There are only two things in a South African’s life that are certain; death and taxes.
A recent client engagement provided the motivation behind this article, given the fact that they would need to pay away 6% of their total investment capital, in order to effect the changes required. However, lets first explain what Capital Gains Tax (CGT) Harvesting is.
This topic has not been covered sufficiently in South Africa to date, despite the material impact that it can have on clients’ investments over time.
Fortunately, CGT Harvesting is a standard part of our value proposition.
What do we know about CGT in South Africa?
- It is certain, both during and post your life!
- CGT is not a separate tax and forms part of Income Tax.
- CGT will be triggered when one makes a profit when selling an asset (an asset for example is an investment). The tax is calculated on the profit made on the asset and not the selling price, as is so often thought.
- 80% of the “gain” of an asset housed in a company or trust, must be included in the relevant entity’s tax return
- 40% of the “gain” of an asset in the hands of an individual, must be included in the individuals tax return.
- Annual “tax-free” (abatement) amount of R40 000 for individuals.
Direct Vs Unitised Investments
In remaining true to our “advice only” business model, Harbour Wealth avoids unitised investments, preferring to build direct investment strategies. This not only removes a layer of fees and allows for greater asset management flexibility but has the added advantage of harvesting CGT over time.
In the case of an investor holding a collective investment scheme (unit trust), they will eventually be taxed on the profit made on the unit price. The investment changes that occur within the unit trust, all occur within the “unit”, and as such, do not attract CGT at the time of the transaction. Instead, the CGT begins to accumulate annually in the unit price, until it is sold or switched out of.
This invariably creates a financial barrier (CGT amount) for clients, who will often prefer to stay in a substandard investment, just to avoid having to pay an amount to the receiver.
A direct investment strategy does not have a unit price and the investor owns the underlying assets directly. This results in a CGT event occurring whenever one of the investments are sold for a profit. It is not deferred ‒ within the unit price ‒ to a later date.
It is important to state, at this point, that the ability to ‘CGT Harvest’ from our investment strategies, remains an attractive by-product of our process, but not the focus. The change in any underlying asset mix, which in turn may trigger a CGT event, is only ever initiated by “idea meritocracy” – an idea or change in asset mix that results in the best outcome for the client.
This is not to be confused with Tax Loss Harvesting, most common in the US, where loss leading investments are sold and rebought in a few minutes apart in a single tax year, to offset some of one’s personal tax.
Undermining Best Practice
Let’s revisit our client’s situation the fact that they would need to pay away 6% of their total investment capital. The CGT had accrued over a 13-year period, as no structural investment changes were ever made. The 6% is a bitter pill for anyone to swallow, and so it became the focal point, instead of a “best idea meritocracy” for their portfolio. It had cemented into a real and measurable cost to the client’s portfolio.
This CGT barrier would not have existed had the client been invested in direct strategies, saving them 6% of their total capital in this instance, and removing the barrier to much needed changes in their portfolio.
Each time our investment team conducts a rebalance within our strategies, it has the effect of increasing our investors’ base cost and allows for the use of each taxpayer’s annual CGT abatement of R40 000.
Simply, over ten years a member could benefit from as much as a R400,000 (R40,000 x 10 years) capital gain exemption, as opposed to the traditional buy and hold unitised investment, where accumulated capital gains invariably occur in a single tax year, losing the 9 years (R360 000) in possible CGT abatements.
In the South African fiscal context, it is hard not to believe that CGT will be increased at some point soon. The ability to mitigate meaningfully against this, and in many cases remove this cost in its’ entirety, makes CGT harvesting an essential consideration for our clients.
If you require professional financial advice, contact one of our qualified independent Financial Advisors at www.harbourwealth.co.za
