Selling shares and options at a loss

A recent Tax Court ruling sheds light on capital gains tax, abandoned options, witness testimonies and understatement penalties.

Peter o’Halloran - Tax advice

A judgement handed down on 14 December 2016 in an appeal by the M Family Trust (M) against the findings of SARS (case 13935, Western Cape Tax Court) should prove valuable to business owners.

Briefly, taxpayer M sold certain shares and options to the trust. After a time, the shares and options were sold to an Australian entity and the proceeds were held by a corporate entity in the Netherlands. Before the funds could be repatriated to South Africa, they were embezzled and lost.

SARS sought to disregard the loss represented by the embezzlement and the loss made when the shares and options were sold. At the hearing, it also sought to increase the understatement penalty.

M wanted to include the costs incurred in the attempt to recover the funds as expenses as borne by the trust.

Here are some points from the judge’s ruling that are worth noting:

  • Much of M’s evidence was unchallenged by SARS and the judge pointed out that if points in dispute had not been challenged in cross-examination, the evidence might have been accepted as truth by the party calling the witness.
  • M had sought to rely on the embezzlement to reduce the proceeds for capital gains tax purposes, utilising Paragraph 35 of the Eighth Schedule. The Court rightly held that the funds had been received by M prior to the embezzlement, and Paragraph 35 could not be used to reduce the value of the proceeds received by the trust.
  • M had mistakenly supposed that (a) some of the options had fallen away and (b) the option-to-share ratio would be one- to-one. It later transpired that the options were exercised on a one-to-10 ratio. He had thus made a loss on the sale of the options and sought to make use of this for tax purposes, relying on Paragraph 20 of the Eighth Schedule, which provides that the expenditure related to the acquisition of an option is part of the base cost. SARS disagreed, saying that Paragraph 18 was applicable and abandoned options should be disregarded. The judge ruled in favour of M.
  • SARS sought to impose even harsher penalties on M. The judge, however, reduced the understatement penalty from 75% to 50%, saying that M had not sought to evade tax, but merely failed to take reasonable care in the completion of his tax return.

The matter was referred back to SARS for re-assessment with no order on costs.