Tax guru Michael Katz has come out in support of a unit trust industry
suggestion that you, rather than your unit trust fund, fork out Capital
Gains Tax (CGT), which is due to kick in next year in April.
Katz, who is chairman of the Commission of Inquiry into the South African
tax system, was speaking in his personal capacity at the Association of
Unit Trusts convention in Midrand this week.
Under the current CGT proposals, domestic unit trust companies are to be
taxed on capital gains on investments that they make at a rate of 7.5
percent. You will not pay the tax yourself.
There are six big problems with the way the government currently proposes
to tax your local unit trust investments.
Problem One - One rate for everyone: By taxing capital growth within a fund
every investor, big or small, will pay CGT at the same rate. So, a small
investor who may not be liable to pay CGT, will pay at the same 7.5 percent
rate of tax as a big investor.
The big investor, on the maximum tax scale for CGT, escapes paying the top
rate of 10.5 percent. CGT on other investments will be based on your
marginal tax rate so the richer you are the more you will pay.
Individuals will benefit from an exemption on the first R1 000 of capital
gains each year, but this will not apply if the fund, rather than you the
investor, is taxed.
Problem Two - Tax without gain: Under the government`s plan tax will be
paid by the fund when it sells the underlying investments.
So the value of your investments will be affected by the tax even if you
don`t sell your own units.
Normally you would only pay the tax if you sold an asset. Your fund could
sell investments for many reasons, including the need for cash, to get out
of poorly performing investments and the need to re-balance portfolios.
Problem Three - Losses not taken into account: Unit trust funds
will not be
allowed to offset losses against capital gains in the same way that you can
with respect to other assets, such as, for example, property investments.
Problem Four - Some will pay and others will not: Depending on the timing
of when investors cash in units and the state of the markets, you could
indirectly land up paying more than you would if the investments were taxed
in your hands.
For example, say the unit trust company paid CGT on an existing situation
and the market crashed the following day and you cashed in your
investments, you would have paid CGT where you may have made a loss.
Problem Five - Double taxation: Katz agrees with the Association that the
government`s proposals could result in double taxation for the investor.
For example, retirement funds and linked product providers, which provide a
single entry to a range of underlying investments, would pay CGT on the
overall gains in their underlying investments such as unit trusts. But the
unit trust funds would also pay CGT.
Problem Six - Offshore not equal to onshore: Another issue is equity
between domestic and foreign unit trusts.
The Association, supported by Katz, argues that taxing foreign unit trusts
differently from domestic unit trusts would give foreign unit trust funds a
competitive edge.
This is because domestic unit trust funds would be taxed at 7.5 percent
whereas foreign unit trust investments would be taxed in your hands at your
own marginal rate. It would be up to you to declare your capital gains to
the tax man.
Katz agrees with the unit trust industry that taxing local unit trust funds
differently from offshore funds would also be unfair.
Stephen Smith, head of the Association of Unit Trusts` Tax Committee, says
the government has chosen this method of taxing local unit trust
investments presumably because it is easier to collect tax from the roughly
30 management companies than from millions of South African investors.
But, he says, the Association feels strongly that a one-size-fits-all
policy does not work when there are many different investors in unit trust
funds, each with a different tax position.
In most European countries, he says, funds are exempt from CGT and
investors are taxed when they sell their investments.
``The proposed CGT would penalise unit trust investors under the current
plan. This could create a strong disincentive to save,`` says Smith.
Di Turpin, chairperson of the Association, says the Association`s view is
that to be fair, investors should be taxed based on their own status.
Katz says overall the proposed introduction of CGT is a good thing.
Foreign experience has shown that this tax has been a factor in
facilitating tax reform.
``CGT is not a tax on wealth,`` he says. It is a tax on income and will make
it unattractive for individuals to sidestep income tax by converting their
income into capital.
What you will pay
If the Unit Trust Association has its way, you will pay Capital Gains Tax
(CGT) on unit trusts like on any other taxable asset. This would imply that
you would pay tax on a quarter of any capital gain that you make at your
marginal rate of tax. In the top marginal tax bracket of 42 percent, the
effective rate of CGT will be 10.5 percent. If the
Association`s proposals
are not accepted, tax on capital gains in unit trusts will be paid not by
you but by the unit trust company at 7.5 percent.
Did you know
It is vital that you keep full and proper records of all your assets,
whether they are on the current list of assets subject to CGT or not. This
should include information on the prices at which you bought or acquired
assets as well as the prices you get when you sell or transfer assets.
Although the government proposes to exempt some assets and to treat others
in different ways, such as unit trusts, the legislation is still being
drafted and there could be significant changes between now and next year
when it comes into effect. Better be safe by keeping good records.