Investors in shares can defer capital gains tax using unit trusts. Section 42 of the Income Tax Act (58/1962) allows a taxpayer to transfer listed shares to a company free of immediate tax consequences if certain requirements are met – for example, the shares must be transferred in exchange for equity shares in the transferee company.
If the requirements are met, the taxpayer suffers no capital gains tax or securities transfer tax in relation to the transferred shares. The taxpayer must account for future capital gains tax when it disposes of the equity shares acquired in exchange for the assets.
Under Section 41 of the Income Tax Act, for the purposes of Section 42, the term 'company' includes "any portfolio of a collective investment scheme in securities".
Under Section 1 of the Income Tax Act, a "portfolio of a collective investment scheme in securities" includes:
"any portfolio comprised in any collective investment scheme in securities contemplated in Part IV of the Collective Investment Schemes Control Act, 2002 [CISC Act] or carried on by any company registered as a manager under and for purposes of section 51 of the CISC Act for purposes of [Part IV of the CISC Act]".
The Collective Investment Schemes Control Act, among other things, governs unit trusts in South Africa which invest in listed shares.
Under Section 41 of the Income Tax Act, for the purposes of Section 42, the term 'equity shares' includes a participatory interest in a "portfolio of a collective investment scheme in securities".
For example, if a taxpayer transfers his or her listed shares to a unit trust in exchange for units in the unit trust, the transfer will not give rise to capital gains tax or securities transfer tax, provided that the unit trust meets the requirements under the Collective Investment Schemes Control Act and the transfer meets the requirements under the Income Tax Act.
Therefore, a unit trust pays no capital gains tax on the disposal of an asset (Paragraph 61(3) of the Eighth Schedule to the Income Tax Act). The unit holder pays capital gains tax when he or she disposes of his or her units in the unit trust. A long-term investor could therefore realise shares, or chop and change his or her share portfolio in the unit trust, without incurring capital gains tax. If the investor held the shares in his or her own name, then he or she would pay capital gains tax as and when shares were realised, even if the net proceeds were promptly reinvested.
Does the transfer of shares to a unit trust in the manner set out above constitute impermissible tax avoidance as it effectively defers the capital gains tax each time a share portfolio is realigned? Arguably not.
Section 42 of the Income Tax Act allows a taxpayer to transfer assets to a unit trust free of immediate tax consequences and therefore take advantage of the favourable regime available if assets are held in a unit trust portfolio. It would be unusual for the Income Tax Act to allow a taxpayer to structure his or her affairs in a way that was tax beneficial, only to deny the benefit once he or she had done so.
Despite these tax benefits, taxpayers should consider the practical and commercial effects. Taxpayers should ensure that the unit trust is properly regulated under the Collective Investment Schemes Control Act. They should also ensure that the transaction is properly planned and implemented. The unit trust manager will charge fees for managing the portfolio. Once the portfolio has been transferred to the unit trust, the taxpayer will hand over control of the portfolio to the manager.
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