With it being tax season, it is important to understand what taxes you may be faced with and how they apply to your various types of investments. Remember, although tax can never be avoided, you can structure your investments strategically so as to reduce your tax liability and, in turn, maximise your returns.
At the outset, let’s understand the different types of taxes that may be applicable:
Income tax: Income tax, also known as pay-as-you-earn (PAYE), is calculated on a sliding scale between 18% and 45% depending on how much you earn. In simple terms, the more you earn, the higher your rate of tax. The tax bracket in which you fall determines your marginal tax rate which, in turn, affects the rate at which you are taxed on any additional earnings.
Dividends withholding tax: Dividends withholding tax (DWT) is a tax payable on dividends received or accrued from South African listed companies or dual-listed non-resident companies. DWT is charged at a flat rate of 20% which is withheld by the company and paid directly to Sars [South African Revenue Service] before the balance of the dividends is paid to the investor, which means that the investor has no further tax obligations once they have received their net dividend. DWT is payable after the company has paid corporate tax of 28% on its net profits.
Capital gains tax: Capital gains tax (CGT) may be payable on the disposal of an asset, with the first R40 000 of a capital gain made in a tax year being tax-exempt. Thereafter, any profits made are taxed at a 40% inclusion rate, meaning that only 40% of the profit you make in excess of R40 000 will be taxed. Capital gains are taxed at your marginal tax rate (see above), meaning that the maximum CGT payable is 18% (i.e. 40% of 45%). Any unused portion of your annual CGT exclusion cannot be carried forward to the next year, so it is important to use your exemptions strategically.
Now let’s unpack how your various types of investments will be taxed, and how to strategically minimise your liabilities.
Cash and bonds
As an individual taxpayer, you are liable to pay tax at your marginal rate on interest earned in your investments, including cash, bonds, stokvels and any money housed in your medical savings account. However, keep in mind that South African tax residents are granted a tax exemption on the first R23 800 earned per year in respect of investors under the age of 65. For those over age 65, the exemption increases to R34 500 per year. When filing your tax returns, local interest must be declared in the ‘Investment Income’ section of your tax return.
If you earn foreign interest, keep in mind that you will need to declare the rand amount to Sars when filing your tax returns and that no annual exemption applies. Once again, you will need to declare foreign interest in the Investment Income section of your tax return, and you should be able to obtain a deduction on foreign taxes already paid.
As an investor, any dividends that you earn from South African listed companies (or dual-listed non-resident companies) do not attract income tax but are subject to DWT at a flat rate of 20%. Generally speaking, if an investor holds less than 10% of equities in a foreign-listed company, any foreign dividends received must be declared and are subject to DWT at 20%, although Sars will allow a tax exemption which equals 25/45 of the rand value of the foreign dividend (i.e. 55.65%), which will be reduced by any foreign tax already paid.
Importantly, keep in mind that you may be liable for CGT when you dispose of shares, so it is important to understand the tax implications of doing so before making a sale. Also, remember that you do not pay CGT when your investment manager or DFM [discretionary fund manager] buys and sells underlying assets in your portfolio. Where you are invested directly through a foreign-domiciled feeder fund, you will not be taxed on currency movement while you are invested – but when you realise all or part of your foreign investment, the foreign capital gain or loss will be calculated and translated into rands using the average exchange rate at the date of sale.
If you are a high-income earner, you can benefit from the favourable tax rate afforded by an endowment structure. When taking out an endowment policy, you swap your tax position for that of the life insurer which means that instead of paying tax on interest earned at your marginal tax rate, you are taxed at a rate of 30% – although keep in mind that no annual interest exemptions apply in this regard. DWT of 20% applies. While endowments may have certain tax advantages for higher-income earners, keep in mind that there are a number of restrictive rules that apply to contributions and withdrawals, making them suitable for an investment period of five years or longer.
Real estate investment trusts (Reits) own income-producing properties such as shopping centres, office blocks, factories, warehouses, hotels and student accommodation, to name just a few. Reits provide investors with a lower-risk investment model with a diversified portfolio of properties. Reits are taxed differently to other listed companies in that they do not pay corporate income tax, and no dividends tax is payable on distributions. If you have Reits in your unit trust portfolio, all distributions must be declared when filing your tax returns and are taxable at your marginal income tax rate. You will not be liable for any dividends received from Reits held in a retirement fund.
Tax-free savings accounts
While all contributions made towards a tax-free savings account (TFSA) are made with after-tax money – meaning that there is no tax deduction on your investment premiums – no tax is payable on interest earned or dividends received, and no CGT is payable on disposal. While the tax benefits of TFSAs are not as significant as those offered by a retirement fund structure, this type of vehicle is more flexible when it comes to accessing your funds.
Without a doubt, retirement funds [including retirement annuity funds] provide investors with the most significant tax benefits. This is because all contributions made towards a retirement fund – up to [a maximum of] 27.5% of your annual taxable income – can be claimed as a tax deduction. Any over-contributions made in a given tax year can be rolled over to the following tax year for tax purposes. Further, no tax is paid on any interest or dividends earned with the fund, and no CGT is payable on disposal. In addition, at retirement, an investor has the option of withdrawing one-third of the fund in cash, with the first R500 000 being free from tax.