With the 2018 tax-filing season for individuals in full swing, it is worthwhile looking at a common misconception regarding the determination of capital gains tax for individual taxpayers, specifically the role of the ‘annual exclusion’. Ensuring that the annual exclusion is applied accurately as determined in the Eighth Schedule to the Income Tax Act, especially where capital losses arise, will assist taxpayers in accurately completing their IT12 income tax returns and equally important, doing proper tax planning for the next tax year.
Apart from certain exceptions, individual taxpayers are required to calculate a gain or loss on the disposal of assets. This includes disposals of investments, property and even interests in private companies or close corporations. These gains or losses, which are calculated by deducting the base cost from the proceeds, should be aggregated to determine the potential tax exposure on the disposal.
Aggregate capital gain or loss
The annual exclusion is applied to determine the aggregate capital gain or loss for a year, which is a two-step process. Firstly, all capital gains for a year are reduced by all capital losses for the tax year, essentially a tally of all gains and losses realised during the year to arrive at a net total. Secondly, the net amount that has been determined, whether a gain or loss, is reduced by the annual exclusion of R40 000. The annual exclusion counts equally to reducing capital gains and losses. Importantly, the annual exclusion is not cumulative, unused portions are not carried forward to future years and it applies only to gains and losses from the current tax year. If the aggregated gain or loss is therefore less than R40 000 in the current tax year, disposal of assets in that year effectively have no impact on a person’s current or future years of assessment (although it is still a requirement to complete the information on the income tax return).
A person’s assessed capital loss from previous years of assessment is not, as commonly believed, reduced by the annual exclusion. Only after the aggregate gain or loss has been established, are capital losses from previous years considered.
Net capital gains or assessed losses
To arrive at a net capital gain or assessed capital loss, any assessed capital losses from previous tax years are deducted from aggregate capital gain, or added to aggregate capital losses, depending on the case. If there is still a net gain after deduction of previous losses, this amount is included in an individual’s taxable income at 40% (known as the taxable capital gain). If the aggregate capital loss of the current year is increased by the losses from previous years, this assessed capital loss is carried forward to be offset against capital gains in future years.
With the introduction of the tax-free savings account regime, it is expected that the value of the annual exclusion (which has increased from R10 000 for year of assessment prior to 2006 to the current R40 000), will not increase in future.
Fortunately, correct application of the annual exclusion is built into the eFiling system for individuals. It is however important that taxpayers understand its proper application in the unlikely event of errors on the eFiling system, and to accurately plan their capital gains exposure for future years.
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This article is a general information sheet and should not be used or relied upon as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice. Errors and omissions excepted (E&OE)