A question of balance ahead of Budget Day

Perhaps the enthusiasm and personality of the previous Minister of Finance, Trevor Manuel, created the aura and interest that surrounds National Budget Day every year.

However, for the investor, the trick is to look at the entire investment landscape and anticipate the potential threats that are inherent in any budget.

Finance Minister Pravin Gordhan’s Budget Speech for the 2013/14 fiscal year is scheduled for 27 February. This is later than usual and only one day before the close of the 2012/13 tax year for individual taxpayers.

That could make 28 February an interesting day. Could we see taxpayers scuttling around desperately trying to avoid tax amendments that will be implemented in time for the  2013/14 tax year?

Be realistic. There is little chance of achieving much in one day.

The 2012/13 National Budget was based on an economic growth rate of 2,5%,  expected to increase slowly to around 4% by 2015. The latest indicators are that this will be difficult to achieve, which makes the prospect of tax increases for the 2013/14 fiscal year very real.

If Pravin Gordhan is desperately short on the 2012/13 budget, he really has only three options:

  1. Increase VAT. This would be a measure of absolute last resort, as it would incur the wrath of organised labour.
  2. Increase corporate tax. This would achieve little, as one third of South African companies are still in an assessed loss position following the global credit crunch. It would also have an extremely negative impact on foreign investment.
  3. Increase personal tax. Although this already accounts for 35% of total tax collection, it remains the only real alternative.

National Treasury will always be reluctant to reverse the fiscal drag (bracket creep) adjustments granted every year since 2000. This means that the only real alternative would be to increase the maximum marginal rate of personal tax, currently 40% on taxable income exceeding R617 000 per annum.

If we have a disastrous Budget Speech on 27 February, the maximum marginal rate could be increased to 42% and the capital gains tax (CGT) inclusion rate to 50%, resulting in a 21% CGT rate.

These increases might sound horrifying, but do they really justify you taking drastic action during February 2013 in anticipation thereof?

What can be done, realistically, in the expectation of a personal tax increase?

Share options

Would February be a good month for executives to take advantage of record highs on the JSE, exercise their share options, pay tax at 40% and enjoy the lower CGT rate in gains in future years?

An executive exercising R10 million in share options in February will probably pay tax at 40%, leaving R6 million to be invested.

Now, would that investor prefer R10 million in capital, growing but taxed at the full rate, or R6 million in capital, growing but taxed at the lower CGT rate?

If the maximum marginal tax rate is increased to 42% and the CGT inclusion rate is increased to 50%, then the tax arbitrage (difference) between a share option and other investments would be, at  most, 21%.

To stunt capital growth by 40% in the hope of scoring an arbitrage of 21% on future income doesn’t make sense. That’s the tax tail wagging the dog. And this achieves about as much as stocking up on tobacco and liquor in anticipation of sin tax increases.

However, for those with little faith in their employers’ prospects, or who wish to diversify the risk inherent ín having a large chunk of wealth dependent on one company’s fortunes, the answer may be different.

The moral of the story: diversification of risk is more important than tax!

Retirement annuities

National Treasury has already announced their intention to cap contributions to retirement funds with effect from the 2014 tax year. Maximum tax-deductible contributions will be limited to:

  • R250 000 for taxpayers under 45
  • R300 000 for taxpayers over 45.

February 2013 is thus the last opportunity to make contributions to retirement annuity funds that are limited to 15% of non-retirement funding income.

An added benefit of exercising share options in February 2013 is that 15% of the benefit can be contributed to a retirement annuity on a tax-deductible basis. This reduces the effective maximum tax rate on a share option from 40% to 34%.

The above avoids any risk of a tax increase, reduces the tax exposure to the share option benefit and diversifies risk. Pretty neat if accumulated unexercised share options run into the millions.

Taxpayers may also benefit by re-advancing a home loan to make a retirement annuity contribution. Home loan rates are now so low that the optimistic investor would hope to generate a better return from a retirement annuity. This will be even sweeter if the tax refund is reinvested in the home loan when received on assessment.

Investment portfolio reviews

The CGT inclusion rate for individual taxpayers was increased from 25% to 33,3% in the 2012 budget. This increased the maximum CGT rate for individual taxpayers from 10% to 13,3%. Conspicuous by its absence was any concession applicable to any component of any individual’s capital gains relating to the period prior to 28 February 2012.

There is more than a chance that CGT inclusion rates will again be increased in this Budget, and again it is unlikely that concessions will be granted on growth achieved prior to 1 March 2013.

If a CGT increase is announced on 27 February, one can expect financial markets to dip the following day as investors attempt to realise capital gains at a lower rate. Avoid this!

However, February remains a fine time to review a portfolio and if there is good reason for changing positions, then avoiding a potential CGT increase could be viewed as an added benefit.

Exchange rate risk

The decline in the balance of payments current account during the latter half of 2012 is alarming. And, by the admission of Reserve Bank Governor Gill Marcus, there is little that can be done to protect the rand should international investors withdraw from South Africa.

During 2013, foreign financial institutions have been tasked with ‘deleveraging’ by US$3 trillion. This does not help South Africa’s cause.

Perhaps the most important person in Parliament on Budget Day, sitting in the visitors’ gallery, will be Gill Marcus.

The above concerns are real enough, even before one considers the effects of rating agency downgrades, uncertainty within the mining sector and slower economic growth rates.

All of the above factors make the rand the biggest risk facing South African investors during 2013. And further bad news in the National Budget Speech on 27 February 2013 will not help the cause.


The time for a review of the outlook for 2013 is now. By Budget Day, the horse could have bolted.

Originally published in the The{Inside}Story glacier by Sanlam.

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