An investigation into the normal tax implications of a carried interest in South Africa

Abstract

‘Carried interest’ is not defined in the South African Income Tax Act 58 of 1962 as amended (the Act), nor has it been subject to scrutiny in South African courts. Uncertainty prevails regarding the classification of a carried interest for normal tax purposes in SA. This article investigated the possible normal tax treatment of a carried interest for a fund manager regarding the definition of a fringe benefit, or, alternatively in terms of the gross income definition of the Act. Distinction was made between the initial receipt of a carried interest and the subsequent cash flow therefrom upon liquidation of the fund. The effect of section 9C of the Act was also considered. The current normal tax treatment of a carried interest in the USA and the Netherlands facilitated an interesting comparison and provided some perspective. Finally, the effect of the guidelines formulated by the South African courts on the underlying investments of, and consequently on a carried interest in, an investment fund was also considered. It was concluded that the cash flow from a carried interest and its subsequent distribution to fund managers is capital in nature, except where one of three exceptions are present. The authors conclude that guidelines are required that consider the hybrid character of a carried interest. It is suggested that specific legislation is considered for the taxation of a carried interest. Such legislation must be researched to ensure that the change will not result in the withdrawal of foreign investment from South Africa, or an exodus of current resident investment funds.