This article was first published in the fourth-quarter 2013 edition of Personal Finance magazine.
When capital gains tax (CGT) was introduced in 2001, the rules for taxing assets in a currency other than the rand were extremely complex.
Taxpayers who held foreign currency, offshore bank accounts and debts owing in a foreign currency were required to keep track of each different foreign currency using a pooling method to calculate a weighted-average rand cost in respect of each currency. Then, on converting such assets into another currency or back into rands, a foreign exchange gain or loss had to be calculated.
Thankfully, the South African Revenue Service (SARS) did away with this with effect from March 1, 2011. Now, when you repatriate the funds in your offshore bank account or convert them into another currency, there is no need to consider the foreign exchange consequences. The same applies to cash held in a foreign currency, traveller’s cheques and debts denominated in a currency other than the rand. An example to illustrate what the change means in practice: US$1 000 acquired when US$1 = R10 and repatriated when US$1 = R12 does not give rise to any taxable gain, even though the taxpayer has made a gain of R2 000 on the transaction. Similarly, should the exchange rate move in the opposite direction, any rand loss will not be taken into account for tax purposes.
Same currency
SARS also simplified the rules for individuals calculating the capital gain or loss that arises on the sale of other foreign assets, such as property outside South Africa, foreign equities, unit trust funds and insurance policies.
Provided the asset is acquired and disposed of in the same foreign currency, the currency gain or loss is not taxed. The capital gain or loss is calculated in the foreign currency and translated into rands. This means that any difference in value between the rand and the foreign currency that arises between the time of acquisition and disposal is ignored. This is best shown by way of an example:
An asset is acquired for US$1 000 when the spot rate is US$1 = R8. The asset is later sold for US$1 200 when the spot rate is US$1 = R9.
Step 1. Calculate the gain or loss in the foreign currency: US$1 200 – US$1 000 = US$200.
Step 2. Convert the foreign currency gain or loss into rands: US$200 x 9 = R1 800.
The full rand gain is R2 800 (proceeds of R10 800 [US$1 200 x R9] – cost of R8 000 [US$1 000 x R8]).
However, the calculation of the gain that is subject to CGT is only R1 800 (US$200 x R9). The difference of R1 000 (US$1 000 x [R9 – R8]) that resulted from the movement of the rand/dollar exchange rate is not taken into account.
On the other hand, should the rand appreciate, the taxpayer may not be as pleased with the results, as the following example shows:
The asset is acquired for US$1 000 when the spot rate is US$1 = R8. The asset is later sold for US$1 200 when the spot rate is US$1 = R7.50.
The full rand gain is R1 000 (proceeds of R9 000 [US$1 200 x R7.50] – cost of R8 000 [US$1 000 x R8]).
However, the calculation of the gain that is subject to CGT is R1 500 (US$200 x R7.50). The currency loss of R500 (US$1 000 x [R7.50 – R8]) resulting from the movement of the rand/dollar exchange rate is not taxed.
These examples use the spot rate, but the average rate of exchange may also be used.
Taxpayers must therefore first calculate the gain or loss in the foreign currency. The foreign currency gain or loss is then converted into rands using either the spot rate on the date of disposal or the average exchange rate for the tax year in which the asset was disposed.
The spot rate is the quoted exchange rate at a specific time, whereas the average rate is determined by using the closing spot rates at the end of daily or monthly intervals during the year of assessment. Fortunately, SARS provides both types of exchange rates on its website (www.sars.gov.za > Legal & policy > Legal & policy publications > Average exchange rates > Table A, or www.sars.gov.za > Customs and excise > About customs / Rates of exchange).
Different currencies: 2012/13
Even with the welcome changes, the treatment of assets held in a currency other than the rand remains complex, particularly if assets are sold in a different currency from the currency used for acquiring them. If you sell an asset in a foreign currency that is different from the foreign currency used to acquire the asset, you must calculate the capital gain or loss as follows:
Step 1. Convert the foreign currency expenditure into the disposal currency (that is, the foreign currency used for the sale of the asset). You must use the average exchange rate for the relevant year in which the expenditure was incurred to calculate this conversion. This may require several separate calculations if, for example, the expenditure was incurred in different years.
Step 2. Calculate the capital gain or loss in the foreign currency (which will be the foreign currency used for the sale of the asset).
Step 3. Convert the foreign currency gain or loss into rands using the average exchange rate for the year in which the asset was sold.
By way of an example: An asset is acquired for US$1 000 when the spot rate is US$1 = R8. Assume that at that date £1 = US$1.6. Assume also that the relevant average rate of exchange for that year is £1 = US$1.55, or $1 = £0.64516.
The asset is later sold for £1 000 when the spot rates are US$1 = R8.60, £1 = R12.90 and £1 = US$1.50. Assume also that the relevant average rate of exchange for that year is £1 = R13.10.
Step 1. The expenditure must be converted from dollars to pounds using the average rate of exchange of the disposal currency in the year in which the asset was acquired, which was US$1.55. Thus US$1 000 = £645 (US$1 000 ÷ US$1.55, or US$1 000 x £0.64516).
Step 2. The foreign currency gain or loss must be determined in the disposal currency: £1 000 – £645 = £355.
Step 3. The gain in pounds must be converted to rands using the average rate of exchange for the year in which the asset was sold, which was R13.10. The gain subject to CGT is therefore R4 650 (£355 x R13.10).
The actual gain made in rands was R4 900 (proceeds of R12 900 [£1 000 at R12.90] – expenditure of R8 000 [US$1 000 at R8]).
The rules aim to tax currency movements between the two foreign currencies, but not the rand-foreign currency difference. However, the requirement to use the average rate of exchange may distort this.
The lesson here is clear: use the same currency when buying and selling. Do not switch the currency of disposal, or you will open yourself up to some painful tax admin.
Special rules: 2012/13
Where the expenditure was incurred in rands, but the proceeds are in a foreign currency, the foreign currency proceeds must be converted into rands using the average rate of exchange for the year of disposal. The gain or loss can then be calculated in rands.
Where the expenditure was incurred in a foreign currency, but the proceeds are in rands, the foreign currency expenditure must be converted into rands using the average rate of exchange for the year in which the expenditure was incurred. The gain or loss can then be calculated in rands.
There are special rules for deemed disposals. There are also special rules for determining the base cost of assets that were held at the start of the CGT regime, that is, October 1, 2001, but these are beyond the scope of this article.
Different currencies: 2013/14
If you delayed disposing of your foreign assets, you will be relieved to know that SARS is proposing to simplify the rules even further, effective from the current (2013/14) tax year. The proposals set out in the draft Taxation Laws Amendment Bill of 2013 are not yet law. But if they are promulgated in their current form, we can expect the following:
* When the proceeds from the disposal are in the same currency as the one used to incur the expenditure, the rules are unchanged. The gain or loss is calculated in the foreign currency and then converted into rands using either the spot rate on the date of disposal, or the average exchange rate for the year in which the asset was sold.
* When you sell an asset in a foreign currency that is different from the one used to acquire the asset, you no longer need to follow the complex rules of converting the foreign currency expenditure into the disposal currency (as set out above). Instead:
– The foreign currency proceeds must be converted into rands, using either the spot rate on the date of disposal, or the average exchange rate for the year in which the asset was sold;
– The foreign currency expenditure must also be converted into rands, using either the spot rate on the date the expenditure was incurred, or the average exchange rate for the year in which the expenditure was incurred; and
– The difference between the two will be the rand gain or loss for CGT purposes.
If we use the same assumptions as in the example set out above for different currencies, using the proposed new rules:
Step 1. The foreign currency proceeds must be converted into rands. Using the spot rate of £1 = R12.90, the disposal proceeds are R12 900 (£1 000 x R12.90). You do, however, have the option of using the average exchange rate.
Step 2. The foreign currency expenditure must be converted into rands. Using the spot rate of US$1 = R8, the expenditure in rands is R8 000 (US$1 000 x R8). Again, you have the option of using the average exchange rate.
Step 3: The capital gain is R4 900 (R12 900 less R8 000).
This approach is much simpler and more logical.
Currency trading
Where a person holds foreign currency, offshore bank accounts and debts owing in foreign currency as trading stock, forward exchange contracts, or foreign currency option contracts, the rules set out above for capital assets do not apply. Instead, currency movements are taxed on an annual basis, regardless of whether the gain is realised or unrealised. These special rules, contained in section 24I of the Income Tax Act, are for specialised currency instruments held by traders and should not affect taxpayers who hold assets as long-term investments.
Where property, equity, unit trusts and other non-monetary assets are not held as capital assets (because the taxpayer has a revenue or speculative intent), the gain or loss will take rand currency movements into account even if the acquisition and disposal take place in the same currency. These rules are contained in section 25D of the Income Tax Act.
The sale proceeds must be converted to rands by applying either the spot rate on the date on which the sales proceeds were received or accrued, or the average rate for that year. The expenditure must be converted into rands by applying either the spot rate on the date it was incurred, or the average rate for the year in which it was incurred. Where the average rate is chosen, the taxpayer must then use the average rate for all transactions that took place in that tax year. Such gains or losses are subject to the marginal rates of income tax (maximum of 40 percent), not CGT.
* Kari Lagler is a registered tax practitioner and independent tax consultant.