Capital gains tax relief when selling a small business

Many small businesses are run by entrepreneurs who want to opt out of the business when they retire or when their health fails them – and the Income Tax Act offers some relief from capital gains tax for these small businesses.

The enterprise may qualify for a R1.8 million exclusion on capital gains tax, although there are several provisions and considerations to qualify for the exclusion.

It is a “fantastic” exclusion, but it does not get the attention it should, Carmen Westermeyer, tax partner at Maitland & Associates said during the monthly Tax Café discussion hosted by The Tax Faculty.

Core requirements

It only applies to active business assets; the asset must be used exclusively for trade purposes; if the entrepreneur is a member of a closed corporation or a shareholder in a business, they must hold 10% of the asset; and the asset must have been held for at least five years prior to disposal.

“This is where a lot of people trip up, either because they don’t meet the five-year requirement because they have just started the business or they have changed the format of the business,” says Westermeyer.

The sale must be a ‘wholesale sale’ since the full capital gain must be recognised within 24 months of the date of first disposal. In its Comprehensive Guide to Capital Gains Tax, the South African Revenue Service (Sars) says the use of the word ‘entire’ means that all the shares held must be disposed of during a year of assessment.

“If a person held 10% of the shares and sold 5% in the first year of assessment and the remaining 5% in the second year of assessment, the transaction would not qualify.”

Sars says this is because the person would not have disposed of the ‘entire interest’ at the end of year one. There would be no way of knowing whether the entire interest will in fact be disposed of in year two and the assessment cannot be held open until the end of year two. “Tax is an annual event and there needs to be finality in the raising of assessments,” says Sars.

Market value

Another consideration is that the market value of the total business, and not just the individual’s share, must be less than R10 million.

Westermeyer also points out that while the exclusion can be applied for multiple businesses, the R1.8 million exclusion is over a lifetime and not per business.

“Realistically you need to look at your stake, how long you have held it, and how many businesses you own. What often happens is that people either do not have a large enough stake [10% threshold] of they have stakes in too many businesses,” she says.

Westermeyer explains that if someone has a 10% stake in a business that is worth R20 million, their share will be far less than R10 million – but the exclusion only applies when the total value of the company is taken into account.

“We can argue that that is unfair but it is what it is,” she adds.

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Business purposes

Sars explains that the concession applies to the extent that immovable property is used for business purposes. It will not apply to the part of the immovable property used for non-business purposes, and an apportionment will be required.

“It follows that the presence of a farmhouse on a farm will not debar the farmer from claiming the exclusion in respect of the rest of the farm,” Sars explains.

A person who operates a shop on the ground floor of a double-storey building and lives on the first floor will be entitled to the exclusion in respect of the gain attributable to the area used for the shop.

However, not all small business assets will qualify for the exemption.

Financial instruments such as loans, advances, debt, debentures, shares, bank deposits, participatory investments in collective investment schemes, futures, options, forward exchange contracts, index-linked investments and cryptocurrencies are excluded.

Furthermore, the exclusion of assets producing rental income applies to both movable and immovable property. It would apply equally to a block of flats occupied by tenants or a fleet of vehicles forming part of a car-hire business, Sars explains.