A bitter-sweet Budget for investors

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By Gielie de Swardt, head of Retail Distribution at Sanlam Investments

It may seem as if the 2019 National Budget did not make much of a difference to investors, but there are definitely covert tax hikes upon closer inspection. It’s also important to consider the potential increases in tax that did not happen and take a deep sigh of relief – for now. We discuss the key take-outs for investors below.

You’re paying more income tax, after inflation

The decision to not increase the personal income tax brackets this year is a tax increase that is cleverly hidden. Every year, as your living expenses tick up by inflation, you would need to receive a raise equal to inflation to be in the same position as the previous year – on a pre-tax basis. To make sure you take home the same level of real net income (adjusted for inflation) SARS would need to adjust the tax brackets by inflation too.

However, since 2017 the SARS income tax tables have not been fully adjusted upwards with the rate of inflation. As a result, high income earners have ended up in a situation where their take-home pay has not been keeping up with inflation. This year, none of the income tax brackets were adjusted upwards, meaning all tax payers who receive a pay increase equal to inflation will, in fact, be taking home less money in real (inflation-adjusted) terms.

Adding to the disappointment, the medical tax credit, which is usually adjusted for inflation, was also left unchanged at R310 for the first two medical aid members. Assuming your gross income is growing at inflation, your net income will now be growing at less than inflation. If then your expenses are growing at inflation – or more –  it could become challenging to keep on saving this year at the rate that you’re used to.

Capital gains tax rate – a pause and wait

Capital gains tax is especially punitive for diligent, long-term investors, as in the South African tax system the base cost of assets is not adjusted by inflation every year. In 2013 the Minister of Finance increased the CGT inclusion rate from 25% to 33.3%. In 2016 was it increased to 40%, and there was speculation that it might be increased again this year. Some good news this year is that Treasury has paused the inclusion rate at 40%.

Example:

Lucky Madaki earns R1.8 million per year, placing him in the 45% tax bracket. Lucky withdraws R500 000 from his unit trust savings to put down a deposit on a property. He sold no other assets during the tax year. The unit trust company calculates that the capital gain on the withdrawal is R200 000. The R40 000 annual exclusion decreases the assessed gain to R200 000 – R40 000 = R160 000. At the current 40% inclusion rate, only 0.4 x R160 000 = R64 000 of this gain is considered by SARS. He pays 0.45 x 64 000 = R28 800 tax on his R500 000 withdrawal.

Dividends tax rate disappoints

In 2017 Treasury raised the dividend withholding tax rate from 15% to 20%. While private share portfolios are associated with the wealthy, SA resident middle-class unit trust investors are also hit by this increase, which is eroding their net investment income. This is particularly punitive in a low-growth environment like the one in which we currently find ourselves. (The returns published by unit trust companies are after dividends tax has been paid over to SARS). The Davis Tax Committee recommended that dividend withholding tax is reduced back to 15%, but this recommendation was not implemented this year, which is disappointing.

Offshore allowance remains at a generous level

Some good news is that the annual offshore allowance for which tax clearance is needed remains at R10 million, in addition to the R1 million discretionary and travel allowance, which requires no tax clearance certificate from SARS.

On the topic of global assets and earnings, those living and working abroad for more than 183 days per calendar year could see their foreign income above R1 million becoming taxable in South Africa from 1 March 2020. This income tax amendment is still at proposal stage, though.

If you’re retired or about to retire from a provident fund soon, take note

Also at proposal stage is an exemption relating to annuities from a provident or provident preservation fund. Once you retire, any contributions to your retirement fund that did not qualify for a deduction from your taxable income are tax-exempt. Currently this exemption does not apply to annuities received from a provident or provident preservation fund. To encourage annuitisation (taking a regular income in retirement), it is proposed that this exemption be extended to provident and provident preservation fund members who receive annuities. The exemption would apply to contributions made after 1 March 2016.

Smoothing out the cash flow of surviving spouses of retirees

Upon the death of a retirement fund member, the surviving spouse may be entitled to receive a monthly spousal pension from the fund. This pension is subject to PAYE by the retirement fund. If you also receive a salary or other income, it is added to the pension to determine your correct tax liability on assessment. The result of the assessment is often that you end up with a tax liability that exceeds the employees’ tax withheld by your employer and retirement funds, since the aggregation of income pushes you into a higher tax bracket. You may not have foreseen the additional tax liability and did not save money to settle the liability, creating a cash flow burden and a tax debt. It is proposed that:

• Surviving spouses are provided with effective communication relating to tax and financial issues

• The monthly spousal pension be subject to PAYE withholding at a specified flat rate

• Tax rebates should not be taken into account in the calculation of spousal pensions.

Keeping the ratings agencies happy

Another less obvious impact of the Budget on you as an investor is the reaction it elicits from ratings agencies. While the rating agencies are not the cause of our economic and –  by implication –  investment woes, the credit rating of our government bonds has a material impact on the returns of the bond component of your portfolio. On 29 March Moody’s is scheduled to assess South Africa’s (rising) debt. A cut to South Africa’s credit rating would see SA government bonds falling out of the World Government Bond Index, with near-certain outflows from the local bond market.

South Africa’s gross debt will cross the 60% threshold in 2023/24 thanks to efforts to stabilise Eskom’s finances. ‘These look like small, incremental changes, but debt is a slippery slope,’ says our investment economist Arthur Kamp. Should Moody’s downgrade South Africa this year, the interest rate at which government will be repaying its debt will definitely rise, meaning less money left to grow the South African economy. Low economic growth often goes hand in hand with low investor returns. A downgrade by Moody’s could potentially be the most bitter outcome of the National Budget.

Use your tax breaks

In the end, rating agencies’ responses to the Budget and market corrections are beyond your control as an investor. But you have control over how much and in which products you invest. Therefore, keep to tax wise products, where possible, if they make sense in the context of your unique needs.

In the light of ever increasing taxes and bracket creep, the two main tax-efficient investment vehicles available to you are retirement funds and TFSAs. The annual contribution limit for TFSAs is still R33 000 per tax year and R500 000 over your lifetime. Any contribution above these limits will be taxed at 40%. In addition, you can invest 27.5% of your total income in retirement products every tax year and receive tax relief from SARS on those contributions.

Taxes are unavoidable, but TFSAs and retirement products are a sure way to minimise your tax and maximise your investment returns.

View our infographic with the history of SA tax since 1971 for the bigger picture of how tax and allowances developed (and, of late, increased) in this country.