What is “capital”?

When a person receives money (or something else) for tax purposes it is usually classed either as a capital receipt or income. If it is income, it is generally taxable, it it is a capital receipt, it is usually taxed at a lower rate in terms of capital gains tax – which we will consider in the following topics.

Similarly, money spent by a business taxpayer on “capital” will generally not be deductible. Only expenditure that is not “capital” expenditure and meets the other requirements of the Income Tax Act is tax deductible for a person carrying on a trade.

The question of capital vs. income is important when a taxpayer is selling an asset. If the taxpayer is selling a capital asset, the proceeds from the sale will not be subject to income tax (but may be subject to capital gains tax). While if the taxpayer sells an asset which is not a capital asset, but rather trading stock, the taxpayer would have to pay income tax on the proceeds of the sale.

So what does it mean for something to be “of a capital nature”? In economics, the basic meaning of capital is simply money and assets that have an economic use[1] and which can be used to generate income or another economic good. South Africa’s Appellate Division (which before the Constitutional Court existed was the highest court in the land) [2] has stated that capital is what forms the “income-producing structure” of a business.

To distinguish between capital and income, the analogy of a tree and its fruits is often used. The tree is the capital, and the fruits are its income. The capital is what is use to generate the income. If someone owns a property and rents it out, the rent is the income and the property is the capital.

You’ll only get this meme once you’ve watched the video!

[1] Economics A-Z Terms, The Economist (accessed at: https://www.economist.com/economics-a-to-z/c#node-21529870)

[2] New State Areas Limited v Commissioner for Inland Revenue 1946 AD 610.