NFB Proficio Issue 69

NFB FINANCIAL UPDATE Issue69 August2013

FROM THE CEO’s DESK

I

have commented recently about the importance of ensuring that your wealth manager shows you how to maintain the real buying power of your portfolio. This is because longevity, which has become kind of a given, is indeed a double edged sword. From one point of view, it lends one more time after retirement to enjoy with your family, notably children and grandchildren, but, from another point of view, exposes you and those responsible for looking after your well being, to much greater risk. These risks include running short of money, inflation, particularly rampant increases in the cost of suitable medical treatment, and so forth.

In my last editorial I also spoke about the importance of diversifying both across asset classes and across geographies. Across geographies really means going global with one's money, and, once there, buying things which will also deliver real returns over time.

I have since been approached by several clients and have had some interesting discussions regarding the "How?" of this proposition.

We are all aware of the danger inflation poses to the "buying power" of portfolios. I guess the question is how to turn this negative force into our ally.

One approach we have adopted, complementing the NFB Model Portfolios which do this for you, is where we have taken a look at major local and global stocks. We have sifted through them with our portfolio specialists and found some long term choices with good records of dividend payment and dividend growth. The same could be said of property investment where the income, mostly in the form of rentals, escalates ahead of inflation over time. However, the property market at present seems a little trickier to enter. What we next looked at was ten years out.

Taking a look at the dividends these quality companies pay now, then going back to see what the share would have cost ten years ago, will give you a sense of what represents an interesting opportunity. Generally, if you invest R100 into a share which enjoys a R3 dividend, the "yield” is 3%.

Assuming this dividend grows over a decade to R10, you are clearly earning the equivalent of 10% on your original investment. And you will also enjoy growth in the share price, although the price will be pretty volatile, being affected by both the company's own performance, but also by markets in general. This amplifies why this is only appropriate for long term monies!

Compare this to cash where, currently, 4 to 5%

financial services group

is all you can expect. On which you pay tax. Rates may very well rise, but this will only be until the cycle reverses and back down goes the return.

And there is zero chance that the bank will give you any extra capital when you ask for your money back!

One has then to compare this with the option of investing in interest-bearing investments. For the majority of our clients, straight forward managed cash investments only make sense either for money which must remain accessible, or for the "in case" reserve some of us like to keep handy. For the rest, the after-tax returns seldom allow real returns. Most notably, when one draws an income from investments the net result is even worse. This would be typical of a retired person.

The graphs we have included spell out the concept outlined above. The problem highlighted above with respect to interest-bearing investments is worsened when you consider the ongoing growth in dividends seen in the graphs, compared to the cyclical trend interest rates follow.

Right now we are at a cyclical low, and in the not too distant future we should see interest rates firming. This typically happens as a reaction to the economy growing. It is engineered by the Central Bank and is intended to slow things a little. The Date

31/12/2002 31/12/2003 31/12/2004 31/12/2005 29/12/2006 31/12/2007 31/12/2008 31/12/2009 31/12/2010 30/12/2011 31/12/2012

Date

31/12/2002 31/12/2003 31/12/2004 31/12/2005 29/12/2006 31/12/2007 31/12/2008 31/12/2009 31/12/2010 30/12/2011 31/12/2012

Date

31/03/2002 31/03/2003 31/03/2004 31/03/2005 31/03/2006 31/03/2007 31/03/2008 31/03/2009 31/03/2010 31/03/2011 31/03/2012 31/03/2013

Price

33.92 44.08 74.02 85.29 106.31 112.59 83.00 102.00 107.55 98.75 118.88

Standard Bank Trailing Dividend 12m Yield DPS 1.40 1.70 1.80 3.00 3.60 4.34 3.86 3.86 3.86 4.25 4.55

4.1% 3.9% 2.4% 3.5% 3.4% 3.9% 4.7% 3.8% 3.6% 4.3% 3.8%

Dividend Yield (Original Price) 4.1% 5.0% 5.3% 8.9% 10.6% 12.8% 11.4% 11.4% 11.4% 12.5% 13.4%

Imperial Tobacco (Offshore) Price Trailing Dividend Dividend 12m Yield Yield DPS (Original Price) 918.06 28.72 3.1% 3.1% 957.22 36.55 3.8% 4.0% 1,241.77 43.51 3.5% 4.7% 1,511.53 48.73 3.2% 5.3% 1,749.10 53.95 3.1% 5.9% 2,359.97 60.48 2.6% 6.6% 1,850.00 63.10 3.4% 6.9% 1,960.00 73.00 3.7% 8.0% 1,968.00 84.30 4.3% 9.2% 2,435.00 95.10 3.9% 10.4% 2,373.00 105.60 4.5% 11.5%

Price

78.60 49.05 72.80 98.00 121.00 159.15 177.01 141.07 214.24 242.62 307.26 485.50

SABMiller Trailing Dividend 12m Yield DPS 2.69 2.14 1.94 2.40 2.72 3.70 4.49 5.34 3.72 5.51 7.06 9.10

3.4% 4.4% 2.7% 2.4% 2.2% 2.3% 2.5% 3.8% 1.7% 2.3% 2.3% 1.9%

Dividend Yield (Original Price) 3.4% 2.7% 2.5% 3.0% 3.5% 4.7% 5.7% 6.8% 4.7% 7.0% 9.0% 11.6%

opposite could then be expected when the economy slows. The expected reaction will be a systematic and controlled reduction in rates until the "cheapness" of money makes it attractive for borrowing and spending which typically restimulates the economy. Whilst lower rates suits borrowers, it harms investors' returns. This wavelike pattern means the investor is unlikely to grow value over time in cash. Add to this the fact that all that is given back after you finally redeem the investment is the same nominal amount you originally invested, and the risk of holding cash becomes clear.

The question next asked is: “why don't we all just put our money in stocks or property and just wait it out?” Unfortunately, the circumstances of each of us as investors needs very careful consideration before this approach is possible.

Differing wealth, needs and factors such as age of investors, their dependants, taxation issues, business and career risk and many more need to be understood before adopting any investment strategy. The fact remains that many very successful investors are on record with the fact that they simply buy stocks with any net cash flow they receive and live off the dividends. It is pretty continued on back page...

P/E ratio

7.6 8.3 11.4 10.8 11.3 9.7 8.3 13.2 14.6 11.1 12.3

P/E ratio

25.7 18.9 23.2 16.0 16.4 20.2 36.6 29.9 13.3 13.7 34.8

P/E ratio

17.0 22.6 21.3 12.5 18.7 19.8 16.1 11.8 24.1 23.5 15.1 25.6

fortune favours the well advised

TAXATION

OF TRUSTS IN SOUTH AFRICA

Whilst trusts remain a rather topical issue, it is useful to recap their current tax treatment and look at current developments. By Philip Shapiro.

T

he income of a trust can be taxed in the hands of 3 possible recipients – the founder or donor, the beneficiary/ies or the trust itself. The principal taxing section for trusts is Section 25B which provides that the income of a trust will be taxed in the hands of the trust itself or in the hands of the beneficiaries, provided that the deeming provisions of section 7 do not apply. Section 7 has the effect of taxing the income in the hands of the donor. If section 7 does not apply then it is possible to take advantage of the income splitting capabilities of a trust.

The 8th Schedule to the Income Tax Act sets out a number of Attribution Rules dealing with the tax treatment of Capital Gains which effectively attribute the capital gain to a taxpayer other than the Trust, i.e. the donor or beneficiary. These rules are similar to the anti-avoidance provisions set out in Section 7.

The deeming provisions and attribution rules applicable to a donor are limited to the extent of the benefit derived from the donation (settlement or other disposition).

TAXATION The following taxes are relevant:

regarded as a person in terms of the Estate Duty Act). There is an exception in the case of a Bewind Trust, where the ownership of trust assets has vested in a beneficiary – such trust assets are subject to estate duty in the hands of the deceased estate of such beneficiary.

TYPES OF TRUST Testamentary Trust: This a trust formed upon the death of the testator/testatrix in terms of the Last Will and Testament of such person.

a natural person i.e. sliding scale from 18% to 40%, but excluding any rebates or interest exemption. The inclusion rate for capital gains is 33.3%.

In the case of a trust created for mental illness or physical disability, the trust additionally receives an annual exclusion for CGT of R30,000, a primary residence exclusion of R2.0m and a personal use assets exclusion.

ADVANTAGES OF TRUSTS = Estate Freezing

Inter-Vivos Trust: This is a trust created during the lifetime of the founder (settlor/donor). Such a trust is created by way of contract, known as a stipulatio alteri, for the benefit of a 3rd person.

Discretionary Trust: Ownership and control vests in the trustees of the trust on behalf of the beneficiaries. The trustees, in their discretion, determine what income and capital the beneficiaries may receive.

=

=

Normal Tax: A trust pays tax at 40% of its taxable income (as defined). Capital gains are included at an inclusion rate of 66.6% and taxed at 40% (effective rate of 26.6%). It does not qualify for any rebates or interest exemption.

Dividend Tax: Dividend withholding tax (DWT) of 15% is applicable to dividends received by a local trust holding South African listed shares. The net dividend (after DWT) is exempt from normal tax.

Transfer Duty: Transfer duty is payable on the acquisition of immovable property (after 23/2/2011) at the same scaled rates as a natural person or company. The 1st R600k is free; next R400k at 3%; next R500k at 5% and thereafter at 8%.

Estate Duty: A trust is not subject to estate duty (not

Bewind Trust: The beneficiaries acquire a vested right to the assets upon creation of the trust, but the control and administration thereof is held by the trustees.

A Local Trust from a South African point of view is subject to the jurisdiction of the Master of the High Court, whereas an International Trust is not (formed outside South Africa).

Special Trust – There are two types: = A special trust created solely for the benefit of a person who suffers from any mental illness or any serious physical disability. = A testamentary trust created for the benefit of a beneficiary who is a relative of the deceased. In this case the youngest beneficiary must be under the age of 18 years of age on the last day of February (previously 21 years of age).

Tax treatment: A special trust is taxed like

=

=

This is the most common perception.

Assets which are expected to grow substantially in value are either sold to a trust (for the benefit of the seller and his family) or acquired by a trust in the first instance. Any increase in the value of assets is excluded from such person's estate for estate duty purposes as the growth in the value of the assets takes place in the trust.

There are, however, many other reasons and advantages in forming a trust: Protection against creditors where a person may be exposed to business risks and creditors' claims.

Estate skipping mechanism whereby an inheritance is passed to a trust on behalf of a beneficiary instead of directly to the beneficiary. This has the benefit of avoiding any further estate duty on such assets, but also acts as an effective planning mechanism for future generations, protection of heir from the consequences of a marriage break-up, business risks and creditors' claims.

Allows for efficient succession where assets are held in trust, there is no impact (in the form of estate duty, delays in administering an estate etc.) on the death of the original donor of the asset or on the death of any one of the beneficiaries of the trust. The asset continues unimpeded for the use and enjoyment by the remaining beneficiaries.

A trust can be used to achieve the same benefits as a usufruct without necessarily creating any estate duty implications on the death of the person enjoying the benefit (usufructuary).

Image credit: 123RF Stock Photo

= Trusts can be used to hold assets, such

as farming property, which are incapable of sub-division in terms of the Agricultural Land Act, receive lump sums from Retirement Funds for the benefit of minor beneficiaries, splitting of income amongst beneficiaries, preserving family assets over time, looking after the founder's family after his death, maintaining a spouse or child after a divorce.

To achieve the above benefits the founder of a trust has to relinquish ownership and control of his assets. If this is not done properly then Section 3(3)(d) of the Estate Duty Act may be applied which deems property of the deceased to include any property which he was competent to dispose of for his own benefit and such property will be included in his estate at market value thereof at date of death (notwithstanding that it may be housed within a trust).

The issue of control, or lack thereof, over assets to be placed in a trust has often been the prime dilemma faced by potential founders of trusts.

legitimate needs of minor children and people with disabilities.

The proposal dealing with discretionary trusts stated that such trusts should no longer act as flow-through vehicles.

Taxable income and loss (including capital gains and losses) should be fully calculated at trust level with distributions acting as deductible payments to the extent of current taxable income.

Beneficiaries will be eligible to receive taxfree distributions, except where they give rise to deductible payments (which will be included as ordinary revenue). = The proposals also dealt with Trading Trusts (on a similar basis) and the treatment of distributions from offshore foundations (as ordinary revenue).

The reference to Offshore Foundation is not that common and indications are that these foundations are not that widely used in South Africa. What is a Foundation? According to a definition by John Goldsworth, founding editor of Trusts and Trustee, a “Private Foundation" is an independent selfrecorded by an official body within the jurisdiction of where it is set up, in order to hold an endowment particular purpose for the benefit of Beneficiaries

In his budget speech this year the Minister noted various measures proposed to protect the tax base and limit the scope for tax leakage and avoidance, stating that the taxation of trusts will come under review to control abuse.

This was outlined in the Budget Review 2013, namely: To curtail tax avoidance associated with trusts, government is proposing several legislative measures during 2013/14.

Certain aspects of local and offshore trusts have long been a problem for global tax enforcement due to their flexibility and flow-through nature. Also of concern is the use of trusts to avoid estate duty, which will be reviewed. The proposals will not apply to trusts established to attend to the

and which usually excludes the ability to engage directly in commercial operations, and which exists without shares or other participation."

What abuse was the minister referring to in his budget speech?

The application of the conduit pipe principle ('flow through' as described above), enables income received by a trust to be rather efficiently dealt with from a tax point of view. For example, interest income could be awarded to a nonresident beneficiary (currently tax free), rental income and capital gains could be awarded to beneficiaries (taxed at their lower tax rates i.e. between 18% to 40%), whilst dividend income could be awarded (tax exempt) to the donor (founder) or utilised to repay any loan account which

Table 1: Illustration of Taxable Income of Trust Vs. Application of Conduit Principle (FlowThrough): Income of Trust conduited to beneficiaries INFORMATION GIVEN (assumed) Income earned by Trust: Rent R50,000 Interest R20,000 Dividends 100,000

Calculate Taxable Income of Trust Gross Income R50,000 R20,000 R100,000 R170,000

CONDUIT Beneficiary 1

CONDUIT Beneficiary 2

CONDUIT Beneficiary 3

R25,000

R25,000

R20,000

R25,000

R25,000

R20,000

Exempt income Interest exemption (individual) Dividends

-R20,000 -R100,000 R70,000

Capital Gain – R150,150 Inclusion rate – 66.6% Inclusion rate – 33.3% Annual exemption Taxable Income

R25,000

R25,000

Nil

R25,000

Nil

Capital Gain (taxable) R100,000 R50,000 -R30,000 R170,000

Note: From 1 July 2013 a withholding tax of 15% will be applied to interest paid to non-residents.

The proposed changes seek to tax beneficiaries on any taxable income distributed to them by a Trust (R170,000 or part thereof in the above illustration) at their individual rates of between 18% - 40% (no interest exemption, no annual exclusion, no reduced inclusion rate for CGT).

governing legal entity, set up and registered or

provided by the Founder and/or others for a

BUDGET SPEECH 2013

the donor may have had.

In this perhaps extreme example, instead of taxing the trust at 40% on the interest and rental income, and including 66.6% of capital gains taxed at 40% or an effective 26.6%, by vesting it in individual beneficiaries there is zero tax on interest awarded to non-resident beneficiaries (see note), capital gains are included at 33.3% and taxed at between 18% - 40%, (depending on the beneficiaries individual tax rate) and tax rebates, individual interest exemption and annual exclusion, where applicable, reduce the taxable amounts even further.

R45,000 Below threshhold

Below threshhold

Meeting between Treasury, SARS and Various Professional Bodies FISA recently reported back to its members that a meeting was held on 14th June 2013 with representatives of the National Treasury and the Commissioner: South African Revenue Service attended by various professional bodies including representatives of the Fiduciary Institute of Southern Africa (FISA), to understand their intentions regarding trusts and the effects of the proposals in the budget.

The meeting was exploratory with no preconceived ideas, nor were they intransigent on the tax proposals. They used the meeting to gather information from delegates and not to put forward any proposals or solutions.

National Treasury indicated that no tax changes regarding trusts have been finalised and that any amendments will first be discussed in depth (via discussion paper released for comment), but that it is unlikely to happen in the short term.

Note: In the Media Release issued by SARS on 4 July 2013 relating to the Draft Taxation Laws Amendment Bill published for public comment, it was noted that Trust reforms (amongst certain other tax proposals) would be dealt with later in the year or as part of next year's process.

Philip Shapiro, CA (SA) CFP®, Director - NFB Gauteng

“Rainy day” Savings

Image credit: 123RF Stock Photo

According to the Cambridge dictionary of idioms: “to save for a rainy day” is to keep something, esp. money, for a time in the future, when it might be needed. By Nicole Boucher.

A

ccording to the Cambridge dictionary of idioms: “to save for a rainy day” is to keep something, esp. money, for a time in the future, when it might be needed.

That need may be retirement, it may be your first house, medical bills, education etc.

Savings, no matter how difficult to achieve, are essential. Not only in the form of retirement saving vehicles, such as retirement annuities, but also in other forms of savings, such as bank call accounts and unit trusts.

The downside of placing all savings into a retirement annuity is that you are not able to access the funds should the need arise. One therefore needs to diversify into more liquid “rainy day” investments to allow for some flexibility and access to capital.

The trick is to turn your savings in the short term into investments over the longer term, but still have access to the funds in the event that it is required. A unit trust portfolio offers you the opportunity to invest

in riskier assets for long term growth, but also allows one to diversify into less risky assets such as cash and bonds.

The fear that most individuals have when placing sums of money into the markets via a unit trust or other investment is market volatility. It is therefore important that, should you decide to put money away, that you give yourself an investment time horizon of at least 3-5 years and that the underlying portfolio is suited to your appetite for risk. No one can forecast those “rainy days”, but at least the unit trust platform will allow you the access to the funds.

Markets will move up and down and you will see your investment fluctuate accordingly. The key is to continue to persevere through this, as over time these fluctuations become more smoothed and you should experience capital growth that will keep the flood waters of inflation at bay.

Remember your investment grows as you earn returns today on the returns you earned yesterday on the returns that you earned the day before, over and above the extra amounts you contribute. This compounding effect becomes more and more attractive and your “rainy day” savings start becoming proper “sunny sky” investments.

Image credit: 123RF Stock Photo

"Life isn't about waiting for the storm to pass; it's about learning to dance in the rain." ~ Vivian Greene

Nicole Boucher Trainee Paraplanner - NFB East London

The key ingredients for reaping rewards are discipline, time and patience: Discipline: instead of purchasing a new car with a salary increase you should put that extra into savings. Try and put a percentage of your salary away each month. The unit trust environment allows for debit orders which assist in creating a

FROM THE CEO’s DESK near impossible or perhaps downright risky to adopt this approach on a Big Bang approach at any given moment.

Of very real importance, however, is the careful consideration of the concept and the gradual adoption of the approach in portfolios. This can also be readily adopted where the investment is done as an ongoing contribution, either monthly or at a different but regular frequency. In mature portfolios, it probably makes sense to split the portfolio into that part which needs safety in order to deliver on income requirements and, separating this first part from that part with which to consider this

regular disciplined investment strategy.

Time: investing the funds for as long a period as possible and not drawing out in times of profit or loss.

Patience: allowing the markets to run their course and not get impatient when things are not going as you would have wanted or expected. Remember that even when there are dark clouds the sun is still shining.

It is ideal to start saving early in life; this will give you longer to save and if you start from, say, your first pay cheque, it will become a habit. If you are used to putting that money away every month then you will tend not to spend it as it comes into your account; essentially you write that money off before you take on extra expenditures. It is important to remember that you can't get back time once you have spent it.

...continued from the front page.

strategy.

Historically we have achieved these joint needs through blending Model Portfolios or Fund of Funds. These are riskprofiled to suit investor's income, growth and risk needs and tolerances. They remain very effective tools as they blend research, keen pricing and active management. A further consideration is timing the market. It is clearly sensible to enter the market when value is on the table. Getting this right is not easy. The market exists and functions because of buyers and sellers having differing views. Whilst it cannot be denied that getting in cheaply makes sense, in the

long run, realizing the importance of real returns and implementing such a strategy is vital in ensuring positive investment outcomes.

In conclusion, making "riskier" investments is not easy, especially when you have always avoided them. People are way more averse to losing capital, than they are scared of missing out on a gain.

But, on reflection, I trust you will agree that this is worth serious consideration.

Mike Estment BA, CFP® CEO - NFB Financial Services Group

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