Taxation of collective investment schemes

Public comment was called for by 13 December 2024, whereafter a workshop with relevant stakeholders was held on 17 January 2025.

In the Budget Reviews, issued with the 2025 Budgets, National Treasury acknowledged the concerns raised during this workshop, and that consultations with key stakeholders on this topic will continue during 2025. In addition to this positive commentary, Treasury has confirmed “…that it does not intend to tax all CIS returns as revenue”. This is a helpful clarification, and provides some hope for the future of the taxation of these investment vehicles.

Less helpfully, Treasury has made clear the need for the tax-neutral provisions relating to asset-for-share transactions and amalgamation transactions, and for their application to a CIS in particular, to “be reviewed”. Treasury apparently sees a “mischief” at play here, in the form of potential tax avoidance.
 

A summary of the key issues in relation to these items follows below.
 

A brief overview of the current CIS tax regime in south africa

While there are many different types of CISs available to investors, these are generally subject to the same income tax rules, with the exception of a CIS in property. In essence, a CIS is regarded as a conduit (flowthrough) insofar as amounts of income are distributed within 12 months of their accrual [as per section 25BA of the Income Tax Act, 1962 (the
Act)]. Such distributions are then taxed in the hands of the unitholders (investors) in accordance with their own specific tax profiles. 

Capital gains and capital losses are exempt in the hands of a CIS [again, with the exception of a CIS in property, in terms of paragraph 61(3) of the Eighth Schedule to the Act]. Unitholders in a CIS will be subject to tax on the ultimate disposal of their units in a CIS on either a revenue or capital basis, dependent on whether they acquired those units as capital assets, or as part of a scheme of profit-making. In certain instances, units held for at least three years in a CIS in securities or a hedge fund CIS will be deemed to be of a capital nature [in terms of section 9C of the Act].

It is worth emphasising that there are no clear definitions of “capital” or “revenue” in South Africa’s tax legislation, and the principles laid down in case law are generally quite archaic, needing to be applied on a caseby- case basis. This can make practical application of these principles a significant challenge, especially in the complex financial services environment of a CIS.

National Treasury expressed some concern in 2018 over certain CISs which, in its view, were “…generating profits from the active frequent trading of shares and other financial instruments” [Draft Explanatory Memorandum on the Draft Taxation Laws Amendment Bill, 2018], and allegedly abusing the capital gains exemption through incorrect classification of these “profits” as capital, and not revenue. Treasury accordingly proposed a legislative change to address this perceived mischief, to the effect that any gains or losses derived from the disposal of a financial instrument within 12 months of the acquisition thereof would be deemed to be revenue in nature.

This proposal was met with vehement opposition from the CIS industry, professional advisers, and certain industry bodies, resulting in National Treasury abandoning it.

New CIS tax proposals set out in the discussion document

The key tax proposals set out in the discussion document are summarised below [Note: A link to the discussion document is provided at the end of the article]. National Treasury made it clear in the workshop held in January 2025 that its main goal with these proposals is to provide certainty on the treatment of income. It stated repeatedly that the goal is not increased revenue collection 

– however, industry remains sceptical, especially as there is consensus that the current CIS tax regime works effectively and does not result in any permanent loss to the fiscus (given that tax is ultimately paid whenever unitholders dispose of their units).

As stated above, and based on the feedback provided during the workshop, National Treasury has made it clear in the 2025 Budget documentation that consultations on these proposals will continue in 2025.

1. Treat all income in the CIS as being revenue in nature

 In the workshop held in January 2025, the proposal to treat all income in the CIS as being revenue in nature was unanimously opposed by industry and other stakeholders, on the basis that a similar proposal had already been put forward and withdrawn in 2018/2019.

Treasury acknowledged this, making it clear in the Budget Speech documentation that it does not intend to tax all CIS returns as revenue. Accordingly, it only cited the remaining three options in that documentation, removing this as a viable alternative.

2. Amend section 25BA to make CIS fully transparent

In essence, this proposal pushes the capital versus revenue question away from the CIS (being fully transparent for tax purposes), and on to the investor. This proposal presents a number of challenges, including the following:
 

• Treasury proposes that the capital or revenue nature of income in the investor’s hands will be determined from the perspective and activities of CISs. This is likely to have unintended consequences for long-term investors that are invested into a CIS. These investors would expect to be taxed on a capital basis but, because the CIS is seen by SARS to be “trading”, they would be taxed on a revenue basis.
• A number of stakeholders submitted comments that current IT systems simply cannot handle the complexities of determining daily amounts at an individual investor

"In this light, the proposal to remove hedge funds from the CIS regulation and tax framework was met with opposition from the industry during the Treasury workshop."

and costly infrastructure and reporting upgrades and investment by each CIS.
 

• This proposal also presents potential cashflow and
  liquidity issues for investors where tax may be due, but
  where the investor’s units in the CIS remain unsold.
• Individual investors would also need to apply for and claim
  any double tax treaty benefits on their own, rather than
  this being done on their behalf by the CIS (as is currently
  done).

For the reasons cited above, this proposal was largely opposed by industry during the workshop held in January 2025.

3. Using a turnover ratio to create a safe harbour

In this proposal, one would consider annual trade volumes compared to the total portfolio size in order to determine how actively trading occurred in that portfolio. If those trades are within a specified ratio, they would be taxed on a capital basis (ie, tax-exempt). For trades in excess of the specified ratio, the cumbersome existing capital or revenue principles would need to be applied, based on relevant facts and circumstances.

Treasury itself stated in the discussion document that any turnover rate proposed would be arbitrary, given the vast diversity of CISs within the industry, and proposes 33%, aligned to the 3-year capital rule currently set out in section 9C of the Act.

Stakeholders emphasised that trade volume is only one measure of determining trading activity, and that frequency of trading is not necessarily an indication of greater profits, but could be for investment mandate reasons, hedging, etc. It was also proposed by certain stakeholders that a list of investment transactions that are not considered trading activities be published by Treasury, similar to the UK’s “White List” [https://www.gov.uk/government/
publications/investment-manager-exemption-and-collectiveinvestment-schemes-expanding-the-white-list].

The safe harbour proposal also has the potential to force fund managers to retain underperforming or overvalued assets, or to avoid rebalancing their portfolios when required, in order to avoid exceeding the prescribed ratio.
 

Stakeholders generally welcomed further discussions with National Treasury on this proposal, recognising that significant changes and further considerations are required in order to arrive at a workable solution.

4. Take hedge funds out of the CIS tax definition

In 2015, after a multi-year process of engagement between the industry, Treasury and the FSB [Financial Services Board, now replaced by the Prudential Authority and the Financial Sector Conduct Authority], hedge funds were included within the CIS legislation. This inclusion provided hedge fund investors with protection, through robust and transparent regulation and compliance. It has also resulted in hedge funds becoming accessible to the public through Retail Investor Hedge Funds (RIHFs) with financial advisor support, better liquidity, and lower minimum contributions.

In this light, the proposal to remove hedge funds from the CIS regulation and tax framework was met with opposition from the industry during the Treasury workshop. The discussion document does not propose how hedge funds would be taxed if they were removed from the CIS framework but, given their complexities and the journey to regularise them in 2015, it is submitted that it would likely take a significant amount of time to develop hedge fundspecific tax legislation.

Stakeholders were vocal in opposing this proposal and were of the view that the hedge fund industry had been unfairly painted in a poor light throughout the discussion document. In reality, many fund managers manage both hedge funds and traditional CISs, with hedge funds often being marketed as the less risky of these two options.

There was general agreement in the workshop that further discussions are required on this proposal, and that simply removing hedge funds from the CIS framework will only create further uncertainty.

Other proposals

1. Asset-for-share and amalgamation transactions 

As a separate item in the discussion document, National Treasury also proposed that a CIS be removed from the “corporate rules” tax relief set out in sections 41 to 47, and specifically the “asset-forshare” transaction relief in section 42 of the Act. Practically, this would be achieved through the removal of a CIS from the definition of “company”, and a unit in a CIS from the definition of “equity share”, both as defined in section 41. Definitions of “asset-for-share transaction” and “qualifying interest” in section 42(1) are proposed
to be amended accordingly.

National Treasury reiterated this intention in the 2025 Budget documentation, widening the application of this removal to amalgamation transactions as well, as set out in section 44.

Per the discussion document, Treasury’s perceived “mischief” here is an apparent avoidance of tax. These provisions are applied to transactions in which a person transfers shares to a CIS in exchange for units (participatory interests) in that CIS. Where the requirements are met, such transfer of shares occurs tax-neutrally, as with any section 42 transaction. In addition, the CIS itself is exempt from capital gains tax (CGT) on the ultimate disposal of those shares [in terms of paragraph 61(3) of the Eighth Schedule, assuming the shares were held by the person on capital account].

The person who transferred the shares will only suffer CGT when the units in the CIS are  disposed, on the difference between the proceeds on that sale, and the base cost of the shares initially transferred to the CIS.

This proposal was also met with strong opposition from stakeholders during the workshop with Treasury in January 2025.

2. Anomaly in the Act relating to capital distributions

South Africa’s tax legislation currently does not provide rules for the treatment of a capital distribution by a CIS to a unitholder. Given that such distribution is permitted by the CIS legislation, Treasury has seen fit to propose potential tax legislation to address this scenario.

The proposal in this regard (set out in the discussion document) is that the unitholder would reduce its CGT base cost of the units (participatory interest) held in that CIS by the amount of the capital distribution so received. To the extent that the capital distribution exceeds the base cost of the unitholder’s units in the CIS, that excess would be regarded as a capital gain. While this clarity is welcomed, in practice, it is rare that a CIS would
make a capital distribution, which would generally only occur on liquidation of the CIS.

Conclusion

While stakeholders welcomed the engagement with Treasury during the workshop held in January 2025, the proposals in the discussion document were generally met with opposition. That being said, stakeholders are eager to continue to engage with and assist National Treasury in establishing certainty on the tax treatment of the CIS industry. While the proposals are a starting point, there is much further engagement with stakeholders required to develop a workable solution, especially in light of the diversity and complexity within the CIS industry. Treasury’s indication in the 2025 Budget documentation that these consultations will continue in 2025 is therefore an encouraging development.

Finally, Treasury has also recognised that the CIS industry is a critical one to the South African economy, both in terms of investment and retirement savings, as well as market liquidity in general. As such, stakeholders cautioned Treasury to take its time in making any changes to the existing tax regime, given the significant impact this may have on the South African economy, and its population’s dire savings culture. For reference, the discussion document can be accessed here

Authors:

Greg Boy, Senior Manager & Graham Molyneux, Partner