Unit Trusts: The Next Tax Target?
20 August 2018 | SA Views | Ian Stiglingh

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Treasury has proposed legislation on taxing Collective Investment Schemes (CIS), more commonly known as unit trusts. The tax amendment aims to tax realised profits (made from selling an asset) that were generated within 12 months of the purchase of the asset/instrument. These profits will then be distributed to investors and taxed as income.

The current situation

There has been a debate about the unequal treatment of tax between CIS and other industries. The profits that individuals or other industries generate are taxed as income if the asset was held for less than 12 months (deemed profit in nature) and as capital gains tax for longer investment periods (seen as capital appreciation from long-term investment). An investor putting money in a CIS would have only been liable for capital gains tax on redemption of the investment, thereby taxing both short term and long-term profits as capital gain. This is significant since an initial amount of capital gain is exempt from tax and the excess is taxed at a lower rate, 40% of the marginal income tax rate.

Why now?

The unequal tax treatment between individuals and CIS is addressed. Hedge funds are going to be regulated and more readily available to investors, and will be a part of the CIS industry. Hedge funds trade more frequently and realise short-term profits more often than traditional unit trusts. Provision must therefore be made to tax short-term profits as income. It could be important to uniformly tax different investment vehicles to discourage tax avoidance.

Impact on investors

There is little doubt that this will negatively impact investors, including pension funds. Retirement money makes up the bulk of unit trust investments in South Africa. Currently, less than 1 in 20 South Africans are able to maintain their standard of living upon retirement, and the proposed legislation may discourage saving for retirement. Investors could pay more tax on their investments, even if no redemption was made.

Impact on fund managers

Fund managers may be incentivised to reduce the amount of income generated from short-term trading activity and financial instruments, since this will result in an outflow of capital from the fund. Outflows reduce the overall management fee paid to the fund manager. Financial instruments are often used to hedge against market risks, and profits from these instruments may, under the proposed legislation, be subject to income tax. This could lead to reduced use of these instruments and potentially result in lower return on the investment.

Passive versus active funds

The proposed legislation includes all types of Collective Investment Schemes. Index trackers are often rebalanced to be in line with index changes, and are required to rebalance, resulting in a potential sale of assets that could be liable for income tax. Actively managed funds are rebalanced at the fund manager’s discretion. Both active and passive funds may experience outflows, and assets are often sold in proportion to cover these redemptions. This may impact existing investors due to the sale of the assets.

Additional admin required

Management companies responsible for pricing funds and maintaining the database of investors are also required to calculate tax for investors and issue tax certificates. The proposed tax amendment could make calculating tax a complex issue and further system development will be necessary. Management companies could increase their fees to compensate for the higher admin burden, and investors will be the ones who pay.

The silver lining

Fund managers can make use of loss harvesting, the process of selling losing positions to offset the realised gains from winning positions. Taxation will be based on the first-in-first-out (FIFO) method where the oldest purchase of an asset is considered when a sale occurs. This could be more meaningful for index trackers, which typically don’t dispose of the newest shares bought into the portfolio, even when redemptions occur. The effect of the tax should therefore have a smaller impact on passive trackers than actively managed funds. There will be equal treatment of tax across industries, eliminating a potential gateway for investors to avoid tax. This makes other types of investments more competitive compared to CIS. Foreign funds are not influenced by the proposed legislation.

Timeline for the tax amendment

This is proposed legislation - nothing has been confirmed yet. Expect to see resistance to the idea from industry players, notably management companies which will be responsible for implementing the changes if approved. Should Treasury succeed in passing the law to amend the tax, we could see it take effect on 31 March 2019. It may depend on how quickly management companies can update their systems to adhere to the regulations, which could delay implementation of an approved tax amendment.


Ian Stiglingh
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 

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