Business as usual for unit trusts

Johannesburg - Dividend income funds will continue to exploit a complex loophole allowing them to avoid tax on interest invested, because the South African Revenue Service (Sars) has not yet taken any steps to stop the practice.

Sars confirmed on Thursday it is looking into possible tax avoidance by dividend income unit trust funds, but could not confirm if or when any funds at fault would be closed down.

"There are concerns that interest income is being transferred as dividend income," said Sars spokesperson Adrian Lackay. "Sars is actively engaging with the Financial Services Board (FSB) and the treasury regarding this issue."

Dividend income unit trusts invest in a variety of preference shares, usually those of the big four banks, which provide tax-free dividends.

According to Pieter Koekemoer, head of personal investments at Coronation Fund, there is no tax arbitrage in listed preference shares as dividends are paid out of the companies' after-tax profits.

Some unit trusts allegedly used this opportunity to create a tax advantage for investors in the money market, which offers a lower risk profile than preference share investing. However, unlike dividend income from preference shares, interest income from the money market is taxable.

Gains made in the money market would apparently then be reinvested in pension funds or other non-tax paying vehicles, which would then pay out non-taxable dividends to the unit trust.

The FSB's Patrick Ward told Fin24.com on Wednesday the "covert instruments" used to place the interest income into non-taxable structures are underhanded methods of avoiding tax.

The FSB issued a circular in January, informing asset management groups of the investigation and warning portfolio managers to prepare exit strategies should some funds be closed down.

- Fin24.com