NFB Proficio Newsletter Issue 75

NFB FINANCIAL UPDATE Issue 75 August 2014

FROM THE CEO’s DESK

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n Johannesburg this July morning the temperature at 4:18 a.m. was -3.5°C, compared to that on the JSE this month of 101°C! I immediately knew what course of action to take as my iPhone alarm wakened me to go cycling. I heeded the advice of our cycling aficionado, turned over, switched the alarm off and stayed in bed for an extra fifteen minutes.

Now I'm up and with a little sense of guilt, writing this editorial about markets, emotions and other more predictable things, whilst a few of my cycling mates are out there doing battle with hyperthermia and hills. This brings me to the subject of markets, indices and logic. Some editions ago I opined on the tremendous sense in staying invested in strong dividend paying shares. This view holds good now and will still be relevant whether a clearly expensive market suffers a setback or maintains its recent trajectory.

My opinion is based on simple

®

Mike Estment CFP professional BA / CEO - NFB Financial Services Group

financial services group

arithmetic. If dividends average out at 3% per annum, and if these are grown at inflation beating returns each year, you will clearly be rewarded by growing dividends. After 10 or more years, the dividends earned expressed as a percentage of your original purchase could easily be in the mid teens. So, provided you have saved hard and invested over many years, you might hold on to shares, whilst the share price follows the trend of the JSE, provided you don't sell, and rely on using the dividends to provide you with income (if needed).

Selling shares should be a luxury reserved for times when they are at new highs and as part of an overall strategy clearly understood by you and your advisor. Being a slave of the market, using funds designated to provide you with income, or worse still, using borrowed money is dangerous and unwise. The most particular example of these is when investing in overheating markets, just like those we find right now in South Africa.

When investing, the logical thing to do is firstly understand your intentions clearly. These would include how much you invest and your targeted maturity value. When this end value is needed, your tolerance to risk in achieving this goal, the likelihood of the cash being needed earlier among other issues is all relevant. Also worth knowing is the “risk free rate” i.e. the return from cash, and the likely premium your chosen investment might deliver. This allows you to assess the risk adjusted return on offer.

Right now, committing the family farm to the JSE would not be very sensible, given the record highs we hear about every other day. We would rather a cost averaging approach be adopted, or that funds be deployed into more conservative yet still growth oriented solutions, and these being monitored and moved to more aggressive alternatives when the market goes through any material corrections.

An indicator of markets being frothy and representing increased likelihoods of sell-offs include the publication of articles which

regard the current winning trend as different to the previous ones which ended in significant corrections in equities and indexes. This time is most certainly NOT different. A further indicator, which is repeated in the latter phases of sometimes protracted and significant bull markets, is the emergence of loads of new listings. This bears careful consideration as not only does this act as a precursor to softening markets, they also warrant careful scrutiny as less than ideal vendors can smokescreen a pile of rubbish into a listing which offers no value to sometimes greedy investors carelessly jumping into stocks without really doing the necessary research or using appropriate expert advisors. In both cases history is littered with sad tales of good money following bad into these traps.

Much has been written recently about certain counters in the property space where vendors are offering not only a property portfolio, but a management company with significant costs involved if the buyers decide to discontinue the management contracts. This doubledip risk would have a material negative impact on the investment case, making the advice of professional advisors or skilled brokers crucial in navigating these cloudy waters.

The business case supporting investment into dividend yielding stocks holds good for both local and offshore portfolios. We look forward to assisting you in allocating funds into appropriate and flexible solutions given a clear understanding of the considerations noted above.

It is time again to start considering the venue for our Spring Party, and just two months later our 2014 Xmas function. My experience of time accelerating is becoming quite scary!

My mom and dad warned me about this phenomenon I never believed.

I guess the nice thing about this is I will not let my mates down as the a.m. temperature will be a balmy 17°C and the market hopefully a tepid and more enduring 75°C.

fortune favours the well advised

Business Continuity & the Value of your Business

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s a business partner in a business, there are many things to consider with the day-to-day running of the company. However, you also need to take the time to consider the continuity of the business should any one of the business partners pass away or become disabled. This unexpected and often unplanned for event can cause havoc and major stress to the surviving partner.

In order to ensure both the continuity of the business and peace of mind for the beneficiaries of the deceased estate, one should consider having a Buy-and-Sell agreement in place. This ensures that both partners have agreed to transfer the agreed value of their shares in the business to the surviving partner on death or disability, thereby ensuring that the surviving partner can continue with the running of the business and the deceased estate receives fair value for the shares.

The benefit of this agreement is that it creates certainty as to what happens to the business interest of the deceased member. The surviving business owners do not have to be concerned about the business interest being inherited by an heir and the heir having different views regarding the future of the business.

The buy-and-sell agreement should be supplemented by a buy-and-sell policy. This is done via a life policy which provides the funding for the buy-and-sell agreement. This policy needs to be owned by the surviving business owners on the life of the deceased owner, and the life cover on this policy needs to be equal to the value of the deceased member's interest in the business. So in the event of death of one of the owners, the others have the necessary funds to be able to pay the purchase price of the deceased owner's interest in the business and the heirs will then receive a reasonable price for the business and will not have to wait to receive payment.

Policies underlying buy-and-sell agreements are usually owned by the co-owner/s of the business and are not employer-owned policies.

age credit: 123RF Stock Photo

BUY-AND-SELL AGREEMENT A buy-and-sell agreement is a formal contract which may be used in a court of law. A buy-and-sell agreement needs to meet the business needs of the client and should deal with the following: = An agreement that the surviving owners of the business will purchase the business interest of a deceased owner. = An agreement that the executor of the deceased

owner will be bound to sell the business interest of the deceased member to the remaining members – a buyand-sell agreement carries more weight than a deceased owner's will. = An agreement regarding the purchase price – there should be an agreed upon method of determining a market-related price at the time of death. This often requires a valuation of the business by an accountant. = The agreement must make provisions for cession of the remaining policies owned by the deceased member on the lives of the surviving members. = The procedure should more than one co-owner pass away simultaneously, or within a short period, should be included. = It should contain an agreement that the co-owners will not sell their interest in the business during their lifetimes without giving first option to purchase to the other business owners. = It should also be agreed upon if the owners would like to purchase the interest of a co-owner in the event of disability. This disability cover purchased will not form a part of the Life Office's Association's (LOA) code of conduct disability limits.

The buy-and-sell must also be aligned to any other binding agreement in the business.

Even if you have this structure in place, you need to ask the following questions: = Have the agreements been reviewed recently? = Is the valuation of the business accurate and up to date? = Is your buy-and-sell agreement accurate? = Have there been any additional partners added?

The value and size of the business is immaterial; provision needs to be made to ensure: = The continuity of the business = Outsiders do not gain a controlling interest = The remaining partners have funds available to purchase the deceased's interest in the business = The business interest is not sold for a value below market value.

TAX IMPLICATIONS Because most buy-and-sell policies are not employerowned policies the business has no income tax liability.

CGT A buy-and-sell policy will usually pay the death or disability benefits to the original beneficial owner of the policy and therefore would be excluded for capital gains tax purposes. However, if the business has been dissolved or the agreement has been cancelled or one business owner has passed away and the policies entered into have been ceded to the lives assured under the policy – the policies will no longer be payable to the original beneficial owners.

These can still be disregarded for capital gains tax only if the following requirements are met: = The policy was taken out with the purpose of purchasing the life assured's interest in the business concerned, and = No premium on the policy was paid by the life assured while the business co-owner(s) was the owner of the policy.

ESTATE DUTY As a buy-and-sell policy is not usually employer-owned, estate duty will not be applicable. A buy-and-sell policy will be excluded for estate duty if the following three requirements are met: 1. The policy must have been taken out or acquired by a person who, at date of death, is a co-business owner of the deceased; AND 2. The policy was taken out or acquired with the purpose of purchasing the deceased's interest in the business; AND 3. The deceased must not have paid or borne any of the premiums on the policy.

SHARES OWNED BY FAMILY TRUSTS: If the co-owners transfer their interest in the business to their respective family trusts, the family trusts would become the owners of the policies on the lives of the other business partners. As the business partner does not hold the shares and a family trust cannot be insured, you would still insure the partner even though he is not actually party to the buyand-sell. The proceeds of a policy would then be 'deemed property' in the estate of the deceased and will be estate dutiable.

To make provision for this, you would need to increase the life cover to cater for the estate duty of 20%. However, to cater for the estate duty on the extra 20%, the total increase on the life cover would in fact need to be 25%.

EXAMPLE: Life cover of R1 000 000 – increase by 20% = R1 200 000

However, the estate duty on R1 200 000 @ 20% = R240 000 therefore leaving you with only R760 000 (R1 000 000 – R240 000).

So you would need to increase the cover by 25%.

Life cover of R1 000 000 – increase by 25% = R1 250 000 Estate duty on R1 250 000 @ 20% = R250 000 therefore leaving you with the correct amount of cover of R1 000 000 (R1 250 000 – R250 000) Please note that the disability cover would not need to be increased as it is not estate dutiable.

Benefits to Dead/Disabled Co-owner or His/Her Heirs: = Receives fair value for his/her interest in the business = Certainty regarding the sale of interest = An immediate cash payment that will compensate survivor's income lost as a result of death or disability of a breadwinner. = Benefits to Remaining Co-Owners: = Certainty regarding the future ownership of the business = Business can carry on with minimal interruption = No risk of new co-owners joining the business who might be unskilled and inexperienced = An inexpensive way of funding the purchase price.

The value of the business is likely to change over time and therefore it is necessary to review buy-and-sell agreements regularly and to increase the cover amounts in line with the value of the business.

There are other business needs that also require consideration such as keyperson cover and contingent liability cover. Keyperson assurance covers essential employees in the business, who, should they pass away or become disabled, would have a detrimental, financial impact on the business. Contingent liability cover is for when you have personally stood surety for a business loan or overdraft. In the event of your death the bank could call up this loan and your estate and family will be responsible for paying this debt. (Both of these covers can be discussed in detail in a separate article).

Should you be a business owner and would like to discuss the intricacies of buyand-sell agreements and policies, please give one of our financial advisors a call at one of the NFB offices in Johannesburg, East London, Port Elizabeth, Stellenbosch or Cape Town.

Article written by Julie Mc Donald, CFP

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professional

B.Com, PGDFP

Risk Assurance Specialist - NFB East London

Important news for NFB Port Elizabeth clients Alex Grunewald and Associates has recently been incorporated into NFB's Port Elizabeth office. This is a very exciting development for us as Alex Grunewald is a highly respected financial advisor in Port Elizabeth and brings to us a wealth of experience as well as a well established clientbase.

The addition of Alex and his staff means that we will soon have additional staff members available to assist our PEbased clients to ensure that they receive nothing short of excellent service and our best attention at all times when making contact with our office at Ascot Office Park in

Conyngham Road.

NFBPE will now also be able to offer consulting in respect of employee benefit schemes as an additional service to owners, directors and managers of businesses directly.

Please rest assured that NFB ensures that the underlying investments of our clients are always in good hands and managed according to our house-views and in line with our standard practices and procedures, irrespective of the financial advisor with whom the client has the main relationship.

Please feel free to contact our office at any time should you need any assistance or advice on 041 - 582 3990.

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Tax ation

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t has become a common view in South Africa that, due to the ever expanding need to fund social security, tax rates will continue to increase. While we were lucky to avoid such an event this year, in part due to the negative sentiment which was strategically avoided during election season, the elephant is still in the room and it may well now be the time for him to blow his proverbial trumpet.

Revenue collections are depressed through stagnant economic growth, increased inflation and a lack of foreign direct investment (FDI). This, all while the budget deficit remains north of the 4% target and the need for social grants balloons with the issue of unemployment remaining paramount.

Bearing the brunt - who, where and why Revenue collections can be broadly split into Personal Income Tax (PIT); Company Income Tax (CIT); Value-Added Tax (VAT) and other, which includes import duties, specific excise taxes (Capital Gains Tax; Estate Duty) and fuel levies. The table below illustrates how the 2008/2009 and 2012/2013 tax revenue figures of R657.7 billion and R813.8 billion respectively were apportioned.

Year 2008/09 2012/13

PIT 31.4% 34.0%

CIT 26.7% 19.8%

VAT 24.7% 26.4%

Other 17.2% 19.8%

The obvious red flag from such a comparison is the drastic fall in Company Income Tax revenue, despite South Africa having one of the highest effective corporate tax rates (sector群specific tax dispensations and deductions applied) in the world. This reduced revenue from corporations can be attributed to the slow economic growth in the country which is further depressed by continued strikes and associated disruptions. As only 266 companies (0.2% of all companies with positive taxable income) account for more than half (58.2%) of all CIT there is a high degree of concentration risk present in our country

during economic cycles.

The fragile nature of the local economy and the intrinsic need for FDI shifts the burden of taxes to the man on the street in the form of PIT and VAT. Targets for such action include an adjustment of the 40% PIT tax ceiling, whilst former Minister of Finance Pravin Gordhan, in his recent budget speech, alluded to a potential increase of VAT from 14% to 15%.

What does this mean for our clients?

The increased financial burden of higher taxes can be mitigated through clever and efficient financial planning: = Investments into more tax friendly vehicles such as retirement annuities and endowments allow for added compound growth due to fixed tax rates on investment returns. = Income can be drawn from an intelligent blend of products including matured endowments, linked unit trusts and living annuities in such a manner so as to minimize the taxable income in one's hands. = Allocation to a high dividend yielding portfolio of blue chip stocks or preferred stock over that of interest yielding assets can lead to a more tax efficient income- generating investment.

It should, however, be noted that any of the above strategies would need to be considered in line with a clients' entire portfolio, with each option presenting certain restrictions or risks themselves. These are all part of the ongoing discussions that we will have with our clients as we seek to provide the best in class service in order for you to meet your financial needs and goals. Please do not hesitate to contact a financial advisor at any one of the NFB offices in Johannesburg, East London, Port Elizabeth, Stellenbosch or Cape Town.

Article written by Matthew Chapman, B.Com honours, PGDFP NFB Gauteng, Representative under Supervision

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