The new Dividend Withholding Tax (DWT) replaced Secondary Tax on Companies (STC) on 1 April 2012. Investors are understandably concerned about the long-term impact of this tax and the real effect on their investments.

Our research shows that although the change in the way dividends are taxed will impact your investment, the net effect of the latest change is relatively small. Any possible benefit or disadvantage should ultimately be weighed against your objectives, circumstances and risk profile, which should form the basis of your investment planning.

What are the key points?

Under STC companies were taxed on dividends distributed at a rate of 10 percent. With the recent changes, the liability for tax on dividends has shifted to the investor and the rate has increased to 15 percent.

Because the new tax is deducted from the dividends received, rather than paid by the company on top of dividends, the effective increase in the rate is slightly higher than five percent. The effect of these changes on existing investments, or investment planning, depends on the underlying unit trusts as well as the investment product.

Only a portion of your investment is affected

All other things being equal, the impact of the change in tax will be to reduce dividend income by a total of 6.5 percent, which will clearly make a difference to those relying on dividend payments.

But investment return is not just made up of dividends distributed by equities, it also includes capital growth and income from interest earned. As its name suggests, DWT only affects the dividend portion of your investment’s overall return. Therefore, the impact on your investment will differ depending on your asset allocation.

The effects of replacing STC with DWT are minimal in a well-diversified discretionary investment, but may be more marked for investors seeking to benefit from the potential for higher capital growth and associated higher dividend yields from equities.

The table below compares illustrative five-year investments into an asset allocation portfolio and an equity-only portfolio, taxed at 10 percent STC and 15 percent DWT. We used five-year returns to 31 March 2012 of the FTSE/JSE All Share Index (including income and gross of all tax) (ALSI: 7.53 percent), the All Bond Index (ALBI: 8.75 percent) and the Short-term Fixed Interest Index (STeFI: 8.4 percent) to represent performance in our example. Over this period, dividends made up 3.29 percent of the ALSI’s total returns. In this scenario, the impact of the change in tax on the final values is very small, even over a five-year period.

Final value of a R1000 investment over 5 years

*Asset allocation: 60% ALSI, 25% ALBI, 15% STeFI

**Equity-only: 100% ALSI

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