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Tax on share portfolios versus unit trusts

Are share portfolios becoming tax dinosaurs when, with collective investment schemes, you get the same thing but pay far less tax?

Craig Gradidge - Gradidge-Mahura Investments

It’s not always advisable to make generalised comparisons. Only a few collective investment schemes (unit trusts) can be compared to share portfolios – namely equity funds. The vast majority of money invested in unit trusts is in multi-asset class funds (such as balanced and flexible funds), which shouldn’t be compared to share portfolios.

There are a number of taxes that an investor may become liable to pay: income tax, Dividends Withholdings Tax (DWT), Capital Gains Tax (CGT), and securities transfer tax (STT). For the purposes of this response I will ignore STT. Nothing has changed from a product perspective in terms of the taxation of share portfolios.

The DWT rate has increased from 15% to 20%, but this will apply whether an investor earned those dividends inside a share portfolio or inside a unit trust fund. Where an investor wants to get part of their income from dividends, a share portfolio may be a better option than a unit trust portfolio. The investor will be able to access that dividend income a lot sooner since a unit trust will only pay out quarterly or bi-annually, but they will benefit from a timing perspective.

One area where share portfolios may be less tax efficient is trading. If the investor buys and sells shares regularly within a share portfolio, those sales will trigger capital gains tax (CGT) if the investor has made a profit. If the investor were to trade the portfolio actively, portfolio gains could be deemed to be income, and would be subject to income tax in terms of Section 9 of the Income Tax Act.

However, if shares are traded within a unit trust portfolio, there is no CGT or income tax implication. The investor will only become liable for CGT once they exit the fund. From this perspective, there may be some tax benefit for the investor – although they will have to cede all investment decisions to the fund manager. One could argue though that an investor in a share portfolio is able to mitigate CGT liability better over time as it is easier to do tax planning with a share portfolio than with a unit trust.

Tax efficient unit trust funds are offered by the likes of Sanlam Investment Management and Prescient, but these cannot be compared to equity investments such as share portfolios. The underlying investments are not in equities. These strategies cannot be replicated in a share portfolio for small investment amounts, so from this perspective there may be more tax efficiency in the unit trust product.

One way of mitigating tax with either a share portfolio or unit trust investment is to invest via a tax-free savings wrapper. Investors will be able to bypass income tax, CGT and DWT this way. The decision would then be one of DIY (share portfolio) versus outsourcing (unit trust), and cost structure.

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