Tax and your Investments.

There are some things that I just don't like doing, such as standing in a queue and paying for parking. Some things I accept as inevitable such as dying and paying taxes, I just don't want to seem over enthusiastic in pursuing them.

Therefore I pay my taxes, but only the proper amount. I can't go into the detail of tax on investments now, but there are some very basic things one can consider when investing and I will highlight them in this posting.

First, let us understand what can be taxed when it comes to investments.

Property

If you own the house you live in and you sell it, you will not be taxed on the first R1.5mil profit made. Profit is calculated by deducting the price you paid for it, together with all the permanent fixtures you added to it, from the selling price. i.e.

Purchase price R1 000 000
Build swimming pool R 50 000
Sell for R2 000 000

Profit is 2 000 000 - 1 000 000 - 50 000 = R950 000

The R950 000 is less than the R1.5 mil so no tax is payable!

BUT , If you sell a flat that you rent out, the full profit will be subject to Capital Gains Tax! (because it is not your primary residence)

AND, If you sell such a flat within 3 years of purchase, you might even pay Income Tax!!

The thing to remember here is that for assets/investments that you owned for 3 years or longer, income tax can't be charged unless it is classified as trading stock in your business. If you sell the asset/investment within 3 years after purchase, you have to prove that it is capital in nature and not income.

WHY is this important? Because the maximum amount of tax you can pay for something that is deemed to be Capital in the hands of an Individual tax payer, is 10%. The maximum tax rate for individuals on Income, is 40%.

How can I apply this tax saving? When you buy a share or unit trust or property, only sell it after 3 years if you have a choice.

Interest earned is the other place you can do some basic tax planning. Every individual younger than 65, can earn R19 000 interest per tax year without paying any tax on it. If you are older than 65, this moves up to R27 500. (figures adjusted every year)

This translates into an investment of R190 000 if you earn 10% interest on this investment, without paying tax on the interest earned! (R270 000 if you are older than 65).

How can I use this?

You have some cash to spare at the end of the year and this amount just happens to be exactly R380 000. Your spouse has nothing left because.....who knows! If you decide to keep the cash of R380 000 in your bank account and earn 10% interest on it, you will get R38 000 interest, R19 000 will be tax free and you will pay 40% (R7 600) tax on the other R19 000 if you are already in the maximum 40% tax bracket, at the end of 12 months.

Now follow closely, if you should donate half (R190 000) of the money to your spouse because you love and trust your better half so much, the spouse will earn R19 000, you will earn R19 000 and you save the R7 600!

Earn Dividends instead of interest.
On cash you earn interest, which is taxed at up to 40%
On property you earn rental, which is taxed at up to 40%
On shares you earn dividends which is taxed at up to 10%

If you do not want to invest in shares but have cash that will be taxed as per illustration above, you can slip out the following backdoor when the Receiver of Revenue walks in the front door.

There are two options:

Preference Shares: All the banks and some big companies allow you to buy their shares but unlike an ordinary share, you are only entitled to dividends declares by them and have no voting rights. I am not going to go into the details of them now but they will give you less risk on your capital than ordinary shares and dividends with a much lower tax rate than cash.

Dividend Income Funds: These are normal unit trust funds. Instead of investing in ordinary shares, they invest in preference shares. So, they do the work for you and the return on the unit trust is tax free. They charge you a fee to invest in the fund so make sure the after cost return is still better than the after tax interest you could have earned on cash.

How can I use this?

Let's say you are 40 years old. You inherited R300 000 from your long lost Uncle in Tousrivier. You want to buy a house in 3 years time so can't invest the money in shares. You already earn a R500 000 + per year salary so you are in the 40% tax bracket.

If you invest all the money in cash, you will earn R30 000 interest, pay R4 400 tax, and get R25 600, so try the following:

• R190 000 in cash, earn 10% interest, R19 000 and no tax.


• R110 000 in preference shares, earn 11.5% dividends, pay 10% tax, clear R11 385

Get R30 385 (R4 785 more)

Okay, let's stop for now and remember, paying tax is good, it keeps you out of jail, but paying too much is sad!