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What you NEED to know about tax and your investments

by , 18 February 2016

“Francois, I'm subscribed to Red Hot Penny Shares and need advice on ways to reduce my tax that I'm paying on my trading profits. I already owe close to R20,000 in taxes for the profits I made last year and I'm worried that for this current year that I might pay a similar amount in taxes.” - Reagan

If you've been investing in shares and you're making money (and I believe you are), you will at one or another stage be faced with a situation similar to the one Reagan finds himself in… You'll be liable to pay taxes on some of the prof its you've made…

Now before you get surprised by a letter from SARS telling you that you owe them money I'd like to show you what kind of tax you can expect to pay on your investment portfolio and when.

When will the taxman come knocking on your door?
You can only be taxed on shares that have been sold out of your investment portfolio. It’s as simple as that. Even if you have a share with a 1000% gain on it, you can’t be liable for tax on the gains until you sell this share.
So, at the end of each tax year – SARS will look at all the shares you sold during the last year to calculate the taxes you owe them. There’s simply NO skipping this taxes. Your broker is legally obliged to supply SARS with a tax statement for your portfolio!
But by knowing how SARS determines the taxes you need to pay you can make some smart moves to minimize the taxes you are liable for. Here’s how:
How to determine what kind of profits you made

SARS considers two reasons for buying shares.
The f irst is buying shares for annual dividend income and long term share price growth. These are called ‘capital assets’.
The second is buying shares only for a quick growth in value and then selling again. These shares are called ‘trading stock’.
Another general r ule of thumb is the ‘three year r ule’. If you held a share for three years or longer it is seen as a ‘capital asset’ otherwise it is seen as ‘trading stock’ by SARS.
So what does it matter if a share is ‘trading stock’ or a ‘capital asset’?
Well, a capital asset is taxed under Capital Gains Tax while ‘trading stock’ is taxed under your normal income tax.
Capital Gains Tax on shares explained
Say you bought R20,000 Redef ine Property shares in 2010 at 640c each (3125 shares). Today they’re worth 930c and you’d have received 165c worth of dividends. If you sell these shares today SARS will see the shares as a capital asset. That’s because you held them for three years or longer and you received a dividend income stream from them as well as capital growth.
So, to calculate how much Capital Gains Tax you need to pay you use this formula:
  1. Selling value of shares – Cost of shares = Capital gain
  2. Add up all your capital gains for the year
  3. Subtract R30,000. (You get a R30,000 capital gains tax exemption every year.)
  4. Times by 33% (the Capital Gains Tax inclusion rate).
  5. Times that number by your personal income tax rate.
So, in this example, if Redef ine was the only share you sold for the year your capital gain would have been R9,062.50 for the year. That’s less than your Capital Gains exemption and you wouldn’t be liable for any capital gains tax.

But let’s say you sold other shares, during the year, equalling R40,000 in capital gains. That brings your total gains to R49,062.50. Subtracting R30,000 gives you R19,062.50. Times by 33% gives you R6,353.53. If your tax bracket is 35% you’d need to pay 35% of R6,353.53 in taxes, which is R2,223.74.
Income tax on shares explained
If you bought Afrimat at 500c in 2012 and sold the share at 910c in 2013 SARS see the share as ‘trading stock’.
That means you’ll need to pay income tax on your profits. 
This is a simple calculation. Your profit is 410c per share. So, if you bought say 5,000 shares in 2012 your profit would be R20,500. That means R20,500 will be added to your personal income at the end of the year when SARS determines your tax liability.
If you are at the top tax bracket of 40%, that means you’ll end up paying R8,200 tax on the profits you made from this share.
If you were in a lower income tax bracket – the profits you make could even end up pushing you into a higher tax bracket.
Some important pointers to minimise your taxes
So, as you can see, most of the shares in our Red Hot Portfolio will be seen as ‘trading stock’. That’s because we very seldom hold a share longer than three years.
What’s important to remember here is if the tax year end comes and you’ve banked a couple of winning trades through the year it’s also a good time to assess the losses you’ve made and sell them as well. That way you reduce your taxes on the winners immediately. If you wait too long and you hold your loss for say three years, it becomes a capital loss and you lose the tax deduction of that on your winners.
Another important thing to think about when you’re selling shares, if you have had a lot of winners in a year and the tax year end is nearing it might be a good idea to hold off on selling more winners until the new tax year begins. That way you at least spread your taxes over two years instead of one.
There are currently some tax reforms underway which could possibly give you a cut on the taxes you pay for shares in your investment portfolio. But until then you need to know that you WILL be liable for taxes. And, unfortunately you NEED to pay them. There’s no other way out.

What you NEED to know about tax and your investments
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