Base Cost Of Improved Assets
Capital gains tax may be triggered upon the disposal of an asset by a taxpayer in circumstances where the proceeds or deemed proceeds arising from such disposal exceeds the base cost of the asset in the hands of the taxpayer.
In terms of paragraph 20 of the Eighth Schedule of the Income Tax Act No. 58 of 1962 (“the Act”), the base cost of an asset is, broadly speaking, the expenditure actually incurred by the taxpayer in respect of the cost of acquisition or creation of that asset together with a number of other costs related to the acquisition or creation of such asset (e.g. transfer costs) and various other asset-related costs.
In particular, paragraph 20(1)(e) of the Eighth Schedule of the Act provides that the base cost of an asset includes expenditure incurred in effecting an improvement or enhancement to an asset provided such improvement or enhancement is still reflected in the state or nature of that asset at the time of its disposal.
For ease of reference we refer to the proviso underlined above as the “improvement proviso”.
Accordingly, where a taxpayer, for example acquired a property for R1 million and incurred an amount of R300,000 in building a swimming pool on such property, the base cost of such property for purposes of capital gains tax should be R1,300,000. Should, for example, the taxpayer close-up the swimming pool prior to the sale of the property the base cost of the property would, in terms of current law, be R1 million as the improvement or enhancement to the property would not exist at the time of disposal.
The Draft Taxation Laws Amendment Bill, 2019 (“DTLAB”) released by National Treasury on 21 July 2019 proposes to remove the improvement proviso – as a result of which the property in the above-mentioned example should have a base cost of R1,300,000 in the hands of the taxpayer – regardless of whether the swimming pool is in existence at the time of the sale of the property.
The Explanatory Memorandum to the DTLAB states that the improvement proviso was adapted from the Australian Income Tax Assessment Act, 1997. However, the improvement proviso was removed from such Australian legislation with effect from 1 July 2005. Accordingly, the DTLAB proposes to remove the improvement proviso in order to align with the Australian tax legislation.
As an aside – it should be noted that a taxpayer should be in a position to prove improvement costs to the extent that such improvement costs increase the base cost of assets. It is therefore advisable for a taxpayer to retain all documentation (e.g. invoices and/or building agreements) in relation to such improvements.