The principles discussed in this article are of application to persons holding share portfolios as a capital asset for investment purposes, with no intention of profit-making. Different principles apply to traders in shares holding such shares on revenue account. The application of the specific provisions discussed below will depend on the factual matrix relevant to a specific taxpayer.
South African tax residents are taxed on their worldwide income and taxable capital gains. The determination of a taxpayer’s taxable income under the Income Tax Act 58 of 1962 (the Act) includes certain income tax deductions and capital allowances. The determination of a capital gain includes, inter alia, the determination of allowable base cost expenditure in terms of paragraph 20 of the Eighth Schedule to the Act.
Section 11(a) read with section 23(g) of the Act (the General Deduction Formula), permits a taxpayer carrying on a trade to deduct from their taxable income “expenditure and losses actually incurred in the production of the income, provided such expenditure and losses are not of a capital nature; (…)”
In other words, deductions may only be allowed when the expenditure and losses:
1. have actually been incurred,
2. in the production of income,
3. which are not of a capital nature, and
4. arose in the course of the taxpayer carrying on a trade.
The General Deduction Formula would typically only apply to share traders holding shares on revenue account. Conversely, persons holding a share portfolio on capital account for investment purposes (i.e. persons who are not share traders) would typically not be able to deduct losses and expenditure as, by way of example, the “trade” and “not of a capital nature” requirements in the General Deduction Formula are not met. Further, with respect to individuals holding shares on capital account, section 23(b) of the Act prohibits the deduction of “private or domestic expenses.”
As a result, many expenses including those incurred in acquiring or disposing of assets are not deductible as such expenses do not comply with the General Deduction Formula. Notwithstanding certain ‘capital’ expenditure not being deductible, other expenditure may nonetheless be taken into account when determining the base cost of an asset for capital gains tax (CGT) purposes. It is this expenditure which increases the base cost of an asset, which in turn decreases the taxable capital gain upon the disposal of the asset.
Paragraph 20(1)(c)(i) of the Eighth Schedule to the Act makes provision for a category of expenditure directly related to the acquisition or disposal of that asset, including remuneration paid to professionals such as valuers, accountants, brokers, agents, consultants and legal advisers. Where these professionals have been remunerated in respect of their services rendered to acquire or dispose of the specific asset, these amounts may qualify as forming part of the base cost of such asset.
Certain professional fees may potentially instead be claimed under paragraph 20(1)(a) of the Eighth Schedule as forming part of the cost of the acquisition or creation of the asset.
Commission or other similar fees paid to an agent or broker upon the purchase or disposal of shares in a share portfolio may also form part of the base cost under paragraph 20(1)(c)(i) as they are directly linked to the acquisition or disposal of the particular share counter in question and are readily quantifiable per transaction.
By contrast, ongoing portfolio management or management fees in terms of a mandate that are payable irrespective of whether any trades occur would not form part of the base cost of a specific share. The difference between general portfolio/management fees and fees payable to the broker or agent for a specific share transaction is that the former represents continuous holding or management expenses, whereas the latter are more attributable to specific transaction costs per share as contemplated in paragraph 20(1) of the Eighth Schedule to the Act.
In conclusion, where share transactions form part of the taxpayer’s investment activity rather than a trade, the associated management and advisory fees are not deductible under section 11(a) read with section 23(g). It is only the costs that are directly attributable to, and quantifiable in respect of, particular acquisitions or disposals that may be included in the base cost for CGT purposes. In the case of a share portfolio held on capital account, this would include any related stamp duties or securities transfer tax, as well as other brokerage charges per share transaction, Strate settlement costs, and so on.
Therefore, taxpayers holding a share investment on capital account should bear the following in mind:
1. Expenses and losses actually incurred will not be deductible for income tax purposes in terms of the General Deduction Formula; and
2. Certain costs attributable to a specific share trade may be added to base cost expenditure for CGT purposes.
