Why does a client pay CGT when an asset manager rebalances a portfolio?

Dear reader,

In order to answer your question, we will need to make some assumptions about your portfolio.

Since you refer to the fact that an asset manager, or portfolio manager, is executing a rebalancing on your portfolio we would assume that you have a targeted investment strategy under which the manager is allocating your funds within a specific mandate.

This would require them to complete a rebalance of the portfolio should prevailing market conditions result in the current holdings drifting too far outside the strategic asset class allocations.

This reallocation of monies results in the sale of units within a particular underlying fund for the purchase of units within another fund to bring the investment strategy back in line with its mandate.

This sale and reallocation of the invested monies will trigger a capital gain event should the units sold have experienced growth from their base cost. Since the investor is seen to be exiting this particular fund, either partially or wholly, due to the repurchase of the units, the gain must be recorded and included in the investor’s taxable income for that specific tax year. Even if an investor does not take this repurchase in cash, income or otherwise, Sars sees this as a taxable event.

Keep in mind that income does not need to be physically received for it to be included in your tax return.

Think of interest received on a fixed deposit – this is included in your annual taxable income even if the monies have not yet been received or become accessible.

While the rebalancing does trigger possible capital gains this also allows the rebasing of the base cost of those specific monies within the investment strategy.

Therefore, although tax may have become payable in the year of the rebalance, in future any disinvestments for income or rebalancing switches are done from this higher base cost.

In practice, this means that potentially your gains over time and the subsequent tax may be spread across multiple tax years utilising the annual exclusion which, given the individual’s personal circumstances, could even result in a net lower tax payable than if the capital gain was applied in a single year.

If you have concerns about future capital gains tax due to rebalancing, you may consider a Fund of Fund approach where multiple underlying funds are used but wrapped within a single fund and unit holdings.

Here, switches and rebalances within the Fund of Fund would not trigger a capital gain event until such time as you issue a withdrawal instruction to the Fund of Fund to either switch to another portfolio outside the Fund of Fund or to be paid in cash.

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