THE TAXATION OF COLLECTIVE INVESTMENT SCHEMES – BACK TO THE FUTURE
11 February 2025
On 13 November 2024, National Treasury issued a discussion document setting out various proposals regarding a revised tax regime for Collective Investment Schemes (“CIS”). Public comment was called for by 13 December 2024, whereafter a workshop with relevant stakeholders was held on 17 January 2025. We unpack our perspectives on the consultation process to date.
A BRIEF OVERVIEW OF THE CURRENT CIS TAX REGIME IN SOUTH AFRICA
National Treasury has made it clear in recent years that improving the retirement savings culture in South Africa remains a key priority in terms of policy and legislation development1.
CIS play an important role in investment and retirement savings in South Africa, making them significant vehicles, especially in light of the following harrowing statistics:
- Only 6% of South Africans are on track to retire comfortably2;
- 72% of respondents to a recent survey cited the inability to save as their primary reason for their retirement plans not being on track1; and
- Nearly 50% of South Africans do not have a retirement plan3.
While there are many different types of CIS available to investors, these are generally subject to the same income tax rules4. In essence, a CIS is regarded as a conduit (flowthrough) insofar as amounts of income are distributed within 12 months of their accrual5. Such distributions are then taxed in the hands of the unitholders (investors) in accordance with their own specific tax profiles.
Capital gains are exempt in the hands of a CIS6. Unitholders in a CIS will be subject to tax on the ultimate disposal of their units in a CIS on either a revenue or capital basis, dependent on whether they acquired those units as capital assets, or as part of a scheme of profit-making. In certain instances, units held for at least three years in a CIS in securities or a hedge fund CIS will be deemed to be of a capital nature7.
It is worth emphasising that there are no clear definitions of ‘capital’ or ‘revenue’ in our tax legislation, and the principles laid down in available case law are generally quite archaic requiring application on a case-by-case basis. This can make practical application of these principles a significant challenge, especially in a complex financial services environment like a CIS.
National Treasury expressed some concern in 2018 over certain CIS which, in its view, were “…generating profits from the active frequent trading of shares and other financial instruments”8, and allegedly abusing the capital gains exemption through incorrect classification of these ‘profits’ as capitaland not revenue. National Treasury accordingly proposed a legislative change to address this perceived mischief, to the effect that any gains or losses derived from the disposal of a financial instrument within 12 months of the acquisition thereof would be deemed to be revenue in nature.
This proposal was met with opposition from the CIS industry, professional advisers, and certain industry bodies, resulting in National Treasury abandoning it.
Based on a comparative study performed by National Treasury, the tax treatment of similar investment vehicles in other international jurisdictions is generally similar to South Africa, with the majority cited in the discussion document as being either conduits or tax transparent.
The public comments were rightly critical of the narrow and highly subjective choice of jurisdictions selected by National Treasury in this comparative study, for various reasons. For example, Hong Kong has a 15% tax rate compared to our maximum marginal rate for individuals of 45%, while key markets like Ireland and Luxembourg, with whom the South African CIS industry has a very close working relationship, were excluded.
NEW CIS TAX PROPOSALS SET OUT IN THE DISCUSSION DOCUMENT
The key tax proposals set out in the discussion document are summarised below. National Treasury made it clear in the workshop held in January 2025 that its main goal with these proposals is to provide certainty on the treatment of income. It stated repeatedly that the goal is not increased revenue collection, however, industry remains sceptical, especially as there is consensus that the current CIS tax regime works effectively and does not result in any permanent loss to the fiscus (given that tax is ultimately paid whenever unitholders dispose of their units).
1. Treat all income in the CIS as being revenue in nature
National Treasury rejects the view taken by industry that all gains made by CIS are capital simply because investors into CIS have a long-term investment intention. Rather, it claims that the emphasis must be on intention of the CIS itself, evaluated under the normal characterisation rules of capital and revenue.
In the workshop held in January 2025, the proposal to treat all income in the CIS as being revenue in nature was unanimously opposed by industry and other stakeholders, on the basis that a similar proposal had already been put forward and withdrawn in 2018/2019. On this basis, it is unlikely that this will remain a viable proposal.
2. Amend section 25BA to make CIS fully transparent
In essence, this proposal pushes the capital versus revenue question away from the CIS (being fully transparent for tax purposes), and on to the investor. This proposal presents a number of challenges, including:
- National Treasury proposes that the capital or revenue nature of income in the investor’s hands will be determined from the perspective and activities of the CIS. This is likely to have unintended consequences for long-term investors that are invested into a CIS. These investors would expect to be taxed on a capital basis but, because the CIS is seen by SARS to be ‘trading’, they would be taxed on a revenue basis.
- A number of stakeholders submitted comments that current IT systems simply cannot handle the complexities of determining daily amounts at an individual investor level. This proposal would, therefore, require significant and costly infrastructure and reporting upgrades and investment by each CIS.
- This proposal also presents potential cashflow and liquidity issues for investors where tax may be due, but that investor’s units in the CIS remain unsold.
- Individual investors would also need to apply for and claim any double tax treaty benefits on their own, rather than this being done on their behalf by the CIS (as is currently done).
For the reasons cited above, this proposal was largely rejected by industry during the workshop held in January 2025.
3. Creating a turnover safe harbour
In this proposal, one would consider annual trade volumes compared to the total portfolio size in order to determine how actively trading occurred in that portfolio. If those trades are within a specified ratio, they would be taxed on a capital basis (i.e. tax-exempt). For trades in excess of the specified ratio, the cumbersome existing capital or revenue principles would need to be applied, based on relevant facts and circumstances.
National Treasury itself stated in the discussion document that any turnover rate proposed would be arbitrary, given the vast diversity of CIS within the industry, and proposed 33%, aligned to the 3 year capital rule currently set out in section 9C of the Income Tax Act.
Stakeholders emphasised that trade volume is only one measure of determining trading activity, and that frequency of trading is not necessarily an indication of greater profits, but could be for investment mandate reasons, hedging, etc. It was also proposed by certain stakeholders that a list of investment transactions that are not considered trading activities be published by National Treasury, similar to the UK’s ‘White List’9.
The safe harbour proposal also has the potential to force fund managers to retain underperforming or overvalued assets, or to avoid rebalancing their portfolios when required, in order to avoid exceeding the prescribed ratio.
Stakeholders generally welcomed further discussions with National Treasury on this proposal, recognising that significant changes and further considerations are required in arriving at a workable solution.
4. Tax hedge funds out of the CIS tax definition
In 2015, after a multi-year process of engagement between the industry, National Treasury and the FSB10, hedge funds were included within the CIS legislation. This inclusion provided hedge fund investors with protection, through robust and transparent regulation and compliance. It has also resulted in hedge funds becoming accessible to the public through RIHFs11, with financial advisor support, better liquidity, and lower minimum contributions.
In this light, the proposal to remove hedge funds from the CIS regulation and tax framework was met with opposition from the industry during the National Treasury workshop. The discussion document does not propose how hedge funds would be taxed if they were removed from the CIS framework but, given their complexities and the journey to regularise them in 2015, in our view it would likely take a significant amount of time to develop hedge fund-specific tax legislation.
Stakeholders were vocal in opposing this proposal and were of the view that the hedge fund industry had been unfairly painted in a poor light throughout the discussion document. In reality, many fund managers manage both hedge funds and traditional CIS, with hedge funds often being marketed as the less risky of these two options.
There was general agreement in the workshop that further discussions are required on this proposal, and that simply removing hedge funds from the CIS framework will only create further uncertainty.
As a separate item in the discussion document, National Treasury also proposed that the tax relief provided by the corporate rules provisions, specifically section 42 of the Income Tax Act should not apply to CIS. While we have not addressed this specifically in this article, we note that this proposal in its current form was also met with opposition from stakeholders.
THE TAKEAWAY
During the workshop, National Treasury initially indicated that it would like to include comments on these proposals in the Minister’s Budget Speech in February 2025. Following the commentary provided and discussions held, it subsequently indicated that the proposals required further engagement with stakeholders before firm decisions could be taken and legislation drafted. It did indicate that, at a minimum, the Minister may confirm in the Budget Speech which of the proposals are not worth pursuing further. This was welcomed.
That being said, stakeholders are eager to continue to engage with and assist National Treasury in establishing certainty on the tax treatment of the CIS industry which, as stated earlier, National Treasury made clear is its key goal with these proposals. While the proposals are a starting point, there is much further engagement with stakeholders required in developing a workable solution, especially in light of the diversity and complexity within the CIS industry.
Finally, National Treasury also recognised that the CIS industry is a critical one to the South African economy, both in terms of investment and retirement savings, as well as market liquidity in general. As such, stakeholders cautioned National Treasury to take its time in making any changes to the existing tax regime, given the significant impact this may have on the South African economy, and its population’s dire savings culture.
4With the exception of a CIS in property
5As per section 25BA of the Income Tax Act
6Again, with the exception of a CIS in property, in terms of paragraph 61(3) of the Eighth Schedule to the Income Tax Act
7In terms of section 9C of the Income Tax Act
8Draft Explanatory Memorandum on the Draft Taxation Laws Amendment Bill, 2018
10Financial Services Board, now replaced by the Prudential Authority and the Financial Sector Conduct Authority
11Retail Investor Hedge Funds.
Authors:
Greg Boy, Senior Manager
Graham Molyneux, Partner
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