Fancy yourself as a share-trader? As with most things in life, SARS is never far away…

STEVEN JONES

IF YOU are making a number of trades within the short-term portion thereof, you may be concerned about being classified as a ‘share-dealer’ for income tax purposes. However, trading in shares is little different to any other form of trade as far as tax is concerned. All that is required is an understanding of the rules, coupled with some sound record-keeping.

Investor or share-dealer?
Think of yourself as an ordinary individual who has recently purchased a new caravan. Most caravans are used fairly sporadically; therefore, it is likely that it’s many years before you consider trading in your caravan on a newer model.

Caravans often increase in value over time (in contrast to the cars used to tow them), and you are likely to end up making a small profit when selling your old ‘van. However, since it is quite clear that your intention was to use (and enjoy) the caravan as a long-term asset, the gain made would fall under the Capital Gains Tax (CGT) rules, subject to any exemptions that may apply.

Now compare your situation with that of the dealer from whom you purchased your caravan. Clearly, the dealer’s intention is to carry on a trade involving the buying and selling of caravans at a profit.

In the dealer’s case, the proceeds from the sale of caravans would be taxed as gross income, whilst the cost of the caravans sold would be deductible from this income (in terms of Section 11(a) of the Income Tax Act). Any caravans remaining on the dealer’s floor at the end of the tax year would be regarded as stock-in-trade. Closing stock is added to the taxpayer’s income, whilst opening stock is subtracted.

Share-dealers are no different, except that instead of trading in caravans, you are trading in listed shares. With a few exceptions, your tax situation will be identical to that of the caravan dealer.

Unfortunately, there are no clear guidelines that SARS can apply in determining whether or not you are a share-dealer. The primary indicator is thus your intention, which can be demonstrated in the following manner:

  • If you have held your shares for a long period of time, demonstrating that your intention is to earn dividend income and long-term capital gains, you are unlikely to be classified as a share-dealer if you have made one or two minor adjustments to your portfolio.
  • On the other hand, if you are constantly moving in and out of the market conducting numerous trades, or engaging in clearly speculative activity such as short-selling, the likelihood of being classified as a share-dealer is far stronger.

Long-term investors in shares are generally taxed under the more favourable CGT rules. More favourable, because not only is the effective rate of tax only 40% of the taxpayer’s marginal rate of tax (in the case of individuals)—the tax is also deferred until the gain is realised, i.e. when the share is actually sold.

Tax provisions specific to share-dealers
Since shares have some unique elements to them, it is understandable that the Income Tax Act should make provision for some of these unique features:

  • Closing stock: Section 22(1) allows a write-down of the value of the stock to below cost if this value has declined due to a change in market value. However, if the stock comprises shares in a share-dealing company, the write-down to below cost is not permitted.
  • Capitalisation shares and options: Section 22(4) provides that capitalisation shares and options awarded on or after 1 July 1957 have no value as trading stock in the hands of the shareholder. The gains on the disposal of such capitalisation shares or options would thus be fully taxable.
  • Share buy-backs: Dividend income is exempt from normal tax in terms of Section 10(1)(k). The exception to this rule is when a company buys back its own shares, and the purchase price includes a dividend component. This typically occurs when the company buys back the shares at a premium to nominal value, and this premium is funded from retained income. Such premium would be fully taxable as income.

Expenses deductible by share-dealers
Many people tend to focus on the tax deductions that one can claim when conducting any business activity, whereas the primary focus should rather be on maximising income! On the other hand, there are legitimate deductions that one can claim, and it would be foolish not to claim those deductions to which you are entitled.

In the case of share-dealers, such deductions would typically include: wear and tear on any computer equipment and office furniture used specifically for the share-dealing operation; telephone, internet, and stationery costs incurred; subscriptions to relevant investment publications (like Personal Finance!); insurance on equipment used; trading and portfolio management fees; and so on.

However, bear in mind that if you earn any dividends on your trading portfolio, this income is classified as exempt.

  • The good news is that although you need to declare this income on your tax return, you won’t pay any tax on it.
  • The bad news is that since the Income Tax Act prohibits deductions against exempt income, you would thus be required to apportion the expenses claimed between the exempt income (dividends) and the taxable income (proceeds from trading).

Steven Jones is a registered SARS tax practitioner, a practicing member of the South African Institute of Professional Accountants, and the editor of Personal Finance and Tax Breaks.