Taxation of Capital Gains and Inflation
Experience indicates once governments embark on the taking of private property, they rarely, if ever, are pursued to abandon that course by sound rational arguments.
Written By: Robert W. Vivian
My colleague Professor Brian Benfield recently wrote an article advocating inflation to be taken into consideration when taxation of capital gains on the sale of capital assets is imposed (Business Day August 21, 2025). I agree with him. I also agree with the reasons he gave as to why this should happen but want to suggest other reasons. His central theme is the current method of CGT sabotages economic growth.
Experience indicates once governments embark on the taking of private property, they rarely, if ever, are pursued to abandon that course by sound rational arguments. The change can come when it is clear that course of action is wrong. The current way capital gains are taxed is fundamentally wrong. Historically speaking, the fundamental principles of taxation were established in 1215 at Runnymede with the sealing of Magna Carta. There is no taxation without consent. There is no taxation outside of the law. That is the common law position. In tax matters we should do something usually not done and that is, to keep the common law of taxation in mind.
So let us take the simple example provided by Professor Benfield. Inflation is running at 4.88%. An investor buys a capital-appreciating asset for R100 000 and ten years later sells it for R200 000; what amount of tax is payable? Some would say there can be no tax payable since the asset is a capital asset and in the common law, capital is not taxed. Others would say the asset was bought for R100 000 and sold for R200 000 and this is a normal trading transaction, and thus the difference is income – and income is taxable. For now, we will put this capital debate aside and go with the R100 000 profit, or income so to speak. Therefore, the R100 000 is treated as income of the taxpayer in the year the transaction took place. This is the so-called capital gain. This is the current position.
It is at this point we encounter a further very modern problem. That is, the almost complete loss of received knowledge. That this is happening is rather disturbing and it is not clear why it is happening. The tax example we are considering may throw light on this problem. Received knowledge is what we already all know. It is what we learnt in the past. We know the earth is not flat. We do not need to re-discover this – we know it. It is part of the received knowledge.
We nowadays seem to have lost much of our received knowledge. A central responsibility of universities is to teach the received knowledge to each successive generation. So, if the received knowledge is lost, we can assume universities have failed in their allotted task. It is easy to see how this can happen in the current example, in the field of taxation since to most, taxation is exclusively something set out in legislation and expounded in court decisions. Those who hold that view do not see a common law of taxation exists.
So, to deal with Professor Benfield’s problem of CGT let us go back and understand what we already know. Before income tax was well established, England had an assessed tax system. As the industrial revolution took root, so capital expenditure was encountered. It did not take too long for businessmen to understand that capital can depreciate so they raised a capital depreciation provision in their accounts. The government of the day would have none of that. Only actual expenditure could be brought into account. But unfortunately for the government of the day, the tax was, as assessed, and assessors permitted the provision.
A capital depreciation provision was correct. Some of the assessors sat in Parliament and the government of the day decided to attack these assessors in parliament announcing that some assessors were committing fraud by allowing a capital depreciation provision. The assessors were not deterred and merely responded that they would always fight fraud with fraud. It was fraud to not allow the provision. The assessors won the day. A depreciation provision is of course nowadays accepted. The common-law of taxation won.
It thus has long been understood that where capital assets are concerned, where appropriate, provisions must be made for capital depreciation and one can argue this is correct where currency depreciation occurs. So, where currency depreciates, where appropriate, this should be recognized. This nowadays appears not to be known. We seem to have lost this bit of received knowledge.
In terms of the common law of taxation, Professor Benefield’s problem is straight forward. Once the asset is purchased then each year the books of account need to reflect a currency capital depreciation provision. If his example is taken, the outcome is indicated in Table 1:
Table 1: Transactions
Every year a currency capital depreciation provision is raised. At the end of the 10-year period the book value is R161 037. The R161 037 is what needs to be spent to acquire the same asset 10 years later, but the market value is R200 000. The difference is R38 963 which is the income for tax purposes, not R100 000. In many cases there will in fact not be any profit since the book value and market value would be the same. In this case there is thus no income and no taxation. In this case we end up in the correct common-law position. Capital is not taxed.
Thus, one would argue that this is the correct position as a matter of law, if the concept of capital gains is accepted. The current tax treatment is not correct.
Robert W Vivian, Professor (Emeritus), School of Business Sciences, University of the Witwatersrand is a Senior Associate of the Free Market Foundation.