The following information has been supplied:
- Business purchased in 2000 for R40K
- Selling Price: R2 400 000
- Business is in a CC: 50/50 members interest; Member 1 (age 64) & Member 2 (age 52)
- Both the Buyer & Seller are VAT registered vendors
SCENARIO 1:
THE BUSINESS IS SOLD OUT OF THE CC
VAT IMPLICATIONS:
Both are registered VAT vendors and assuming the going concern concept applies and the Agreement of Sale contains the necessary clauses to effect this, the transaction will be zero rated as regards VAT.
CAPITAL GAINS TAX:
The capital gain is represented by the proceeds on disposal (R2.4mil) less the base cost.
The base cost will include the cost of acquisition and the cost of improving the asset. As no valuation of the business was done in October 2001, the time apportionment method will be used to calculate the base cost.
For the purpose of this exercise, we have assumed the following: ((R2.4mil less R40K)/17years) = R138K less R40K = R98K estimated base cost October 2001 with October 2001 being the date CGT came into effect. Note the actual calculation is more complex and this example is for illustrative purposes only.
Capital gain then estimated at: R2 302 000.
80% of this amount will be included in the taxable income of the CC @ R1 841 600.
This in turn will be subject to company tax at 28% (Note you may find some additional small relief if the CC qualifies for SBC tax rates but, for the purposes of a comparison between scenario 1 and scenario 2, we have used 28%).
Expected company tax payable: R515 648
DIVIDEND TAX:
Any distribution of the resultant amount received (for purposes of the exercise estimated at R2.4mil less R516K = R1 884 352) will attract dividend tax at 15%.
Estimated dividend tax payable: R283 000
SCENARIO 2:
THE MEMBERS INTEREST IN THE CC IS SOLD
VAT IMPLICATIONS:
The transaction represents the sale of a financial instrument and is therefore an exempt supply. Accordingly, no VAT is payable.
CAPITAL GAINS TAX IMPLICATIONS:
Each member will have a separate CGT calculation.
The capital gain will be the Proceeds on disposal (R2.4mil/2 members = R1.2mil) less the base cost.
The base cost will be the original cost of acquiring the members interest (R40K/2 members) = R20K.
An additional exclusion amount for Member 1 i.t.o. para 57 of the 8th Schedule up to an amount of R1.8mil will only apply where a person who has reached age 55 disposes of an ENTIRE direct interest of at least 10% of the CC.
There are also 3 other requirements for Member 1 to qualify for this exclusion:
- The interest must relate to active business assets
- The business must be a Small Business (The market value of the assets should not exceed R10mil)
- The owner must have held the business for at least 5 years
- The owner must have been substantially involved in the business
CGT calculation for Member 1 based on this assumption:
R1.2mil less R20K = R1 180 000 less exempt amount R1 180 000 = Zero taxable Capital Gain.
CGT calculation for Member 2:
R1.2mil less R20K = R1 180 000 less R40K (annual exclusion) = R1 140 000.
R1 140 000 at inclusion rate of 40% = R456 000.
This amount is subject to tax at the taxpayer’s marginal tax rate. We have assumed a marginal tax rate of 36%.
Estimated CGT liability for Member 2 will be R164K
CONCLUSION AND RECOMMENDATIONS:
Given the assumptions used above, there is a significant tax saving should the members sell the members interest as opposed to selling the business out of the CC and trying to retain the members interest.
However, there would be a disadvantage for the Purchaser should they opt to purchase the members interest in the CC as opposed to buying the business out of the CC: The Purchaser will assume the CC’s underlying CGT and dividends tax liability when they sell the business down the line.
Need A Tax Consultant?
We offer a comprehensive range of accounting services for trusts, companies and individuals, both locally and internationally.
Chat to our expert accountants and tax consultants about bookkeeping, payroll, income tax preparation, and financial statement creation.
