What is base cost?
Base cost is the amount against which any proceeds upon disposal are compared in order to determine whether a capital gain or loss has been realised.
For assets held on the valuation date (1 October 2001) that were acquired before that date base cost is equal to the “valuation date value” of the asset plus any further qualifying costs incurred on or after that date (paragraphs 20 and 25 of the Eighth Schedule).
For assets acquired on or after the valuation date the base cost of the asset generally comprises the costs incurred in acquiring the asset and improving it. Paragraph 20 of the Eighth Schedule sets out what costs qualify to be part of base cost.
An asset can also be deemed to be acquired for a base cost equal to the market value of the asset at the time of acquisition (for example, if the asset is acquired by donation or for a non-arm’s length price from a connected person (paragraph 38 of the Eighth Schedule).
Base cost includes those costs actually incurred in acquiring, enhancing or disposing of an asset that are not allowable as a deduction from income. Thus, the base cost of trading stock would generally be nil because its cost would have been deducted from income.
The following are included in the base cost of an asset:
The costs actually incurred in acquiring or creating an asset. For example, these costs could include the cost of purchasing an asset or the cost of erecting a building. The expenditure should not have been claimed against income.
- Incidental costs of acquisition and disposal
Any of the following costs actually incurred as expenditure directly related to the acquisition or disposal of an asset.
- The remuneration of a surveyor, valuer, auctioneer, accountant, broker, agent, consultant or legal advisor, for services rendered
- Transfer costs
- Stamp Duty, Transfer Duty, Securities Transfer Tax or similar duty or tax
- Advertising costs to find a seller or to find a buyer
- The cost of moving the asset from one location to another
- The cost of installing an asset, including the cost of foundations and supporting structures
- A portion of donations tax paid according to a formula
- If that asset was acquired or disposed of by the exercise of an option (other than the exercise of an option acquired before the valuation date), the expenditure actually incurred on the acquisition of the option
- Value-added tax not allowed as an input deduction (section 23C)
- Capital costs of establishing, maintaining or defending title or right to an asset
These costs would include, for instance, legal costs actually incurred in respect of a court dispute relating to maintaining your right or title to an asset you own.
- Cost of improvements or enhancements
- The improvement or enhancement must still be reflected in the asset’s state or nature at the time of its disposal.
- Valuation date value of an option
- One third of the interest incurred in acquiring listed shares or unit trusts
- Certain amounts that have been included in the person’s income and amounts arising as a result of value shifting arrangements.
And what about current costs such as interest, repairs, insurance and rates and taxes?
They are normally allowed as deductions from income or are incurred for personal use and are not allowed as part of base cost.
Base cost – composite acquisitions
Assets are sometimes acquired with other assets as part of a composite acquisition. For example, a single contract of purchase may be entered into at an inclusive price embracing multiple assets. In these circumstances the purchase price must be apportioned to the respective assets broadly by reference to their market values at the date of acquisition. The onus rests on the taxpayer to justify any allocation.
What if an asset was acquired before the valuation date?
For an asset acquired before the valuation date and disposed of after that date, CGT will be payable only on the capital gain attributable to the period after the valuation date. In other words, any gain attributable to the pre-valuation date period is not subject to CGT. The gain attributable to the period of ownership of an asset before the valuation date is excluded from CGT by establishing its “valuation date value” on 1 October 2001 using one of three methods: market value on 1 October 2001, time apportionment and 20% of proceeds. A fourth method, namely, weighted average base cost, is available for certain identical assets such as listed shares and unit trusts
I hold units in a unit trust through a management company that charges me a monthly fee. Is this fee deductible from any capital gain that I may make?
No, this is a current expense that does not enhance the value of the assets concerned.
I hold units that are held in income and gilt unit trusts. These pay interest (on which income tax is paid), and which is reinvested. On selling these units will I have to pay CGT on the difference between the original capital amount and the redeemed amount bearing in mind that this increased amount will include the reinvested interest amount on which income tax has already been paid?
No, income reinvested in the unit trusts will be used to purchase additional units, which will have their own base cost. As an example, assume that you hold 100 000 units with a total base cost of R50 000 and interest of R5 000 is reinvested to purchase an additional 800 units. The total base cost will increase to R55 000 and, if the 10 800 units are sold for R75 000, the capital gain will be R20 000, not R25 000.
If, after 1 October 2001, an investor were to add monthly to units in a unit trust fund acquired before valuation date and then sell all the units how would the loss/gain be calculated?
Two features of the legislation reduce the record-keeping required of a monthly investor in a unit trust.
The weighted average cost method is one of three asset identification methods for determining the base cost of identical assets such as unit trusts. The other methods permitted are specific identification and first in, first out (FIFO).
In essence, the method involves keeping running totals of the number of units bought and sold in a particular fund. It is best explained by way of an example.
Units in a unit trust are purchased on dates indicated.
|1 October 2001||100||15.00||1500|
|1 November 2001||50||16.00||800|
|1 December 2001||150||17.00||2550|
|1 January 2002||100||13.50||1350|
On 28 February 2002 125 units are sold for R2 125.00
The weighted average unit cost is R6 200 / 400 = 15.50
The base cost of 125 units is therefore 125 x R15.50 = R1 937.50.
The capital gain is R2 125.00 – R1 937.50 = R187.50
|28 February 2002||-125||15.50||-1937.50|
If an additional 100 units were bought for R18.00 each on 1 April 2002, the weighted average cost may be calculated as follows:
|1 April 2002||100||18.00||1800.00|
The weighted average unit cost is R6 062 / 375 = R16.67
If you have acquired units before and after valuation date, the opening entry on 1 October 2001 in any such calculation would be the number of shares owned on that date and the market value of the shares on that date. Thereafter purchases and sales could be recorded in the normal way.
Unit trust management company reporting
In order to simplify matters still further, management companies have been given the responsibility of submitting returns of the sale of units by investors. These returns are similar to the annual returns of interest earned that are already prepared by the management companies and disclose the–
- Number of units disposed of by the unit holder;
- Cost of those units determined on the weighted average basis;
- Proceeds on disposal of those units; and
- Gain derived from, or loss incurred in respect of, the disposal of those units.
Unit holders who do not wish to use the weighted average cost method to determine capital gains on the disposal of their units are not bound by this return. However, they will have to keep the records necessary to support the alternative they select.
Unit holders who adopt the weighted average method are obliged to adopt the method for all their units in the various unit trusts in which they have an interest. For example if a unit holder holds units in three different unit trusts and adopts weighted average for one of them, he or she will also have to use the method for the other two.
I bought LISTED shares in 1999 for R100 each. The average price at the starting date for CGT (1 October 2001) is R60. I then sell these shares at a date after 1 October 2001 for R70. Am I now liable for CGT on the R10 being the difference between the realised price and the valuation date value when in fact I made an actual loss of R30 per share?
The answer depends on which asset identification method you have adopted.
First in, first out or specific identification
If you adopted the first-in-first-out or specific identification method for identifying which shares you have disposed of, your valuation date value will be restated to R70 under paragraph 27(3)(a) of the Eighth Schedule. There will, therefore, be no capital gain or loss on this transaction. A similar principle applies under paragraph 26(3) when an asset is sold for less than its valuation date market value but more than its historical acquisition cost.
If you adopted the weighted average identification method, the market value gain of R10 (R70 – R60) must be brought to account. The reason is that this method uses the market value of your shares on 1 October 2001 as its starting point. The gain and loss limitation rules do not apply if you adopt this method.
Do paragraphs 26 and 27 apply to listed shares and units in a unit trust?
Generally yes, but these rules do not apply to –
- foreign listed shares and foreign unit trusts for which you have not determined a market value; or
- when you have adopted the weighted average method for determining the base cost of the relevant assets.
Can interest incurred on the acquisition of shares in a private company be added to base cost?
No – this is specifically prohibited by paragraph 20(2)(a) of the Eighth Schedule. In the case of listed shares and unit trusts, however, paragraph 20(1)(g) allows one-third of the interest incurred to be added to base cost.
Why does the time-apportionment method give different results in the scenarios set out below?
An individual acquired an office block 16 years before 1 October 2001 for R250 000. A set of storerooms were added at a cost of R60 000 two years before 1 October 2001. A new wing was added at a cost of R300 000, a year after 1 October 2001. The office block was sold for R2 000 000, two years after 1 October 2001.
The same facts but the cost of adding the storeroom and new wing was all incurred one year before 1 October 2001. Why is it that if you incurred it over a period your gain is higher than if you incurred it once?
Well, in SCENARIO 1:
Expenditure incurred pre- and post- valuation date
Pre-valuation date expenditure is R250 000 + R60 000 = R310 000
Post-valuation date expenditure = R300 000
Total expenditure = R610 000
Proceeds R2 000 000
Period property held before valuation date = 16 years.
Period held after valuation date = 2 years.
Total = 18 years.
Pre-valuation date proceeds = Proceeds x pre-valuation date expenditure
Total expenditure = R2 000 000 x R310 000
= R1 016 393
Gain produced by pre-valuation date expenditure =R1 016 393 – R310 000 = R706 393
Portion of capital gain attributable to period before valuation date = R706 393 x 16 years
= R627 905
Valuation date value = R310 000(pre-valuation date expenditure) + R627 905 = R937 905
Total base cost = R937 905 + R300 000
= R1 237 905
Capital gain = proceeds – base cost
= R2 000 000 – R1 237 905
= R762 095
and in SCENARIO 2:
Expenditure all incurred in the year of purchase before CGT
Proceeds are all attributable to pre-valuation date expenditure = R2 000 000
Total costs = R610 000
Gain = R1 390 000
Time apportionment base cost R1 3900 000 x 16/18years = R1 235 556
Base cost = R610 000 + R1 235 556 = R1 845 556
Capital gain = R2 000 000 – R1 845 556 = R154 444
It is not the fact that you incurred the costs over a period rather than all at once that necessarily affects the result. The gain in scenario 1 is higher than in scenario 2 because nearly half the costs were incurred after valuation date and thus generated nearly half of the post CGT gain.
In scenario 2 all these post-valuation date costs are thrown back 16 years to the date of acquisition prior to the valuation date with the result that 16/18 of the gain is attributable to the pre-valuation date period.