Ordinary Taxpayers Face More Unwelcome Surprises in Proposed Tax Legislation

This year’s proposed changes to the Income Tax Act introduce an unexpected challenge concerning the taxation of collective investment schemes (CISs).

Tax specialists indicate that investors holding units in these schemes now face an unforeseen tax liability, even without having sold any of their units.

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The National Treasury contends that while the current tax structure for CISs and corporate reorganisations is essential, the tax-neutral transfer of shares to a CIS has led to “unintended tax avoidance” during shifts in shareholdings of listed companies, as gains on shares are not taxed upon transfer.

Treasury now plans to remove the tax-neutral treatment of fund mergers or amalgamations and the roll-over relief for asset-for-share transactions.

Another proposed modification is to categorize any distribution from a CIS that isn’t classified as income as a capital gain, which would then impose tax on the investor.

No more roll-over relief

The existing asset-for-share provision permits an individual to transfer an asset (like shares in a publicly 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 tax deferral is referred to as “roll-over relief,” as outlined by Treasury in the draft Taxation Laws Amendment Bill (TLAB).

Current laws provide similar tax deferral benefits during mergers or amalgamations, allowing asset transfers between merging entities without immediate tax consequences.

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This creates a “loophole” that Treasury aims to target. Treasury clarifies that investors can transfer shares with unrealised gains in a listed company to a CIS under the “asset-for-share” transaction framework. As a result, the investor avoids CGT when transferring and receives units in the CIS.

If the CIS subsequently sells the same shares during a merger or as part of its investment strategy, it 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 the point of “economic realisation,” according to Treasury.

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The investor’s tax liability is deferred until they decide to sell their units in the CIS, which may occur years later or might be circumvented through untaxed distributions by the CIS.

“This creates an imbalance compared to an investor who directly sells their shares and promptly pays CGT,” Treasury notes in its explanatory memorandum for the TLAB. Hence, the proposal to abolish the current provisions is proposed.

Stealth tax

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

“It undermines the long-term, tax-efficient compounding that makes a CIS an attractive investment choice,” they caution.

“This policy change is especially concerning given South Africa’s precarious savings landscape, where less than 6% of South Africans can retire while maintaining their standard of living.

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“Considering this stark reality, all aspects of fiscal policy should focus on actively encouraging and simplifying long-term savings through CISs. By introducing unforeseen tax liabilities and reducing the tax efficiency of CISs, the proposed amendments directly undermine the savings culture that South Africa critically needs,” they add.

Another proposed change could affect the disposable income of South Africans employed abroad.

Treasury proposes an adjustment to the definition of “remuneration proxy,” which is used as a benchmark for calculating certain tax benefits, thresholds, and values when actual remuneration for the current year may not be accessible.

Treasury highlights that some taxpayers who qualified for a foreign employment income exemption in the prior assessment year might encounter an artificially reduced remuneration proxy in this assessment year.

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

Fringe benefits

Leap Group managing partner Jonty Leon clarifies that the proxy is mainly used to determine the taxable value of certain fringe benefits, especially employer-provided housing.

This adjustment aligns with the South African Revenue Service’s objective of preventing the undervaluation of non-cash benefits. “It ensures that expatriates receiving substantial employer-provided benefits, particularly housing, are taxed according to their actual earning capacity.”

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Leon mentions that, although the R1.2 million foreign income remains exempt, the overall tax burden for expatriates enjoying employer-provided benefits is likely to increase.

The deadline for comments on these extensive proposals is Friday, 12 September.

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