South Africa: Proposed Amendments To Taxation Of Employee Benefit Plans Not Without Complications

Last Updated: 12 October 2011
Article by Hanneke Farrand and Caroline Rogers

Most Read Contributor in South Africa, September 2018

The Draft Taxation Laws Amendment Bill, 2011 (the "Draft Bill") contains proposed amendments that will give rise to certain income tax and employees' tax implications in respect of employee benefit plans.

The employer generally bears the obligation to make the contributions to the various insurers. On this basis, the practice is currently not to subject the contributions to the insurance funds to fringe benefits tax as a benefit paid or service rendered on behalf of the employees. The ultimate payments made to the employees, will, however, often then be subject to employees' tax.

Going forward, should the draft legislation be promulgated, the analysis will be more complicated.

proposed amendments to the seventh schedule

In terms of the amendments proposed in the Draft Bill, premiums paid by an employer in respect of insurance policies for the benefit of employees will constitute a taxable fringe benefit in the employees' hands. The Draft Bill proposes that a taxable benefit will arise in terms of paragraph 2(k) of the Seventh Schedule to the Income Tax Act, Act 58 of 1962, as amended ("the Act") where such a contribution is made.

The cash equivalent of this taxable benefit is calculated in accordance with the new paragraph 12C of the Seventh Schedule:

"(1)

The cash equivalent of the value of the taxable benefit contemplated in paragraph 2(k) is the amount of any contribution or payment made by the employer in respect of a year of assessment to any insurer ...... in respect of any premiums payable under a long-term insurance policy directly or indirectly for the benefit or on behalf of the employee or his or her surviving spouse, child, dependant or nominee.

(2)

Where any contribution or payment made by an employer contemplated in subparagraph (1) is made in such a manner that an appropriate portion thereof cannot be attributed to the relevant employee, the amount of that contribution or payment in relation to that employee is deemed ..... to be an amount equal to the total contribution or payment by the employer to the insurer during the relevant period for the benefit of all employees divided by the number of employees in respect of whom the contribution or payment is made.

(3)

If in any case the apportionment of the contribution or payment amongst all employees in accordance with subparagraph (2) does not reasonably represent a fair apportionment of that contribution or payment amongst the employees, the Commissioner may direct that the apportionment be made in such other manner as to him or her appears fair and reasonable." [our underlining]

The Draft Bill provides that the application of paragraphs 2(k) and 12C(1) will be retrospective and will be deemed to have come into operation on 1 January 2011 and apply in respect of premiums incurred on or after that date. (However, the Explanatory Memorandum refers to the effective date as being any year of assessment commencing on or after 1 January 2011, which will make the effective date 1 March 2011.) The exact date of implementation and whether or not the changes will be implemented retrospectively is therefore not entirely clear.

proposed amendments to "gross income" definition

proceeds

The proposed amendments to the Act also aim to clarify the tax implications of proceeds derived from long-term insurance policies. The amendments have the effect of initially including all amounts, directly or indirectly received or accrued from an insurer, into the gross income of the recipient.

In principle, the amendments aim to achieve the result that if the premiums were funded with post-tax contributions, the policy proceeds will be tax-free, whereas if the premiums were funded with pre-tax contributions, the policy proceeds will be taxable.

It is proposed that paragraph (m) of the gross income definition be amended to include any amount directly or indirectly received or accrued from any long-term insurer.

exemptions

However, an exemption is proposed where the proceeds of a long-term insurance policy are received by or accrue to a person other than the policyholder.

Insurance proceeds received by a non-policyholder beneficiary, for example, the employee, will be tax exempt only if all the premiums did not "rank for" a deduction by the policyholder (we assume this means that the employer did not deduct the contributions for tax purposes). This is, however, subject to the exception that even if the premiums were claimed as a deduction, the policy proceeds will be fully exempt as long as the contribution was taxed as a fringe benefit in the hands of the employee.

However, if the taxable premiums were deducted by the employee in his/her tax return, the proceeds of the policy will be taxable in the employee's hands.

An apportionment mechanism is proposed where "tainted contributions" are made, for example, deducted without a corresponding fringe benefit or with a corresponding fringe benefit deducted by the beneficiary. The exempt portion of the policy proceeds is then limited to the amount of the "non-tainted" premiums contributed.

Accordingly, the effect of the above proposed amendments appears to be to match the taxation of the proceeds to the deductibility of the premiums.

The Draft Bill proposes a further exemption in terms of the proposed new section 10(1)(gG) of the Act in respect of insurance proceeds received by a policyholder to the extent that the premium contributions were not deductible. Section 10(1)(gG) exempts from tax:

"(i)

if no amount of any premium was deductible in respect of any policy as defined in section 29A, any amount received by or accrued to a policyholder in respect of that policy;

(ii)

in any other case, an amount equal to the aggregate amount of any premiums that were not deductible by a policyholder in respect of that policy"

Read together with the proposed amendment to paragraph (m) of the gross income definition in section 1 of the Act set out above, the draft amendments contained in section 10(1)(gG) could result in a gross income inclusion for the policyholder (which in most instances would be the employer), in respect of policy proceeds received by or accrued to it, to the extent that the premiums were deductible.

It is proposed that the above amendments will come into operation on 1 January 2012. We believe this to be a drafting error and assume that the final legislation will introduce co-ordinated dates of implementation to coincide with the date on which the contributions become taxable.

deductions

Subject to certain exceptions, section 23(m) of Act disallows the deduction of section 11 expenses against remuneration.

The Draft Bill broadens the exceptions currently contained in 23(m)(iii) which applies to amounts qualifying under section 11(a) as insurance premiums paid on an income-protection policy to the extent that they cover a loss of income caused by illness, injury, disability or unemployment and the amounts received in terms of the policy constitute or will constitute 'income' as defined in section 1.

The exception will be broadened in that it now also includes such contributions or payments made by the employer.

conclusion

The draft legislation provides welcome certainty to the taxation of contributions to and payments made by various long-term insurance funds. It is, however, clear that the implementation and administration of the proposals appear to be quite complex.

Employers will have to keep accurate record of the contributions made and how they were treated for tax purposes to ensure that the payment made to employees is correctly treated for employees' tax purposes. This monitoring process could become even more complicated if employees claimed deductions for contributions against their remuneration in terms of the broadened section 23(m) which the employer was not aware of.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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