This tax workaround is closing soon

Investors with large, concentrated shareholdings have just over a year to act before a long-standing tax planning route is closed.

From January 1 2027, section 42 of the Income Tax Act – long used to exchange a concentrated shareholding for a diversified portfolio without triggering an immediate capital gains tax (CGT) event – will no longer apply to transactions involving collective investment schemes (CIS). National Treasury has now legislated the change, after years of signalling its intent.

Importantly, the rules remain unchanged until that date. Transactions implemented before then are still governed by the current regime, but the window to act is finite.

The appeal is obvious

Section 42 was originally designed to facilitate corporate reorganisations. Over time, however, it has found a second life in private wealth management.

In practical terms, it has allowed an investor holding a single share position – often with a large embedded gain – to exchange that position for a diversified portfolio via a CIS without triggering an immediate CGT liability. The base cost of the original shares rolls into the new investment, and the tax liability is deferred.

To illustrate: an investor holding listed shares worth R10m with a base cost of R2m has an unrealised capital gain of R8m. Selling those shares outright would trigger an immediate CGT liability – at the top marginal rate, roughly R1.4m. Under the current section 42 rules, an investor can instead transfer the shares to a CIS in exchange for participatory interests, deferring the CGT event. From January, that route closes.

In a country where many fortunes have been built through concentrated equity exposure – often via long-term holdings or participation in equity incentive schemes such as share option plans or restricted-share plans – this has been more than a technical provision. It has been a release valve.

It has enabled investors to reduce concentration risk, diversify globally, and reposition portfolios without the immediate tax drag that would ordinarily accompany such a move.

There comes a point in a family’s wealth journey where the protection of capital begins to outweigh the pursuit of maximum return. The ability to reorganise assets efficiently can play a meaningful role in achieving broader objectives – including risk management, succession planning and long-term capital preservation.

It is therefore not surprising that this approach has attracted scrutiny.

Concentration is the real risk

While the tax change is the catalyst, the underlying issue is not tax. The South African Revenue Service will collect in time. The more significant concern is concentration risk.

South African investors, perhaps more than most, tend to carry meaningful exposure to a single stock. Whether it is a long-held position in a retailer, a bank, a mining house or a dual-listed global proxy, portfolios often become increasingly dominated by what has worked in the past.

This is rarely a deliberate strategy. More often, it is the by-product of success combined with a reluctance to incur the tax cost of change.

The consequence is a structural imbalance: wealth becomes tied to a single corporate outcome, a single management team and a single set of risks. As the position grows, so too does the difficulty of unwinding it.

For executives and founders, there is often an additional dimension. The holding can represent years – even decades – of effort, identity and achievement embedded in one company. Recognising the need to diversify requires both financial discipline and emotional detachment.

Section 42 has, until now, provided a rational bridge out of this position. It has allowed investors to transition from concentration to diversification without an immediate tax penalty.

That specific pathway is now being curtailed.

Why the timing matters

Tax policy, when it shifts, tends to do so decisively. Once implemented, these changes rarely reverse in the same form.

January 1 may appear distant, but in practical terms, it is not. Structuring, evaluating and executing these transactions – particularly for larger portfolios or more complex ownership structures involving companies and trusts – can take time.

By the time the deadline approaches, the effective window to act may be significantly shorter than it appears today.

Alternative restructuring strategies may remain available, but the specific ability to achieve tax-neutral diversification through a CIS structure will be materially reduced.

There is no universal answer. Not every concentrated position should be unwound, and not every investor will benefit from a section 42 transaction. The suitability depends on individual tax profiles, portfolio objectives and long-term plans.

However, the nature of the decision has changed.

For investors with significant embedded gains in a single stock, the question is no longer whether the regulatory environment might change. It is how to respond within the time that remains.

The greater risk now may be allowing a concentrated position to persist by default – particularly in a shifting tax landscape.

There are moments in investing, as in tax, where inaction becomes a decision in itself.

Mark MacSymon is a wealth manager at Private Client Holdings and was awarded the Financial Planning Institute’s Financial Planner of the Year in 2017.

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