WHAT THE FUTURE HOLDS

2012 is nearly done and dusted. Time to take a break and start afresh in the new year.

Maybe not! 

There have been some significant developments within the National Treasury this year, as confirmed by Pravin Gordhan’s Medium Term Budget Policy Statement to parliament last month. Furthermore, Gill Marcus has left little to the imagination in the Reserve Bank statements.

2013 will be a tough year.

How does it affect investors? And what trends can we take forward into 2013?

Lesson 1: SA government struggles to collect enough taxes

Gone are the glory days of Finance Minister Trevor Manuel, when tax collections increased by 12% per annum from 2003 to 2008. Most of this was achieved through growth rates of above 4% and inflation rates above 6%. Growing SARS' efficiency and tightening up tax legislation also helped.

Today, Pravin Gordhan faces a very different challenge. Growth rates have declined to 2.5%, and the SA tax base cannot be broadened without a substantial increase in tax rates or the imposition of new taxes (for example, carbon emission taxes).

The National Budget Speech in February 2013 will be a very interesting event. 

Even if SARS achieves its 2012/13 budgeted tax collection target, it would seem the National Treasury will need even more during the 2013/14 tax year. Where will National Treasury find another R100 billion a year to keep SA on track?

Based on certain trends identified in the SARS Statistics 2012 (released in October 2012), increases in corporate tax rates seem unlikely as the principal problems are lower corporate earnings and assessed losses brought forward from the financial crisis of 2008/9.

A VAT increase is the obvious answer, but this would not be received well by organized labour and will probably be avoided.

This leaves personal income tax increases as the only real alternative for National Treasury. The question is rather: ‘what form will it take?’ 

Will National Treasury attempt to increase the super-tax level above 40% on taxable income above R617 000 per annum? This is unlikely as there are simply not enough super-tax taxpayers to make a substantial difference.

Will Capital Gains Tax inclusion rates be increased? This possibility cannot be ignored. But this would be more a measure to contain reduced collections from CGT (now only about R6 billion per annum) rather than generate a new source of income.

Or, will the shortfall be made-up by simply containing the tax-relief granted to all taxpayers? Yes, that is probably the only realistic alternative.

The pressure is on for SARS to find more options. This, coupled with the implementation of the new Tax Administration Act, will mean that penalties and interest charges for the errant taxpayer will be a very unpleasant experience. And there is little that even the most brilliant tax specialist will be able to do to try and get these charges waived or reduced.

For the investor this means that when considering any investment it is critical to ensure that the manager can report tax information timeously and accurately.

Other tax factors are becoming equally critical. ‘The quality of the income’ has become increasingly important.

• Is it fully taxable revenue income or partially taxable capital income?
• What type of taxpayer receives the income?
• Is it a company, an individual, an insurance policy or a trust?

The playing rules in this arena have changed in recent times and should be regularly reviewed when placing investments.

Lesson 2: The SA government cannot borrow its way out of trouble

Pravin Gordhan is almost permanently at war with international rating agencies regarding SA’s credit and investment status and resultant ratings.

Critical in this debate is the extent of SA’s fiscal debt. Simply put, the national deficit cannot be allowed to increase above 4% of Gross Domestic Product. 

The knock-on effect is that the Reserve Bank is under enormous pressure to contain interest rates at current levels as government itself would not be able to absorb the increased interest costs without increasing national debt.

Current after-tax interest yields are below inflation and likely to remain so for the foreseeable future.

The result is that for the investor to generate any real growth, there has to be an exposure to equity-based investments. And with that goes the management of risk profiles of investments. That is a science better left to portfolio managers.

Lesson 3: Lower interest rates and other factors leave the Rand vulnerable

Over the past few years, overseas investors have propped up SA’s balance of payments current account with inward investments seeking to take account of SA’s favourable interest rates.

Recent indications are that international banks will have to deleverage by $4-5 billion during 2013. There is simply not that much money around at present and this has already had a substantial adverse effect on the balance of payments current account and exchange rates against the Rand.

As indicated above, the Reserve Bank cannot increase SA’s interest rates to attract inward investment to prop up the Rand.

Even if one ignores SA’s political risk, the Rand is very vulnerable at present and investors should always be on the lookout for Rand hedge investments. 

Remember, a substantial decline in exchange rates can easily squander a year of carefully generated returns.

Lesson 4: The debate on retirement funds is not over, not by a long way

On paper other investment vehicles simply cannot currently match the tax profile of retirement funds. Where else does the investor enjoy a tax-deductible contribution, followed by tax-free growth and a partially taxable withdrawal?

But this could all change.

Currently, there is a range of proposals released by National Treasury for public comment. At the very least this will lead to capping of tax-deductible contributions with effect from the 2014 year of assessment.

Investors are reminded that for the 2013 year of assessment, contributions to retirement annuity funds are only limited by the 15% of non-retirement funding rule. 

Over the next few years there are sure to be changes affecting preservation requirements and investment allocations within retirement funds. Certainly current concessions granted to living annuities and Regulation 28 of the Pensions Fund Act are bound to receive attention.

There is bound to be much speculation on the final outcome of the National Treasury proposals. The only sure way of containing risk to change is through diversity of investment vehicles.

Lesson 5: The residential property market has not recovered

Back in 2008 American economists Carmen Reinhart and Kenneth Rogoff made news with their publication, ‘The aftermath of a financial crisis’. At the time they predicted that it would take seven years for residential property markets to recover.

At present there has been little recovery in the residential property market and there are few commentators who can sincerely suggest that good times are just around the corner. Some say the recovery of the residential property market will take a decade, others have even suggested a generation.

Meanwhile, the holding costs of residential property have skyrocketed to the extent that some are wondering whether residential property is an asset or liability.

Many SA investors are ‘overweight to residential property’. And perhaps the time has come for many to cut their losses rather than attempt to ride out the market.

Lesson 6: The new energy crisis is here to stay

It seems plain crazy that SA celebrated when the 2012 Eskom increases were contained at below 20%.

Although oil prices dipped below $100 a barrel in the early part of 2012, it did not last long. And the recovery of oil prices, coupled with a weakening exchange rate has taken fuel prices back to R12 a liter.

The Gauteng fuel debacle is not yet over and the resultant loss to National Treasury is running at R5 billion a year. Pravin Gordhan is going to have to recover the position by way of a massive increase in fuel levies with effect from 1 April 2013.

South Africans will be lucky if energy cost increases for 2013 are contained at below 20%.

An integral part of financial planning is to contain expenditure. It would seem that even a Ponzi scheme would struggle to outperform the expected increase in energy prices.

Conclusion

With US President Barack Obama now safely back in the White House, his first challenge is to address the ‘fiscal cliff’. What will the US do to contain its staggering national debt? And with Republican and Democrat America now completely divided on the issue, this has every potential to push the US back into recession during 2013.

The effect of a US recession would have a massive impact on all investors. This is no time to take risks. 

Investment strategy is not so much about how much is made in good times but rather how much is not lost in bad times.

Article written by: Matthew Lester, Professor of Taxation Studies