PART I: TAX BASICS
When a South African company declares dividends to a South African shareholder, the dividends are generally exempt from income tax. Instead, the dividends are subject dividends tax.
Dividends Tax is a withholding tax (meaning it’s paid directly to SARS on the investor’s behalf) and is levied at 20% of dividends received. For example, if a company were to declare a dividend of R100, only R80 will be paid to the shareholder. The remaining R20 is paid to SARS on the shareholder’s behalf.*
To best explain how Capital Gains Tax (CGT) is calculated, we’ll detail each part of a single transaction.
In our example, you bought 250 shares at R150 a share. Let’s assume your transaction fees and securities transfer tax amounted to 2% – R3 per share. These two amounts added together is your base cost. After holding these shares for four years, you sell them at a profit for R475 a share (proceeds).
Your CGT would be the difference between your proceeds (R475) and base cost (which is R153, R150 plus R3 fees). So in our example, the CGT would be R322 per share and R80,500 in total for all the shares. However, this is not the amount you’ll be taxed on. If you held these shares in your personal capacity (not via a company), SARS gives you an annual exclusion of R40,000 per year.
This means that your R80,500 is reduced by R40,000, leaving you with a taxable amount of R40,500. Again, this is not the amount you’ll be taxed on. If you held these shares in your personal capacity, only 40% of the R40,500 is taxed. This is called the inclusion rate. In our current example that would be R16,200.
The amount you will be taxed on, at your income tax rate, is R16,200. If your income tax rate is 31%, you will pay R5,022 CGT on the transaction.
If you receive shares instead of dividends, the base cost of your shares will be R0. You also won’t be paying any dividends tax. To illustrate this scenario, let’s base our CGT calculation on 250 shares (received instead of dividends) at R10 per share. Assuming you sell all 250 shares for R475 a share after a period of 4 years, your tax payable will be R9,765.
R475 per share (proceeds) x 250 shares = R118 750
R118 750 – R0 (base cost) – R40 000 (annual exclusion) = R78 750
R78 750 x 40% (inclusion rate) = R31 500
R31 500 x 31% (income tax rate) = R9 765
PART II: TOTAL RETURN ETFs
Total return ETFs reinvest all dividend payments on your behalf. Total return ETFs save on brokerage fees. Instead of paying for the transaction to buy more ETF units, the transaction happens within the ETF. You never receive the dividends in cash, but the dividend amount gets reinvested on your behalf with no brokerage.
There are two ways of structuring a total return fund.
First option: the fund does not distribute the dividends and merely rolls the value up into the NAV of the fund. As the dividends are not distributed to the investor, the fund retains them beyond 12 months and they become taxable as income in the fund at either 28% (fund structured via company) or 45% (fund structure via trust). This taxation erodes the unitholders’ NAV. The NAV of the investors’ units increases with the value of the dividends net of the 45% tax in the fund. No dividends tax is applied and the base cost of the units remains unchanged.
Second option: the fund applies the distribution within 12 months and auto-reinvest all dividends. All dividends are distributed to investors without a cash flow and automatically reinvested in their units. This results in growth of the NAV equal to the dividend net of dividends tax and a step up in base cost equal to the net dividend reinvested. Provided this is done within 12 months of receipt/accrual of the underlying dividend, there would be no tax implications for the fund.
*Dividends declared by foreign companies are treated differently and not discussed in this post.
Being tax efficient is an important part of great financial management. In this blog, a group of South African tax experts share their tips and explanations on tax issues. Learn everything you need to know about tax, from deductions you never knew about to retirement savings and capital gains. The first Tuesday of every month is Tax Tuesday. Don’t miss it!