Tax warning for South African investors

The National Treasury is looking to close loopholes exploited by South African investors to avoid or defer paying tax on the sale of shares. 

Investors exploited this loophole by transferring shares to collective investment schemes (CIS) and then selling them. The primary benefit of these kinds of transactions is the deferment of capital gains taxes. 

A portfolio of a 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.

The National Treasury is now looking to review CIS involvement in these schemes to close the loophole and further narrow South Africa’s tax gap. 

This was included in the publication of the 2025 Draft Tax Bills and Draft Regulations for Comment by the National Treasury and SARS. 

These draft tax bills and draft regulations contain tax proposals made in the 2025 Budget on 12 March 2025 and updated on 21 May 2025.

Included amongst these are the review of the low-value importation of goods, a clarification of the tax treatment of foreign retirement benefits, and clarity on the reversal of VAT hikes. 

One of the more important changes for South African investors is the review of the loophole used to defer capital gains taxes. 

Often termed an asset-for-sale or amalgamation transaction, this loophole is the most prevalent  when it comes to physical property. 

These transactions typically exploit Section 42 of the Income Tax Act, which provides a beneficial mechanism for tax-neutral asset transfers. 

This section allows individuals to transfer or dispose of an asset to a local company in exchange for equity shares in that company. The particular benefit afforded through this transaction is the deferral of capital gains tax. 

Increasingly, South African investors have been using this loophole to defer capital gains taxes on equity investments by transferring them to a CIS. 

This transfer is also tax-neutral, and so no taxes are levied as a result of the transfer that took place, provided anti-avoidance measures are not triggered. 

Furthermore, these transactions may also result in the entities not having to pay any VAT on the transaction, provided both parties are VAT-registered. 

Big changes for Collective Investment Schemes

Late last year, the National Treasury proposed significant changes to how CIS are taxed in South Africa to close various loopholes and improve oversight. 

This has been under review since 2020, when the Treasury said it would conduct a study of the income tax treatment of amounts received by portfolios of CIS. 

Proposed changes were revealed in a National Treasury discussion document and 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. 

To solve these challenges, the National Treasury proposed two options for public comment, which broadly mimic systems used in more developed economies. 

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 withdrawing funds from the unit trust or investment scheme. This would mark a significant departure from the current tax system.

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.