National Treasury published several proposals at the end of last year aimed at providing certainty to the collective investment scheme (CIS) industry on the taxation of returns within funds.
This follows calls for clarity from fund managers because of continual audits by the South African Revenue Service (SARS). However, industry players have since alerted Treasury to the negative impact its proposals will have on liquidity in the South African market and on saving.
In 2018, Treasury attempted to provide more certainty with the 12-month rule, where gains were considered to be capital in nature if they were not distributed within 12 months. However, draft legislation to this effect was withdrawn.
One of the recent proposals is to create a new tax dispensation that will make CISs fully transparent. The CIS will not be a taxable entity in its own right, but merely a conduit.
The safe harbour proposal
Another proposal is to use a turnover ratio to create a safe harbour. Although the proposal was not opposed, it raised serious concerns. It proposes considering total trade volumes over a tax year relative to the overall portfolio size to obtain a better sense of how actively traded a fund is.
Treasury proposes a turnover limit of 33%. If the trades are within this ratio, they will be taxed as capital. If the trades exceed the 33% ratio, the current rules apply, where gains will be taxed as either capital or income depending on the facts and circumstances.
Treasury believes this could eliminate the uncertainty of the tax treatment of gains within the CIS, as long as turnover remains within the prescribed limit.
“However, for CISs with a higher turnover ratio, the uncertainty will persist, and if any gains are subsequently treated as revenue and taxed accordingly, the new holders of the participatory interests would still face the tax burden even if they were not the holders at the time of the transactions in question.”
Setting the ratio at 33% may also cause CIS managers to engage in excessive trading close to the end of the year if they know the turnover over the whole period will be below the set level, creating another level of distortions.
Frank discussions
Earlier this month, several industry players, including Investec, Standard Bank, the Association for Savings and Investment SA, the Banking Association South Africa, and tax and fund managers held frank discussions with Treasury officials.
Investec felt the proposals would be an “unmitigated disaster” for the market. Will Ridge, head of equities, said there were several practical implications that were not sufficiently thought through.
He sketched a scenario where there is a massive macro event in the market and the fund is close to the safe harbour limit. Is the fund manager supposed to “sit on his hands” to avoid tax uncertainty, he asked.
Fund managers will now have to think about the tax consequences of a decision rather than focus on their primary objective, which is to perform in line or above what is in their mandate to help someone to retire well, he said.
A solution is to have some carve-outs or exclusions, similar to the so-called whitelist in the United Kingdom. This is a list of specified investment transactions that are generally considered to be investment activities not seeking to catch swings in daily market movements.
Erica Bruce from the South African Institute of Stockbrokers noted that carve-outs and exclusion will complicate matters. It will be near impossible to automate a process where certain trades count and others don’t.
Several industry players consider the 33% threshold to be too low. Even if it is increased, it will impact liquidity, a commentator noted. It creates a line that fund managers will want to remain under to prevent uncertainty. “This will result in a decline in trading activity, which will impact negatively on other taxes.”
Tax collections
Modelling done by industry players indicate that it could potentially reduce liquidity on the JSE by about 23%. It will also result in lower tax collections of about R2 billion.
Another concern is the impact on foreign investments. Foreign investors run quantitative liquidity models. If a stocks volume is below a certain threshold over a 30-day period, they cannot invest in the stock, or they divest from the stock. This creates selling in the market followed by passive flows, which compounds the problems.
Treasury deputy-director Chris Axelson reassured the CIS industry that it will not act in a rash way that may impact the savings culture or liquidity. Treasury realises that it will not be possible to have something concrete for this year’s Budget Speech on 19 February.
However, the discussion document has created unease in the market, and it is possible that Treasury will at least announce what it will not do.
Amanda Visser is a freelance journalist who specialises in tax and has written about trade law, competition law, and regulatory issues.
Disclaimer: The views expressed in this article are those of the writer and are not necessarily shared by Moonstone Information Refinery or its sister companies. The information in this article does not constitute financial planning, legal, or tax advice that is appropriate to every individual’s needs and circumstances.
It would appear as though the Treasury now wants to tax after-taxed income monies used to invest with. This government just keeps on taxing what is left in South Africa to tax. No wonder companies and investors are placing future plans on tax-friendly countries such Mauritius and Isle of Man.