Capital gains tax is ‘sabotaging South Africa’s economic growth’

Debate about the punitive impact of capital gains tax (CGT) on the economy has been sparked by recent articles from academics and members of the Free Market Foundation (FMF).

The main criticism of the current regime is that it does not take inflation or currency fluctuations into account, effectively sabotaging economic growth by taxing “phantom” gains.

CGT was introduced in 2001 with the policy objective of enhancing equity and fairness, preventing tax avoidance, and aligning South Africa with global norms.

Most countries have introduced CGT. Most do not allow for inflation indexing. They include the United States, the United Kingdom, Australia, and Canada. Countries that do allow some form of inflation indexing include Brazil, Mexico, India, Spain, and Israel.

“South Africa’s economic malaise is not due to a shortage of plans, policies, or summits; it is due to a chronic shortage of invested capital. Government policy is actively making this worse by punishing the very investors and savers who could help turn the tide,” writes Brian Benfield, a board member of the FMF.

In its current form, CGT is taxing phantom gains, illusions created by inflation and currency depreciation, he wrote in an article initially published by Business Day.

The hidden tax

Benfield calls CGT a hidden tax that erodes returns, discourages long-term investment, and undermines the foundational principle of tax fairness, which is to tax real income, not accounting fiction.

The effective CGT rate for individuals ranges between 7% and 18%, depending on their income tax bracket. The effective rate is applied to 40% of the capital gain after the annual exemption (inclusion rate).

When the tax was introduced, the inclusion rate for individuals was 25% and the exempt amount R10 000. The exempt amount is currently R40 000.

The inclusion rate increased in 2016 to 40%, and the effective tax rate has increased from 13.3% to 16.4% and 18%. It has remained at 18% since 2017.

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Benfield, a retired Wits economics professor, gives an example where an investor buys an asset for R100 000 and sells it 10 years later for R200 000. In terms of the current CGT regime, the gain is R100 000.

However, if inflation averaged 4.88% a year over the period, the real gain would be about R40 000. “The other R60 000 is purely inflationary mist. Yet, CGT is levied on the full R100 000. That is not taxation; it is wealth confiscation dressed up as fiscal policy.”

Real returns

He says the simple idea behind a market economy is that only “real returns” should be subject to “real tax”. The government should get out of the way of voluntary, wealth-creating activity. This includes ensuring that taxes do not confiscate returns that are illusory and never really made, adds Benfield.

Robert Vivian, emeritus professor at Wits and senior associate of the FMF, agrees with Benfield’s arguments.

However, he adds that experience indicates that once governments embark on taking private property, they rarely, if ever, are persuaded to abandon that course by sound rational arguments.

“The change can come when the course of action is wrong. The current way capital gains are taxed is fundamentally wrong.” Vivian refers to the common law of taxation where there can be no taxation without consent and where taxation cannot happen outside of the law.

We forget to keep the common law of taxation in mind when dealing with tax matters. We have an almost complete loss of “received knowledge”, he argues.

Common law

Most people consider the field of taxation as something set out in legislation and expounded in court decisions. “Those who hold that view do not see a common law of taxation exists.”

Vivian takes his argument back to the times in England when income tax was not well established, and the country had an assessed tax system.

“It did not take too long for businessmen to understand that capital can depreciate, so they raised a capital depreciation provision in their accounts,” says Vivian.

Although the government of the day only wanted actual expenditure, tax assessors permitted the provision. For many years, it has been the general practice to make provision for capital depreciation, where appropriate.

“One can argue this is (also) correct where currency depreciation occurs. So, where currency depreciates, where appropriate, this should be recognised. This nowadays appears not to be known. We seem to have lost this bit of received knowledge,” says Vivian.

He takes Benfield’s argument to illustrate his point.

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The R161 037 is what needs to be spent to acquire the same asset 10 years later, but the market value is R200 000. The profit would be R38 963 instead of R100 000.

“Thus, one would argue that this is the correct position as a matter of law, if the concept of capital gains is accepted. The current tax treatment is not correct,” Vivian argues.

According to Benfield, inflation indexing would be a “straightforward reform”. All that is required is to adjust the base cost of an asset using the Consumer Price Index over its holding period.

The South African Revenue Service already has the administrative mechanisms in place. However, says Benfield, the political will to “unshackle capital from inflationary erosion” is missing.

Amanda Visser is a freelance journalist who specialises in tax and has written about trade law, competition law, and regulatory issues.
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