Like a squirrel methodically stashes its nuts away for the winter, so can you ‘store’ your capital gains each year as part of a broader tax-management plan. Known as capital gains tax harvesting, this tool is extremely popular in the United States and the United Kingdom. But how does it shape up in Africa?
Key African markets like Mauritius and Zambia do not have capital gains tax (CGT) regimes, but the likes of Zimbabwe and South Africa do. In the case of South Africa, where capital gains is taxed at an effective 18% for the highest taxpayers, the country offers a yearly CGT exemption which, if taken annually, can reduce the tax payable by the investor when realising capital gains. This annual exclusion sits at R40 000 per annum.
CGT harvesting represents only a small part of the Carrick Wealth planning approach, in part because many of the solutions we offer involve structures which already have in-built tax benefits for our clients, who can buy and sell without triggering CGT. Similarly, investment structures such as retirement annuities do not incur CGT.
That said, Anthony Palmer, Group Commercial Director at Carrick Wealth, notes that “we use this tool as and when required for the benefit of our clients – but not just for the sake of doing so”.
Adds Palmer: “While CGT harvesting is not a particular focus for Carrick Wealth, there are times when we take over a client and may find it necessary to sell some investments to realign the portfolio. Sometimes the CGT implications of doing so require that we don’t execute these changes all at once, but rather slowly – and during this time we will make use of the annual R40 000 exclusion.”
How does CGT harvesting work?
In order to capitalise on an annual CGT exclusion – whether it’s the R40 000 in South Africa or the £12 300 ‘use it or lose it’ allowance available to United Kingdom tax residents – the strategy is still the same: to minimise tax liability.
Your wealth manager might, for instance, analyse your portfolio and harvest – by selling – a certain amount of stock held in a particular company, collective investment scheme or investment product to release the appropriate amount of capital gain. With the right calculations and execution, you will legitimately not have to pay tax on the capital gains made, provided you are within the exclusion limit.
There is also another side to the CGT harvesting coin: where you sell assets at a loss in order to deduct that loss from any capital gains due. This approach hinges on immediately reinvesting the value at which the stocks are sold into a new, similar acquisition. Ideally, when using this approach, funds would be reinvested without delay to ensure the integrity and long-term financial ambitions of your portfolio.
Notably, you can implement a CGT harvesting strategy at any time during the financial year, not only at year end.
Is this for me?
While there are tax benefits to be had from CGT harvesting, you never want the tail wagging the dog and it should only be used if the benefit outweighs the time and costs involved. For example, you never want the administration and trading costs of this process to outweigh the tax benefits.
“The balance you achieve across your portfolio must always be regarded as the primary motivator for any readjustments, rather than looking for ways to harvest CGT,” says Palmer. In short, don’t force it.
Bear this in mind
If the idea of rebasing your capital gains each year to achieve tax savings is appealing to you, then – before you embark on this exercise – it is advisable to speak to your wealth manager or tax consultant about the costs involved and the implications for your investment portfolio.
It is also vital to understand the ins and outs of the regulations at play. For example, in South Africa the South African Revenue Service does make provision for CGT harvesting in the tax law, but it is required that you hold the shares in question for three years for it to be seen as a capital gain, rather than, potentially, ordinary income.
“Given the costs associated with selling, the buy and hold strategy is, in the case of South Africa at least, still preferential to an annual CGT harvesting approach and most often works out as being more optimal,” says Palmer.