Suitable legal structures
The two obvious legal structures available to the club to choose from are;
- Form a general partnership
- Register a company with the purpose to trade in shares
The term “legal” is used although it does not strictly apply to partnerships. The partnership is not a legal entity, but under certain conditions will be treated almost as if it was a legal entity.
The legal structure of the club will require careful consideration since they differ substantially in complexity and associated tax implications. The tax implication alone required more homework and the existing earnings scale and level of personal tax of the members will also be a determining factor. It is strongly advised that that the club research this properly and that the advice of a tax consultant or practitioner is sought in this regard.
A Partnership is not a legal entity and is therefore not registered for income tax purposes. A partnership is entered into simply by the signing of an agreement which would normally have been drafted specifically for the partnership i.e. the Partnership Agreement. The Partnership Agreement is basically the founding document of the partnership. The partners in a Partnership will share in the profits of the partnership in a pre-determined ration. The ratio will be set out in the Partnership Agreement and each partner’s share will normally be in the same ratio as he / she contributed to the partnership. This means that since each partner will receive income from the Partnership in the predetermined ratio share, each partner is also liable for the income tax in the same ratio.
It is important to note that the Partnership (Club) is not liable for tax and is not required to submit financial statements to SARS on a yearly basis. The liability for tax is however passed on the members of a Partnership (Club) in their personal capacity as individual tax payers. The earnings of the investment club is passed on to each individual member who is required to pay the taxes on their share of the earnings.
Any gains / taxable amounts (capital gains / losses, dividends, interest on un-invested cash and income) therefore has to be allocated to members in accordance with their individual percentage shareholding of the club’s portfolio
Each member in his / her personal capacity as individual taxpayer has an “annual exclusion” amount of R30 000 (2014 tax year) for the purposed of capital gains tax liability.
A club with for example ten members, each with an equal share of 10% in the club, and an accumulated total capital gain of R300 000 in a particular year of assessment will distribute R30 000 of the capital gain to each member and no capital gains tax (CGT) will be payable by any of the members (provide members do not have other capital gains from any other sources)
The partnership arrangement creates an extremely favourable tax regime for a club with a focus on long-term investing and who will therefore mainly be confronted with capital gains tax.
Many clubs may find the “general partnership” structure very applicable for their purpose. It is further simple to arrange and mange.
Companies are taxed at a flat tax rate of 28%. If the members of the investment club are at the top of the earnings scale and they fall in the 30%, 35% and 40% tax brackets, then they will be paying far more in taxes than a company would.
Companies are further allowed to deduct business expenses to lower the amount of taxes it would have to pay. These expenses would typically be;
- Telephone bill
- Newsletter subscription
- Data download for charting software
- Internet access
- Annual brokerage account admin fees.
- Salary to admin person
Passive Income Company: An important SARS ruling to remember is that SARS defines companies as a “Passive Income Company” if it:
- Generates more than 80% of its income from passive investments like shares in the form of dividend income, bonds (interest income) and other financial instruments.
- And has less than six shareholders
If SARS deems a company a “passive income company” it will be taxed at 40% instead of the normal company tax rate of 28%. The investment club would need to avoid this if they are to take advantage of the tax savings a company structure can offer. To do this the investment club needs to ensure:
- The company generates active income from trading (buying and selling shares in less than a year) and
- Income from dividends and interest amounts to less than 80% of its income.
Investment clubs are started for a variety of reasons which may vary from being a focused business to a social club with investment interests only.
Clubs that are planned with a serious business focus is advised to seek assistance from a tax consultant or tax practitioner.