Page 432 - SAIT Compendium 2016 Volume2

IN 43 (5) Income Tax acT: InTeRPReTaTIon noTes IN 43 (5)
Example 9 – Cancellation of debt used to nance the acquisition of qualifying shares
Facts:
On 1 March 2010 Individual A acquired listed shares as trading stock at a cost of R100 000. The acquisition was funded by a loan of R100 000 from Company B. On 1 June 2013 Company B cancelled the debt owing by Individual A because Individual A was unable to pay the amount outstanding. On 30 November 2013 Individual A disposed of the shares for R115 000.
Result:
As a result of the debt cancellation on 1 June 2013 the value of Individual A’s opening stock reduces to nil under section 19(3) (R100 000 – R100 000). On 28 February 2013 the shares had been held for three continuous years. Accordingly, under section 9C(2) the proceeds on disposal of the shares on 30 November 2013 will be of a capital nature since they comprise qualifying shares as de ned in section 9C(1). Since the amount of R100 000 has already been taken into account under section 19(3) no amount must be included in Individual A’s income under section 9C(5). The base cost of the shares is reduced to nil under paragraph 20(3)(a)(i) because the expenditure of R100 000 was ‘allowable’ at the time it was incurred under section 11(a). Individual A will accordingly realise a capital gain on disposal of the shares of R115 000 (proceeds of R115 000 less base cost of nil).
Note: In determining the base cost of the shares the expenditure that is recovered or recouped as a result of the cancellation of the debt is not reduced under paragraph 20(3)(b) of the Eighth Schedule. Paragraph 20(3)(b)(iii) suspends the base cost reduction rule by stipulating that it does not apply when the amount of a debt reduction has been applied to reduce an amount taken into account in respect of trading stock as contemplated in section 19.
10. Share-dealers
Section 9C draws no distinction between a share-dealer who carries on a distinct business of buying and selling shares for pro t and a person who invests in shares as a long-term investment but speculates in some shares from time to time. The holding of shares by a share-dealer or the occasional speculator for at least three continuous years converts the amount derived on disposal from income to an amount of a capital nature. Amounts previously allowed as a deduction (for example, opening stock or interest on monies borrowed to buy shares) must be recouped on disposal of the shares and a capital gain or loss determined as if the shares had been held on capital account from the date of acquisition. Both categories of persons are subject to section 9C and do not have an option to elect out of the provision in order, for example, to claim revenue losses on shares held for three years or longer.
In the year of acquisition a share-dealer will be entitled to claim the cost of acquisition of shares under section 11(a). At the end of that year of assessment the value of the share must be brought to account as closing stock under section 22(1). With effect from years of assessment commencing on or after 1 January 2011 the amount to be included in closing stock is the cost price of the shares, and no reduction is permissible if the market value of the shares is lower than cost.* Before the amendment to section 22(1)(a),† only corporate shareholders were prevented from writing down the value of shares held as closing stock.
The closing stock of a previous year of assessment becomes deductible as opening stock under section 22(2). This process continues even after the three-year period has passed, since the shares remain trading stock as de ned in section 1(1). The de nition of the term ‘trading stock’ includes (apart from some exceptions not relevant for present purposes) –‡
‘anything produced, manufactured, constructed, assembled, purchased or in any other manner acquired by a taxpayer for the purposes of manufacture, sale or exchange by the taxpayer or on behalf of the taxpayer’.
Equity shares held as trading stock are normally acquired for the purposes of sale and thus satisfy the above part of the de nition. For income tax purposes a share-dealer is entitled to deduct certain ongoing expenses incurred in respect of shares held as trading stock under section 11. Examples of such expenditure include –
• technical analysis software to manage trading portfolios;§
• monthly download fees incurred for the above-mentioned software;
• bank charges;
• interest incurred on money borrowed to nance the acquisition of shares;
• internet access charges;
• scrip custody fees; and
• cost of telephone calls.
These expenses will be deductible during the three years following the date of acquisition of the shares to which they relate. However, as from the beginning of the fourth year any further expenditure of this nature will no longer qualify for deduction under section 11(a) since it will no longer be incurred in the production of income. At the beginning of year 4 any proceeds on disposal of the shares can only be of a capital nature under section 9C(2).
Could these expenses be said to be in the production of the income in the form of the recoupment under section 9C(5) of opening stock in the year of disposal? In order for expenditure relationship to be in between the production of income there must be a close causal the expense and the income to which it relates.¶
The recoupment under section 9C(5) of the value of opening stock nds its originating cause in the deduction of the acquisition cost of the shares at the beginning of year 1. The expenses incurred in year 4 and beyond have no impact on
* Section 22(1)(a) now excludes the write down of nancial instruments.
† Section 39(1)(a) of the Taxation Laws Amendment Act No. 7 of 2010.
‡ Paragraph (a)(i) of the de nition of the term ‘trading stock’ in section 1(1).
§ See Interpretation Note No. 47 (Issue 3) dated 2 November 2012 ‘Wear-and-tear or Depreciation Allowance’ for the
write-off periods under section 11(e) for software.
¶ Port Elizabeth Electric Tramway Company Ltd v CIR 1936 CPD 241, 8 SATC 13.
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