Inflation: How government is collecting more tax revenues by stealth
These three CGT exclusions have remained unchanged for five years.
Over the last few years government has collected a significant amount of tax revenue by not fully adjusting the personal income tax tables for inflationary increases in earnings, thereby increasing the effective tax rate of individuals.
A middle-class individual earning a taxable income of R400 000 per annum in the 2016 year of assessment, would have seen her after-tax income increase by only 5.42% and 5.05% in the 2017 and 2018 tax years respectively, even if her taxable income increased by 6% every year.
During his most recent budget speech, finance minister Pravin Gordhan collected more than R12 billion of the R28 billion in additional taxes he needed from the personal income tax system in this way.
In a similar fashion, taxpayers may now become liable for capital gains tax (CGT) purely because three of the exclusions have not been adjusted for the effects of inflation since March 1 2012.
1. The primary residence exclusion
When taxpayers sell their primary residence and realise a capital gain on the transaction, an exclusion of R2 million applies.
Louis van Vuren, CEO of the Fiduciary Institute of Southern Africa (Fisa), says if the exclusion was adjusted for inflation over the past five years, it would have increased to around R2.6 million over the period.
For someone who bought an upper middle-class house in Cape Town for R650 000 in 2002 and who wants to sell it now, this has significant implications.
Van Vuren says today the house would be worth roughly R3 million. If it were sold, the capital gain realised would amount to R2.35 million (assuming no capital improvements and a base cost of R650 000). Due to the primary residence exclusion, R2 million would be disregarded, and 40% (the inclusion rate for individuals) of the capital gain of R310 000 (after deduction of the R40 000 annual exclusion) would have to be included in the individual’s taxable income.
At an assumed marginal income tax rate of 41%, the individual would have to pay R50 840 in CGT, purely because the primary residence exclusion hasn’t been adapted for inflation, he adds.
2. The year of death exclusion
Apart from the primary residence exclusion, the South African Revenue Service allows for a capital gain exclusion of R300 000 on all other assets in the year of an individual’s death (instead of the normal R40 000 annual exclusion). Personal use assets like artwork, jewellery and vehicles do not attract capital gains tax.
Van Vuren says if someone had invested R250 000 on the JSE in March 2009 in the wake of the financial crisis and it kept track with the performance of the All Share Index, the investment would have grown to roughly R700 000.
Since the individual would be deemed to have disposed of the investment upon death, the capital gain would amount to R450 000, which would reduce to R150 000 after the R300 000 exclusion had been deducted.
Van Vuren says if the exclusion kept track with inflation it would have been around R400 000 today and the gain would be only R50 000 (R700 000 minus R250 000 minus R400 000).
At an inclusion rate of 40%, the R100 000 “additional gain” that had been realised will add R40 000 to the individual’s taxable income, which, at a marginal tax rate of 41% would lead to R16 400 in CGT, purely due to inflation.
3. Special exclusion for small business owners
Van Vuren says because the retirement provision of small business owners are often locked up in the value of their companies, it would be quite harsh to levy capital gains tax in the normal way when they dispose of their interest in the business upon retirement.
As a result, small business owners receive a special capital gains exclusion of R1.8 million upon retirement (minimum age 55 years) or death, subject to certain conditions (and over and above the R40 000 annual exclusion):
- The individual must own at least 10% of the business;
- The total business assets of all businesses the person is involved in must not exceed R10 million;
- The individual must have been actively involved in the business for at least five years;
- If at retirement, the disposals must all happen within a 24-month period.
If the exclusion had been adjusted for inflation, it would have been roughly R2.3 million by now, Van Vuren says.
If an individual sold her small business assets for R2.3 million, she would have a capital gain of R460 000 (R2.3 million minus R1.8 million minus R40 000), resulting in CGT of R75 440 (R460 000 x 40% x 41%) purely because of inflation.
A small business owner who wants to scale down by selling his primary residence (using the values above) and move to a retirement village could pick up a CGT bill of R132 840 [(property gain R350 000 plus business gain R500 000 less R40 000 annual exclusion x 40% x 41%)] in the process, due to the inflationary impact.
Van Vuren says the successive Ministers of Finance have effectively collected more money by stealth, just by leaving CGT exclusions unchanged and surrendering them to the effect of inflation.