For novice investors, understanding the tax implications of investing can help to maximise returns and optimise wealth creation, provided these are aligned with the investment objectives. This is according to Ettiene Retief (pictured), chairperson of the National Tax and Sars Committee at the South African Institute of Professional Accountants.
Retief says when choosing between the various investment vehicles, the first thing to know is that the decision should not be based on tax savings and exclusions alone.
“I’ve come across cases where people are so anxious to try and do whatever it takes to avoid the tax. And then, once you take all the costs and the lack of growth and everything else into account, they’re actually worse off. And then you ask yourself, well, why did you do it that way?”
Second, know why you are investing. Is it to save for retirement or to go on holiday? Are you saving for a rainy day or to buy a new TV?
“When we consider the tax consequences, just like when you do on investment, you have to align it with your strategy or your objective. Where you invest, what kind of growth you are looking for, how much risk you want to take, and the tax consequences all have to align with your goal.”
Take a retirement annuity, for example. Retief says this “easy vehicle” is a good starting point for the average person who wants to save for retirement and who, for instance, isn’t already contributing to a pension or provident fund. It has a positive tax position because you receive a deduction for your contributions up to a limit. But he says, there can come a point when the effectiveness of this tax deduction becomes watered-down.
“If I’m just putting R500 a month away, it’s not a big issue. But when I’m getting to a point where it’s substantial amounts, then you have to ask if that really is the best option.”
This is when your strategy needs to be considered. For example, is your plan to save enough money to pay off your debts at retirement and invest the rest to cover living expenses, or are you looking to invest in a portfolio of properties to generate an ongoing income? Retief says the outcomes will vary depending on your plan.
“Let’s say I’m going to invest in a portfolio, and I can do a mechanism where I’m tied in with buying and selling of shares or trading futures, then things like capital gains tax (CGT) are going to be a key component. And in the interim, there will be dividends – also a tax concern.”
Motivation also plays a role, he says. For example, if you want to teach good saving habits to a child, then opening a tax-free savings account (TFSA) for him or her is a good option. But again, this option has its limitations.
A TFSA has an annual contribution limit of R36 000. Anything more than that is not part of the tax-free environment. It also has a lifetime contribution limit of R500 000.
“If I maximise my annual contribution of R36 000, I am going to hit my lifetime limit in just short of 14 years. Also, because it has a lifetime limit of contribution, I can’t treat it like an ATM.”
High fees and a possible low interest rate could also result in your money losing value over time if the investment doesn’t keep pace with inflation.
“So, a tax-free investment is one vehicle, but you need to do your homework.”
Interest earned
But whatever vehicle an investor selects, be it directly trading in shares or a unit trust fun d, Retief says you must accept there’s very little you can do that’s not going to end up being taxed.
Three sources of tax apply: interest earned, dividends received, and CGT.
When it comes to interest earned per year, a small exclusion exemption applies: R23 800 for persons under 65 and R34 500 for persons 65 and older.
“If I have a money market account for my short-term savings (to go on a holiday or buy a new fridge) and I’m earning interest on that, it’s tapping out my R23 800 interest exemption.
“If I want to hold some extra cash for the long term, then something like a tax-free interest-bearing savings account is maybe not a bad consideration because I’m not getting taxed, and I’m still utilising my interest exemption to its fullest,” Retief explains.
Once interest earned exceeds the exemption amount, the rest is included in normal taxable income.
“Also, because you’re earning income other than employment income, you likely become a provisional taxpayer, which adds on to the admin. If you get it wrong, there are penalties.”
Dividends tax
Historically, the tax on dividends, which was called Secondary Tax on Companies, was paid by the company that issued them. When South Africa moved to a proper dividends tax system, the liability shifted from the company to the recipient. However, the company issuing the dividends is responsible for withholding 20% dividends tax.
As Retief explains, the company has an obligation to withhold the dividends tax, just like an employer would have an obligation to withhold employee’s tax from the salary it pays you.
“Yes, I’ve got this taxable income in the form of a dividend, which has a fixed tax to it. But at the same time, the 20% dividends tax that applies to it has already been withheld. So, come the end of the year, I don’t have this big shock of having to pay tax I didn’t plan on.”
Capital gains tax
Without delving too deeply into exclusions, inclusions and definitions, Retief says the basic concept of CGT is that the South African Revenue Service aims to tax the gain made.
“If I invest R100 and I sell it for R150, then my gain is R50. The base cost – the cost that you incurred to acquire or to dispose of that asset – first gets deducted from the proceeds to determine the gain,” he explains.
If you are a natural person, the first R40 000 does not get taxed. Of the gain that is left after the R40 000 has been excluded, only 40% is included in an individual’s income.
In other words, if you invest R100 000 and then sell that asset later for R200,000, the gain is R100 000. The first R40 000 is excluded. That leaves R60 000, of which only 40% (R24 000) is included in taxable income.
“That leaves you with an effective maximum tax rate of 18%. That’s at the absolute maximum personal income tax rate.”
Retief says one of the best things about CGT is that until you have disposed of the asset, there’s no tax.
“Your capital appreciation keeps growing and doesn’t attribute to tax until the point where there’s a disposal.”
Assets such as your primary residence (with limitations), vehicle, furniture, and clothing are not subject to CGT. Krugerrands, however, are.
Whether you decide to take advantage of a TFSA, earn dividends through investments, or capitalise on CGT exemptions, Retief warns there are complexities involved.
“You need to do your homework, and you need to get advice. Partner with a reputable and registered financial adviser and make sure you get a registered tax practitioner to advise on tax, because if you get it wrong, it can be quite costly,” he says.
