I have R50 000 I want to invest but I want to understand how tax works on investments.
Tax is an important part of investing. There are three taxes that are deducted when you invest.
Income tax on interest
Any interest earned on your investment is included in your gross income for that particular tax year even if you have re-invested the interest. This means that you would pay tax based on your personal tax rate – if your average tax rate is 25%, then you would pay 25% tax on that interest, for example.
You do, however, qualify for an interest exemption so you will not pay income tax on the first R23 800 of interest if you are under the age of 65, or R34 500 if you are over 65.
If, for example, you invested in a bank savings account or money market account which paid 5% interest each year, you would receive R2 500 a year in interest and would fall below the taxable amount.
Dividends tax is also payable each year on the dividends you receive as a natural person ‒ even if your dividends are re-invested. The company that declares the dividend of the fund is responsible for withholding and paying the dividends tax to SARS. Dividend withholding tax (DWT) is levied at 15% on the dividends earned by an investor but may be reduced if you are subject to a double taxation agreement. Even though you don’t pay dividends tax yourself, you should disclose your dividends in your personal tax return.
In your case, although you would never actually pay the tax in your personal capacity if, for example, you invested the full R50 000 into shares on the JSE and earned 3% a year in dividend income, you would have earned R1 500 in gross dividends but only received R1 275 (post tax).
Capital gains tax
Capital gains are taxed very differently from interest and dividends, as you only pay tax when you dispose of the asset.
The growth on capital normally means the movement in price of the asset over a particular period of time. As the price of the asset increases, so does the capital appreciation of the asset, which in this case may be a unit trust fund or a share, for example. Capital gains tax (CGT) is levied on the capital gain which arises on disposal, in other words, the difference between what you bought the shares for (base cost) and what you sold them for (‘proceeds’). This means that whenever units or shares are sold, a capital gains event will be triggered.
Natural persons and some special trusts are eligible for a CGT exemption of R30 000 per year which reduces the impact of the potential tax payable by the investor. Only capital gains over R30 000 will subject to CGT.
Capital gains tax is calculated based on your marginal tax rate. A third of the capital gain (33.33%) is included in your gross income for that specific year and taxed at your marginal rate.
In your case, if you invested R50 000 in shares and after 10 years it was worth R100 000 and you sold those shares, the capital gain would be R50 000. You would receive a tax exemption on the first R30 000, so only R20 000 would be used for the capital gains tax calculation. A third of that amount (R6 666) would be taxable at your marginal tax rate.
It is worth mentioning that tax-free savings accounts (TFSAs) as well as retirement funds are exempt from all of the above taxes, which makes them very attractive savings vehicles.
You are allowed to invest a maximum of R30 000 per year into a TFSA – this could be a good starting point for your R50 000 investment. Keep in mind that if you invest more than R30 000 per year you will be taxed at 40% on the excess amount, so limit this year’s investment to R30 000.