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The market value formula method vs. the specific identification method

South Africa

The Eighth Schedule to the Income Tax Act creates a tax liability known as capital gains tax which applies generally where an asset is disposed of. A loan is regarded as an “asset” as it is an incorporeal asset whereby the lender acquires a right to claim payment from the borrower. Taxand South Africa explores how to determine the base cost of repayment of an interest-free loan acquired for less than face value.

Paragraph 33 contains 2 formulae for determining the part of the base cost repaid: the market value formula method and the specific identification method. The market value formula method in paragraph 33(1) of the Eighth Schedule provides that the base cost of the entire asset must be apportioned in the ratio that the market value of the part bears to the market value of the whole asset. In terms of this paragraph the base cost of the part of the loan repaid will be calculated as follows:

Base cost of the part of the loan repaid = market value of the part repaid / market value of the total loan x base cost of the total loan

The difficulty with the market value formula method is that it requires the market value of the loan to be determined immediately before each repayment. Should there be numerous repayments it would accordingly be administratively burdensome to apply this method and practically difficult to implement. As an alternative, the specific identification method can be applied to determine the part of the base cost repaid. 

The specific identification method in Paragraph 33(2) of the Eighth Schedule provides that the market value formula method will not apply where the expenditure as determined in Paragraph 20 of the Eighth Schedule or the market value as determined under Paragraph 29(4) of the Eighth Schedule can be directly attributed to the part of the asset which is disposed of or which is retained. Therefore, the market value formula method will not apply where the expenditure or market value in respect of the part disposed of can be specifically identified.

The South African Revenue Service’s Comprehensive Guide to Capital Gains Tax states that the specific identification method recognises the fungible nature of a loan, that is, that all parts of the loan have an equal cost, are indistinguishable and identifiable by nomination. Therefore, in terms of Paragraph 33(2) of the Eighth Schedule and following this statement, the base cost of the part of the loan repaid will be calculated as follows:

Base cost of the part of the loan repaid = amount repaid / the total loan x base cost of the loan 

Discover more: The market value formula method vs. the specific identification method


Your Taxand contact for further queries is:
Okkie Kellerman 
T. +27 11 269 7900
E.  okellerman@ens.co.za

Esther Geldenhuys 
E. egeldenhuys@ens.co.za

Also published in Thomson Reuters' Taxnet Pro, 4 April 2014

Taxand's Take

The specific identification method recognises a simplified calculation in that all parts of the loan will have equal cost. As it will be administratively burdensome to use the market value formula method and since this method is specifically excluded in terms of Paragraph 33(2) of the Eighth Schedule where the expenditure or market value in respect of the part disposed of can be specifically identified, the specific identification method will generally be used. It is, however, important to note that where the loan is interest bearing the provisions of section 24J of the Act will apply and the loan repayment should be dealt in the manner prescribed by that section. 

Taxand's Take Author

Okkie Kellerman
South Africa

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