Move to scrutinise collective schemes raises tax concerns
The National Treasury’s intention to re-examine the tax treatment of trading profits in collective investment schemes has raised concerns about the potential effect on the industry and investors in these schemes.
The perceived abuse of the schemes requires more clarity on the rules governing the tax treatment of trading profits.
Collective investment schemes are tax exempt as these investments are held in long-term capital accounts. Their investors are taxed on their capital gains only when they sell their equity shares.
The Treasury said in the national 2018 budget that some collective investment schemes were trading frequently and arguing that the profits were of a capital nature (and therefore not taxable).
Should the trading profits made by fund managers in collective investment schemes be reclassified as income rather than capital, they could be taxed at a rate of 45%.
Peter Dachs, joint head of the ENS Africa tax division, says this is the first warning shot that the authorities will be looking at schemes that may be abusing their tax-exempt status by trading in underlying assets.
The Treasury and the South African Revenue Service (SARS), he says, have for years been concerned that some schemes are trading in underlying assets, which is contrary to the principles of collective investment schemes, which are considered passive investment vehicles.
SARS has argued that some schemes have been making trading gains that should be taxed as revenue.
Dachs says fund managers often rebalance their portfolios by selling poor-performing shares and buying good performers. They hold the assets in capital accounts and do not actively trade from revenue accounts.
There is an "awareness" in the industry that assets can be transferred into collective investment schemes so they can benefit from the exemption on capital gains tax.
Dachs says most schemes are set up in a trust and the tax rate for trusts is 45%. If the schemes’ trading gains are taxed as income, it may result in double taxation since the investors will also be taxed at 18% (capital gains tax rate) when they sell shares in the portfolio.
"This will be devastating for investors in collective investment schemes," he says.
The South African Institute of Tax Professionals says retail fund managers trade frequently and alternative approaches that would provide more certainty should be explored. "Given the large number of transactions performed by retail fund managers, and the various reasons they may buy and sell investments, it may be difficult for these funds to discharge the burden of proof that any specific transaction is on revenue or capital account," it says.
The collective investment scheme industry offers investors who are not confident to trade independently a user-friendly investment vehicle, Dachs says.
The Association for Savings and Investment SA says the schemes held R2.3bn in assets at the end of 2017. This is up from R2bn in 2016. "To prevent panic from investors and random auditing of schemes by SARS, clear guidelines will have to be developed to distinguish between trading gains of a revenue or capital nature," the association says.
Its senior policy adviser, Peter Stephan, says although the Treasury only mentions collective investment schemes, buying and selling assets for capital or revenue account could also apply to retail collective investment schemes, and life and hedge funds.
"We would like to see a holistic solution for at least all retail funds that are regulated and that have investment restrictions applying to them, not just for collective investment schemes," he says.
The law presently applies the test of whether an accrual is for a capital or revenue account.
Stephan says in the Capstone case, in which shares were sold during a business rescue, judges well schooled in tax matters came to different conclusions.
"It is this uncertainty that we would like to resolve to support the long-term savings industry as a whole," he says. The association has requested a meeting with the Treasury.