Dividends Tax on Unit Trust Returns

The impending replacement of Secondary Tax on Companies (STC) by Dividends Tax (DT), effective from the 1st of April this year, will have a multi-faceted and far reaching impact on the Collective Investment Schemes industry. You have surely seen article upon article on this topic, all dealing with one or more of these facets. This article focuses primarily on the possible effect that Dividends Tax may have on unit trust investor returns.

Prior to the 1st of April 2012, dividends paid by companies to unit trusts did not succumb to any further taxation in either the hands of the unit trust or the investor because the tax burden lay with the company declaring the dividend, in the form of STC (a 10% tax payable by the company prior to distribution of the dividend amount).

From the 1st of April 2012, the burden of tax will move away from the company, to the recipient of the dividend, in the form of Dividends Tax (a 15% tax payable by the beneficial owner).

What does this mean for unit trust investors…

At first glance this appears to be very bad news for unit trust investors as, in simple terms, 15% of the dividend income that they previously received tax free, will be withheld from them and paid to the tax man instead.

For an investor utilising dividend yield and the positive compounding effect of the reinvestment of dividends as a component part of their financial plan to achieve their investment objectives, this new tax appears to present a serious threat to their plan’s ability to succeed. It could cause investors and advisers alike to have to consider a rethink of their approach when it comes to the contribution dividends make, now that they will no longer be tax free, to both the yield component and tax efficiency of their existing financial planning.

This said, there may well be some silver lining waiting in the wings for all investors as it has been muted in the industry that companies, once free from the 10% STC, may well decide to increase their dividend payments proportionately, thus mitigating some (two thirds in theory) of the impact of the new tax.

Furthermore, for unit trust investors, the legislation permits fees to be deducted from the gross dividend amount paid by the company to the unit trust, for the period that the dividend is held within the unit trust. For a unit trust that declares its income just once a year, the 15% tax will only apply to the balance of the gross dividend that remains after a period of up to 12 months of fees having been paid from it.

All of the consequences of the introduction of Dividends Tax, quite understandably as we look at it today, cannot be fully understood yet. A reasonable enough period of time must pass, with the tax in operation, to provide enough real information and data for analysis. What we are able to do today is to interpret the legislation and identify possible consequences. One that is quite clearly evident is that the implementation of this tax could prove to prompt a shift by advisers and individual investors towards structured products such as unit trusts. The motivation for this shift being that a direct investment on the stock market will attract a 15% taxation of the entire dividend amount paid, which will not be the case with an indirect investment. In his 2012 budget speech, Pravin Gordhan made multiple references to savings such as looking “…to invigorate household savings…” and “…to improve preservation of retirement fund assets to ensure higher levels of income in retirement.” A sentiment that was clearly reflected when he spoke about the new Dividends Tax and confirmed that “Pension funds will benefit from this transition as they will receive dividends tax free.”

So, is Dividends Tax, a good or a bad thing, and what should investors and advisers be considering when executing their ongoing financial planning and managing unit trust return expectations within this?

It is important to be aware of the impact that this new tax may have on the existing dividend yield contribution to your overall portfolio return and take whatever action may be necessary to mitigate this and keep your portfolio on track to meet your existing expectations. Be sure to update your knowledge on the detail of the legislation, including the exemptions proffered that may apply to you. Understand the importance of ensuring that all of the necessary information is attained and handed on to the relevant financial services and product providers in order for this tax to be applied correctly to your investments.

Don’t judge a book by its cover….

Generally speaking, to the investing public and the army of advisers that serve them, the concept of replacing a 10% tax paid by companies with a 50% higher tax paid by the investor sounds like something that would definitely serve to have a negative impact on returns. Once looked at more closely, the English idiom “don’t judge a book by its cover” comes to mind. Should companies go the route of increasing their dividends by 10%, and investors utilise the multitude of indirect investment products available that may allow for fee deduction from the gross dividend amounts received, or indeed, may be exempt from the tax completely, then this new tax may not prove to deliver the negative impact on investor returns that one would be forgiven for assuming was certain to be the case.

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