Investors will carry a heavier burden and could be ‘disincentivised’ to invest in such schemes.
Those who invest in a collective investment scheme (CIS) should take note of the “seriously negative impact” the latest proposed tax changes to these schemes could have for them.
The most drastic proposal in the recently published discussion document is to treat all income in a CIS as revenue in nature. This will force a CIS to distribute all income to its investors annually to avoid paying income tax on any gains.
CISs are exempt from capital gains tax, but amounts considered as revenue in nature are taxable in the portfolio of a collective investment scheme, unless they are distributed to participatory interest holders within 12 months of accrual.
Webber Wentzel partner Joon Chong says the proposal would result in unit holders being subject to income tax annually on all net income of the CIS.
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Unduly punitive
Government is eager to collect taxes, but is trying to increase tax revenue from an ever-shrinking tax base. It has been reported that 3% of taxpayers contribute around 76% of all personal income tax.
“We do not recommend this proposal as it is unduly punitive to investors, particularly individuals who invest in CISs for long-term growth and who want to have available cash prior to retirement,” says Chong.
She adds that the income tax payable by the unit holders would be a “dry tax” if the investors do not sell their units in the CIS. Investors may be forced to sell their units to fund the new tax burden.
“I can imagine that investors will be disincentivised to invest in CISs. This is unfortunate given our low savings rate. The proposals are negative.”
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Better policing
Albertus Marais, director of AJM Tax, does not think there is a “fundamental problem” with the existing legislation. He believes better policing could achieve a better outcome.
“It is an enormous task to police everything, but the proposed changes will make these savings products less competitive compared to insurance and retirement products.”
Chong adds that people do not only save for retirement. There are many who have shorter savings goals, such as paying for their children’s education or for a deposit on a home.
The injustice of the proposed change is that capital gains (which used to be exempt in the fund) will now be taxed as revenue in the hands of the investors.
Government has been considering tax reforms to the CIS industry since 2018. In the draft Taxation Laws Amendment Bill of that year National Treasury said it had come to its attention that some CISs were generating profits from the frequent trading of shares and other financial instruments.
It was then proposed that all gains and losses derived from the disposal of financial instruments within 12 months of their acquisition in CIS portfolios be deemed income of a revenue nature.
The amendment was withdrawn to allow more time to find solutions that would not negatively affect stakeholders.
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Legitimate reasons
Marais says National Treasury is effectively treating the fund as a separate entity with a separate intention towards the assets. This cannot be the case. There are legitimate reasons why a fund may buy and sell shares on a shorter-term basis.
One reason is to rebalance a fund when capital flows in or out of the fund. The effect of the proposal is that investors will be punished with a higher tax burden when gains are generated because of a rebalancing exercise.
He adds that there will be an added layer of tax.
There will be an annual income tax charge as well as an additional capital gains tax when the investor disposes of their units in the fund.
National Treasury notes in the discussion document that CIS investors already receive favourable tax treatment through the deferral of capital gains until their participatory interest is sold. It is not proposed that a further tax concession be provided for returns that would be of a revenue nature.
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Data sharing
Marais suggests that the industry be given time to improve its data sharing capabilities with the South African Revenue Service (Sars).
There are legitimate reasons for short-term investment activities, such as corporate actions or rebalancing transactions to maintain the risk profile of a fund.
Only if the gains cannot be linked to legitimate trading activities should those amounts be deemed as revenue in nature.
However, he believes the real problem should be addressed through the Collective Investment Schemes Control Act and not the Income Tax Act.
There is a practice where individual investors engage with CISs in asset-for-share transactions, where investors sell their shares to a ‘private’ CIS and receive units in return without paying capital gains tax. The ‘private’ CIS then buys and sells those shares on behalf of the investor, again escaping capital gains tax.
Marais proposes that rather than amending the Income Tax Act, National Treasury should consider amendments to the Collective Investment Scheme Control Act to address the creation of these ‘private’ collective investment schemes.
Industry commentators only had a month from the publication of the discussion document to consider the significant proposals that will impact the savings of individuals and market liquidity.
A National Treasury workshop is scheduled for 17 January.
This article was republished from Moneyweb. Read the original here.
