Page 69 - Profiles's Unit Trusts & Collective Investments - September 2024

Costs and Pricing

Under the Unit Trusts Control Act (UTCA), management companies were obliged to account
separately for income and, after recovery of their own charges (which could only be deducted from
income), to distribute the income to unitholders.
Most unit trusts have continued with this practice. Because the SA tax system treats income
from interest and dividends differently, management companies provide investors with a
statement showing the split between interest and dividends on any particular distribution.
Under CISCA, a unit trust can elect not to make distributions – provided this is clearly spelled
out to investors and incorporated into the trust deed. (A fund already making distributions would
have to get such a change approved and give unitholders plenty of notice.) A fund structured in this
way simply absorbs income received into the portfolio, using the proceeds to buy more assets. This
type of fund, known as a “roll-up fund”, is fairly common overseas.
Reinvestment of Distributions
As we saw when we discussed compounding, most unit trusts in South Africa offer automatic
reinvestment of income as a benefit to investors. Investors who elect automatic reinvestment don’t
receive a cash distribution; instead, the value of the distribution is used by the CIS manager to buy
further units in the portfolio for the investor. From an administrative point of view, this occurs on
the same day that payments are made to those investors who are receiving cash distributions.
Note that what happens with reinvestment of dividends is not the same as what happens in
roll-up funds (also known as accumulating funds).
In a roll-up fund, income received by the portfolio (interest and dividends) is simply absorbed back
into the portfolio. It becomes part of the cash of the portfolio, and can be used to purchase further
assets. A roll-up fund does not report interest accruals to each investor, but accounts for interest and
deals with any tax issues within the portfolio itself. Due to the unfavourable way that roll-up funds
would be affected by tax in South Africa (ie, the portfolio would have to pay income tax on all interest
received and Dividend Withholding Tax (DWT) on dividends), there are no roll-up funds in SA at the
moment. Some offshore funds offer investors a choice of “accumulation units” or “income units”.
With reinvestment of distributions, the fund keeps track of income accruals in respect of each and
every investor, and either pays or reinvests the income due to that investor. As previously mentioned,
distributions for a fund holding equities usually consist of two parts, dividends and interest.
Note that the investor receives a statement of the split between interest and dividends for a
particular distribution whether the income payment is automatically reinvested or not. The tax
liabilities of the investor do not change because the distribution has been reinvested – the investor
remains liable for tax on the interest portion if his or her total interest income exceeds the tax free
allowance for the year in question, even if the distribution has been reinvested.
DWT is deducted from securities before dividends are credited to a portfolio and to each
investor – the dividend portion is net of DWT and therefore there is no further tax liability for
individual investors when it comes to the dividend portion of a distribution.
Certain entities, like companies and retirement funds, are exempt from DWT. If units in a
collective investment scheme are held via a company, application can be made to the fund manager
to pay the gross dividend. Similarly, non-residents holding South African unit trusts may qualify
for a reduced rate of DWT if a double-taxation agreement exists between South Africa and the
investor’s country of residence. Most fund managers provide application forms for investors who
qualify for a reduced rate of DWT. Investors can also apply for DWT refunds where too much tax
has previously been deducted.
Cum and Ex Div
The terms “cum div” and “ex div” (cum dividend and ex dividend in full) derive from the stock
market. They are also used informally in the unit trust industry, however, although the word
“dividend” is something of a misnomer as the distributions made by unit trusts consist of
dividends and interest. As a rule, the word dividend used in the context of a payout by a unit trust
really means the distribution or income declaration.
“Cum” in this context means “with” or “including”, and “ex” means “after” or “excluding”.

Profile’s Unit Trusts & Collective Investments — Understanding Unit Trusts 67