If you have reached the age of 55 years, and are thinking of selling your small business, read on to find out more about the special capital gains exclusion of R1,800,000 which may apply to you.
Before getting into the detail, let’s first highlight the three different scenarios where this exclusion may apply:
1. You are selling your business, which you operate as a sole proprietor. 2. You are selling your share of a business, which you run through a partnership. 3. You are selling your entire direct interest in a company, which relates to “active business assets” (more on this term later) of the company AND you must hold at least 10% of the shares of the company.
Now lets look at how you may qualify in some more detail:
• The gain you make on the sale must be due to you in your personal capacity
This special exclusion is only available to individuals (i.e. people) and not to companies. If a company sells off its business assets and makes a gain that is recorded in the company’s book, the exclusion does not apply!
• The market value of all the assets in your small business must be less than R10m
It is important to note, that you need to ignore the business’s liabilities here and only consider the value of all of your assets. You don’t need to consider the nature of the assets (i.e. what they are). This comes later.
If you run your business in a partnership, the R10m threshold relates to the assets of the partnership as a whole and not your individual share. This is best illustrated by way of an example:
Dale and Lerato run their business through a partnership whereby they each own a 50% share of the business. The combined market value of their business assets (in the partnership as a whole) are R12m i.e. Dale and Lerato each own R6m assets in their individual capacity. They will not qualify for the special capital gains exclusion because the total business assets of the partnership exceeds R10m.
One last thing to note here is that if you own more than one small business, the combined assets of all your businesses must be less than R10m. This prevents a taxpayer from splitting up their business into multiple “small” businesses to take advantage of this exclusion.
• The exclusion only relates to “active business assets”
Once you have established that your business assets are less than R10m, you need to look at the nature of each asset individually to see which are eligible for the capital gains exclusion.
The exclusion only relates to “active business assets”. These are moveable assets (for example, furniture and equipment) which you use exclusively for business purposes. This means it must not be used at all for personal reasons. In the case of immoveable assets like a building, the condition is different in that it can be part used for personal purposes but the exclusion will only apply to the part of the building used for business use.
The exclusion does not apply to assets generating passive income i.e. investment income, rent and royalties. It therefore excludes financial instruments (e.g. loans, options, shares, unit trusts etc.) as well as assets held mainly to earn rental income (e.g. a block of flats rented to tenants).
• You must have held the business assets for a continuous period of at least five years
• You must have been substantially involved in the running of the business during the five year period
Therefore, if you own a business but have employed a manager to run it on a full time basis, you will not qualify for this exclusion.
• You must be at least 55 years old or must be selling due to ill health or death
• The capital gain from the sale of your business must be realised within two years from the date of the first disposal
This means that if you sell your business in stages (i.e. you don’t sell off 100% all in one go) then you will only qualify for the exclusion if the full capital gain is realised within two years.
Please note, the R1,8m is a once-off cumulative exemption over the taxpayer’s lifetime. This means that if you sell your business this year and claimed R500,000 as a capital gains exclusion, you still potentially have R1,3m to deduct against the capital gain of another business that you may sell in the future.
Let’s look at an example:
Brandon runs a small printing business. He has been fully involved in the day-to-day management of this business for the past ten years. He has not registered a company but operates as a sole proprietor. In addition, he also owns two flats, which he rents to tenants. He manages the rental of these flats himself. Brandon is 65 years old and has decided to retire and sell off his assets in order to buy a new house. He sells his printing business as well as his two flats for market value.
Brandon has found a buyer who is willing to pay R460,000 for his printing business.
The breakdown of the selling price is as follows:
Inventory (paper, stationery, etc.)
R 10 000
R 7 500
Furniture and equipment
R 250 000
R 300 000
R 200 000
R 460 000
R 307 500
The flats cost R1,1m each and were sold for R2m each.
Since Brandon is over 55 years old, he may qualify for the R1,8m capital gains exclusion provided all the conditions are met.
Step 1: calculate market value of all business assets to make sure less than R10m
Total market value = R460,000 + R2,000,000 + R2,000,000 = R4,460,000
Since the combined values of all of his assets are less than R10m, Brandon may qualify for the capital gains exclusion. Because he is renting out his flats, which are generating business income, they are also included even though they are not “active business assets”. Remember the first check is to see whether Brandon’s business is small enough to qualify for this capital gains exclusion and therefore the market value of his total business assets are considered.
Step 2: calculate capital gain on “active business assets”
Inventory: the profit on sale is subject to normal tax and is not a capital gain
Furniture and Equipment: R250,000 – R300,000 = R50,000 loss
Goodwill: R200,000 – 0 = R200,000
R 200 000
Flats (rental income is excluded from “active business assets”)
Apply R1,8m capital gain exclusion (limited to R200,000)
(R 200 000)
Total Capital gain
Step 3: Add capital gain on “non-active business assets”
Capital gain on flats: (R2m – R1,1m) X 2
R 1 800 000
Total capital gain on sale of business assets
R 1 800 000
In summary, Brandon will have to pay capital gains tax as normal on the profit from the sale of his flats, however he does benefit from the special R1,8m capital gains exclusion which he can apply to the capital gain he is making on the disposal of his small business.
To make things even easier, you can check out our decision tree to see if you qualify.