(3A) must likewise be exercised in respect of the disposal of the first affected share on or after 18 March 1992 and such election must be exercised in the taxpayer's return of income in respect of the year of assessment in which he disposed of the said first affected share. This election is once again binding on the taxpayer in respect of all affected shares which are disposed of by him thereafter and in this regard section 9B(3A) (b) provides that the provisions of subsections (2), (3) and (4) shall mutatis mutandis apply to the replacement election. To enable the taxpayer to either alter or confirm his election an appropriate question will be included in the return of income.

Should a taxpayer, therefore, have made a positive election under the 10 year rule and he does not want the 5 year rule to apply to him, he has the opportunity to withdraw that election and replace it with a new election when he disposes of his first effected share on or after 18 March 1992 that the provisions of section 98 should not apply to him. Likewise, a taxpayer, if he did not make the provisions of section 98 applicable to him under the 10 year rule but as a result of the 5 year rule wishes that the provisions should be applicable to him, has the opportunity to make the provisions applicable to him when he disposes of his first affected share on or after 18 March 1992.

However, should a taxpayer have elected that the provisions of section 9B should be applicable to him in terms of the 10 year rule and he wishes to remain within the provisions of the section, notwithstanding the reduction in the holding period to five years, the reduced holding period of five years will automatically be applicable to him in respect of affected shares which are disposed of by him on or after 18 March 1992.

6. The Influence of Section 9B on Section 24A

With the original insertion of section 9B into the Act, subsection (5) of that section provided that the provisions of section 9B would not be applicable to shares which were acquired by means of an exchange in terms of section 24A. Subsection (5) of section 9B was, however, repealed by section 11 of the Income Tax Act, 1991, which has the effect that the provisions of section 98 are applicable to affected shares which were acquired in terms of a section 24A arrangement where such shares are disposed of on or after 12 July 1991.

7. Recoupment of Costs and Losses

In terms of subsection (6) of section 98, any costs or losses which were allowed to a taxpayer in respect of an affected share, will be recouped in the hands of the taxpayer on disposal of an affected share if he has elected that the provisions of section 9B should apply to him. This recoupment also includes any reduction in the cost price of the share in terms of the provisions of section 22(1) of the Act, but excludes any costs or losses which have been allowed as a deduction in the determination of the taxpayer's taxable income from dividends. In cases where no records of costs are available because the affected shares disposed of were, for instance, acquired many years ago, the relevant Receiver of Revenue may be approached in this regard. Each such case will, therefore, have to be dealt with on its own merits.

8. The Application of the FIFO Method on Disposal of Affected Shares

To determine whether a share has been held for the qualifying period of five years so as to be classified as an affected share, subsection (7) of section 98 of the Act provides that where a taxpayer holds affected shares in a specific company which he acquired on various dates and disposes of any of such shares, the FIFO method must be applied.

Example

Facts:

Mr. A purchased and sold the following shares in B Ltd:

Solution:

Should Mr. A have elected that section 9B be applicable to him—

9. Tax Treatment of Share Transactions where no Affected Shares are involved

It is important to note that where listed shares which have not been held by a taxpayer for five years (in other words, shares which are not affected shares) are disposed of, the proceeds received from the disposal of such shares will not summarily be subjected to tax. Receipts and accruals of this nature will be treated according to the normal guidelines which have been set down by South African case law over the past years. Similarly the ordinary rules will also apply in respect of the disposal of shares by a taxpayer who has not made the provisions of section 9B applicable to him.