Mail & Guardian reporter
The South African Revenue Service (Sars) set the seemingly arbitrary date of October 1 this year as the date that capital gains tax (CGT) came into effect and the base cost of units is determined. But the date turned out to be anything but arbitrary.
As fate would have it, just three weeks earlier the terror attacks in the United States precipitated a world-market panic that has seen the global marketplace recoil. Equities dropped about 10% overall, with some shares dropping up to 25% in what was not a sustained fall and was, by all accounts, a sudden and cruel jolt. The market saw some recovery over the five days prior to the evaluation period, but it was still in what commentators are describing as an artificial pricing rut.
The October timing would have been disadvantageous in normal market conditions, with unit trusts having their worst quarter yet, but the terror attacks dramatically exacerbated the problem and the market is starting to recover some of its pace.
The legislation that made October 1 the assessment date, with the pricing of the unit taken as the mean sale price averaged out over the preceding five business days, could not have come at a worse time.
Economists are divided on the effect the poor market conditions will have on investors.
Econometrix’s Azzar Jammine says that that while the market has fallen by about 15% since the attacks, this drop will have little effect on the capital gains of an investor in the market for the medium to long term.
Citadel’s Steven Stein argues that market conditions are certainly to the detriment of taxpayers.
“For an investor the market weakness was the worst possible scenario.”
He explains that shares were all valued at a low base-cost and that capital gains will be reflected as soon as the markets start rising.
M-Cubed Capital’s head of retail asset management Paul Stewart agrees. “As confidence starts creeping back into the market as the aftershocks from the US wear off the price of shares will start moving back to an equilibrium,” he says.
“That price rise will be calculated as a capital gain, where it would otherwise be a dip.”
Assume you have invested two lump sums of R50000 in unit trusts over the past five years to take your investment up to R100000. Let’s also assume that the bearish market pulled the value of this investment down to R70 000 by mid-September and down a further R5000 by October 1. The base cost of the units will be set at R65000.
You sit the market turmoil out and decide in 2003 to sell your unit trusts, now valued at R90000. You are eligible to pay CGT on the profit of R25 000, despite the fact that you have a financial loss of R10 000.
“It’s unfortunate timing,” says Stein, “but the date has been set for quite a while and no one could have foreseen the current market conditions.”
Sars says it’s “monitoring the situation”, but seems set on sticking to the current valuations published on its website.
But the evaluation over the five days prior to October 1 is not the only avenue an investor has open. Investors holding shares or unit trusts bought prior to October 1 have two methods open to them to calculate base costs.
The first, discussed above, takes the weighted average over five working days of trade prior to October 1. The second method is worked out on a time-apportioned basis and calculates the base cost over the time the asset has been held.
The Association of Unit Trusts (AUT) explains that for share port-folios and unit trusts bought henceforth the actual cost paid for the units, including any initial charges, is used to calculate the base cost. The unit trust management company will track your cost of purchases over time on a weighted average base cost so that when you sell units the base cost will have been automatically calculated over time.
Each time you buy units the management company will recalculate the weighted average base cost by multiplying the existing number of units by the existing base cost of the units The total cost, calculated at the buy price, of the new units bought is added to obtain a new monetary value. This is then divided by the sum of existing units and new units to arrive at the new weighted average base cost of all units in the account.
The above method of calculating the base cost of units has been adopted as an AUT standard and is the method management companies are required to use when reporting capital gains to Sars.
However, a unit holder is entitled to use any of the methods provided for in the Eighth Schedule of the Income Tax Act when computing gains or losses. Section 30 of the schedule provides for the time- apportionment method and Section 32 deals with the base cost of identical assets and provides for using any one of the specific identification, first-in/first-out or weighted average methods.
A unit holder wishing to use any method other than the weighted average must ensure all records are available to be furnished with the annual income tax return.
“Investors need to think carefully about which evaluation method they chose to calculate the base cost when they decide to sell,” says Old Mutual Asset Management MD Tim Cumming. He says the time-based method may be the best one for shares that have been held for a while and which the investor intends selling shortly.
He takes the hypothetical example of an investor who bought shares in a firm two years ago when the shares were valued at R12. The shares were valued at about R14 using the five days prior to October 1. But they are expected to rise, in line with the market, to about R15.
An investor using the first method would have a base cost of R14 a share and a capital gain of R1 a share should they sell.
An investor using the time-based method would have a base cost of about R14,80 a share should they sell at R15 a share making a capital gain of 20c.
Cumming suggests investors take advice on how to calculate this in a way that best suits them when they are facing calculating CGT on a tax return, a sentiment echoed by the AUT. He stresses that the two major factors that will determine which method yields the best results for the investor are how long you have held the asset and when you intend to sell.
The new tax is a difficult one to swallow, and not just for the investor. Cummings described the move as a “costly and very complex exercise to calculate taxable amounts not expected to raise huge amounts of money for the fiscus.”
ENDS
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