Afrikaanse Handelsinstituut (AHI)
1. It is trite that the basic objectives of tax reform are equity, simplicity and efficiency.

2. It is generally recognised that the only effective manner in which to address the dire poverty and unacceptable level of unemployment in South Africa is through economic growth and increased productivity.

3. The Afrikaanse Handelsinstituut (AHI) supports every attempt to encourage economic growth in general and direct foreign investment in particular. We believe that the tax system and tax reforms play an important part in making South Africa a winning country (economically speaking).

4. However, we are aware of an increasing perception amongst SA taxpayers that the Government’s main objective with tax reforms appears to be to use the tax system for political motives as a redistribution channel. This perception is given credibility inter alia by the number of new taxes, levies and charges referred to in for example the 1998 Finance Committee White Paper. This perception inevitably leads to a reduction in tax morality as the objectives are perceived to be unfair. One should also be very careful not to fall into the attractive trap of attempting to rectify the inequalities in our society by placing too heavy a burden on the relatively small sector of the economy and economically active individuals who carry the largest part of the tax burden. Should this happen, it is likely that the flight of economic and human capital from our country will increase.

The reduction in tax morality is exacerbated by the general perception that the SA law enforcement system is neither effective, nor efficient. I need not remind you of the number of incidents of criminals escaping from custody, police dockets and files disappearing, public prosecutors being prosecuted and dismissed for misconduct and the number of people escaping the tax net.

Tax evasion must not be tolerated. Culprits must not only face the full brunt of the law. Their misdemeanors should be widely publicised to serve as a warning to all and sundry.

5. While we acknowledge and applaud the vast progress made to improve the administrative capacity of SARS, the Commissioner himself has acknowledged that there remains room for improvement. CGT will undoubtedly place increasing demands on the administrative capacity and capability of SARS.

6. Against this background we would like to advocate very strongly the postponement of the introduction of the proposed capital gains tax.

7. There exist cogent arguments against the introduction of CGT and we assume that this Committee will consider the impact of CGT on the SA economy and whether SARS in fact does have the administrative capability to enforce the tax rules in a cost effective manner.

From the Katz Commission’s Report and the budget speech of 23 February 2000 the following appear to be the main arguments to support the introduction of CGT:

7.1 The absence of CGT introduces distortions into the economy, encouraging taxpayers to convert otherwise taxable income into tax free capital gains.

7.2 This has negative implications for the efficiency and overall equity of the tax system.

7.3 The integrity of the personal and corporate tax system needs to be protected.

7.4 It is international best practice of our major trading partners.

7.5 It makes the overall tax regime more efficient by limiting the benefit from transactions designed to convert income into capital. Time will tell whether these results are achieved.

8. We would like to stress the point that with the introduction of CGT our country will be the only Commonwealth country boasting such a large number of capital type taxes, namely,
- transfer duty, which is payable on the transfer of fixed property;
- marketable securities tax, which is payable on the transfer of equities and other financial instruments;
- estate duty, which is payable on the death of a person;
- donations tax, and now
We would like to reaffirm the plea which we recently made to SARS and the Department of Finance with regard to the forthcoming annual budget presentation to Parliament, to seriously consider the scrapping of some or all of these capital type taxes in lieu of a comprehensive CGT. We believe that such a step will not only enhance the credibility of government with local taxpayers, but also with foreign investors, and will release additional capacity within SARS to concentrate on the proper administration and collection of CGT and (hopefully) reduce the already heavy compliance burden.

9. We do however express our grave reservations that now is the right time for the introduction of CGT in this country. We advance the following reasons:

9.1 Although SARS published guidelines on capital gains tax early last year, it is extremely difficult to judge the total impact that CGT may have on a business from mere guidelines. The devil is in the detail. The detailed draft Bill (which was incomplete) was only released in mid December 2000, with the deadline for comments being 10 January 2001. This meant that we had to consult with members during the high holiday season, which proved fatal. I have guaged from my counterparts in other business organisations that they had the same experience. In our submission, this makes the process fundamentally flawed and casts serious doubt whether the process can genuinely be said to have been consultative and transparent.

9.2 SARS was allocated one week within which to review the comments received by it and to make the necessary amendments where appropriate before the issue is debated before this Committee. The mere fact that this meeting had to be postponed by a week, confirms our view, we suspect, that insufficient time has been allowed for a proper debate and consideration of all material aspects of CGT and its implications for individuals, business and government.

9.3 In terms of the draft Bill, certain financial institutions are required to provide information on a regular basis to SARS. This requires changes to computer and other administrative systems. These changes cannot be made without the detailed legislation in its final form. One cannot expect business to make costly changes based on guidelines or draft bills. We believe that it is neither feasible nor reasonable to expect businesses to effect the required changes after promulgation of the CGT legislation but before 1 April 2001.

We believe that Parliament should be guided by the practical realities in this regard. We propose that the implementation date be extended to 1 March 2002

10. I now proceed to deal with some of the more fundamental issues regarding the contents of the draft Bill: (We have submitted a detailed report, but in this address I will limit my comments to some of the main issues of principle.)

10.1 We cannot accept the arguments for not allowing for any form of inflation indexation. Even at a relatively low annual inflation rate of 6% the value of an asset will double every 12 years. It is inequitable to extract taxation from anything but real gains. To tax notional gains in this fashion is tantamount to confiscation.

In the absence of inflation indexation, taking into account the current relatively low rate of inflation, we believe that the Bill should contain a clause to the effect that, should the inflation rate increase beyond say 6% , some form of indexation will be introduced.

10.2 There is no logical reason to disregard interest expenses in determining the base cost of an asset for CGT purposes. In our view there is no justification for such a provision. Obviously, if interest expenses have been claimed as a deduction against normal income, no deduction of the same expense should be allowed for CGT purposes. It is common in other jurisdictions with CGT to allow some form of relief for interest expenses. The absence of such relief in effect results in a double inflation penalty on the taxpayer.

10.3 The method for determining the tax rate is very harsh on taxpayers with a taxable income below the 42% marginal rate threshold and exacerbates fiscal drag. We propose that the tax rate for the capital gain be determined by excluding the capital gain from other income, as in the case of retirement benefits.

This principle (ie of including the gain in taxable income to determine the rate) is directly in contrast to the disallowance of a capital loss against other income. In the interest of equity, this inconsistency should not be allowed.

If the proposed method of determining the rate is retained, consistency and equity demands that capital losses be treated in the same manner, ie if capital gains are added to other income, then capital losses should be deducted from other income, or both should be disregarded to determine the rate.

10.4 In our view, there is no reason to treat closed investment companies differently to unit trusts for CGT purposes, especially in the light of SA’s dismal savings record. There seems to us to be no justification for not exempting a closed investment company from tax on capital gains, while affording unit trusts such an exemption. The UK rules in this regard provides adequate protection to ensure that no abuse occurs.

The existing uneven playing field regarding unit trusts (who are not taxed on their trading profits) and closed investment companies (who are taxed on their trading profits) is exacerbated by the differentiated CGT treatment of unit trusts and closed investment companies. In our view Government has a duty to ensure that CGT is not the death knell of closed investment vehicles. The State President, in his first speech in parliament on 25 June 1999 said: "… We have to work to increase both the level of investment and the savings ratio. This will include further steps to eliminate dissaving by the state and to introduce incentives to encourage saving." Let us not disappoint the State President !

10.5 There is no justification for taxing a capital profit in respect of aircraft, boats, certain rights and interests and designated intangible assets, while disallowing any capital loss in respect of those assets.

10.6 There is no apparent reason not to extend the same exemption from transfer duty afforded to a company or close corporation owning the primary residence of a taxpayer, to a trust, should the taxpayer wish to transfer his/her primary residence into his/her name.

10.7 One of the major impediments to economic growth in SA is the lack of job creation. To this end heavy reliance has to be placed on entrepreneurs. To subject small business assets to CGT will negatively impact economic growth. Any capital gain from the disposal of small business assets should be exempt from CGT, provided it is reinvested in other small business assets.

We also believe that the exemption of R500 000 in respect of small business assets disposed of after age 55 is insignificant and should be extended to 50% of the gain with a minimum of R500 000 and a maximum of R2,5m.

11. In conclusion, I trust that our comments will be viewed in the serious light in which they were intended in our sincere desire to contribute positively to make our country, not only a preferred destination for foreign investment, but a winning country for all its citizens. In order to achieve this, we ought to look forward to find solutions which, objectively, are in the best interests of all our people.

Like Martin Luther King jr, I have a dream: to be part of a winning nation. In this quest I wish to echo the words of Martin Luther King: "let us not seek to satisfy our thirst …. by drinking from the cup of bitterness".

We need to work together.
CHAIRPERSON: Tax Policy Committee

Afrikaanse Handelsinstituut


Ad sec 1 (4)


The word ‘or’ in subsec (1) should be deleted.






Ad sec 1 (7)


The wording is exceptionally wide. Very often, the trust creator or estate planner is an income beneficiary, but may not be a capital beneficiary. The ‘term’ beneficiary should be qualified to include only a capital beneficiary.






Ad sec 1 (1)


This definition will be very harsh on low to middle income earners. The effect is that any taxable capital gain is added to normal income, which would inevitably lead to a higher rate of tax, on income and taxable gains. We propose a similar solution as in the case of the taxation of retirement lump sums (4th Sch. The amount of any taxable capital gain should be excluded from taxable income to determine the tax rate. The tax rate applicable to normal income (excluding the taxable capital gain) should then be applied to the total taxable income including taxable capital gain.)








This concession will have no impact on taxpayers with a taxable income (excluding taxable capital gains) in excess of R120 000, but will be a major concession to lower income groups. The inclusion of a taxable capital gain in ‘taxable income’ is inconsistent with the exclusion of capital losses from ‘taxable income’.






Ad sec 2 (1)(d)


Note: This should be sec 3 and not sec 2








The expression ‘the currency in which it conducts the majority of its transactions’ could lead to confusion and unintended consequences where an entity conducts transactions in a number of different currencies. The number of transactions should also not be conclusive. If an entity does two major transactions in a year in different currencies, and conducts the rest of its business in another currency (say ZAR), in which currency was the majority of its transactions conducted ?


Ad sec 4


Refer comments in par 3 above.






Ad sec 7


These provisions should include closed investment trusts. Attached hereto is a memorandum setting out an alternative proposal for the capital gains tax treatment of closed investment trusts.








The differentiation between unit portfolios and other similar investment vehicles for tax purposes is unjustified. The un-level playing field between unit trusts (who are for some inexplicable reason not taxed on their trading profits) and closed end trusts (who are taxed) is exacerbated by the exemption of unit portfolios from capital gains tax while closed investment trusts do not enjoy the same benefits.






Ad sec 7,8 and 9


It is impossible for major organisations such as insurance companies, banks and portfolio managers to change their computer systems in the limited time before the proposed implementation date of capital gains tax. Firstly, no changes can be made to systems until the legislation has been finally approved and promulgated by Parliament. Even if this were done by the end of January 2001 (which, in our submission, is probably not achievable), it leaves only two months to adjust computer systems, in order to comply with these new legal requirements.






Ad sec 19


Eighth Schedule







Ad sec 19.1


Definition of ‘active business asset’ : insert the word ‘business’ between ‘and’ and ‘asset’ in line 1, and change ‘an’ to ‘a’. Alternatively, delete the definition of ‘business asset’.








Definition of ‘boat’


Delete the word ‘for’ in line 2.








Definition of ‘disposal’


What does the expression ‘when a person is treated as having disposed of an asset’, mean ? We propose that the wording be changed to read : ‘when a person is in law deemed to have disposed of an asset’.








Definition of ‘financial instrument’


This definition is bound to cause problems because of the number of specific inclusions.










A simpler and more efficient definition would be as follows : ‘includes any ‘security’ as defined in the Stock Exchanges Control Act, 1985, any ‘financial instrument’ as defined in the Financial markets Control Act, 1989, or any similar instrument’.








Ad par 3(b)


The inclusion of the term ‘capital loss’ in sub par (i) may lead to double taxation, or to the taxation of an amount which should not ordinarily be subject to capital gains tax : e.g. if an amount expensed by the tax payer in respect of an asset has not been taken into account in determining the capital loss, and such amount is recovered by the tax payer, it should (according to the wording of the paragraph) be included in his capital gain, when in fact he has made no gain ! He just recovered his cost. Surely the paragraph must only apply where the amount recovered has in fact been taken into account, and not where it has not been taken into account in determining his capital loss !








Ad par 4(b)


Similarly, if an amount has not been taken into account in respect of the base cost of an asset, when determining the capital gain of a tax payer, such amount should not be included in that person’s capital loss, when such amount has been paid or has become due and payable, because the taxpayer will not have suffered any loss.








Ad par 5


The annual exclusion of R10 000 is extremely low and should be increased to at least R50 000.








Ad par 10


There is no reason why a trust (other than a special trust) of which the beneficiaries are natural persons, should not be treated in the same way as a natural person.










In the absence of this concession, a moratorium should be provided to enable taxpayers, who have used intervivos trusts (or other entities) to transfer the assets of such trusts into the name of a natural person, without any tax costs (i.e. transfer duty, stamp duty, etc).








Ad par 12 (2)


Add ‘the’ between ‘of’ and ‘base cost’ in the last part of the sentence.



Ad par 13 (1)


Add ‘a’ between ‘for’ and ‘consideration’ in the second line.








Ad par 14 (1)(a) (vi)


Add the words ‘or abandoned’ after ‘forfeited’ at the end of the sentence.








Ad par 17


It is not clear why a capital loss in respect of the assets listed in sub par (e) to (d) should be dis-regarded, but the capital gain in respect of those assets be taxable. If a capital loss is not allowable, the capital gain should not be taxable.








Ad par 18


The same comment as in 8.12 above applies.








Ad par 19


We object to the exclusion of forfeited deposits from determining the aggregate capital gain or loss.








Ad par 20


We object to the requirement that for the exemption to apply, the returned securities must be registered in the name of the lender. In practice the same securities may be lent again or even disposed of without it being registered in the name of the lender. The requirement of registration creates an unnecessary administra-tive burden which serves no legal purpose. We suggest that the expression ‘and registered in the name of that lender’ be deleted in sub par (a) and (b).








Ad par 21


While the objective of this provision is clear, it could have very harsh consequences for hedging transactions involving financial instruments, especially in volatile markets. Hedging rules ought to be provided to alleviate the consequences for genuine hedging transactions.

The definition of straddle assets is too wide, and will lead to unintended consequences : a unit in a unit trust portfolio falls with the definition (it is a financial instrument as defined in the Eighth Schedule). If a holder sells his units before a year-end, and repurchases units after year-end, within the 90-day period, because of changes in market conditions, this paragraph will apply.

The 90-day period is far too long for a volatile market.








Ad par 22 (2)


It is our submission that repairs and maintenance costs actually incurred in respect of an asset should form part of the base cost of that asset.

There is no reason why interest cost should be excluded from the base cost. This has a severe impact on an investment company such as Genbel SA. If it borrows money to invest in equities (which are capital assets) it cannot claim any tax deduction of its interest cost for tax purposes (because of the capital nature of its assets). In addition, it cannot include the interest cost in the base cost of its capital assets for CGT purposes. This is patently unfair.








Ad par 23 (3)


It is not clear what the objective of this sub par is. The limitation of a capital loss in this manner is unacceptable.








Ad par 23 (8)


Change ‘an’ to ‘a’ in the expression ‘listed on an recognised exchange’.








Ad par 24


We object to the averaging value of shares. In any event, in our view an average of the ‘last price quoted’ ’over a five trading day period will not achieve a result much different to the closing price on the valuation date.








Ad par 25


This has adverse consequences for any compromise with creditors in terms of the Companies Act. It defeats the object of a compromise !








Ad par 26(a)


Insert ‘to’ between ‘equal’ and ‘the market value’ in the second line.










Delete the words ‘treated as having’ and replace with ‘deemed to have’ in both paragraphs.










The way in which par 26(a) is worded provides a benefit to the disposer if he receives a value in excess of the market value of the asset.








Ad par 27 (1)


It is unacceptable that capital losses be disregarded in this fashion.








Ad par 28


If a person is liable to pay donations tax, and CGT in respect of the same donation, this results in double taxation.








Ad par 29


It is not uncommon for an heir or legatee, in order to preserve one or more assets in an estate, to accept a liability or debt of the estate. Provision should be made in such a case, for the pro rata increase in the base cost of the assets received, or if the liability or debt is in respect of a specific asset, the base cost of that asset.

The same objection applies to this paragraph : If, at a person’s death, he or she is deemed to have disposed of his/her assets to his estate at market value, that transaction will, it seems, be subject to CGT. The estate will however, be liable for estate duty in respect of the same assets. This double taxation is unacceptable.








Ad par 30


There is no apparent reason why the date for determining an exchange rate should not be the same for the proceeds and an expense. The date should be the accrual date in respect of the proceeds and the date of incurral in respect of an expense.








Ad par 31


This paragraph, as currently worded, could have unintended and bizarre consequences. If a person disposes of shares and realises a capital loss, and reinvests the proceeds from the realisation in other shares (a substantially similar asset) within 90 days, the provisions of this paragraph will apply. Even more bizarre if a person disposes of shares at a loss, and within 90 days his brother (a connected person) acquires other shares (a substantially similar asset) the provisions of this paragraph will apply !








Ad par 33


Sub para (a) of the definition of primary residence should include a residence owned by any other entity, provided the provisions of sub par (b) are complied with.








Ad par 34


This is a dramatic deviation from the guidelines published earlier. The full capital gain in respect of a primary residence should be exempt.








Ad par 44


An acceptable way to value a business, is to use the net asset value. It does not, in our view, make sense to use the gross asset value to define a small business. It would exclude too many genuine small businesses.

One of the major impediments to economic growth in South Africa is job creation. To this end, reliance has to be placed on entrepreneurs to achieve this. Subjecting small businessmen to CGT (even with the concessions provided for in par 44) will not encourage entrepreneurship. There ought to be a total exemption from CGT on the disposal of small business assets.








Ad par 11 (1)(f)


Although the CGT guidelines published earlier referred to special provisions for share incentive schemes, the only special provision we have been able to identity is the reference to sec 8A in par 22 (I) of the Eighth Schedule. The CGT provisions will have a major impact on employee share incentive schemes. In most instances, options are granted to employees for no consideration. This is regarded as a disposal (par 11 (I)(f)).










Furthermore, shares are usually acquired by the Share Trust, either at the par value when issued by the Company to the Trust, or at a value which is lower than the value at which the shares are sold to the employees.










This results in double taxation.








Ad par 47


If the terms of a transaction include a specific date for or rate of conversion of a currency, that date or rate, as the case may be, should be used for CGT purposes.








Ad par 61


Delete the word ‘from’ in the expression ‘dividend from a share’ in line one, and replace it with ‘in respect of’.








Ad par 64


Where a capital reduction is effected by a share buy-back in terms of the Companies Act, the provisions of this paragraph has unintended and unfair consequences e.g. company A buys back 10% of its shares, and funds the purchase through its share premium account. The shareholders who sold their shares to the company, will be taxed on the full gain (if any).










There is no reason why the remaining shareholders should reduce the base cost of their shares. They have not received any benefit.








Ad sec 20


This exemption should be extended to primary residences owned by a trust.





















The draft Bill does not seem to cater for the situation where a taxpayer who is subject to SITE only, and therefore not required to submit a tax return, realises a taxable gain during a year of assessment where his normal income is subject to SITE. The inclusion of the taxable gain in his income in terms of sec 26 A of the Income Tax Act (sec 4 of the Draft Bill) is likely to result in an increase in the person’s marginal tax rate and consequently an under-recovery of tax on his/her normal income. This matter needs to be addressed as proposed in par 4 and 5 of this submission.






The impact on Investment Trusts
An investment trust is a company, normally listed on an exchange, which holds long term investments, normally equities, which may be listed or unlisted.

A closed investment trust is not to be confused with a unit trust. The latter is an investment vehicle regulated in terms of the Unit Trust Control Act. It, principally, is an investment vehicle, which provides, inter alia, an investor with the opportunity to make regular monthly investments into a number of different investment vehicles. (Lump sum investments are of course also possible).

The structure of a unit trust (UT) is such that the investor buys units at a specified price. These units give the investor exposure to the underlying assets of the trust. The investor can at any time buy or sell units in the trust. The trust is by law obliged to buy the units from the investor when it is offered to the trust. The law also prescribes inter alia certain limits regarding the assets in which a trust may invest.

2. Genbel South Africa Limited (a closed investment trust listed in the investment trust sector of the JSE and on the London Stock Exchange) provides an investment product very similar to unit trusts to its investors via the Genbel Shareplan. In terms of the rules of the Shareplan, an investor can invest a minimum of R250,00 per month in the Shareplan, or a maximum of R1m as a lump sum. His investment gives the investor exposure to a portfolio of listed and unlisted equities.

3. The closed investment trust is not subject to the limitations of the Unit Trust Control Act, (UTC Act) and can for example use gearing (borrowings) which is prohibited by the UTC Act.

4. The closed investment trust provides very similar benefits to the investor as does a UT.

5. However, from the guidelines on Capital Gains Tax (CGT) published by SARS earlier this year it appears that the treatment of closed end trusts is very different from UT’s and would result in the death of a very competitive and necessary investment vehicle.

6. It appears from the Guidelines that a UT will be exempt from CGT, and that only the investor will be subject to CGT on the disposal of units. In the case of a closed end trust, on the contrary, both the trust and the investor will be subject to CGT. This of course creates a very unlevel playing field.

7. In the UK, a special CGT dispensation exists for closed end trusts.

7.1 An investment trust will not be liable to corporation tax on any chargeable gains arising from disposals of its investments provided that it is approved by the Inland Revenue as satisfying the conditions set out in section 842 Income and Corporation Taxes Act 1988 ("section 842") throughout each relevant accounting period. Without this exemption shareholders would be subject to two levels of tax, first on the gains of the investment trust on the sale by it of its investments and second on the chargeable gains made by the shareholders on the sale of their shares (at a price which will reflect the gains made by the investment trust).

7.2 Section 842 lays down seven conditions, all of which have to be complied with throughout an accounting period for the Inland Revenue to grant investment trust status for that accounting period. The seven conditions are:

7.2.1 the investment trust must not be a close company at any time during the accounting period (section 842(1)) (a close company is a company with less than 5 shareholders who control the company) see 7.4.1 below;

7.2.2 the investment trust must be resident in the United Kingdom for the whole of the accounting period (section 842(l)(aa));

7.2.3 the investment trust’s income must consist wholly or mainly of eligible investment income ie income deriving from shares or securities or eligible rental income (section 842(l)(a));

7.2.4 no holding of shares or securities in a company must represent more than 15 per cent by value of the investment trust’s investments (section 842(l)(b));

7.2.5 every class of the investment trust’s ordinary share capital must be listed in the Official List of the London Stock Exchange (section 842(l)(c));

7.2.6 the investment trust’s Memorandum and Articles of Association must prohibit the distribution by way of dividend of surpluses arising on the realisation of investments (section 842(l)(d));

7.2.7 the investment trust must not retain for any accounting period more than 15 per cent of its eligible investment income (section 842(l)(e)).

These conditions are considered in greater detail below.

7.3 Investment trust status is granted by the Inland Revenue in retrospect. However, it is common to evidence the intention of being an investment trust by including appropriate wording in the relevant circular on launch.

7.4 Conditions which must be satisfied for investment trust status:

7.4.1 The company must not be a close company. A close company is one that is under the control of five or fewer participators (basically shareholders) or under the control of any number of directors. Shareholdings of associates are aggregated with those of participators and directors. However, as a general rule, participators which are themselves non-close companies can be ignored.

7.4.2 The company must be resident in the United Kingdom. A company is resident in the United Kingdom, broadly, if it is incorporated here (unless it is treated as resident elsewhere under a double taxation agreement) or if it is centrally managed and controlled in the United Kingdom wherever it is incorporated. Central management and control refers to the highest level of control of a company, including the setting of policy and strategy, as opposed to day to day operations.

7.4.3 The company’s income must consist wholly or mainly of eligible investment income, ie income deriving from shares or securities or eligible rental income. Income for this purpose is understood to mean gross statutory income of the company before tax, management expenses and interest. It should be noted that income is that which is so defined in the accounts where this differs from amounts which are treated as income for tax purposes "Income deriving from" means income generated by the holding of shares rather than income generated from trading in shares. The Inland Revenue accept that income is derived "wholly or mainly" from shares and securities where more than 70 per cent of a company’s income is generated from such sources. In the accounting period in respect of which a company first applies for investment trust status, the Inland Revenue generally accept that the "wholly or mainly" test is satisfied if more than 50 per cent of the income is derived from shares or securities. This allows a newly launched investment trust to invest its money initially in a high interest deposit account whilst it assesses the opportunities for a permanent form of investment in shares and securities. (A deposit account is not a form of "security"). It is questionable whether this relaxation would also apply to an established company converting to investment trust status. It is understood that "derived from" in these circumstances means "comes directly from". Where certain jurisdictions require an entity resident in that jurisdiction (other than a company) to hold the shares and securities as an intermediary between the underlying investments and the investment trust, this requirement may not be satisfied. There is no definition of "securities" in section 842 but the Inland Revenue applies the definition of securities in section 132(3)(b) TCGA 1992 which includes loan stock, both secured and unsecured, of any government, local authority or company in the UK or elsewhere. "Shares" also includes units in unit trusts. Certificates of deposit and sterling commercial paper do not amount to securities. The Inland Revenue accepts that US Treasury Bills and UK Treasury Stock are securities but in the case of bills of exchange and other types of instrument with which they are not already familiar they usually require the investment trust to send in a copy of the prospectus of the issue or other details of its terms. Short dated instruments (generally less than six months) are particularly likely to be considered not to be securities.

Problems can arise where an investment trust acquires futures contracts or short-life assets if the transactions amount to dealing in such instruments as opposed to capital investments. If this is the case (or if the investment trust intends to deal in any other type of security), then the company should set up a subsidiary dealing company which will be liable to corporation tax on its profits but should not jeopardise the investment trust status of the parent company. In its Statement of Practice SP 14/91, the Inland Revenue stated that in relation to forward currency and other financial futures and options transactions entered into by investment trusts, it has to be ascertained in each particular transaction whether it should be treated as capital (eg is it ancillary to a capital transaction, ie a hedge against a specific capital liability?) or revenue (eg is it ancillary to a trading transaction?). In the Inland Revenue’s view, any profit on a financial futures or option transaction which is of a revenue nature would constitute income not derived from shares or securities. The Inland Revenue would be prepared to review any case where an investment trust infringed the test in consequence only of a profit on a financial futures or options transaction being treated as of a revenue nature for tax purposes if the infringement was an isolated occurrence and the trust income otherwise derived from shares and securities for the accounting period did not fall far below 70 per cent. The Finance Act 1996 extended the permitted investments of investment trusts to certain categories of residential property to be let on assured tenancies. Rental income from such properties is "eligible rental income" for the purpose of paragraphs (a) and (e) of section 842 ICTA 1988.

7.4.4 No holding of shares or securities in any single company may represent more than 15 per cent by value of the investment trust’s investments. Different classes of shares and securities held in any one company will be aggregated to form a single holding. Also holdings in companies within a 51 per cent group will be aggregated in deciding whether the 15 per cent limit has been breached.

Where an investment trust is itself a member of a group, money lent by the investment trust to another group member is to be treated as a security and as a "holding" in the company owing the money.

The restriction does not apply to a holding in another investment trust, or a company which only fails to qualify as an investment trust because it does not satisfy the requirement of having its shares listed in the Official List of the London Stock Exchange. It also does not apply to a holding in an authorised unit trust or OEIC if the income of such trust or OEIC derives wholly or mainly from "eligible investment income" (SP 3/97).

It is often the case that an investment trust acquires an interest in a company (at a time when that interest is worth less than 15 per cent of its total investments) but such interest increases in value so that it becomes worth more than the 15 per cent limit. It would clearly be inequitable if this caused the investment trust to lose its approved status. Accordingly, the rules provide for the test to be satisfied only when an interest in a company is acquired and whenever an "addition" is made to that holding. This means that once a holding of shares in a company is worth more than the limit, no further shares can be acquired in that company. In effect, whenever an addition is made to an existing holding, the entire holding must be re-valued at that date to see if the 15 per cent rule has been breached.

An "addition" is made to a holding when shares or securities are acquired otherwise than by being allotted for no consideration (ie bonus issues). However, as mentioned above, all members of a 51 per cent group are treated as a single company and when money becomes owing from one member of a group to another, that debt is treated as a "holding" in the debtor company. This means that if the investment trust has a subsidiary company (or companies), the value of which exceeds the 15 per cent limit, it must ensure that no money becomes owing to it from such company/ies. This could happen inadvertently, eg by the subsidiary declaring a final dividend.

The relevant "value" is the open market value of the shares or securities and, where relevant, the London Stock Exchange price will be accepted. In the case of unquoted securities, directors’ best estimates will usually be accepted but in cases of doubt, the Inland Revenue may require Shares Valuation Division to opine on the value. "Investments" (for the purpose of valuing the investment trust’s total investments) means all assets capable of producing income, so that interest-bearing bank deposits are included in the definition even though these are not "securities".

7.4.5 Every class of the investment trust’s ordinary share capital must be listed in the Official List of the London Stock Exchange. This means that all share capital, except that with only a fixed dividend, must appear on the Official List; quotation on AIM will not suffice. On the launch of investment trust companies, the Inland Revenue accept that this condition is satisfied if the ordinary share capital is quoted within one month of the beginning of the accounting period for which investment trust status is first claimed (see IR manual). This allows for a delay between issue of the prospectus and the date of obtaining a quotation. The Inland Revenue may also allow some flexibility where a listing is lost during winding-up of the company provided that all the chargeable assets are disposed of at a time when the listing is still in place. This has not yet been included in the manual so it is advisable to write to the Inland Revenue in each case to seek confirmation of this informal concession.

7.4.6 The condition that the Memorandum or Articles of Association must prohibit the distribution by way of dividend of surpluses arising on the realisation of investments corresponds with section 266 Companies Act 1985 which prohibits investment companies from distributing capital profits. It should be noted that the requirement prohibits an investment trust from distributing any gain arising on the disposal of a material interest in an offshore fund, even though such gain will be taxed as income. On the face of it this could give rise to problems in connection with the requirement referred to in paragraph 2.8 below although, as will be seen, this is not the case. Another grey area is whether discounts and premiums on redemption of loan notes and debentures which are taxed as income under the loan relationships taxation regime (see paragraph 7.5) will be treated as income from shares and securities (which must be distributed) or as surplus on realisation (which may not be distributed).

7.4.7 The investment trust must not retain in respect of any accounting period, more than 15 per cent of its eligible investment income. The Inland Revenue have interpreted "income derived from shares and securities" as the gross amount of statutory income computed on normal taxation principles and before deduction of expenses and it appears likely that the same principle would apply to the income of investment trusts which have eligible rental income. It does not require the investment trust to distribute 85 per cent of such income; it merely requires that no more than 15 per cent of it is retained. Thus income which is applied in meeting expenses will reduce the amount retained. The Inland Revenue regard the amount retained as being the amount shown as retained in the accounts, ie the increase over the accounting period in the amount of unappropriated profits before any transfers to or from reserves but after allowing proper provision for liabilities. This means in practice that amounts equal to all income other than that from shares and securities must also be distributed.

Although this treatment is concessionary it is arguable that the "retention" of the income arising on the disposal will not in any event prejudice the investment trust status. This is because section 842(2A) and (2B) provide that investment trust status will not be lost where the company is required by the Companies Acts or any other law to retain more than 15 per cent, provided that it does not retain more than the amount required by the Companies Acts or other law. However, where the maximum amount which it could distribute is less than £10 000, a de minimis provision applies so as not to oblige the company to pay a small dividend.

These sub-sections also prevent investment trust status from being lost where accumulated losses in earlier years prohibit the company from making the required level of distribution in a year in which it has surplus income.

7.5 Taxation of investment trusts

7.5.1 An investment trust is generally taxed on the following basis: dividends from companies resident in the UK will not be subject to corporation tax; rental income will be taxed at the small companies rate ie 20 per cent; all other income (including interest, trading income and deemed income under the offshore fund rules) will be chargeable to corporation tax in the normal way; and there is no withholding tax on dividends paid by the company.

7.5.2 As to capital gains: the gains of an investment trust are not chargeable gains and are therefore not liable to corporation tax; and the normal relief afforded to disposal of assets between members of a 75 per cent group of companies (the no gain/no loss rule) is not available in respect of any disposal to or by an investment trust.

7.5.3 A tax deduction is available for expenses of management and for charges on income (but can no longer lead to a claim for repayment of tax credits on UK dividends. In practice the types of expenses which are deductible are fewer than for a trading company).

As from 1st April 1996 the effective yield on debt securities (both interest and any premium or discount) will generally be taxed as income.

The taxation treatment of shareholders of an investment trust in respect of dividends which they receive from it and gains and losses which they incur in relation to transactions in shares will be the same as in relation to holdings of shares in most other UK resident companies.

(With acknowledgement to Ms Pat Dugdale of Olswang Solicitors, London)

8. Although the closed end trust industry has not yet developed to the same extent in SA as in the UK (15 listed in SA compared to more than 300 in the UK), I am making a strong appeal to follow the UK example and to treat closed investment trusts that comply with conditions imposed by SARS, in the same way as proposed for UT’s.

8.1 The seven conditions referred to in clause 7.1 above are easily measurable. SARS could insist that the company’s auditors provide confirmation that all the relevant conditions were complied with, before granting investment trust status. Some of the conditions could be adapted to take account of local circumstances.

9. In a country where the encouragement of savings is a vitally important ingredient for growth in our economy, it will be a sorrowful and disgraceful day if a valid and valuable investment vehicle is withheld from investors because of the unfair imposition of capital gains tax.

10. Without being threatening in any way, if the Revenue authorities do not accommodate the appeal from Genbel SA, the only alternative to closing down the vehicle, is to relocate its tax residence to the UK. My advice is that this is easily achievable, since Genbel SA is already listed on the London Stock Exchange and complies with most of the UK requirements.

I trust that the above appeal, to treat closed investment trusts in the same way as it is proposed to treat unit trusts in South Africa, will be favourable considered when drafting Capital Gains Tax legislation for South Africa.