The Association for Savings and Investment South Africa (ASISA) has rejected as “untenable” the notion that a collective investment scheme portfolio – offered to the public as an approved investment – can later be reclassified as a profit-making scheme.
The future tax treatment of CISs has been under scrutiny since National Treasury released a discussion document in November last year. This follows a review announced in the 2019 and 2020 Budget Reviews and stems from concerns raised in 2018 about CISs generating trading profits through frequent transactions.
Tax amendments proposed in 2018 were withdrawn to allow for further industry consultation. The latest discussion document revives the debate.
Treasury invited stakeholders to submit comments by 13 December 2024 and held a workshop on 17 February to discuss the industry’s concerns.
Market players have since warned that the proposed changes could reduce market liquidity and impact savings.
Read: Industry raises red flags over tax treatment of collective investment schemes
Providing an update on the process, Dr Stephen Smith, ASISA’s consulting senior policy adviser, shared the Association’s response and perspective on National Treasury’s proposals during a media conference on 4 March.
The core issue in a nutshell – capital gains vs ordinary income
A CIS pools investors’ funds to invest in assets such as shares, bonds, and property. These portfolios are considered separate taxpayers and classified as vesting trusts for tax purposes.
Under section 25BA of the Income Tax Act, capital gains within a CIS are exempt from tax until an investor disposes of their units. Non-capital income, such as interest and dividends, is taxed unless distributed within 12 months, in which case it retains its nature and is taxed in the hands of investors.
Capital gains and ordinary income are taxed at different rates in South Africa, a distinction with significant implications for investors in a CIS.
- Ordinary income is taxed at progressive rates ranging from 18% to 45%, depending on the income bracket. This includes wages, interest, and other non-capital gains income.
- Capital gains tax (CGT) is calculated differently. Only 40% of the capital gain is included in an individual’s taxable income, which means the effective tax rate on capital gains is lower than that on ordinary income. The maximum effective tax rate on capital gains for individuals is 18% (which is 40% of the maximum marginal rate of 45%).
South African law does not explicitly define what constitutes a capital gain versus ordinary income (“business” or “trading” income). Instead, the courts apply a “facts and circumstances” approach, considering factors such as asset type, holding period, and transaction frequency. There is no single, definitive test – the key factor is always the taxpayer’s intent. The courts assess each case individually, determining whether a transaction formed part of a profit-making scheme or a long-term investment.
This lack of statutory definition, says Smith, is “a good thing”.
“In America, it is defined in statute, and it’s just litigated endlessly.”
In CIS portfolios, both the investor and the fund are considered taxpayers.
In practice, CISs – particularly trust structures – pass all income through to the unit holder, while capital gains remain exempt within the fund.
“This policy was designed to encourage savings by deferring taxation on gains.”
However, Smith warns of a potential risk: “Should a capital gain in a portfolio be re-characterised by SARS as ordinary income, that creates an unforeseen tax liability within a portfolio.”
Tax policy proposals
In its discussion document, National Treasury outlined three tax policy proposals for CISs:
- Option 1: Make CIS fully tax transparent. This would require daily valuations and detailed records of disposals. The CIS would serve only as a conduit, with all tax obligations falling on investors.
- Option 2: Introduce a safe harbour. A threshold would be set – such as a portfolio trading turnover ratio, for example, of 33% – to determine the tax treatment. Below this threshold, proceeds would be classified as capital gains. Above it, a “facts and circumstances” approach would be applied to distinguish between capital and income.
- Option 3: Remove hedge funds from the CIS dispensation. Hedge funds, which differ from traditional CIS portfolios in terms of investor profiles and investment strategies, tend to have a more short-term focus.
Regarding Option 1, Smith states that members of ASISA believe it is not a viable proposal.
He explains that they have always assumed, and it has been informally understood, that these schemes are solely about investment. However, he notes that introducing the idea of activities beyond pure investment, such as trading stocks and securities, would require a business model focused on share-dealing rather than investing.
“Now you’ve got something which has a dual nature, and that’s never been part of the way we have thought about this in any space… That creates a complexity which really bedevils a lot of what follows.”
Regarding Option 2, Smith notes that members see more merit in the safe harbour approach than in full tax transparency.
“However, the conceptual design of a safe harbour is critical. Imposing a turnover ratio across such a broad spectrum of funds and market circumstances is viewed as arbitrary and fraught with operational consequences.”
He says that using the turnover ratio to establish a safe harbour is not an effective test of intention for capital revenue. “There’s no magical number,” he explains, adding that regardless of which turnover ratio is chosen, there’s no reason to believe it will be relevant to the margin across 1 878 funds.
Regarding Option 3, Smith emphasises the need to distinguish between the Collective Investment Schemes Control Act (CISCA) as a means to regulate hedge funds as a participatory scheme and taxation.
“On the 17th, we made it clear in our dialogues there [the stakeholder engagement workshop] that being in CISCA is a pooling regulatory issue. The work that is done is, does this fit in a pooling arrangement as specified by CISCA? And the end determination there was, it does. It’s off-balance sheet; it makes sense, and the tax treatment of it has got nothing to do with CISCA.”
He says ASISA members are of the view that hedge funds should not be removed from the CIS regulatory regime.
However, Smith adds that there is room to explore a structured approach to hedge fund categorisation to address tax concerns.
“A principle around the tax treatment of a QIHF (Qualified Investor Hedge Fund) that operates outside the investment regulatory framework applicable to a RIHF (Retail Investor Hedge Fund) or other long-only CISs could be discussed.”
Keep it simple
Smith says the notion or possibility that a regulated CIS portfolio, after being offered to the public as a scheme approved for investment, could somehow be re-characterised as a scheme for profit-making is “untenable”.
“Since 1965, unit trust schemes (CIS) in securities have been treated as savings schemes which make professional investment management skills available to the public – they cannot translate into a scheme of profit-making or have a dualistic nature.”
He adds that ASISA’s members would prefer the avoidance of special conventions that disturb the natural portfolio management function.
“You can see the numbers, this savings arrangement, set up the way it is – it works. It’s been working for years, and it’s trusted.”
Smith says portfolio managers are not tax professionals, so why add an additional dimension that is either transaction-limiting or has tax issues associated with it?
“For example, if a limit was 33%, every portfolio manager or the governance committees would anxiously have to be weighing up at the margin, whether those trades beyond that frequency are worth it, right? Because the market or circumstances are driving a necessary decision. But now, what do I do? And we don’t think that’s a particularly good idea.”
Most importantly, he says, “any changes to the CIS taxation regime should be in line with efforts to encourage more savings while retaining the principles of a fair tax system”.
“And if you look at the graphs going back to the 60s and the way we’ve been doing [it], we think that savings need all the encouragement possible.”
Going forward, Smith suggests that rather than focusing on the mechanics initially, a set of guiding principles should be used to find solutions, including:
- Macroeconomic considerations – growing domestic savings.
- Tax certainty.
- An equitable tax framework that promotes broad public access and limits the interests of special groups.
- “Simplicity” as an overarching objective.
- Internationally recognisable regulatory standards and tax conventions.
“We provided extensive input [in response to the Treasury’s discussion document] relying on HMRC (Her Majesty’s Revenue and Customs) statutory instruments. The UK relies on similar case law principles and faced the same challenges,” says Smith.
Looking ahead
Smith says ASISA supports the view that regulators are working on the need for a range of new alternative investments in the South African market.
“Alternatives are way under, I mean infrastructure we mentioned earlier, private markets and their growth with listings declining around the world. These are things we’re working on,” he explains.
However, he notes that this is not about tax.
“It’s about something else, and so the industry is not supportive of just yanking it out after all that work,” he adds.
Looking ahead, Smith says ASISA agrees with National Treasury that there must be certainty. He believes the facts and circumstances approach is not practical or appropriate.
Instead, ASISA believes that “the pre-eminent test of intention will remain with the investor and portfolio management function or powers better defined for ‘investment’”.
According to Smith, Treasury commented on 17 January that they are not looking to increase taxes from CISs.
“That’s off the table. The matter is definition. National Treasury says they are open to alternatives. So, we’re not limited by those three [options], and you don’t have to worry about which one might happen,” he states.
He says further engagement will be a refining exercise that will most likely span years.
“So, my view is that there will be, hopefully, that kind of activity around definition to improve certainty, rather than any other big changes.”
He says ASISA looks forward to engaging with National Treasury, the FSCA and SARS and “working together to find a solution that retains the elegance of the current tax treatment and keeps faith with our savings and tax policy principles”.
