Most Read Contributor in South Africa, September 2016
The Eighth Schedule to the Income Tax Act, 58 of 1962 ("the
Act") creates a tax liability known as capital gains tax which
applies generally where an asset is disposed of. A loan is regarded
as an "asset" in terms of the definition in paragraph 1
of the Eighth Schedule as it is an incorporeal asset whereby the
lender acquires a right to claim payment from the borrower. Where
part of a loan is repaid it constitutes part of an asset disposed
of and it will be necessary to allocate a part of the base cost of
the loan to the part of the loan repaid in order to determine the
capital gain or capital loss in respect of the disposal of that
part. Where a loan is acquired for less than its face value, i.e.
the base cost of the loan is less than the amount actually owed by
the borrower; the part-disposal method in paragraph 33 of the
Eighth Schedule to the Act will apply.
The base cost of the part repaid
Paragraph 33 contains two formulae for determining the part of
the base cost repaid, i.e. the market value formula method and the
specific identification method. The market value formula method in
paragraph 33(1) of the Eighth Schedule provides that the base cost
of the entire asset must be apportioned in the ratio that the
market value of the part bears to the market value of the whole
asset. In terms of this paragraph the base cost of the part of the
loan repaid will be calculated as follows:
Base cost of the part of the loan repaid = market value of the
part repaid / market value of the total loan x base cost of the
The difficulty with the market value formula method is that it
requires the market value of the loan to be determined immediately
before each repayment. Should there be numerous repayments it would
accordingly be administratively burdensome to apply this method and
practically difficult to implement. As an alternative, the specific
identification method can be applied to determine the part of the
base cost repaid.
The specific identification method in paragraph 33(2) of the
Eighth Schedule provides that the market value formula method will
not apply where the expenditure as determined in paragraph 20 of
the Eighth Schedule or the market value as determined under
paragraph 29(4) of the Eighth Schedule can be directly attributed
to the part of the asset which is disposed of or which is retained.
Therefore, the market value formula method will not apply where the
expenditure or market value in respect of the part disposed of can
be specifically identified.
The South African Revenue Service's Comprehensive Guide to
Capital Gains Tax (Issue 4) states that the specific identification
method recognises the fungible nature of a loan, that is, that all
parts of the loan have an equal cost, are indistinguishable and
identifiable by nomination. Therefore, in terms of paragraph 33(2)
of the Eighth Schedule and following this statement, the base cost
of the part of the loan repaid will be calculated as follows:
Base cost of the part of the loan repaid = amount repaid / the
total loan x base cost of the loan
Therefore, where a loan with a face value of R100 million is
acquired by a company at a cost of R80 million and R10 million is
repaid in the first year, the base cost of the part of the loan
repaid will be R8 million (i.e. R10 million / R100 million x R80
million). The capital gain will accordingly be R2 million (R10
million less R8 million) with capital gains tax of R373 340 payable
at an effective rate of 18,667%. Using the above example and as all
parts of the loan have equal cost, R1 of the R100 million loan will
accordingly have a cost of 80 cents. This creates a simplified
calculation in that should a repayment of R10 million be made on a
loan with a face value of R100 million which is acquired for R80
million the base cost of the part of the loan repaid can simply be
calculated as follows: R10 million x 80 cents = R8 million.
The specific identification method therefore recognises a
simplified calculation in that all parts of the loan will have
equal cost. As it will be administratively burdensome to use the
market value formula method and since this method is specifically
excluded in terms of paragraph 33(2) of the Eighth Schedule where
the expenditure or market value in respect of the part disposed of
can be specifically identified, the specific identification method
will generally be used. It is, however, important to note that
where the loan is interest bearing the provisions of section 24J of
the Act will apply and the loan repayment should be dealt in the
manner prescribed by that section.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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