Potential erosion of savings in collective investments schemes.
Another rather nasty surprise in this year’s proposed amendments to the Income Tax Act is a change to the taxation of collective investment schemes (CISs).
Tax specialists note that investors in these unit trust schemes are facing an unexpected tax bill on their holdings – even if they have not sold any units.
National Treasury believes that, while the existing tax framework for CISs and corporate reorganisations serves an important purpose, the transfer of shares to a CIS without tax implications has allowed for “unintended tax avoidance” during changes of shareholdings in listed companies. The realised gains on the shares are not taxed upon transfer.
Treasury now wants to scrap the tax-neutral treatment of fund mergers or amalgamations, and the roll-over relief for asset-for-share transactions will also be removed.
Another proposal is to treat any distribution from a CIS that is not income as a capital gain, taxable in the hands of the investor.
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No more roll-over relief
The current asset-for-share provision allows a person to transfer an asset (for example, shares in a listed company) to another company in exchange for shares in that receiving company, without immediately triggering taxes such as capital gains tax (CGT) on the transfer.
This is referred to as “roll-over relief,” deferring the tax consequences, explains Treasury in the draft Taxation Laws Amendment Bill (TLAB).
During mergers or amalgamations, the current legislation provides similar tax deferral relief for certain company mergers or amalgamations, allowing assets to be transferred between merging entities without immediate tax consequences.
This creates a “loophole” that Treasury now wants to plug. Treasury explains that an investor can transfer shares with unrealised gains in a listed company to a CIS in an “asset-for-share” transaction. The investor avoids paying CGT at the time of the transfer and receives units in the CIS.
Should the CIS then sell the same shares during a merger or acquisition involving the listed company, or simply as part of its investment strategy, the CIS itself does not pay CGT on that sale due to an exemption under section 61(3) of the Act.
Although a capital gain on the original shares is “realised” in the market, neither the original investor nor the CIS pays tax on that gain at the point of its “economic realisation,” says Treasury.
The investor’s tax liability is deferred until they eventually sell their units in the CIS, which could be years later, or potentially avoided entirely by untaxed distributions by the CIS.
“This creates an imbalance compared to an investor who directly sells their shares and immediately pays CGT,” notes Treasury in its explanatory memorandum to the TLAB. Hence the proposal to remove the current provisions.
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Stealth tax
This, says Webber Wentzel tax executives Joon Chong and Graham Viljoen, will introduce potential “stealth” taxes for investors.
“It negates the intended long-term, tax-efficient compounding that makes a CIS an attractive investment vehicle,” they warn.
“This policy shift is especially concerning when viewed against the backdrop of South Africa’s precarious savings landscape, with fewer than 6% of South Africans being able to retire and maintain their standard of living.
“Given this stark reality, every aspect of fiscal policy should be geared towards actively promoting and simplifying long-term savings using CISs. By introducing unexpected tax liabilities and eroding the tax efficiency of CISs, the proposed amendments actively deter the very savings culture South Africa desperately needs,” they add.
Another proposed change could affect the take-home pay of South Africans working abroad.
Treasury proposes an amendment to the definition of “remuneration proxy,” which serves as a reference point for calculating certain tax benefits, thresholds, and values where actual remuneration for the current year may not be available.
Treasury says some taxpayers who qualified for a foreign employment income exemption in the previous year of assessment may have an artificially reduced remuneration proxy in the current year of assessment.
“Since the remuneration proxy excludes exempt income, this can create unintended tax advantages in multiple contexts, including, but not limited to, fringe benefit calculations.”
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Fringe benefits
Leap Group managing partner Jonty Leon says the proxy is mainly applied to establish the taxable value of specific fringe benefits, particularly employer-provided housing.
The change is consistent with the South African Revenue Service’s policy objective of preventing the undervaluation of non-cash benefits. “It ensures that expatriates receiving substantial employer-provided benefits, especially housing, are taxed in line with their actual earning capacity.”
Leon adds that, while the R1.2 million foreign income remains exempt, the overall tax liability for expatriates benefiting from employer-provided perks is likely to increase.
Time to comment on these far-reaching proposals ends on Friday, 12 September.
This article was republished from Moneyweb. Read the original here.