An analysis of the taxation of the disposal of financial instruments by collective investment schemes in South Africa

Abstract

Collective investment schemes dispose of financial instruments for a number of reasons. These include the rebalancing of the fund, the obligation to redeem units from investors, index tracking and hedging. Previously, proceeds from these disposals were treated as capital in nature. In the Taxation Laws Amendment Bill of 2018, the National Treasury proposed that disposals of financial instruments by these schemes within 12 months of acquisition should be treated as revenue in nature. The National Treasury was of the view that various schemes actively and frequently trade with financial instruments and only hold investments for a short period. The proposal raised concerns in the investment industry, as amounts that are revenue in nature could be taxed as high as 45% in the funds, resulting in lower returns for investors. This would be problematic, as collective investment schemes provide an opportunity for investors to diversify their investments at a low cost. This study aimed to identify and evaluate alternative methods for the taxation of disposals of financial instruments by these schemes. In order to achieve this objective, principles other than taxation that affect these schemes were identified and discussed. The current taxation treatment of these schemes and disposals of financial instruments were explored. Lastly, alternative methods were identified and explored to effectively tax the disposal of financial instruments by these schemes. An exploratory and qualitative research method was followed to conduct this study. The findings of this study indicated that the tax policies followed by the countries aim to tax direct and indirect investments held by investors similarly, to ensure that tax implications do not result in investments distortions. The effect of this is that disposals of financial instruments by the schemes are usually deemed to be capital in nature. Alternative methods used by different countries to achieve this were identified. The first method entails local shares held by eligible funds being deemed to be held on capital account, foreign shares are subject to tax at an amount of 5% of the open market value at the beginning of the tax year (irrespective of any dividends received and capital movements) and gains on other financial arrangements are taxed upon realisation. The second method is a list setting out transactions that are deemed to be investment activities as opposed to trading activities of a fund if it meets the genuinely diversely owned condition. Lastly, the method of using case law was identified, however it was clear that funds are still permitted to frequently trade and gains are deemed to be capital in nature. The reason behind the treatment of proceeds as capital in nature is due to the fact that most investors hold the units with a long-term intention. Capital proceeds are furthermore exempt in the fund to ensure that double tax does not occur when the investor subsequently disposes of its units in the fund.