New capital gains tax: Change your mindset | Fin24

New capital gains tax: Change your mindset

Mar 11 2016 07:00
Schalk Louw

For many years, we’ve been taking the odd family trip to Hermanus and we have always taken the same national road to get there.

Assuming that because it’s a national road it has to be the fastest way, we never even considered alternative routes. I never bothered to consider them, because this is the way it has always been and I thought it always would be.

On a whim at the beginning of our family holiday last December, we decided to take the coastal route to Hermanus, and what a surprise! Residential developments along the national road have had a negative impact on traffic over the past few years, not only making the coastal route a breathtakingly beautiful option, but even a faster option at times.

At the recent Budget Review, finance minister Pravin Gordhan suggested quite a few tax adjustments. Capital gains tax (CGT) adjustments had to have stood out for investors as a great potential threat in their expected future after-tax profit growth.

Until these announcements were made, CGT calculations in personal capacity were based on the principle that 33.3% of your total capital gains is included and then calculated against your personal marginal tax rate.

The first R30 000 capital gains accumulated in a given tax year was exempt from CGT. Although this amount has now been increased to R40 000, it is the increase to 40% of your total capital gains that is included in your personal tax calculations, which will have a negative impact on your tax payments.

If you are currently taxed at the maximum rate (41%), your effective capital gains rate of 13.7% will increase to 16.4% (2.7% more, compared to previous tax legislation).

For those of you who invested your assets and investments in a trust over the years, things look even worse. A trust’s taxable portion of capital gains used to be 66.6%, but has now been increased to 80%, which means that its effective CGT rate increases from 27.3% to 32.8% (at a fixed tax rate of 41%). This means that nearly a third of any capital gains generated within a trust will have to be paid over as tax.

This announcement has refocused my attention on endowments. Before you declare all your possible aversions towards these products, I would like to explain why these products attracted my attention. As with my misconception on the national road as the best route to Hermanus, older-generation endowments have caused many to overlook the fact that these products have become extremely cheap and flexible over the last few years.

These days you can manage your personal share portfolio directly within an endowment while enjoying all the endowment-related tax benefits.

With all the changes made to CGT, the effective CGT rate in endowments has also been increased, but only from 10% to 12%, within the individual policyholder fund. This is a change of only 2% more within the endowment, compared to 2.7% more for natural persons.

As income taxes have remained unchanged for this financial year, it means that the interest accumulated within an endowment is only taxable at a rate of 30%, versus the maximum personal income tax rate of 41%.

Let’s suggest that you invested R1m in either your personal capacity, or via your trust, and used the last 15 years’ movements on the local stock market as a benchmark. By using a 6% money-market rate (before taxes) in both instances, you would now like to sell your shares after 15 years. Originally, you had a more balanced portfolio distribution with 75% of your capital invested in shares and the remaining 25% in the money market.

With the new tax legislation in effect, your investment within the trust (according to the five-fund approach, where all beneficiaries of the trust are natural persons) would be worth roughly R965 000 less after 15 years due to taxes.

If you had invested your capital in an endowment, however, you would have been able to pocket a gross after-tax amount of more than R300 000 in your personal capacity and close to R1.3m more in your trust. Of course there are certain variables that have been excluded from these calculations, such as costs/fees, but the picture is relatively clear.

My message this week is straightforward: With regard to the new CGT rates, don’t just accept that the road you’ve always taken is necessarily better than the one you haven’t travelled. There is no harm in finding out more about alternative products, especially if they are more tax efficient.

This article originally appeared in the 17 March 2016 edition of finweek. Buy and download the magazine here.


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