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BUSINESS NEWS - There are only two certainties: death and taxes.
The difference between them, however, is that death does not get worse when the Government meets.
The biggest mistake investors make when constructing investment portfolios is to focus on only one aspect – returns. There is another important aspect to consider: tax!
Upon reviewing or constructing an investment portfolio, the tax effects and structures of the investment vehicle should also be considered and understood, as the taxman can and will stake his claim on portfolio growth.
The purpose of this article is not to explain tax in detail. The purpose is rather to indicate that investors should not always react negatively when incurring Capital Gains Tax (CGT) on their investment portfolios. Tax is the result of positive returns!
Tax vs your investment portfolio:
Ask the following question: Would I be happier by being invested in a portfolio with exceptional growth which will result in paying slightly higher taxes, or will I be happier by minimizing my tax burden and being invested in a stagnant portfolio with below benchmark returns?
The growth in your investment portfolio is positively correlated with the tax burden incurred. But, before you consider all is lost, have a look at the following example of two investors.
In SA, two main taxes are applicable:
1. Income Tax:
2. Capital Gains Tax (CGT)
Assume Investor 1 and Investor 2 each inherited R1m. Both have marginal tax rates of 18% and decided to invest it in different investment portfolios with two different managers. Both had a time horizon of 5 years, being January 2015 to December 2019. Let’s review their performance together with their tax implications:
Investor 1:
- Portfolio consists of overweight SA equity funds and SA cash and bonds.
- Returns of 7% pa over 5 years.
- Capital after year 5: R1 402 551 before CGT paid.
- Growth: R402 551
- CGT on growth: R26 103
- Net amount: R1 376 448 after tax.
Investor 2:
- Portfolio consists of feeder funds invested in largely offshore equities.
- Returns of 15% pa over 5 years.
- Capital after 5 years: R2 000 000
- Growth: R1 000 000
- CGT on growth: R119 040
- Net amount: R1 880 960 after tax.
Investor 2 has four times the tax liability of Investor 1. However, Investor 2 is almost R600 000 better off.
As mentioned, the amount of CGT tax payable is positively correlated to growth in a portfolio. Even with a higher tax bill, investor 2 is far better off.
Ruan Breed is a financial advisor at Brenthurst Wealth Stellenbosch and George. Contact him on ruan@brenthurstwealth.co.za.
Tax benefits of investing directly offshore
There is one small tax advantage that investors are not always aware of. When investing capital in feeder funds, the depreciation of the rand and the growth of the asset will both effectively be taxed. That is because the unit price of the fund you invest money in is priced in rand, which will form the base cost of your investment and considers not only the growth of the actual underlying asset but also the depreciation of the rand over time. This increases the growth of the portfolio.
When investing capital in the same assets directly offshore, the CGT is only calculated on the growth of the underlying asset that is bought. You are not taxed on the depreciation of the rand to the Dollar.
A fine is a tax for doing wrong. A tax is a fine for doing well.
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