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How is tax calculated when you sell an ETF?

Reader’s questions answered.

CAPE TOWN – In this advice column Jamey Lipschitz from Sanlam Private Wealth answers a question from a reader who is thinking of cashing in some investments and wants to know what tax he may be liable for. 

Q: I have been investing in a local exchange-traded fund (ETF) since January 2006. I started with an initial lump sum of R10 000 and added to that with a monthly debit order of R1 000, which I increased each year by 10%. All my dividends have been reinvested. 

I now want sell my holding to buy the house I have been saving for and I know that the South African Revenue Service (Sars) will want to charge me tax on this investment. What I want to know is how this will be calculated?

In order to contextualise the answer it is important to understand that both ETFs and unit trusts are portfolios established under registered collective investment schemes regulated by the Financial Services Board. That means that they are pooled vehicles whereby the assets held in the portfolio are acquired using investors’ funds and are collectively managed by the asset manager.

As the shares and other securities are held in the collect investment scheme, SARS will not treat a sale as trading income. This is different to direct share investments, where proceeds may be treated as income if a share is held for less than three years.

With collective investment schemes only capital gains tax (CGT) will be applied on the sale of units. This is even though they may have been bought monthly and held for less than three years.

On top of this, it is also important to note that all the income received by way of distributions is taxed in the hands of the investor in the tax year in which it is received. Income distributions comprise mainly actual dividends declared by the underlying constituents held in the portfolio.

The dividends received by the portfolio are subject to dividends withholding tax at a South African rate of 15% for taxpayers that are not exempt in terms of the Income Tax Act. The dividends withholding tax will be deducted by the final regulated intermediary and paid over to SARS.

Therefore all distributions will be received by the investor net of dividends withholding tax. Distributions also include interest and scrip lending income (if applicable), which will be taxed as normal income in the hands of the investor.

That means that the only tax you will pay at the point of selling your securities is CGT. This is calculated based on the current ETF price less the ‘base cost’.

The ‘base cost’ will include the original lump sum investment of R10 000, plus your monthly debit orders, plus all the dividends, interest and scrip lending income reinvested into the ETF.

For example, if all of that came to a total of R100 000 and the current value of your investment is R140 000, your capital gain would be R40 000. You would then subtract from that the annual CGT exclusion, which is currently R30 000.

That means that your net capital gain would be R10 000. A third of that is taxable. In this case, R3 333.

This final, taxable amount, is what is added to your taxable income and taxed at your current rate.

Jamey Lipschitz is a wealth manager at Sanlam Private Wealth in Cape Town.

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What happens if only a part of the investment is sold (e.g. R25 000 of the R100 000)? What is seen as the base cost? Is the dividends etc. added to the initial R25k, or kept for the last portion of the money to be disinvested?

What about if the ETF has holdings in REITs. REIT dividends are usually taxed as income, rather than as dividends, so what happens in the ETF case?

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