National Treasury has proposed three major amendments affecting portfolios of collective investment schemes (CISs) in the draft 2025 Taxation Laws Amendment Bill (TLAB).
Read: Draft Bill hides a ‘stealth tax’ in your unit trust investments
The first amendment is the removal of tax-neutral roll-over relief for “asset-for-share” transactions under section 42 of the Income Tax Act (ITA) for all CISs. This change is due to what National Treasury terms “unintended tax avoidance”. The Explanatory Memorandum highlights a scenario in which an investor transfers listed shares to a CIS, which then sells them, with the subsequent capital gains being tax-exempt at the CIS level.
The provenance for this amendment can be traced back to 29 September 2016 shortly before the SABMiller/AB InBev take-over, when the South African Revenue Service (SARS) issued a media release warning that a CIS acquiring listed shares from an investor and which disposes of them shortly afterwards may be on income account or may be engaging in an impermissible avoidance arrangement.
The second amendment excludes CIS mergers from the definition of an “amalgamation transaction” under section 44 of the ITA. A merger of one CIS (CIS 1) with another CIS (CIS 2), where investors in CIS 1 exchange their CIS 1 units for CIS 2 units, will no longer be tax neutral for the investors. It will instead be treated as a barter or exchange transaction, triggering a disposal and, hence, a capital gain or loss in the investors’ hands. To the extent there is a capital gain, the unitholders will receive a step up in the base cost of their CIS 2 units.
The third amendment introduces a new paragraph 82A in the Eighth Schedule, under which a distribution that is neither gross income nor income (colloquially a “capital distribution”) made by a CIS to its investors before a disposal of their units will result in a capital gain for the investors without any base cost offset.
This article discusses three possibilities of what “capital” in a capital distribution could be in the context of a portfolio of a CIS.
‘Capital’ as initial capital invested by the investors
The first possible interpretation of a capital distribution is a distribution of the initial amount invested by the investors to acquire units in the CIS.
If the portfolio distributes the initial “capital” to the investors, it will result in a capital gain in their hands. Arguably, such a distribution should be treated as a reduction in the base cost of the investors’ units under paragraph 20(3)(b) of the Eighth Schedule.
However, given that there is a “necessary implication” against the same amount being taxed twice in the hands of the same taxpayer, the proposed paragraph 82A would take precedence over any base cost reduction. It could lead to some anomalous results, such as triggering a capital gain upon distribution and a capital loss when the units are redeemed, because the base cost of the units would remain intact.
Although taxing the return of contributed capital to a unitholder as a capital gain is not theoretically correct, it is unlikely to happen in practice.
Distributions of gross income or income previously taxed in the CIS in a prior year
Section 25BA provides for the taxation of an amount (other than an amount of a capital nature) in the CIS if not distributed by the CIS within 12 months of accrual, or in the case of interest, within 12 months of receipt.
Under trust law principles, an amount received by or accrued to a trust that is taxed in the trust in the current year and distributed to the beneficiaries in a later year of assessment would form part of trust capital.
Treating such amounts as a capital gain on distribution would result in economic double taxation for the portfolio and unit holder. The portfolio would already have paid tax on the income at 45% and on distribution the unit holder would pay CGT of up to 18%. Such a situation clearly offends against the conduit principle established in cases such as Armstrong v CIR and SIR v Rosen.
Distributions of capital gains derived by the CIS in a current year or previous year
Capital gains arising in the portfolio are disregarded under paragraph 61(3) of the Eighth Schedule. Under paragraph 61(1), unitholders must account for a capital gain or capital loss only upon disposal of their units. There was therefore an apparent loophole if such an amount were to be distributed before disposal of an investor’s units.
It therefore seems there is a valid basis for taxing unitholders on the distribution of such capital gains. However, there could be situations in which a capital gain that arose prior to a unitholder investing in the CIS could be distributed to the unitholder with harsh consequences because the unit holder did not enjoy the benefits of the capital gain. It would be more equitable to treat such a distribution as a base cost reduction.
It is difficult to understand why a CIS would distribute such a disregarded capital gain, because the purpose of a CIS is to grow the funds invested with it, not to return those funds to its investors by way of a distribution.
Regardless of whether any such capital distributions have occurred in practice, paragraph 82A closes a perceived loophole and should act as a strong disincentive for portfolios of CISs from making such distributions.
The proposed paragraph 82A comes into operation on 1 March 2026 and applies to disposals on or after that date.
This article was written by Joon Chong, a partner at Webber Wentzel, and Duncan McAllister, a consultant at the same law firm.
Disclaimer: The views expressed in this article are those of the writers and are not necessarily shared by Moonstone Information Refinery or its sister companies. The information in this article is a general guide and should not be used as a substitute for professional tax advice.
