Tax can be a difficult maze to navigate for unit trust investors. Not only is there more than one type of tax applicable, but the types of products available in the market that invest in unit trusts are also taxed differently. Retirement products like retirement annuities do not pay tax on any of the returns from the unit trusts they are invested in. Investments that do not form part of your retirement saving do have the burden of tax and that includes unit trust investments.
Capital Gains Tax (CGT)
The investor makes an investment in a unit trust by buying units of the unit trust at a price that will be specified on the investor’s statement. The price of the units tracks the movements of the underlying investments (equity, bonds etc) and increases in value as the portfolio grows. The increased value is the profit that the investor makes and is known as a capital gain.
When is a tax liability triggered?
When the investor sells his units (by withdrawing from the investment or switching from a unit trust to another), there may be a tax event on the realised capital gain. It’s important to note that if the investor doesn’t withdraw from the fund then there is no tax liability. The investor could simply hold onto the investment and watch it grow without being liable to pay tax and defers the tax liability to a later date when the investment is cashed in.
How much is CGT?
An investor must pay tax on 40% of the realised capital gain, which is then included in the investor’s taxable income. This means 40% of your profit is taxed at your marginal income tax rate. Everyone has an annual exclusion of R40 000, which means that the CGT only comes into effect if your realised capital gain exceeds R40 000.
If you invested R100 000 in a unit trust a few years ago and decide to withdraw your investment that is now worth R160 000 then your realised capital gain is R60 000. The first R40 000 is excluded, which means you will only need to pay CGT on the additional R20 000 profit. That means R8 000 (40% x R20 000) will be added to your taxable income and will be taxed at your marginal income tax rate.
Dividend Withholding Tax (DWT)
An investor indirectly holds the companies that the unit trust invests in. Dividends that are declared by the companies are subject to 20% DWT. This tax is withheld and the cash from the net dividend is paid out by the unit trust to the investor (usually quarterly or semi-annually). The investor will not be required to make an additional DWT payment to SARS when conducting a tax return.
Tax on Income
Real Estate Investment Trusts (REITs) is a type of property company structure that requires the company to distribute more than 75% of its profit as income. This is like receiving income from rent when letting out property. The income from REITs is added to an investor’s taxable income and taxed at the marginal income tax rate.
Tax on Interest
Unit trusts invest in several instruments that pay out interest. This includes bank accounts and other income assets like bonds and is included in your taxable income. An individual does get the first R23 800 (R34 500 for persons 65 and older) interest income exempt from tax, which means only the interest received above this amount over a tax year will be added to taxable income and taxed at the marginal income tax rate.
Unit Trust Distributions
Unit trusts include all the above-mentioned payments (dividends, income and interest) into one cash distribution that can be paid out or reinvested. The payments from the underlying instruments are accumulated in the unit trust and then periodically (monthly, quarterly or semi-annually) paid out. At the end of the tax year the investor receives a tax certificate that details exactly what portion of the distribution consists of dividends, income and tax.
Quantitative Investment Analyst
Ian Stiglingh is a full time quantitative analyst, responsible for research of equities across all industries. Ian completed his degree in Mathematical Science in 2013 and his Honours degree in Financial Risk Management in 2014, both at the University of Stellenbosch. During his studies, Ian worked as an intern at Old Mutual Actuaries & Consultants as well as J.P. Morgan in Johannesburg, and is currently a CFA candidate