plan4CGT - Disposals and deemed disposals - Basic rules

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This page - disposal rules; events treated as disposals; events not treated as disposals & simultaneous disposals and acquisitions without change of ownership.

 

 

Disposals and deemed disposals.

The disposal of an asset triggers the CGT legislation. Therefore, in order to spread the net as wide as possible, “disposal” should be widely defined. And it is - virtually any means of disposing of an asset is covered.

Outline of legislation -

Traditional disposal events -paragraph 11(1)

Non-disposal events - paragraph 11(2)

Events treated as simultaneous disposals and acquisitions - paragraph 12

Closely related to the disposal concept are the timing rules. These rules specify the times that the disposals take place and as a result determine the tax year in which the disposal should be accounted for. The timing rules are peculiar and this is an area where things can really go wrong! Catastrophically wrong!

The first thing to understand is that a disposal does not have to be a bilateral event. By this we mean that a disposal does not necessarily arise by way of agreement between two parties. For example, a disposal can arise via Acts of God, (earthquakes); by “forbearance” i.e. the failure to do something, (typically by failure to enforce the payment of a debt); by the actions of a third party (by the operation of law), such as divorce.

Another thing to remember is that a disposal does not necessarily mean that the asset has to change hands. The destruction of an asset would clearly fall into this category, but other forms of disposals are a little more obscure, for example-

    The creation of an asset is a disposal. A typical occurence here is that the granting of an option in respect of an asset constitutes the creation of an asset i.e. the option itself is the asset that is created.

    The variation of an asset is also regarded as a disposal. What the legislation has in mind here is somewhat vague! If, for instance, you convert your house into a bed and breakfast, could that be a variation of an asset? We somehow doubt it! And, in any event, what consideration would you have received? Nevertheless, a variation of a restraint of trade could fall into this category. For instance, Company A has restrained Company B in terms of which Company B is not permitted to trade in a particular product in sub-saharan Africa. Company A has not penetrated Angola nor is it likely to, but Company B has good contacts there. As a result, Company B pays Company A to amend the restraint to allow it to trade in Angola.

Disposals - the detail, (what we refer to as traditional disposals, these include the specific inclusions)              

Basic definition of disposal

A disposal is any-

That results in the-

The above definition seems to be fairly comprehensive and straightforward but it goes on to specifically -

  • include certain events,
  • exclude certain events and in some cases
  • deem certain events to be simultaneous disposals and acquisitions, (usually without an asset changing hands).

This should become clearer!

Disposal events specifically included are-

  • The sale, donation, expropriation, conversion, grant, cession, exchange or any other alienation or transfer of ownership of an asset.
  • The forfeiture, termination, redemption, cancellation, surrender, discharge, relinquishment, release, waiver, renunciation, expiry or abandonment of an asset.
  • The scrapping, loss or destruction of an asset.
  • The vesting. of an interest in an asset of a trust in a beneficiary.
  • The distribution of an asset of a company to a shareholder.
  • The granting, renewal, extension or exercise of an option.
  • The decrease in value of a person’s interest in a company, trust or partnership as a result of a value shifting arrangement.

Certain arrangements that would otherwise be caught by this wide ranging disposal concept are excluded from the CGT net. This is because, by their very nature, they should not give rise to a CGT event. For example, unissued shares in a company would have no base cost in the company’s hands. As such, the issuing of shares by a company to an incoming shareholder would, without the exclusion, give rise to a CGT event on the part of the company. This would be a ludicrous result!

Most of the events below require no further explanation.

Disposal events specifically excluded (i.e. non-disposals) are-

  • The transfer of an asset as security for a debt, or by a creditor who transfers that asset back to that person upon the release of that security.
  • The issue or cancellation, by a company, of a share in that company, or the granting, by a company, of an option to acquire a share or debenture in that company.
  • The issue of a partcipatory interest in a collective investment scheme by that collective investment scheme, or the issuing of an option to acquire such an interest by that scheme. (This would include unit trusts and the like.)
  • The issuing of any bond, debenture, note or other borrowing of money or obtaining credit from another person.
  • The distribution of an asset by a trustee of a trust to the beneficiary of that trust where the beneficiary has a vested interest in that asset prior to the distribution.
  • The correction of an error in the registration of immovable property, in that person’s name, in the deeds registry.
  • The lending of any marketable security in terms of a “lending arrangement” as defined in the Stamp Duties Act.
  • The (temporary) vesting of assets of a spouse in the Master of the High Court or trustee, as a consequence of the insolvency of that person’s spouse. The subsequent release of those assets to the spouse is also excluded. 

The events described above are those that are specifically excluded. In a similar vein there are certain events that do not constitute disposals despite the fact that they appear to be disposals. In law the following events are not disposals and as such do not need to be specifically excluded in the CGT legislation itself  - 

  • Trustees, executors, curators and the like do not hold assets in their own capacity, but hold them in a fiduciary capacity. The change of appointment of a trustee, etc. would not constitute a disposal of the trust assets on the part of the trustee.
  • If a company convers to a close corporation, a co-operative converts to a company, or a close corporation converts to a company, the respective entities are treated as one and the same person. As such, no disposal would take place upon conversion.

Events treated as (simultaneous) disposals and acquisitions (usually without the asset changing hands)

The types of transactions that fall under this general (disposal) heading can be grouped into a number of categories.

Category 1 - Events treated as simultaneous disposals and acquisitions at market value, (the actual timing of the event is the day before the event occurs). In all cases the asset is retained by the owner -

There is really a two-pronged purpose to the scenarios in categories 1, 2 and 3 below-

  • to trigger a capital gain or loss; or
  • to establish a base cost.

The following deemed disposal and acquisition events apply in ‘category 1’

  • Assets that are held otherwise than as trading stock, when they commence to be held as trading stock.
  • An asset that ceases to be a personal-use asset otherwise than by way of disposal.
  • An asset that is held otherwise than as a personal-use asset, when that asset becomes a personal-use asset.
  • Assets of a person who becomes a resident, (other than fixed property, certain interests in fixed property and assets of a PE).
  • An asset of a person who is not a resident, where that asset
    • becomes an asset of that persons permanent establishment, (usually a branch), other than by way of acquisition
    • ceases to be an asset of that person’s permanent establishment other than by way of disposal.
  • In both cases described below all assets belonging to that person are deemed to be disposed of apart from fixed property, certain interests in fixed property and assets of a permanent establishment, (branch). this applies to
    • a person who ceases to be a resident; or
    • a person who as a result of the application of a double tax agreement is treated as being non-resident.

Category 2 - Event treated as a simultaneous disposal and acquisition at market value on the day the event occurs, (again without the asset changing hands).

  • an asset transferred by an insurer as per section 29A from one fund, (as per section 29A(4), to another fund. (This applies to life insurance companies only - a detailed discussion of the above is beyond the scope of this site).

Category 3 - Event treated as a simultaneous disposal, (not necessarily at market value), and acquisition at that same value on the day preceding the actual event. (This is similar to category 1, apart from the fact that market value may not always apply - again the asset does not change hands).

  • Assets held as trading stock, when they cease to be held as trading stock, otherwise than by way of disposal.

Category 4 - This one is really in a category on its own! It invloves the waiver of debts and turns what was a liability on the part of a debtor to an asset so that the CGT legislation can tax the debtor on it, (it only taxes the disposal of assets). A summary of the process is set out below and our elaboration is on the link at the end.

    Where a debt owing by a debtor to a creditor has been reduced or discharged for either-

    • no consideration
    • or for a consideration that is less than the face value of that debt,

    the debtor is treated as having acquired a claim for the amount that was forgiven, (to which a zero base cost is attributed), and disposed of that claim for the amount forgiven.

    This paragraph does not apply to transactions of this nature in the following circumstances-

    • where a capital gain has been taken into account  by recognizing a reduction in base cost under what we refer to as the following year adjustment provisions
    • where the amount has been taken into account in reducing an assessed loss of ther debtor
    • where the base cost of an asset has been adjusted downwards by reason of, for example, the debt raised on the acquisition of that asset not ever being paid
    • debts arising between spouses.