It is proposed in the draft Taxation Laws Amendment Bill,
released for comment on 4 July, that hedge funds should be included
in the tax regime for collective investment schemes (other than
collective investment schemes in properties). Certainly, normal tax
principles are inadequate to cater for hedge funds and a special
tax dispensation will provide certainty as to the tax treatment.
The special tax dispensation will only apply to hedge funds that
have been declared by the Minister to be a collective investment
scheme in terms of the Collective Investment Schemes Control Act.
The regulatory framework to deal with hedge funds in terms of the
Collective Investment Schemes Control Act is still in the process
of being finalised and the tax proposals, intended to take effect 1
January 2014, may be premature.
The tax proposals include changes to the existing tax
dispensation for collective investment schemes, following an
overhaul of this tax dispensation as recent as 2010. The first
welcoming simplification is to completely exempt the investment
vehicle and to only levy tax at the investor level. The current tax
rules require a distribution of income to investors within 12
months, failing which the investment vehicle must recognise the
income for tax purposes. The second proposal will at first glance
sacrifice fair treatment for simplicity. It is proposed that all
distributions to investors are subjected to income tax (as opposed
to the lower capital gains tax rate), except:
The repurchase of units by the investment vehicle. This will,
as in the case of the disposal of units of exchange traded funds in
the market, be subject to normal tax principles.
The distribution of dividends. Local dividends will generally
be exempt from income and subject to withholding of Dividends Tax
(which is levied at a lower rate than income tax and with the
potential of a Dividends Tax exemption applying).
The proposal to subject distributions to income tax potentially
increases the tax rate where capital gains realised by an
investment vehicle are distributed to investors. However,
collective investment schemes in any event do not distribute
capital profits, but reinvest. This is not necessarily the case
with hedge funds.
In addition to the above, there is a proposal to prevent hedge
funds to act as a character converter. What does this mean? The
hedge fund will be exempt from tax. The investment growth of an
investor that remains invested in the fund for more than three
years will be subject to the lower capital gains tax rate. However,
if the hedge fund was not exempt from tax, normal tax principles
would have applied and revenue profits in the hedge fund will have
been subject to the higher income tax rate. Specific mention is
made in the Explanatory Memorandum of the greater potential for
revenue profits where hedge funds enter into derivatives. Because
the hedge fund will be exempt, there could effectively be a
'conversion' of the revenue gains in the hedge fund to
capital gains in the hands of the investors. It is proposed that a
distinction is drawn between retail hedge funds (open to the
public) and restricted hedge funds. Investors disposing of units in
restricted hedge funds will always be subjected to income tax.
Investors disposing of units in a retail hedge fund can rely on
automatic capital gains tax treatment after a 3 year holding
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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