Section 25BA prior to 1 January 2014
Prior to the amendments contained in the Taxation Laws Amendment Act No. 31 of 2013 (the TLAA), a Collective Investment Scheme (CIS) was taxed on a semi-flow through regime in terms of section 25BA of the Income Tax Act No. 58 of 1962 (the Act).
Accordingly, amounts (other than amounts of a capital nature) received by or accrued to a portfolio of a CIS (other than a portfolio of a CIS in property) were deemed to have directly accrued to a person to the extent that the amounts were distributed by the CIS to such person not later than 12 months after its accrual to the CIS and if that person was entitled to the distribution by virtue of holding a participatory interest in the CIS.
Section 25BA after 1 January 2014
The provisions of section 25BA have been amended in terms of the TLAA which was enacted on 12 December 2013. These amendments apply with effect from 1 January 2014 in respect of years of assessment commencing on or after 1 January 2014. It was stated in the Explanatory Memorandum to the Taxation Laws Amendment Bill 2013, that the tax treatment under section 25BA created a problem in that interest may accrue to the CIS in terms of the provisions of section 24J of the Act, while it may not actually be received by the CIS. It was indicated in the Explanatory Memorandum that the CIS could not distribute to the participants interest which has accrued, but has not yet been received by it. The CIS would therefore be taxable on the interest in the year of assessment that is 12 months after such interest would ordinarily have accrued to it. For example, if the interest would, in the absence of section 25BA, have accrued to the CIS in terms of section 24J on 1 December 2013 and the interest is not distributed to a participant by 30 November 2014 because it has not yet actually been received by the CIS, the interest will be deemed to have accrued to the CIS on 30 November 2014 in terms of section 25BA. Assuming the CIS has a year of assessment ending on 31 December; it will therefore be deemed to have accrued the interest in its 2014 year of assessment if it is not distributed to the participants by 30 November 2014.
The Explanatory Memorandum commented on the proposal that section 25BA be amended to tax the holder of the participatory interest in a CIS on interest distributed by the CIS not later than 12 months after the receipt of the interest by the CIS. The CIS will then be taxed on interest not distributed by it within 12 months of the receipt of the interest.
Accordingly, in terms of the amended provisions of section 25BA, irrespective of when interest accrues in terms of section 24J, a portfolio of a CIS will only be taxed on interest in the year of assessment that is 12 months after its receipt, except to the extent that it distributes such interest within 12 months of the receipt to holder, in which case the interest will be deemed to have directly accrued to the holder.
Capital gains tax (CGT) in a CIS context
In terms of paragraph 61 of the Eighth Schedule to the Act, a holder of a participatory interest in a portfolio of a CIS (other than a portfolio of a CIS in property), must determine a capital gain or capital loss in respect of the participatory interest only upon the disposal of that participatory interest. Any capital gain or capital loss in respect of a disposal by a portfolio of a CIS (other than a portfolio of a CIS in property) must be disregarded.
Accordingly, the portfolio of a CIS will not be liable for CGT in respect of disposals of capital assets made by it and the participant will only be subject to CGT upon a disposal of its interest in the portfolio of a CIS.
Specific considerations in relation to hedge funds
It was furthermore proposed in the Explanatory Memorandum that section 25BA must be amended to clarify that the CIS tax provisions (and not the partnership tax provisions) will apply if a hedge fund is in the form of a partnership. This is on the basis that hedge funds will be declared a CIS in terms of the Collective Investment Schemes Control Act, probably within the first quarter of 2014. As of August 2014, hedge funds have not yet been declared a CIS in terms of such Act. In other words, it was proposed that regulated hedge funds in the form of partnerships should be treated the same as a CIS.
The TLAA introduced a new section 25BA(2) which provides that where a portfolio of a hedge fund CIS is constituted as a partnership any amount allocated by that portfolio to the partners in that partnership must be treated as having been distributed by that portfolio to the partners in that partnership by virtue of those partners being holders of participatory interests in that portfolio. This section was also inserted with effect from 1 January 2014 and in respect of years of assessment commencing on or after that date. However, the definition of a portfolio of a hedge fund collective investment scheme in section 1 of the Act (as used in the new section 25BA(2)) is not yet effective. This definition will only take effect from the date on which the Minister (in accordance with section 63 of the Collective Investments Schemes Control Act) declares a hedge fund business, in which a portfolio is held, to be a collective investment scheme.
Collective Investment Scheme Control Act: Section 63
ITA: Sections 24J, 25BA and paragraph 61 of the Eighth Schedule