This article was first published in the first-quarter 2014 edition of Personal Finance magazine.

An investment club is not a taxable concept that is separately dealt with in the Income Tax Act. The tax treatment depends on the legal form the club chooses to take.

The most common forms are private companies and partnerships. Although no new close corporations (CCs) may be created, CCs in existence may continue, and their tax treatment would be the same as that for a company.

Companies (including CCs)

Trading profits and losses from share portfolio transactions are taxed in the company (the club) at the company tax rate of 28 percent. Capital gains and losses that are subject to capital gains tax (CGT) are taxed at an effective rate of 18.6 percent (66.6 percent of the gain is taxable at the company tax rate of 28 percent).

Dividends received by the company from South African investee companies and non-resident companies listed on the JSE are exempt from dividends tax of 15 percent. This means that returns can be reinvested gross of tax, which is good for growing the investments managed by the investment club.

The shareholders of the company are the investment club members, so there will be a tax consequence for them as individuals when they sell their shares in the club or when the investment club company makes distributions to them.

When a member sells shares, any gain or loss made is likely to be treated as capital subject to CGT, the intention of the member having been to hold the share as a long-term investment. One third (33.3 percent) of the capital gain is included in the member’s taxable income and taxed at his or her individual marginal tax rate. The maximum marginal rate is 40 percent, so the maximum effective rate of CGT applicable to individuals is 13.3 percent (33.3 percent inclusion at 40 percent maximum marginal rate).

When a member receives dividends from the investment club company, dividends tax of 15 percent applies. If the member had invested directly in the share portfolio, rather than through the company, dividends tax would have been deducted earlier, when the dividend was declared by the investee company.

Using the form of a company therefore gives rise to two layers of tax: company tax in respect of its share portfolio transactions and then another layer of tax when the member extracts value from the investment club in the form of dividends or by way of a sale of the company shares.

If the member sells to a third party, which could include another member of the investment club, the sale should be subject to CGT (13.3 percent maximum effective rate). However, should the member sell the share back to the company by way of a share buyback, the gain on the sale is likely to represent profits made by the company on the share portfolio transactions, giving rise to a dividend, which will be subject to dividends tax of 15 percent.

Only if the amount paid by the company is paid out of “contributed tax capital” of the company will the amount not be regarded as a dividend. “Contributed tax capital” in an investment club company is likely to be made up of the amounts contributed by the members as capital contributions.

Taxation of share portfolio transactions

Section 9C of the Income Tax Act is important because it deems the gain or loss made on the sale of certain shares held for more than three years to be capital. The section is non-elective. Any qualifying share held for the requisite period will be subject to the provisions of the section. The section applies to:

* South African equity shares;

* JSE-listed shares of non-resident companies (dual-listed companies, such as Old Mutual, Investec and SABMiller); and

* Units in collective investment schemes (CISs).

It does not apply to:

* Foreign shares (unless listed on the JSE);

* Shares in share block companies; and

* Shares that contain debt features (known as hybrid equity instruments).

Given that investment clubs are likely to invest in JSE-listed shares, the section is certain to apply if the share is held for a continuous period of at least three years.

The advantage is the lower effective rate of tax that will apply to any gain. On the other hand, any loss will be allowed to be set off only against capital gains made in the same year or in future years and not against revenue profits.

There are also a number of administrative requirements that make compliance with this section onerous. The company is required to keep track of the period a share is held using the first-in-first-out (Fifo) method. An investment club may acquire shares in a single JSE-listed company in several tranches, so its holding at any particular time may be made up of shares with different acquisition dates. The more usual method of calculating the cost of the holding is the weighted-average method. After a number of years of operation, an investment club may have bought and sold various tranches of a particular company’s shares, and keeping track of the age of the shares, using Fifo, and the cost, using weighted-average, could be administratively cumbersome.

Another requirement is that if expenditure related to that share was claimed as a deductible expense in earlier years, it has to be added back for tax purposes. Such expenditure may form part of the share’s base cost and be eligible for deduction under the CGT rules, but not all expenditure will be eligible. For example, many of the day-to-day running costs of the investment club are unlikely to qualify as deductible items for CGT purposes. This creates an administrative burden, in that expenses have to be allocated in some reasonable and consistent manner between profits treated as trading profits and profits treated as capital gains.

The South African Revenue Service (SARS) has issued Interpretation Note 43, which deals with section 9C in detail and includes illustrative examples. The Interpretation Note can be accessed on the SARS website, > Legal and policy > Interpretation and Rulings > Interpretation notes.

Share dealers

Where the company’s strategic objective is to make short-term profits by way of dealing in shares – in other words, to act as a share dealer – the profits and losses from share portfolio transactions will be treated as revenue profits subject to company tax at 28 percent. The shares will be treated as trading stock, with the purchase cost allowed as a deduction in the year of purchase and any proceeds of sales fully taxable. Shares held at year end will be included in taxable income at their cost price. The closing stock at the end of a year forms an opening stock deduction in the following tax year.

Various expenses of running the investment club are allowed as deductions, for example:

* Bookkeeping or accounting fees;

* The cost of software to analyse the share market;

* Bank charges;

* Internet access charges;

* Telephone and other communication costs;

* Scrip custody fees; and

* Brokerage account administration fees.

If a share that has been held for more than three years is sold, the provisions of section 9C could apply and expenses previously claimed would have to be added back. Where a share dealer who normally buys and sells within short time frames happens to hold a particular share for more than three years, any expenses related to that share, or a proportion of the general costs that can be reasonably be allocated to that share, may no longer be claimed as a deduction in respect of that share. This is because those expenses will no longer be incurred in order to earn income; the sale of the share will give rise to a deemed capital gain rather than income, hence the disallowance.

Shares held for less than three years

Section 9C regulates only the tax treatment of qualifying shares held for more than three years, by deeming the gain or loss to be of a capital nature. The capital or revenue nature of shares held for less than three years depends on the taxpayer’s intention and the facts and circumstances of the sale.

Where the majority of transactions fall within the section 9C holding period of three years or more, and the sale is not speculative but fills another need, such as raising cash for paying out an exiting member, it may be possible to support an argument for capital treatment. Where the strategy of the investment club is to hold shares for long-term investment purposes, with a view to earning a growing dividend yield, and this is supported by the actual transactions, this will be supportive of capital treatment.

Where there are frequent share purchases and sales within short time frames, the profits will be regarded as trading profits subject to full income tax rates.


A partnership is not a legal entity separate from its members and is not taxable in its own right. Income that accrues to the partnership, and expenses incurred by the partnership, are deemed to accrue to and be incurred directly by the partners in the ratio of their profit share as and when such items accrue to and are incurred by the partnership.

It is for this reason that partnership accounts tend to be drawn up to the same year-end as individuals’ tax (February 28). Partners are required to include income and expenses in their personal tax returns annually and such income and expenses are subject to tax at the rates applicable to the individuals. This is the case regardless of whether partnership profits are withdrawn from the partnership. This can create a cash-flow issue, so the partnership may have to distribute cash from time to time (known as drawings) in order to assist the partners to pay their tax.

Dividends from the shares held in the portfolio will be received after the deduction of 15-percent dividends tax (as a so-called withholding tax, it is deducted by the entity paying the dividends, before distribution), so there is no tax on drawings when cash is distributed to the partners.

The remarks above in respect of section 9C about share dealing and the capital-versus-revenue nature of shares sold within three years of acquisition apply equally to partnerships.

As previously stated, the partnership itself is not a separate entity for legal or tax purposes. When a partner exits the partnership, the partnership comes to an end. A new partnership (with a different profit share) is created between the remaining partners. Similar concepts apply when a new partner joins: a new partnership is created. The property of the partnership is regarded as being held jointly by the partners in their respective profit shares.

Exits and entries can, in theory, give rise to the disposal and re-acquisition of partners’ interests, even though the partners who remain have done nothing. Thankfully, SARS has advised that this strict legal approach will not be applied. Instead, a practical approach will be taken in which each partner is regarded as having a fractional interest in each of the partnership’s assets.

This and other useful guidance, together with examples, can be found in the “Comprehensive guide to capital gains tax” on the SARS website, > Types of tax > Capital gains tax.

For the purposes of the three-year holding period in section 9C, the partners are similarly regarded as having acquired a fractional share (in their profit-sharing ratio) of each share on the date the share is acquired by the partnership.

While this is a pragmatic approach, it does require meticulous bookkeeping. Different partners may have different base costs in the same shares held by the partnership, depending on when they entered the partnership and whether they acquired an exiting partner’s share, for example.

Partners are “connected persons” in relation to each of the other partners and any persons who are connected persons in relation to them, so relatives of the other partners may be regarded as being connected persons in relation to you. (A “connected person” in income tax terms is anyone who stands

to benefit from the actions of another who is connected through family relationship, trust, partnership, or shareholding.)

The Income Tax Act contains various anti-avoidance rules that govern transactions between parties regarded as being connected persons, so you should be careful of entering into a partnership and should review the other partners’ relationships and shareholdings to assess whether they could have any adverse impact on any other business in which you may be involved.

Company vs partnership

The example (see link at the end of this article) shows that the difference in the after-tax rate between a company and a partnership is not that significant when gains are treated as trading profits. This is because a company is taxed at 28 percent plus 15-percent dividends tax when members extract cash from their shares, which, combined, is similar to the maximum marginal rate for individuals (40 percent). The company option may, however, yield a timing benefit because the 15-percent dividends tax is deferred until the member extracts value from the company. The benefit will grow the longer the profits in the club remain untouched, because the company is able to keep reinvesting more money after tax than higher-taxed individuals would be able to do.

Compare this to the position where share profits are regarded as capital in nature (see link at the end of this article). The picture changes quite dramatically if the share portfolio profits are taxed as capital gains. This is because the share portfolio gains of a partnership are taxed directly in the partners’ hands. A partnership does away with the second layer of tax that arises when the club is a company: the tax members pay when their shares in the investment club are sold or otherwise redeemed. Also, the effective rate of tax on a capital gain for a company (18.6 percent) is higher than that for an individual (maximum 13.3 percent).


The use of a company to house the share portfolio transactions frees the investment club members of the annual tax burden of including the profits and losses from share portfolio transactions in their personal tax returns. The use of a partnership can introduce administrative complexities, especially when members exit the investment club or new members join.

The tax treatment also varies significantly between the two types of entity. Where share portfolio profits are treated as trading profits, the net tax effect may not be that different, although the timing of the payment of tax may have an impact and may favour the use of a company.

If, however, profits from the share portfolio are taxed as capital gains – for example, where the deemed capital treatment of section 9C applies – a partnership is a clear winner from the perspective of minimising tax.

* Kari Lagler is an independent tax consultant.