The Capital Gains Tax rules appear to ‘punish’ those who leave the country

Some of the ‘colours’ in our ‘rainbow’ come from beyond our shores, and many people originally hailing from other countries have spent a major portion of their lives here. However, such people may have assets (and even income streams) from both foreign and South African sources, and the question arises: How does the fiscus ensure a fair contribution by that person to the economy of the country in which they live?

One of the hallmarks of a sound tax system is that it must be substantially fair. Until a few years ago, South Africa taxed its residents on a “source” basis, which essentially meant that income earned here is subject to South African tax, whilst income derived from foreign shores is not.

Because many other countries followed the ‘residence’ basis of taxation, an inherently unfair situation arose whereby a taxpayer whose income was split between local and foreign sources paid less tax in South Africa than one whose income is derived wholly from South African sources.

To come in line with international jurisdictions, South Africa changed to a ‘residence’ basis of taxation. This is widely seen as a fairer basis of taxation, since in crude terms, the principle followed is ‘you live here, therefore you pay tax here’.

But family ties are strong, and the saying ‘blood runs thicker than water’ can be applied to virtually all cultures. It is therefore natural that as people advance in years, some may wish to return to the land of their birth to be reunited with their families-particularly if no such ties exist in South Africa.

So what happens from a taxation point of view when you leave South Africa permanently? Income tax is not a problem, since you are taxed in South Africa until the time you leave, and are taxed in the foreign country (assuming that they follow a residence-based system) once you arrive.

However, Capital Gains Tax (CGT) is a potential time-bomb. Paragraph 12(2)(H) of the Eighth Schedule to the Income Tax Act states that a person who ceases to be a resident of South Africa is deemed to have disposed of all of their assets as of the date of departure, irrespective of whether or not such assets were actually disposed of.

The assets are deemed to have been disposed of at market value, and include all assets held world-wide by virtue of our residence-based system of taxation.

The deemed disposal will give rise to CGT on the difference between the market value and the base cost, in accordance with the normal rules applicable to CGT as contained in the Eighth Schedule.

I recently received an e-mail from a concerned would-be emigrant who has a substantial asset base both here in South Africa and abroad. Whilst this person did not have any objection to paying CGT on gains made from assets that will physically be disposed of, he has a strong objection to being subject to this tax on the assets that he is keeping.

He is particularly aggrieved at the potential CGT liability on his foreign assets, given the fact that these assets were either inherited or purchased with capital generated from foreign sources, i.e. the funds were not earned in South Africa and taken offshore for investment.

The rules would apply equally to any assets held world-wide, i.e. you will pay CGT on any gains made on disposal (or in this case, deemed disposal) of assets. This gain would be the difference between the base cost and the proceeds or market value in the case of deemed disposals.

One can sympathise with this person’s plight. After all, in the normal course of one’s life, whenever a CGT liability arises, you would (hopefully) have the physical cash from the gains made on the sale to pay the tax. Unfortunately, in the case of a deemed disposal, you end up with the tax liability without necessarily having the cash to pay the tax.

The law as it stands seems rather harsh and unjust. A fairer provision would be for the CGT liability to be calculated as at the date of departure, but only become due and payable when the asset is actually disposed of

However, this has other practical implications. For example, when you leave South Africa permanently, you effectively cease to be a taxpayer in terms of South African tax law. This means that it would be very difficult (if not impossible) for SARS to keep track of a person who has emigrated to ensure that the relevant CGT is collected once the asset has been disposed of,

Under normal circumstances, assets purchased on or after l October 2001 will have the actual cost thereof making up the lion’s share of the base cost for CGT purposes, whilst those purchased prior to this date will have a base cost determined by an actual valuation as at that date, or by the so-called ‘time-apportionment formula’.

But what happens if you have owned assets for donkey’s years, but only became a South African resident after 1 October 2001? The base cost will be the market value of the asset as at the date you became a resident, whilst the proceeds of the deemed disposal will be the market value as at the date you cease to be a resident. For example, if you arrived in South Africa on l March 2005, and left on 31 December 2008, you will only be taxed on the capital gain accruing between these two dates.

There is a strong argument for scrapping the whole concept of ‘deemed disposals’ in their entirety. After all, CGT does not exactly generate all that much revenue for SARS when compared to personal and corporate income tax, or VAT.

Until such time as National Treasury sees fit to amend the CGT legislation, one has to make the best of the situation as it currently stands. It is however critical that you do the calculations correctly, particularly with regard to the base cost of the asset, and especially if your period of residence in South Africa is fairly short.