Many investors will have at least some part of their savings invested in a collective investment scheme (CIS), which allows a group of investors to pool their money and invest in a range of underlying securities managed by an experienced investment manager. The most common CIS in SA is a unit trust.
Investors in a CIS share the risks and benefits of investment in the scheme in proportion to their participatory interests. The ownership an investor has in the CIS is shown as units. The value of these units — known as the unit price or net asset value — fluctuates as the value of the underlying securities rise and fall. Units are priced at a set time each business day. The unit price value includes both capital and net income.
The capital portion is the value of the underlying investments the fund owns. This may include local and offshore shares, bonds, money market and property. The capital portion increases when there is an increase in the value of the underlying investments (decreases in the value of the underlying investments can also lead to capital losses).
It’s critical that investors invested in a CIS understand the composition of the fund return, which is important from both a tax and reinvestment of distributions point of view
The main sources of income for a fund are interest from interest-bearing investments such as money market instruments and bonds, and dividends from investments in shares. Funds also have management and trading expenses that need to be paid from this income. Net income (income after expenses) is added to the capital value to calculate the unit price on a daily basis.
Investors may notice that when the fund declares an income distribution, the unit price falls by a similar amount. The reason for the fall in unit price is that the net income forms part of the value of the fund before the distribution. Once the distribution takes place the unit price drops by the amount distributed, including any movement in the underlying investments. The lower unit price is known as the “ex div” price.
Income distributions usually take place quarterly or bi-annually. On the distribution date the net income of the fund since the previous distribution date is allocated to be reinvested or paid out to investors.
Investors who require an income from their investments will probably elect to have the distributions paid to them, while those who are still accumulating wealth for the long term and don’t require income from their investment will probably choose to reinvest the distributions. The investment manager may then buy additional units in the fund on their behalf.
It’s critical that investors invested in a CIS understand the composition of the fund return, which is important from both a tax and reinvestment of distributions point of view. For example, the total return for funds such as money market and multi-asset low equity funds will have a higher component of interest income when compared to a high equity fund. Therefore, if you elect not to reinvest the distributions this will have a more noticeable impact on your investment value than if you were invested in an equity fund.
Equity funds generate relatively lower income as they aim for growth through capital appreciation rather than income generation. Investors in higher income tax brackets will find it preferable to have investments in funds that rely on growth through capital appreciation and dividends.
From a tax point of view, the income and capital gains on a unit trust may be subject to dividends withholding tax, tax on interest and capital gains tax. Dividends withholding tax is levied at 20% and is withheld on the dividend portion of the distributions. Tax will be levied on the interest portion of the distributions to the extent that the interest portion exceeds your annual interest exemption (currently R23,800 for those under 65 and R34,500 for those over 65).
To the extent that your profit on selling your investment exceeds your annual exclusion (currently R40,000 per annum) capital gains tax will apply. Tax on distributions apply irrespective of whether distributions were paid out as cash to the investor or reinvested. These taxes don’t apply to unit trust-based tax free savings accounts, nor to retirement annuities.
If you need assistance in structuring your investment consider speaking to a certified financial planner. If you do not have a financial planner, visit the website of the Financial Planning Institute, click here.
•Bezuidenhout is director and investment planner at Netto Invest.
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