Asset managers beware

There has always been a very fine line between what constitutes trading and what constitutes a careful management of an asset or share portfolio and/or the rebalancing thereof from time to time. Our courts have indicated that prudence and foresight cannot be equated with an intention to speculate. Neither in law nor in logic can dogged adherence to a counter or carelessness in the management of a share portfolio be posited as pre-requisites for qualification as a capital investor.

22 Feb 2018 2 min read Article

On the other hand, proceeds from the operation of business in carrying out a profit making scheme were held to be on revenue account. On this basis specific rules have been introduced to the effect that, if shares have been held for a period of three years, the proceeds associated therewith would be on capital account.

In the current volatile economy it is very difficult to hold on to a specific share portfolio for a period of three years. These shares are either rebalanced relatively frequently, for instance quarterly, alternatively derivative instruments are entered into in order to hedge or lock-in the inherent value in a specific share price.

On this basis asset managers have been successfully arguing that proceeds from the entering into of these type of transactions would always be on capital account. In the context of the portfolio of a collective investment scheme in securities this is quite critical given the fact that such portfolio (CIS) is exempt from the payment of capital gains tax.

However, a CIS is in itself subject to tax to the extent that it does not distribute income within a period of twelve months after its accrual to its unit holders (or in the case of interest,
the receipt thereof).

The anomaly has been created that the active management of asset portfolios could be seen to be equivalent to trading on the basis that these proceeds are then subject to income tax and not capital gains tax.

It has always been argued that the tax consequences of a derivative should follow the tax consequences of the asset that is sought to be hedged. For instance, if an option is realised and it hedges an underlying share that is held on capital account, the option proceeds should then also be on capital account. SARS has indicated that this rule does not apply automatically and that one should consider the specific circumstances of the case. For instance, if an entire range of options is entered into, it may well be that proceeds are on revenue account and not on capital account. Also, if there is no specific correlation between the derivative and the underlying share counter, it may well be that there is an argument that the asset manager is seeking a minimum return as opposed to hedging a specific portfolio.

It has thus been proposed that rules be clarified to provide certainty on the treatment of trading profits by especially CISs. This proposal will most probably create significant concerns within the asset management industry as it may also extend to the management of other assets as opposed to being confined to CISs. If this is the case, it will most probably result in an entire re-think in the way in which assets are managed, specifically with reference to targeting minimum returns and/or hedging strategies. 

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