In our financial advisers` guest column, Beric Croome, a tax partner
at Kessel Feinstein, takes a look at the tax consequences of switching
funds.
Taxpayers are generally very sensitive to the fact that if they buy and
sell shares regularly they may be regarded as dealers in shares and hence
liable to income tax on the proceeds of the sale of shares.
In such a case,
the net gain realised would be added to the taxpayer`s normal income and
taxed at the taxpayer`s marginal rate.
It is difficult to state categorically whether a particular taxpayer is a
dealer in shares and hence liable to normal tax on the proceeds of the sale
of shares, or an investor, in which case the gains realised constitute a
gain of capital nature and are not liable to normal tax.
The majority of tax cases in South Africa deal with the capital versus
revenue debate and the courts have specified a number of tests that can be
used as an aid in determining whether or not a tax payer should be liable
to tax on the proceeds of the sale of shares.
Many taxpayers choose not to invest in shares personally but rather to
invest in equities via the range of unit trusts available in South Africa.
Clearly the interest received from such unit trusts and with effect from
February 23 2000, foreign dividends received from unit trusts, will be
liable to tax. Where a person invests in one unit trust and switches to
others on a regular basis and realises a gain thereon, the question that
arises is whether such gain is liable to income tax or not.
According to figures recently reported, the unit trust industry attracted
inflows of some R100 billion during the last year. Only R4,5 billion
represented net inflows. The balance of R95,5 billion represented funds
switched from one unit trust to another.
It is clear that a substantial amount of funds is moved from one unit trust
to another and this raises the question whether the proceeds received by
investors constitute revenue or capital for the purposes of tax.
In those cases where a unit holder regularly switches from one unit trust
to another in order to realise a profit and to keep in step with the top
unit trusts in the country, the gains realised, in my view, will be subject
to income tax.
Such a taxpayer would be regarded as a dealer in unit
trusts, no different to a dealer in shares, and fully liable to normal tax
on the proceeds received.
In these cases, the taxpayer generally does not receive the funds but
merely gives instructions to divest from one unit trust and to reinvest in
another.
The taxpayer does not receive cash, but from a tax point of view
an amount has accrued in his or her favour, which has immediately been
re-invested in another unit trust. This does not remove the tax problem
that could arise from regularly switching from one unit trust to another.
Trevor Manuel, the Minister of Finance, in his Budget speech on February
23, indicated that capital gains tax (CGT) would be introduced into South
Africa with effect from April 1, 2001. He advised that an investor in unit
trusts would not be liable to CGT on gains realised but that the unit trust
itself would be liable to CGT on gains realised on shares or other
investments sold by it.
Resident unit trusts will therefore be liable to
CGT regardless of the nature of the investor.
This does not, in my view, detract from the risk attached to investors in
unit trusts being classified as dealers in unit trusts if they regularly
buy and sell units.
The introduction of CGT does not solve the capital revenue debate. It only
makes one point certain and that is that some form of tax will be paid when
unit trusts or shares or other assets for that matter, are disposed of.
The
imposition of CGT merely determines that tax will be paid either at the
natural person`s marginal rate or CGT will be paid in the manner
attributable to the individual taxpayer.
The S A Revenue Service (SARS) is introducing the New Income Tax System
and interfaces are being introduced between SARS, the Registrar of
Companies, the banks, financial institutions, the Johannesburg Stock
Exchange and others.
In time it is more than likely that SARS will be aware
of the volume of transactions in the unit trust industry and will be able
to follow up the switching taking place.
Taxpayers must be aware of the fact that if they are regularly buying and
selling unit trusts, they will be regarded as dealers and have a duty to
disclose such information in their personal income tax return.
The
non-disclosure of material facts in the tax return is a serious offence and
can result in substantial financial penalties as well as criminal sanction.
The fact that a taxpayer switches from one unit trust to another and does
not retain the cash from the disposal of the unit trusts but merely
reinvests it in another fund, does not remove the need to disclose details
of the transactions undertaken in a particular tax year.