SARS is coming after these investments in South Africa

Proposed tax changes to collective investment schemes (CIS) mean that investors could soon see higher and earlier tax bills, less flexibility in restructuring investments, and possible double taxation risks.

Webber Wentzel partner Joon Chong and consultant Duncan McAllister explained that the National Treasury has proposed three major amendments in the 2025 draft Taxation Laws Amendment Bill (TLAB) affecting CIS portfolios.

The first amendment removes tax-neutral rollover relief for ‘asset-for-share’ transactions under section 42 of the Income Tax Act (ITA) for all CISs. This change is due to what the National Treasury terms “unintended tax avoidance”.

The Explanatory Memorandum highlights a scenario in which an investor transfers listed shares to a CIS, which then sells them. The subsequent capital gains are tax-exempt at the CIS level.

This amendment’s origins can be traced back to 29 September 2016, shortly before the SABMiller – AB InBev takeover.

The South African Revenue Service warned that a CIS acquiring listed shares from an investor and disposing of them shortly afterwards may be on an income account or engaging in an impermissible avoidance arrangement.

Chong and McAllister said the second amendment excludes CIS mergers from the definition of an “amalgamation transaction” under section 44 of the ITA.

“A merger of one CIS (CIS 1) with another CIS (CIS 2), where investors in CIS 1 exchange their CIS 1 units for CIS 2 units, will no longer be tax-neutral for the investors,” they said.

Instead, it will be treated as a barter or exchange transaction, triggering a disposal and capital gain or loss for the investors.

“To the extent there is a capital gain, the unit holders will receive a step-up in the base cost of their CIS 2 units,” they said.

Capital distribution

Chong and McAllister explained that the third amendment proposed in the TLAB introduces a new paragraph 82A in the Eighth Schedule.

It states that a distribution that is neither gross income nor income, also known as a “capital distribution”, made by a CIS to its investors before disposing of their units will result in a capital gain for the investors without any base cost offset.

Naturally, this raises the question of what “capital” in a capital distribution could be in the context of a CIS portfolio. Chong and McAllister suggested three possibilities.

“The first possible interpretation of a capital distribution is a distribution of the initial amount invested by the investors to acquire units in the CIS,” they said.

“If the portfolio distributes the initial ‘capital’ to the investors, it will result in a capital gain in their hands. Arguably, such a distribution should be treated as a reduction in the base cost of the investors’ units under paragraph 20(3)(b) of the Eighth Schedule.”

However, they added that since there is a ‘necessary implication’ against the same amount being taxed twice by the same taxpayer, the proposed paragraph 82A would take precedence over any base cost reduction.

“It could lead to some anomalous results, such as triggering a capital gain upon distribution and a capital loss when the units are redeemed, since the base cost of the units would remain intact,” they said.

“While taxing the return of contributed capital to a unit holder as a capital gain is not theoretically correct, it is unlikely to happen in practice.”

Double taxation risk for investors

Chong and McAllister explained that the second possibility is that “capital” in a capital distribution could mean previously taxed gross income or income.

Section 25BA provides for the taxation of an amount other than a capital amount in the CIS if it is not distributed by the CIS within 12 months of accrual or, in the case of interest, within 12 months of receipt.

“Under trust law principles, an amount received by or accrued to a trust that is taxed in the trust in the current year and then distributed to the beneficiaries in a later year of assessment would form part of trust capital,” they said.

“Treating such amounts as a capital gain on distribution would result in economic double taxation for the portfolio and unit holder.”

This is because, as Chong and McAllister explained, the portfolio would already have paid tax on the income at 45% and on distribution, and the unit holder would pay up to 18% CGT.

“Such a situation clearly offends against the conduit principle established in cases such as Armstrong v CIR and SIR V Rosen,” they said.

The final possibility is that “capital” in a capital distribution could refer to the capital gains derived by the CIS in a current year or previous year. “Capital gains arising in the portfolio are disregarded under paragraph 61(3) of the Eighth Schedule,” they said.

Under paragraph 61(1), unit holders must account for a capital gain or loss only upon disposal of their units. Therefore, if such an amount were to be distributed before the disposal of an investor’s units, there would be an apparent loophole.

As a result, Chong and McAllister pointed out that there seems to be a valid basis for taxing unit holders on the distribution of such capital gains.

However, there could be situations in which a capital gain that arose before a unit holder invested in the CIS could be distributed to the unit holder with harsh consequences.

This is because the unit holder did not enjoy the capital gain benefits. “It would be more equitable to treat such a distribution as a base cost reduction.”

“It is difficult to understand why a CIS would distribute such a disregarded capital gain, since the purpose of a CIS is to grow the funds invested with it, not to return those funds to its investors by way of a distribution.”

Chong and McAllister added that, regardless of whether any such capital distributions have occurred in practice, paragraph 82A closes a perceived loophole. It should act as a strong disincentive for portfolios of CISs from making such distributions.

The proposed paragraph will become effective on 1 March 2026 and apply to disposals on or after that date.

The table below shows the possibilities of what “capital” in a capital distribution could mean and the risks associated with each interpretation.

Interpretation of “capital”	Description	Tax risk for investors
Initial capital invested	The CIS distributes the original funds contributed by investors to buy units.	Triggers a capital gain even though it’s just the return of invested money, leading to possible double taxation (gain now, loss later when units are redeemed).
Previously taxed income	Income (e.g., interest, other returns) that was already taxed at CIS level but distributed later as “capital.”	Double taxation: CIS already paid tax (up to 45%), and investor pays CGT (up to 18%) on distribution.
Capital gains in the CIS	Gains made inside the portfolio that would normally only be taxed when the investor disposes of units.	Investors may be taxed prematurely, even on gains accrued before they invested. Leads to unfair outcomes and extra tax liability.