For income tax purposes, a collective investment scheme in securities (CISS) must distribute any income that it receives or that accrues to it, to unit holders within 12 months in order for that CISS to avoid being taxed on the income.
The income streams that typically accrue to a CISS are composed of interest, dividends, and profit arising from the sale of investments. A dividend is broadly defined by the tax law as any distribution from a company to its shareholder, other than a return of capital. There are instances when a CISS receives a distribution that is a return of capital; these distributions fall outside the definition of a dividend.
When the CISS holds the underlying share with a capital intention, the return of capital would not constitute gross income, and the CISS would not be subjected to tax on the receipt thereon.
The CISS therefore would not be subject to tax when it receives a return of capital and does not distribute this amount within 12 months of receipt or accrual, and in this instance, the subsequent on-distribution would not be taxed in the hands of unit holders.
How do shareholders of listed companies know when they are the recipients of a return of capital?
Listed companies are required to release a stock exchange news service (SENS) and/or a circular when any corporate action, such as a return of capital, is planned. The tax law requires a company to inform its shareholders when it is returning capital to the shareholder by the time the distribution or payment is made. Companies are required to inform the shareholders that a distribution constitutes a return of capital.
Corporate actions – (potential) tax liability is in the detail
Certain corporate actions, such as an unbundling, can result in the distribution of a dividend in specie, or a return of capital, to shareholders. If the SENS announcement is unclear with regard to the nature of the distribution that arises from the unbundling, the shareholder would have to seek clarity from the unbundling company with regard to the nature of the distribution. Any uncertainty could result in a tax liability for the CISS when it records the distribution as a return of capital, but in fact the distribution was a dividend.
There are additional complexities to consider:
CISS’s must pay careful attention to the nature of receipts and accruals arising from the various investments it holds. When the CISS inadvertently applies the incorrect treatment of an income receipt, there could be adverse tax consequences for both the CISS as well as the unit holders.
Read a November 2019 report [PDF 342 KB] prepared by the KPMG member firm in South Africa
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