Tax Talk – Capital receipts are exempt from tax – what are they?

ALTHOUGH we have heard on a number of occasions that capital gains tax will be introduced in Namibia, we can count our blessings that it has not been introduced to date.

Receipts of a capital nature therefore remain exempt from tax. What are capital receipts, is the real question.The Income Tax Act has not attempted to define the term “of a capital nature” and in cases of uncertainty it is left to the courts to decide whether or not a receipt is of a capital nature.Because this area has been the subject of many disputes, there is a wealth of legal precedent on which to rely when deciding whether a receipt of a capital or revenue nature.When you receive income, it must be either capital or revenue.If it is capital, it is exempt from income tax; if it is revenue, it is taxable.Generally, a revenue receipt is income that arises from a business activity or the employment of capital, either by using it or by letting it.In many instances, very little difficulty is encountered in deciding the nature of income.The problems arise in the marginal situations where the classification becomes subjective and the Receiver of Revenue thinks it is revenue and the taxpayer considers the same receipt to be of a capital nature.An analogy that is often used which serves to illustrate the principle very well is that of the tree and its fruit.In this case, which was heard in 1936, the court held that the tree is the capital asset which is used as means of producing fruit, which in turn is equivalent to the revenue income.When money is invested in a bank it gives rise to interest (the fruit), the money invested being the capital asset (the tree).The rule is therefore fairly simple – income is produced by an income-producing asset and as such the income is of a revenue nature and taxable.The income from the disposal of an income-producing asset is of a capital nature and therefore not taxable.The problem that arises is that it is often difficult to establish which is the income-producing asset and which is the income.This is so because different people hold assets for different purposes.When a baker sets up a business, his objective is to bake bread and sell it at a profit.He acquires certain assets such as equipment and delivery vans.The proceeds from selling bread are the fruit and are taxable.Once the vans become worn out, they will have to be sold.The amounts he receives from the sale of vans will be of a capital nature because he would have disposed of a capital-producing asset (the tree).These proceeds will, therefore, not be taxed.Compare the baker to a car dealer.The car dealer that purchases the vans from the baker sells vehicles with objective to make a profit.They are the equivalent of the baker’s bread.The amounts he receives on sale of the vehicles are therefore taxable.The car dealer’s capital asset is his showroom and on sale of the premises, the proceeds are of a capital nature and therefore exempt from tax.The sale of the same property by a property dealer would however be of a revenue nature and taxable.This so because land and buildings are to property dealer what the bread is to the baker and what the vans are to the car dealer.The real problem in deciding when a receipt is capital or revenue is not so much what type of asset you have, but rather the way you deal with it.One person may choose to hold an asset as an income-producing machine while another may choose to be a dealer in the same asset.Next time we’ll look at your intention, which also plays a major role in deciding whether a receipt is capital or revenue in nature.* Should readers have queries, they are invited to send them to cameron.kotze@za.ey.com.What are capital receipts, is the real question.The Income Tax Act has not attempted to define the term “of a capital nature” and in cases of uncertainty it is left to the courts to decide whether or not a receipt is of a capital nature.Because this area has been the subject of many disputes, there is a wealth of legal precedent on which to rely when deciding whether a receipt of a capital or revenue nature.When you receive income, it must be either capital or revenue.If it is capital, it is exempt from income tax; if it is revenue, it is taxable.Generally, a revenue receipt is income that arises from a business activity or the employment of capital, either by using it or by letting it.In many instances, very little difficulty is encountered in deciding the nature of income.The problems arise in the marginal situations where the classification becomes subjective and the Receiver of Revenue thinks it is revenue and the taxpayer considers the same receipt to be of a capital nature.An analogy that is often used which serves to illustrate the principle very well is that of the tree and its fruit.In this case, which was heard in 1936, the court held that the tree is the capital asset which is used as means of producing fruit, which in turn is equivalent to the revenue income.When money is invested in a bank it gives rise to interest (the fruit), the money invested being the capital asset (the tree).The rule is therefore fairly simple – income is produced by an income-producing asset and as such the income is of a revenue nature and taxable.The income from the disposal of an income-producing asset is of a capital nature and therefore not taxable.The problem that arises is that it is often difficult to establish which is the income-producing asset and which is the income.This is so because different people hold assets for different purposes.When a baker sets up a business, his objective is to bake bread and sell it at a profit.He acquires certain assets such as equipment and delivery vans.The proceeds from selling bread are the fruit and are taxable.Once the vans become worn out, they will have to be sold.The amounts he receives from the sale of vans will be of a capital nature because he would have disposed of a capital-producing asset (the tree).These proceeds will, therefore, not be taxed.Compare the baker to a car dealer.The car dealer that purchases the vans from the baker sells vehicles with objective to make a profit.They are the equivalent of the baker’s bread.The amounts he receives on sale of the vehicles are therefore taxable.The car dealer’s capital asset is his showroom and on sale of the premises, the proceeds are of a capital nature and therefore exempt from tax.The sale of the same property by a property dealer would however be of a revenue nature and taxable.This so because land and buildings are to property dealer what the bread is to the baker and what the vans are to the car dealer.The real problem in deciding when a receipt is capital or revenue is not so much what type of asset you have, but rather the way you deal with it.One person may choose to hold an asset as an income-producing machine while another may choose to be a dealer in the same asset.Next time we’ll look at your intention, which also plays a major role in deciding whether a receipt is capital or revenue in nature.* Should readers have queries, they are invited to send them to cameron.kotze@za.ey.com.