Investing can be an effective way to build wealth, but it’s essential to consider the tax implications that come with it.
These taxes can significantly impact the net returns on your investments, which could make a big difference to your overall financial goals.
In this article, we’ll delve into the various tax implications on local and foreign interests, dividends, Real Estate Investment Trusts (REITs), and capital gains.
Investment Income and Tax Consequences
In South Africa, the primary types of investment income that have income tax implications are local and foreign interests, foreign dividends, interest from REITs, and capital gains. Selling investments like shares also triggers a capital gains tax event. Local dividends earned attract Dividends Withholding Tax (DWT), which is automatically withheld by the issuing company, thus not requiring any further action from the investor.
The actual tax you pay is contingent on your marginal income tax rate and the type and amount of investment income and capital gains you earn. As a rule of thumb, the higher your marginal income tax rate, the more tax you will pay.
It is advisable to use your financial institution-issued tax certificate (IT3b) to complete the investment section of your tax return. This certificate ensures that your taxable income is calculated correctly, incorporating the appropriate interest, foreign dividends, and foreign tax credits.
Local Interest Income
Investments like bonds or bank deposits generate interest that is subject to income tax. The same applies to unit trusts, where the interest earned is also taxable. This interest income is taxed at your marginal tax rate.
However, individual taxpayers enjoy an annual exemption on all South African interest income. For the 2024 tax year, this exemption is set at R23 800 for individuals under 65 years old, and R34 500 for individuals 65 years and older. You must declare local interest in the Investment Income section of your tax return.
Foreign Interest Income
If you earn foreign interest, you must report the Rand equivalent amount to the South African Revenue Service (SARS). Unlike local interest, there is no exempt portion, but you can deduct any foreign tax you pay. Declare this foreign interest in your tax return, alongside any foreign tax credit paid in another country.
Local Dividend Income
For equities excluding listed property companies, a DWT of 20% is withheld before it’s paid out or reinvested. Note that DWT is only payable on dividends distributed by the companies, post the payment of 28% corporate tax on net profits.
Foreign Dividend Income
South African residents earning foreign dividends are generally taxed on these dividends. The tax paid depends on the amount and type of shares held in the foreign company. In cases where the taxpayer holds less than 10% of the equity shares and voting rights in the foreign company, the foreign dividend received will be taxed. However, SARS allows a tax exemption equivalent to 25/45 of the Rand value of the foreign dividend. Any foreign tax paid on the dividend must also be declared and will be offset against the local tax.
On the other hand, if the taxpayer holds at least 10% of the equity shares and voting rights in the foreign company, the entire foreign dividend will be exempt from local tax.
Income from Real Estate Investment Trust (REIT)
The tax dynamics for listed property companies or REITs are slightly more intricate. Unlike other listed companies, REITs do not pay corporate income tax, and their investors do not incur DWT on distributions received. Instead, investors pay income tax on the distributions from these REITs at their marginal income tax rate. These distributions must be declared in the investment income section of your tax return.
Capital Gains Tax (CGT)
Capital Gains Tax is a key consideration for investors. This tax is incurred when an investor decides to sell part or all of their investments, such as units in a unit trust. If the value of these units has appreciated since the initial investment, the increase is classified as a capital gain. Conversely, if the value has diminished, it results in a capital loss.
In South Africa, 40% of the capital gain (not the total proceeds from the sale) is added to your annual taxable income. This inclusion rate makes the maximum effective CGT rate for individuals 18%. This rate is calculated by multiplying the maximum marginal tax rate for individuals, which is currently 45%, by the inclusion rate of 40%.
Understanding the tax implications of your investments is crucial for optimising your returns and meeting your financial goals. It’s advised to consult with a professional tax advisor or financial planner to help you navigate these complex tax matters, ensuring your investments are not only profitable but also tax-efficient.