To be or not to be a share dealer...

SINCE INCOME TAX is levied at a relatively high rate of up to 40% and capital gains tax (CGT) at a relatively low effective rate of up to 10%, taxpayers who sell shares at a profit have an incentive to deny they're share dealers and insist they're share investors. Conversely, where investors sell shares at a loss, they have an incentive to portray themselves as dealers in shares so that the loss is deductible for income tax purposes, thereby diminishing their overall taxable income.

Share traders are usually individuals who make their living by trading shares on behalf of others, such as brokers, while share investors usually play the stock market themselves.

According to Kyle Mandy, head of National Tax and Technical at PricewaterhouseCoopers (PwC), that's common practice among share dealers but isn't limited to shares: it includes all asset classes. He says there are also no anti-avoidance provisions contained in the Income Tax Act that prohibit such behaviour and that the Act doesn't contain any specific definitions of those terms.

Says Mandy: "The issue at hand is whether the consideration for the sale of the shares is of a capital or revenue nature. If it's of a revenue nature it will be included in gross income and subject to income tax. But if it's of a capital nature it will be excluded from gross income and therefore will be subject to CGT.

However, it should be noted that Section 9C of the Act deems the income from certain shares held for a period of at least three years to be of a capital nature. There's a wide body of case law providing guidance as to the nature of income from the sale of assets. The case law can be summed up on the basis that if the asset is acquired for the purpose of resale at a profit, the income will be of a revenue nature. However, if the asset is acquired to hold as an investment from which income will be earned, the income from the disposal thereof will be of a capital nature.

"The difficulty comes in determining the purpose of the taxpayer in relation to the asset, which requires an examination of the subjective intention of the taxpayer," adds Mandy. For example, if a taxpayer regularly and systematically buys and sells shares that are held for a relatively short period, the income from the sale of these shares is more likely to be regarded as being revenue in nature.

But that's not in itself decisive. If a taxpayer holds a portfolio of shares intended to mirror an index, the regular buying and selling of those shares to rebalance the portfolio may not result in income of a revenue nature (as was the outcome of a recent binding ruling issued by the South African Revenue Service (Sars)).

"The overriding test is the intention of the taxpayer," says Mandy. "However, two points are worth noting in that regard. First, the deeming provisions of section 9C referred to above apply equally to shares actually held as capital assets. Second, the Act contains provisions regulating the implications of a change of intention."

For example, if a taxpayer originally acquired a share as a capital asset and later changed his intention to holding the share for the purpose of trading he'll be deemed to have disposed of the share at its market value at the time of the change of intention for CGT purposes (thereby resulting in a capital gain or loss) and to have acquired it for that market value for income tax purposes (thereby establishing a new base from which any revenue profit or loss will be determined). The opposite applies in relation to assets originally acquired as revenue assets.

So as the share market waxes and wanes through its periodical booms and busts, won't taxpayers argue in boom times they're share investors and in downturns they're share dealers?

"There's very little guidance from an SA tax law perspective in this regard," says Mandy. "With the current economic downturn, lower share prices and depleted tax revenues I think Sars is very well aware of the likelihood taxpayers will argue their losses are of a revenue nature, and will be on the lookout for such arguments and will investigate such claims where appropriate."