EMPLOYEE BENEFITS AND RETIREMENT PLANNING

According to Broomberg, (Tax Strategy), most people at the best of times dislike paying tax; but nothing infuriates them more than the knowledge that others (in like circumstances) are honestly and legitimately paying less tax.

Any retirement plan should form part of an overall plan for minimizing both income tax and estate duty (which will be covered by a separate module). Its principle objectives should be to ensure that an individual will have sufficient income to meet his needs after retirement, and once this objective is secured, to achieve the greatest possible saving in taxation on benefits receivable at or subsequent to retirement.

It is, therefore, evident that while there is a need for tax awareness, a sense of proportion must be retained. In addition one must remember that the parties to an agreement often find themselves in an adversary situation when it comes to tax planning. While the ultimate goal would be exemption from tax for the recipient and simultaneously an allowable deduction for the paying party, this situation will only in rare cases materialise.

Tax planning would thus entail the minimization of net remuneration subject to taxation by recognising all exempt income and claiming all permissible deductions. Not only is exemption important, but advantage should also be taken of deferral opportunities, for tax rates may alter, the status of the taxpayer may change, tax rules may be varied and the time value of money as well as inflation should always be borne in mind.

This module is not intended to be a complete summary of all relevant aspects of employee benefit and retirement planning but is rather meant to focus your attention on some important sections which could be useful in this regard. You are therefore referred to your prescribed text-books for more detailed information, especially Broomberg, Chapters 15 to 19. Read the book in consultation with the Seventh Schedule of the Income Tax Act.

See also Silke Chapter 4

It goes without saying that the Seventh Schedule of the Income Tax Act should not merely be read but studied in detail, especially the exemptions and exclusions since these are the aspects which encourage tax planning.

2 ANNUITIES

The term "annuity" is not defined in the Act, but in ITC 761, 19 SATC 103, the court outlined the

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following characteristics:

- fixed, annual payments which might be divided into instalments

- the payment is repetitive - even if made, say quarterly, during the year

- it is chargeable against some person i.e. there is an obligation to pay (voluntary payments, even if they are repetitive, do not constitute an annuity).

Receipt by employee

Par (a) of the definition of gross income specifically includes in gross income any amount received or accrued by way of an annuity. This paragraph overrides the capital provision of the general definition and as a result any annuity automatically falls into gross income. However, if already taxed in a foreign country, a tax rebate is given for foreign taxes paid.

An annuity can lose its character in certain statutory circumstances. Dividends are a good example (why? - statutory exception - see section 10(2)(b) and paragraph (a) of the definition of 'gross income’). If an annuity is received from a trust and portion of the annuity consists of interest received by the trust, then there is an argument that the first R21 000 (R30 000 for a person 65 and older) interest received by the individual is exempt from tax (section 10(1)(i)). The aspect of the 'conduit pipe’ principle in regard to trusts will be dealt with in the module on estate planning.

An employer may deduct annuities paid to former employees and former partners (provided certain conditions are met) in terms of section 11(m). The amount which may be deducted is unlimited. The amount that can be deducted (provided it is not excessive) is unlimited. Annuities paid to dependants of former employees or former partners are also allowed as a deduction.

LUMP SUM PAYMENTS ON TERMINATION OF SERVICE

Any lump sums (other than lump sums from pension, provident or retirement annuity funds) will fall into gross income either in terms of par (c), (d) or (f) of the definition. Where the recipient receives such amounts because of retirement due to ill health, infirmity or superannuation it will be taxed subject to the provisions of section 10(1)(x), section 7A(4A)

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and section 5(10).

These provisions (paragraphs (c), (d) and (f)) thus ensure that any amount received as a consequence of employment will be included in gross income regardless of the fact that such receipt might be of a capital nature. Where a contract of employment was prematurely terminated by agreement and the taxpayer received payment of the amount he would have been entitled to had the contract run it's course, the amount was held to fall into gross in-come (ITC 517, 12 SATC 263). The same will apply where the taxpayer is paid in lieu of notice (ITC 63, 2 SATC 253) or leave (but see the section 10(1)(x) provisions).

ROT payments

In terms of para (cA) of the definition of “gross income” any compensation received by or accrued to a natural person, labour broker or personal service provider in respect of a restraint of trade after 23 February 2000 is now included in such person’s “gross income”. Note that paragraph (cA) does not refer to a company or close corporation. Prior to that date such compensation was regarded as a receipt of a capital nature both in the hands of individuals and trusts and companies.

However, section 11 (cA) was introduced and such compensation when included in the abovementioned person’s “gross income” may be deducted over the number of years in respect of which the restraint is in force or three years, whichever is the longer period, by the payer (employer).

Payments on termination of service

Section 10(1)(x) provides for an exemption of R30 000 per taxpayer of amounts received under par (d) of the definition of gross income (i.e. lump sums and not annuities) or if the requirements of section 7A(4A) are met. This exemption is applied cumulatively and both husband and wife qualify separately for this exemption.

Please read and study paragraph (d) of the definition of “gross income”, section 10(1)(x) and section 7A(4A).

In terms of section 7A(4A) such lump sum amount (where certain requirements are met) will be taxed according to the rating formula contained in section 5(10). However, in order to avoid any abuse of this concession, section 5(10)(d)(iA)(bb) limits the total amount qualifying to the lesser of

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- the taxable amount of the gratuity; or

- three times the annual average salary received during the preceding three years.

It is the practise of revenue to regard accumulated leave pay paid to a retiring employee as a payment which qualifies for the section 10(1)(x) and section 7A(4A) relief.

See also section 5(10)(f) in relation to the average rate of tax to be used for any lump-sum received.

Payment by employer (deductibility)

In the production of income

A deduction may only be claimed in respect of expenses incurred for the purpose of producing income for the employer (section 11(a)). Furthermore, there must be a reason-ably close connection between the expenditure by the employer and the production of his income: And a retired employee does not normally produce income for his ex-employer.

See ITC 1326, 43 SATC 44, where, in its return of income for the tax year ended 28 February 1975, the appellant, a private company whose sole shareholders and directors were A and B, sought to deduct the sum of R9 000 paid out, in the circumstances hereinafter stated, to B as ‘compensation award to retiring director’. The deduction was disallowed. Both A and B worked for the company until B became suddenly ill in mid-1974, after which date his services to the company were hardly more than nominal. In October 1974, B disposed of his shares in the company and in December 1974, discontinued participating in the operations of the company. In October 1974, the company concluded a service contract with A, B, Mrs C and D. The purpose of this contract was stated thus: ‘To remunerate employees who have devoted long years of service to the company by the time of their retirement’. After recording that retirement age meant the normal retirement age of 65 years, the contract continued: ‘If the employee retires from the employment of the company at retirement age or due to ill health or other infirmity before retirement age, the company will pay an amount set out in a separate annexure hereto.’ In terms of the annexure, A and B were each to receive a gratuity of R9 000 and Mrs C and D were each to receive R1 000. After B’s retirement in December 1974, it was decided to pay him the amount of R9 000 (being the amount in issue) as at the end of the tax year (namely 28 February 1975) upon which date B entirely ceased to be employed by the company.

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At the hearing before the Special Court it appeared that the directors’ remuneration for the year ended 28 February 1974 was R40 000, divided approximately equally between A and B. For the tax year ended 28 February 1975, the relevant amount was R31 000, of which A received R26 000 and B R5 000.

Held:

That appellant had failed to discharge the onus of showing that the R9 000 in issue had been paid out in the production of income and that the said sum was, therefore, not deductible.

Voluntary awards on retirement of employees do not stand on the same footing as bonuses payable to staff from whom continuing service can be expected. So, where the taxpayer made ex gratia payments to retired employees in recognition of past services, the finding of the court was that the payments were not expenditure in the production of income.

In W F JOHNSTONE & CO LTD v CIR, 1951(2) SA 283(AD), 17 SATC 235, the appellant company had established a superannuation and provident fund for the benefit of its employees in the year 1934. At that date certain of its employees were too old to be given the benefit of the provisions of the fund. In the year of assessment ended 30th June, 1945, four of these employees retired from the service of the company. One was awarded a pension of £10 a month and to the other three gratuities were paid on retirement. The resolution of the Board of Directors under which these gratuities were paid recorded that the payments were made ‘in recognition of services rendered to the company’.

The Commissioner for Inland Revenue having disallowed the deduction of these amounts in the determination of the appellant’s taxable income, the company appealed to the Special Court for Hearing Income Tax Appeals.

The Special Court dismissed the appeal and confirmed the assessments made by the Commissioner, holding that the payments did not form part of the ordinary operations undertaken by the company for the purpose of conducting its business, nor were they payments made for the purpose of earning income, nor were they payments made wholly and exclusively for the purpose of appellant’s trade.

In the case stated by the Special Court, it was set out that: ‘the policy of appellant’s Board was to “look after” its employees. This involved the making of various payments in proper cases to or for the benefit of the employees over and above the company’s legal obligations to them. The Board considered, and found, that this policy tended to aid efficiency, and the payments herein referred to were in conformity with the policy.’

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In giving judgment the President of the Special Court said: ‘It does not appear that such a policy had been pursued in the past. These gratuities were the only cases. The Court therefore is of opinion that these were extraordinary payments and that the real reason that influenced the directors in making them was in recognition of past services rendered to the company.’

On appeal from the decision of the Special Court it was contended on behalf of the appellant that the statement in the stated case that ‘the payments herein referred to were in conformity with the policy’, was a finding of fact by the Special Court that the payments had been made in pursuance of the stated policy of the Board of the company, and that this finding of fact was decisive, subject to there being evidence upon which it could be found.

Held, dismissing the appeal, that in view of the fact that the judgment was to be regarded as part of the statement of case, any finding of fact in that judgment must be regarded as a finding of fact set out in the statement of case;

Held, further, that once the Special Court had given judgment it was functus officio and could not modify any finding of fact in its judgment in any subsequently prepared statement of facts; consequently any finding of fact in the judgment must prevail over any statement included in the stated case;

Held, further, that as it had been found that the payments were made in respect of past services, they did not constitute ‘expenditure and losses actually incurred in the Union in the production of the income’ nor were they ‘wholly and exclusively paid out or expended for the purposes of trade’ (this was the previous requirement of section 23(g), which now refers to the ‘extent . . . laid out for the purposes of trade).

Per Curiam: The fact that payments made constitute income in the hands of the recipients is irrelevant to the question whether such payments are admissible deductions.

Where the payments (although voluntary) are designed, not merely to reward past services, but also as an established policy to promote settled conditions of employment and through these the production of income, they are deductible. A policy of this nature tends to promote a happy and contented staff; each individual is thereby motivated to remain with the employer and to generate income for him in the future.

Please note that, in the past, an appeal could only be made on the basis of law, not on facts. An aggrieved taxpayer may now appeal on both the law and the facts.

In PROVIDER v COT, 1950(4) SA 289, 17 SATC 40, the appellant company had inaugurated

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two schemes for the benefit of its employees – a ‘Life Assurance Scheme’ and a ‘Service Bonus Scheme’. In terms of these schemes, which were non-contributory, and could be withdrawn at will by appellant company, the company undertook to pay, firstly, a bonus upon retirement to any employee who had been in the company’s service for a certain period, and, secondly, a benefit to the dependants of men who died in the company’s service, the amount of the bonus or benefit, as the case might be, being graduated in accordance with length of service.

In their income tax return for the year ending 31st March, 1949, appellant company sought to deduct, as ‘expenditure actually incurred by the employer in the production of income’, an amount representing payments made during that tax year in terms of these two schemes. The Commissioner of Taxes allowed as a deduction the amounts paid as bonuses but not the amounts paid as benefits to dependants.

Held, allowing the appeal, and directing the Commissioner to alter his assessment, that no clear distinction could be drawn between the two sets of payments and that since both were clearly designed by appellant to induce appellant’s employees to enter and remain in appellant’s service, they could be validly deducted as constituting expenditure actually incurred in the production of income.

An employer could also succeed where he is obliged to effect the payment to the employee by reason of the provisions of an existing contract of employment which would be especially persuasive where the contract was entered into at the inception of employment.

KEY-MAN INSURANCE POLICIES

In order to provide for liquidity at the time of termination of services or office, an employer may take out an insurance policy on the life of his employee or director. The maturity value of such a policy will normally more or less correspond with the lump sum to be paid to the employee or director at the time of termination of services or office.

Receipt of an amount in terms of a policy

Such amounts are covered by par (m) of the definition of gross income and are thus taxable, but only if any premium paid in respect of the policy is or was deductible from the taxpayer's income whether in the current or any previous year of assessment.

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ANTEDATED SALARY OR PENSION

Section 7A(2) provides the taxpayer with the option to have the antedated amount spread over the accrual period but limited to two years before the commencement of the tax year in which the antedated amount is received (in which case it can be taxed in 3 equal annual instalments). This could be used to good effect in cases where the employee's marginal rate of tax in prior years was lower than the current year maximum rate for the individual person.

Read and study this section.

ENTERTAINMENT ALLOWANCES AND DEDUCTIONS

Such amounts will be deemed to have been received by the employee for services rendered (par (c) provision (iii) of the definition of gross income).

An entertainment allowance no longer qualifies as a deduction, even if such expenditure can be proved to be expended in the production of income. See also section 23(m) in this regard.

TRAVELLING, SUBSISTENCE AND OTHER ALLOWANCES

An allowance paid to a taxpayer in respect of expenses of travelling, subsistence or any other service as the Commissioner is not satisfied was actually expended on such travelling, subsistence, or other service is included in gross income (section 8(1)). They are therefore not per se income receipts but are deemed to be such to the extent that the Commissioner is not satisfied that it has been so spent. This section was also amended in 2002 and must be read and studied.

note that deemed private distance travelled is 18 000 km per annum unless a logbook is kept which proves that a lower distance is travelled for private purposes. The travel allowance is also subject to PAYE on 60% of the allowance. Also note that, for the 2009 fiscal year, for any vehicle with a value (including value-added tax), the deemed expenditure may not be claimed on an amount exceeding R400 000.

Subsistence - Section 8(1)(c)

A subsistence allowance may be granted in the following circumstances:

- The recipient proves to the Commissioner how much he spent on expenses in respect of accommodation, meals, or other incidental costs while away on business. This is limited to the amount of the subsistence allowance, so the recipient cannot use this

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provision to get a deduction from his taxable income.

- Alternatively, the exclusion for each day or part of a day that the recipient is away from his or her usual place of residence is, but he or she must be away from his or her usual place of residence for at least one night.

- An amount per day in respect of meals and other incidental costs, as determined by the Minister by way of notice in the Government Gazette for the year. The Minister will set the limits for inside and outside South Africa. These limits are:

a) Where the accommodation to which that allowance or advance relates is in the Republic, an amount equal to -

i) R73,50 if that allowance or advance is paid or granted to defray the cost of incidental subsistence expenses only; or

ii) R240 if that allowance or advance is paid or granted to defray the cost of meals and incidental subsistence expenses;

b) where the accommodation to which that allowance or advance relates is outside the Republic, an amount equal to US$215, plus accommodation costs.

- The daily exclusion is limited to the actual allowance and does not apply where the employer has borne the expenses in respect of which the allowance was paid or granted for that day or part of that day.

- The $215 per day does not apply in the Rand Monetary Area (Common Monetary Area), i.e. South Africa, Namibia, Lesotho, and Swaziland.

- Normally the subsistence allowance only applies to continuous periods not exceeding six weeks away from home.

SHARE OPTIONS

Section 8A, dealing with share options, was deleted with effect from 26 October 2004 (although the provisions are still relevant for transactions entered into before that date) and replaced with sections 8B and 8C. Please read and study these sections carefully. FRINGE BENEFITS

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In terms of par (i) of the definition of gross income in section 1, gross income includes the cash equivalent, as determined under the provisions of the Seventh Schedule, of the value during the year of assessment of any benefit or advantage granted in respect of employment or to the holder of any office, being a taxable benefit as defined in the Schedule.

The Seventh Schedule, therefore

- determines all taxable benefits; - contains the rules for determining the value of taxable benefits; and- determines the cash equivalent of the value of taxable benefits.

Taxable benefits, which are granted by an associated institution, will be deemed to be granted by an employer to an employee (par 4).

Par 16, in turn, provides that an employee is deemed to have been granted a taxable benefit if as a benefit or advantage of or by virtue of the employee's employment or as a reward for his services

- it is granted to a relative of the employee; or - anything is done by the employer under any agreement, transaction or arrangement so

as to confer a benefit or advantage upon any person other than the employee and such benefit or advantage, if it had been granted directly to the employee, would have constituted a taxable benefit to him or her.

Note (this is very important) that it must be a benefit or advantage of or by virtue of the employment or as a reward for services rendered or to be rendered by the employee to the employer. If the cause or reason for the benefit is something else, the benefit is not a taxable benefit. Please be aware of this principle before attempting the assignment.

In ITC 1626, 60 SATC 17, a loan was granted to an employee by an employer with no interest payable. The taxpayer received director’s remuneration from the company. Owing to financial pressure the company’s bankers required guarantees from the taxpayer before the company’s overdraft facility was extended. The bank was willing to accept life insurance policies in support of the guarantee. The taxpayer took out insurance policies on his life and ceded them to the bank. The taxpayer was unable to pay the premiums, hence the company advanced the said premiums and debited the taxpayer’s existing loan account with the amounts thereof, interest free. The question was whether the interest-free loan from the company was a benefit to be taxed in the hands of the taxpayer in terms of paragraph 2(f) of the Seventh Schedule to Act 58 of 1962.

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Held that, notwithstanding the relationship of employer and employee, the interest-free loan was not granted by way of an advantage or asset from or as a result of taxpayer’s employment with the company and hence not taxable in his hands. Held accordingly, that the interest-free loan had been granted to the company in order to enable the taxpayer to take out the policies in question and to maintain them to the advantage of the company. Held accordingly that the payment of premiums by the company and the debiting of the taxpayer’s loan account with the amounts thereof, created a convenient, practical method to advance the company’s own interests and in no way fell within the ambit of paragraph 2 of the Seventh Schedule to Act 58 of 1962. Held that paragraph 2 only comes into operation if there is a causal connection between the employee’s employment and the granting of the advantage. Held, accordingly, that the interest-free loan in no way was a result of or a consequence of the office held by the taxpayer in the company.

Although not dealing with fringe benefits, the case of STANDER v CIR, 59 SATC 212, illustrates three major considerations in analysing a problem area, namely, the importance of identifying the relationship between parties (employer - employee, professional - client, etc) and causality.

In STANDER’S case, the taxpayer was an employee of a certain franchise dealer. The franchiser decided to award a prize to the top five employees of certain franchise dealers. The taxpayer was adjudged one of the top five bookkeeper/accountants of one of the franchise dealers. In recognition of achieving excellent standards of performance in financial management he was awarded a prize consisting of an overseas holiday for himself and his wife. The cost to the franchiser of the trip amounted to R14 000. Commissioner for Inland Revenue assessed to tax the value of the said prize as R14 000. The question before the court was whether such award fell within the definition of ‘gross income’ in s 1 of the Income Tax Act 58 of 1962. Common cause was that the award to taxpayer was of a fortuitous nature like an ordinary donation it was an award of a capital nature and therefore did not fall within general opening paragraph of definition of ‘gross income’.

Held that if taxpayer assessable to tax on the prize it could only be on the basis that the prize in question fell within the ambit of para (c) of the definition of ‘gross income’ in s1 of Act 58 of 1962 (the prize was not taxable in terms of paragraph (i) of the definition of 'gross income’ because there was no employer - employee relationship between the employee of the franchise dealer and the franchiser). In order to fall within provisions of para (c) of definition of ‘gross income’ taxpayer must have received ‘an amount’ which would include a ‘voluntary award’ and ‘amount’ would have had to be ‘in respect of services rendered’ or ‘by virtue of any employment or the holding of any office’. Held that, having gone on the trip, the taxpayer had not received any ‘property’ on which a monetary value could be placed in

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his hands and it did not constitute a right that could be ‘turned into money’. Held that, having regard to the conditions applicable to the enjoyment of the award, the said trip had no ‘value’ in the taxpayer’s hands, which brought it within the terms of para (c) of the definition of ‘gross income’. Held further that trip could not be said to have been given ‘in respect of services rendered’ as taxpayer had rendered no services to franchiser but had rendered services to his employer and fact that his services were beneficial to franchiser did not mean that award had been received ‘in respect of’ services rendered. Held further that taxpayer also did not receive award by virtue of ‘the holding of any office’. Held accordingly that prize in question was on no basis subject to tax and should not have been included by Commissioner as part of taxpayer’s income.

Please note that the case also dealt with the principle that if an amount is not money’s worth or cannot be turned into money’s worth then it cannot be taxable. This was obiter (an aside) and was not necessarily for the purposes of the decision in this case. See BRUMMERIA PROPERTIES.

Please note that the Seventh Schedule to the Income Tax Act does not provide for any exemptions. Instead it allocates a 'nil’ value to certain fringe benefits. The difference between an 'exemption’ and a 'nil’ value is important because if a fringe benefit were exempt in terms of the Seventh Schedule, the Commissioner could tax it under the provisions of paragraph (c) of the definition of 'gross income’. Paragraph (c) contains six provisos, the first of which reads as follows:

'The provisions of this paragraph shall not apply in respect of any benefit or advantage in respect of which the provisions of paragraph (i) apply.’

By giving the fringe benefit a 'nil’ value in the Seventh Schedule the legislature has made this fringe benefit subject to the provisions of the Seventh Schedule. This, in turn, means that the Commissioner cannot tax this fringe benefit under paragraph (c). The overall result is that these fringe benefits with 'nil’ values in the Seventh Schedule become tax-free benefits to the employee recipient thereof.

Acquisition of asset at less than actual value

Note that movable property (other than marketable securities), acquired by an employer to give to his employee, or trading stock (other than marketable securities) may be disposed of at cost (or the market value in the case of stock where the market value is lower than the cost) without any taxable benefit accruing to the employee.

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Also take note of the assets falling under par 5(3) on which no value is to be placed. See also par 5(2)(a) relating to long service and bravery awards, where the value of an asset awarded to an employee which does not exceed R5 000 has a nil value.

Right of use of any asset (other than residential accommodation or any motor vehicle)

Once again note the benefits on which no value will be placed. See par 2(b) and 6.

Right of use of motor vehicle

If the employee is granted the right to use the vehicle twelve months or more after the employer first acquired the vehicle or the right of use of the vehicle, the determined value thereof is reduced by 15% on the reducing balance method for each completed 12 month period from the date on which the employer first obtained the vehicle or right of use to the date on which the employee is first granted the right of use.

The determined value of a specific vehicle would as a result remain unchanged if it was allocated to any one employee for a number of years. By swopping vehicles (between employees) on a regular basis (eg. yearly), a substantial reduction in the determined value of the vehicle and the taxable benefits could be achieved, although the practical implications thereof should also be considered.

Par 7(7) provides that where accurate records of private use are kept, the Commissioner may reduce the value placed on private use if such travelling for the year is less than 10 000 Km.

No value is placed on the private use of vehicles in some instances eg. when the vehicle is available to and is in fact used by employees of the employer in general, etc.

The fringe benefit on company cars is calculated at 2,5% of its cost per month, while the benefit on a second car is 4% of its cost per month. The cost excludes the VAT portion paid.

Meals, refreshments and refreshment vouchers Note the situations where no value will be placed upon this benefit. See par 8.

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Residential accommodation

See par 2(d) and 9.

The formula (set out in par 9(3)) used in calculating the value of residential accommodation is as follows:

a) the taxable value of the employer provided housing is calculated on the basis of 17%, 18% or 19% of remuneration.

(b) if the employer does not own the property, the greater of the cost of the accommodation to the employer or the formula will be the basis of the tax valuation unless the provisions of paragraph 3A(b) are met in which case the formula applies.

(c) An abatement equal 54200 is deducted from the employee's remuneration factor in calculating the value of such residential accommodation. A valuable fringe benefit could thus be given to an employee earning a low salary (by supplying a house or flat as part of his remuneration package.

"Nothing is added to the value of C where board, meals or water are supplied with the accommodation. The supply of board or meals as part of residential accom-modation is excluded from the taxable benefit [in par 2(c)] ... and therefore escapes taxation. Foodstuffs such as groceries not in the form of a prepared meal and beverages supplied to the employee at the expense of the employer constitute, it is considered, taxable benefits under ['acquisition of asset at less than actual value']...

The supply of services (cleaning staff, etc) at the cost of the employer will fall under ['free or cheap services']... Repairs to and maintenance of the accommodation at the cost of the employer will however be part and parcel of the provision of residential accommodation".

Regarding holiday accommodation, (paragraph 9(4)(a)), in cases other than where the employer hires accommodation from a person other than an associated institution, the taxable benefit is calculated at the prevailing daily rate at which it would normally be let to any non-employee.

Where the holiday accommodation is hired from a third party, the actual rental paid by the employer is taxable in the employee’s hands.

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Free or cheap services

Refer to services upon which no value will be placed and in particular to transport services by an employer to convey employees between their home and work. The right of use of a motor vehicle

cannot be supplied to each and every employee but such benefit could in part be substituted by this benefit.

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PENSION, PROVIDENT AND RETIREMENT ANNUITY FUNDS

Receipts from a pension, provident and retirement annuity fund arise in one of three ways and may take the form of a lump sum payment, or an annuity or a combination of these. The three events which give rise to receipts from such funds are resignation, retirement and death.

One of the requirements of pension and retirement annuity funds is that not more than one third of the annuity due from the fund may be commuted for a single payment (lump sum) which means that members of such funds are obliged to take at least two thirds of their benefits in the form of an annuity. The definition of a provident fund does not contain such a requirement and consequently benefits from such funds usually take the form of a lump sum only.

Annuities

Annuities from pension and retirement annuity funds fall into gross income in terms of par (a) of the definition if they are received from a South African source. Annuities from a non-South African source may be deemed to be partly from a South African source in terms of section 9(1)(g). This section applies if the services in respect of which the annuity is granted, were performed within the Republic for at least two years during the ten years immediately preceding the date on which the annuity becomes due.

This concession is still available in spite of the new legislation which deems a South African residents’ worldwide income from 1 March 2001 to be included in his “gross income”.

Lump sums

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Lump sum benefits received by or accrued to a member of a pension, provident or retirement annuity fund to the extent that they are derived from a source within or deemed to be within the Republic, are also taxable (par (e) of the definition of gross income) but only in respect of amounts determined in accordance with the provisions of the Second Schedule. Note that section 9(1)(g) will also be applied in the case of lump sum benefits.

As from 1 October 2007, the taxable portion of a lump sum is the lump sum, less R300 000, less any contributions that have not been allowed as a tax deduction, plus any tax-free portion previously claimed.

TAXABLE PORTION OF THE LUMP SUM RATES OF TAXR0 – R300 000 18%R300 001 – R600 000 R54 000 + 27,5% of the amount in excess of

R300 000R600 001 + R135 000 + 36% of the amount in excess of

R600 000

Lump sum benefits on resignation enjoy an R1 800 exemption and are taxed at the average rate. The taxable lump sum cannot be set-off against any assessed loss to the taxpayer.

Contributions by employer

Contributions to any pension fund, provident fund or benefit fund (but not to a retirement annuity fund) for the benefit of the employee will be allowed in terms of section 11(1)(l) (see maximum limit of 10% of approved remuneration of the employee imposed in terms of section 11(1)(l). In practice, however, Revenue allows an amount of up to 20% of the approved remuneration of the employee).

An amount paid by an employer to a pension fund in compensation for a loss by the fund was held not to be a deductible contribution on the ground that it was not a contribution in terms of the fund's constitution and therefore not a contribution within the meaning of the section (ITC 904 (1961), 24 SATC 84).

Note that an employer's contributions to medical aid, pension funds, benefit funds etc. on behalf of his employees are not considered to be taxable benefits in their hands. However, there are restrictions, for example, in respect of medical aid payments. Salary Sacrifice

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Salary substitution, that is, offering fringe benefits in return for a reduction in cash salary, is a perfectly valid method of structuring and employee’s remuneration package.

In KBI v BOTHA, 62 SATC 264, the taxpayer had been in the service of the Free State Technikon as a buyer and had used his private motor vehicle in carrying out his duties. In the ordinary course of his employment, the taxpayer received an annual service bonus. The taxpayer launched a scheme in terms of which the existing annual service bonus could be converted into a motor vehicle allowance and in respect of which all teaching and administrative personnel could exercise a choice either to receive the annual service bonus at the end of their birthday month, or not receive an annual service bonus but to receive a monthly motor vehicle allowance instead. In other words, the annual service bonus was converted into a monthly motor vehicle allowance. The memorandum that was sent by the Registrar to all teaching and administrative staff stated, inter alia that “the advantage of a motor allowance is that the tax rate is currently significantly lower than in the case of the service bonus. In addition, it will improve the monthly cash flow of personnel”. The taxpayer exercised his choice in favour of the motor vehicle allowance and received a total amount of R3 654,12 as a motor vehicle allowance during the year in question. He claimed an amount of R2 484,96 in respect of travelling costs against the allowance. The Commissioner disallowed the amount of R2 484,96 as a deduction in respect of travel costs on the basis that the election between a service bonus and a motor vehicle allowance by an employee amounted to a concealment of the material facts, which gives rise to an abnormality as intended in section 103(1) of the Act. The taxpayer’s evidence in the Special Court revealed that he had accepted the motor vehicle allowance because he regarded it as compensation for travel expenses which he had incurred and which were previously not reimbursed by his employer. He stated that he would have exercised his choice in favour of the motor vehicle allowance even if it had held no tax advantage for him.

The issue was whether a salary which is substituted for a fringe benefit is an abnormal transaction for the purposes of section 103(1) (and now section 80A).

The court held that the test for abnormality was an objective test and is measured against the practices of commerce, that is, “entered into by ordinary businessmen”. That by virtue of his position as a buyer, the taxpayer was obliged to incur travel expenses in the course of carrying out his duties and he was therefore entitled to a motor vehicle or travel allowance in the ordinary course and for his employer to give him a choice to convert his annual service bonus into a monthly motor vehicle allowance in such circumstances was the normal action of a reasonable businessman and it was also seen as such by the taxpayer. That, objectively viewed, there was nothing abnormal in the scheme as proposed or in the transaction as concluded between the taxpayer and his employer; on the contrary, it bore the hallmark of a realistic and fair arrangement between reasonable businessmen. That, further, no room

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existed to label the agreement as a sham transaction. Accordingly, section 10391) could not be applied in the circumstances.

The Commissioner had previously won his case in relation to salary substitution. In the earlier case the Commissioner was able to show that not all the employees knew about the scheme or if they did, they did not know how it worked and they never individually agreed to the salary substitution. Thus, in cases where a salary substitution is contemplated, the employee must know about the scheme and agree formally to such scheme to be implemented for the salary sacrifice to be valid.

Therefore, where an employer intends to introduce a salary sacrifice system, he must ensure that the employees are aware of and understand what is happening and that both the employer and employee agree formally to the substitution or sacrifice.

Correct personal tax planning can achieve large savings in taxation. It is important, however, not to forget when devising a remuneration package or a retirement plan, that an individual still needs money to live on. It is no use for him to have the best car in South Africa (because the tax man is ultimately paying a substantial portion of the car costs) if as a result he cannot afford to pay the bond costs on his residential home, or even purchase food for his family.

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