Hidden within the new tax bill is a covert tax on your unit trust investments

For millions of South Africans, a unit trust or a portfolio of a Collective Investment Scheme (CIS) serves as a financial future pillar for retirement savings, children's education funds, and long-term wealth creation. However, a draft Tax Laws Amendment Bill (TLAB) is set to shake up this landscape, potentially undermining CISs as a long-term investment vehicle.

The draft TLAB favours a comprehensive removal over a specific remedy for the concerns about tax avoidance in section 42 transactions. One of the proposals introduces potential 'stealth' taxes for investors, as the institution aiming to abolish the tax neutrality of fund mergers is the German Federal Ministry of Finance (Bundesministerium der Finanzen) in its draft bill on changes to the Investment Tax Act and related regulations.

Under the current rules, a CIS merger is tax-neutral for all parties under section 44 of the Income Tax Act (ITA). In a CIS merger, the original CIS transfers its assets to the new CIS in exchange for units in the new CIS, which are then distributed to investors. This tax-neutrality is set to change, as the draft TLAB proposes to scrap tax-neutrality for CIS mergers, making the merger have the same tax impact as a unit sale.

For tax purposes, investors are deemed to have disposed of their CIS units at their tax cost, resulting in capital gains tax (CGT) deferral until a sale of the new CIS units occurs. However, the proposed amendments to section 42 for CIS transactions would no longer provide for tax-neutrality. This proposal triggers an immediate CGT liability for the unitholder on any capital gain. An investor who wishes to remain fully invested would have to fund the CGT as a 'dry tax' either in provisional tax payments or upon assessment.

The quantum of capital distributions in a CIS context may be significant due to the proposed amendments to section 44 to exclude CIS mergers. Any CIS distribution that is not income or gross income would trigger a capital gains tax (CGT) event for the investor. It is unclear what constitutes a capital distribution in a CIS context, but the draft TLAB's Explanatory Memorandum provides no specific examples of how section 44 amalgamations are being used for tax avoidance.

The proposed changes negate the intended long-term, tax-efficient compounding that makes a CIS an attractive investment vehicle. Alternatively, investors could be forced to sell a portion of their new CIS units to pay the tax bill, reducing their overall asset worth. The policy shift actively deter the savings culture South Africa needs, especially given the country's precarious savings landscape with fewer than 6% of South Africans being able to retire and maintain their standard of living.

In conclusion, the proposed tax changes could have a significant impact on CIS investors in South Africa. It is crucial for investors to stay informed and seek professional advice to understand the potential implications for their financial future.