More Unpleasant Surprises Await Ordinary Taxpayers in Draft Tax Legislation

This year’s proposed amendments to the Income Tax Act bring another unpleasant surprise regarding the taxation of collective investment schemes (CISs).

Tax experts point out that investors in these unit trust schemes now face an unanticipated tax obligation on their holdings, even if they have not sold any units.

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The National Treasury argues that while the existing tax framework for CISs and corporate reorganisations serves a crucial role, the tax-neutral transfer of shares to a CIS has facilitated “unintended tax avoidance” during changes in shareholdings of listed companies because realised gains on shares are not taxed at transfer.

Treasury now aims to eliminate the tax-neutral treatment of fund mergers or amalgamations, along with the roll-over relief for asset-for-share transactions.

Another suggested change is to classify any distribution from a CIS that isn’t income as a capital gain, which would then be taxable for the investor.

No more roll-over relief

The current asset-for-share provision allows an individual to transfer an asset (like shares in a listed company) to another company in exchange for shares in that receiving company, without triggering immediate taxes such as capital gains tax (CGT) on the transfer.

This deferral of tax consequences is known as “roll-over relief,” as explained by Treasury in the draft Taxation Laws Amendment Bill (TLAB).

During mergers or amalgamations, the current laws provide similar tax deferral relief, enabling asset transfers between merging entities without immediate tax repercussions.

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This creates a “loophole” that Treasury seeks to address. Treasury clarifies that an investor can transfer shares with unrealised gains in a listed company to a CIS under the “asset-for-share” transaction framework. Consequently, the investor avoids CGT at the time of transfer and receives units in the CIS.

If the CIS then sells the same shares during a merger or acquisition involving the listed company, or as part of its investment strategy, the CIS itself does not incur CGT on that sale due to an exemption under section 61(3) of the Act.

Even though 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 its point of “economic realisation,” according to Treasury.

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The investor’s tax responsibility is deferred until they eventually sell their units in the CIS, which may occur years later or may be entirely avoided through untaxed distributions by the CIS.

“This creates an imbalance as compared to an investor who directly sells their shares and immediately pays CGT,” Treasury notes in its explanatory memorandum for the TLAB. Thus, the proposal to eliminate the current provisions is put forward.

Stealth tax

According to tax executives Joon Chong and Graham Viljoen from Webber Wentzel, this could introduce potential “stealth” taxes for investors.

“It negates the desired long-term, tax-efficient compounding that makes a CIS a desirable investment option,” they warn.

“This policy shift is particularly troubling in the context of South Africa’s fragile savings environment, where less than 6% of South Africans can retire while maintaining their standard of living.

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“Given this stark reality, every aspect of fiscal policy should focus on actively promoting and simplifying long-term savings through CISs. By introducing unforeseen tax liabilities and undermining the tax efficiency of CISs, the proposed amendments directly discourage the savings culture South Africa desperately needs,” they add.

Another proposed change could impact the take-home pay of South Africans working abroad.

Treasury suggests an amendment to the definition of “remuneration proxy,” which serves as a reference for calculating certain tax benefits, thresholds, and values when actual remuneration for the current year may not be available.

Treasury notes that some taxpayers who qualified for a foreign employment income exemption in the previous assessment year may experience an artificially lowered remuneration proxy in the current assessment year.

“As the remuneration proxy excludes exempt income, it can create unintended tax advantages in various contexts, including, but not limited to, fringe benefit calculations.”

Fringe benefits

Leap Group managing partner Jonty Leon explains that the proxy is primarily used to establish the taxable value of specific fringe benefits, particularly employer-provided housing.

This adjustment aligns with the South African Revenue Service’s policy aim of preventing the undervaluation of non-cash benefits. “It ensures that expatriates receiving significant employer-provided benefits, particularly housing, are taxed in accordance with their actual earning potential.”

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Leon adds that, while the R1.2 million foreign income remains exempt, the overall tax burden for expatriates benefiting from employer-provided perks is likely to increase.

The window for comments on these extensive proposals closes on Friday, 12 September.

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