Big tax changes for South African investors on the cards

The National Treasury has proposed significant changes to how collective investment schemes are taxed in South Africa, which it has been developing since the 2020 Budget Review. 

A portfolio of a Collective Investment Scheme (CIS) is a pool of assets created through the contributions of different investors and operates as an investment vehicle on behalf of those investors.

These are most commonly known in South Africa as unit trusts. They are managed by a professional asset manager who invests the investors’ funds in listed shares, bonds, or other financial assets. 

In the 2020 Budget Review, the Treasury said it would conduct an overview of the income tax treatment of amounts received by portfolios of CISs. 

The proposed changes, which were included last week in a National Treasury discussion document, primarily address whether income tax or capital gains tax applies when investments in these funds are sold.

For instance, profits from buying and selling shares are typically subject to income tax at the investor’s marginal rate. However, if the investor can demonstrate that the shares were held as a long-term asset, the lower capital gains tax rate is applied instead.

In 2018, the Treasury first proposed amendments to provide certainty about when profits should be subject to income tax or capital gains tax. 

However, after it reviewed public comments on these amendments, the proposed changes were withdrawn to allow for further consultation with the industry. 

In general, CISs are subject to a special tax dispensation in terms of capital gains not being taxed within the portfolio. The taxation of the underlying capital gains is deferred until an investor withdraws their funds from the portfolio. 

The National Treasury is not necessarily concerned with this process but is rather focused on portfolio managers engaging in frequent buying and selling. 

It says some of this activity should be taxed at the income tax rate as it is not a long-term asset. 

Currently, the legislation does not provide a definition or guidance of when exactly an activity should be taxed as capital gains versus income. 

As such, South African courts often have to assess the intention with which an asset was acquired, held, and disposed of to determine how the activity should be taxed. 

The solutions

The first option proposed by the National Treasury is the “full flow-through” option, which is the same system that is used in the US. 

Under this system, the tax will be calculated every day on a unit trust investment, with the gains from short-term trading taxed as income and other profits as capital gains tax. 

At the end of the tax year, the investment manager will give each fund investor a tax return detailing what they owe to SARS. 

This proposal has met pushback from both individual investors and investment managers. 

Under this option, investors will have to pay tax on gains in their funds even without them withdrawing funds from the unit trust or investment scheme. This would mark a significant departure away from the current tax system. 

In its discussion document, the Treasury admitted that this could cause cash flow issues for unit trust investors.

Investment managers would also have a problem, as such a significant change would require a major overhaul of current systems and may take years to implement. 

The second option outlined by the National Treasury is referred to as the “safe harbour” option and is commonly used in Europe. 

Under this proposal, unit trusts will be measured by the amount they traded during the year and compared to a specified ratio. 

The Treasury proposes comparing total trade volumes to the overall portfolio size. If this ratio is below a specified threshold, it will be taxed as capital gains.

“However, if the level of turnover is above a particular level, the current rules would apply and whether the gains are capital or revenue in nature would be based on facts and circumstances,” Treasury explained in its discussion document. 

National Treasury said that the ratio will be somewhat arbitrary, presenting a significant disadvantage.

After the public consultation process is concluded, the draft proposals will be revised to consider public comments, and announcements will be made in the 2025 Budget. The closing date for comments is the close of business on 13 December 2024.