Every year National Treasury notes its intention to make changes to tax legislation via the Taxation Laws Amendment Bill. While the Bill proposes many changes, we have selected a few of those proposals to explain below, what the consequences will be for financial planning.
Changes to the retirement fund contribution deduction
As of 1 March 2016, the calculation of retirement fund contributions tax deduction was harmonised to one calculation. Retirement fund members contributing to either a pension fund, provident fund or a retirement annuity fund (RA) can now claim a tax deduction of up to 27.5% against the higher of taxable income or remuneration. Previously however, a member contributing towards an RA could claim a deduction of up to 15% of non-retirement funded income. One of the unintended consequences of the legislation change meant that an RA member could no longer claim a deduction against ‘passive' income (e.g. interest, rental income). This is the case because Sec 11(k) of the Income Tax Act allowed for a deduction against income from ‘carrying on a trade’. The Bill now seeks to address this by allowing deductions for contributions to all retirement funds to be set off against passive income. If passed, the deemed effective date proposed is 1 March 2016.
Retirement annuity funds and emigration
Previous legislation required that an RA member living abroad had to ‘formally emigrate’ if they wanted to withdraw from their RA prior to retirement age. Formally emigrating meant applying to the South African Reserve Bank for approval however, foreigners working in South Africa who took out an RA to supplement their savings for retirement where unable to formally emigrate from South Africa. Then, in the 2015 Budget, National Treasury indicated that they would amend legislation to allow foreigners invested in a South African RA to withdraw from their RAs when they moved back home. The 2015 Taxation Laws Amendment Act catered for the anomaly however it changed the ‘formal emigration’ requirement to ‘no longer resident’ in South Africa.
This requirement is less onerous and South Africans living abroad who were no longer resident but hadn’t formally emigrated had the opportunity to withdraw from their RAs as well. National Treasury has now indicated in the explanatory memorandum of the Bill that this was an unintended consequence and the Amendment Bill seeks to address this by reverting back to the ‘formal emigration’ requirement for South Africans. This proposal is also set to be effective from 1 March 2016.
Trusts and tax
Just about every year we see treasury introducing ways to close tax loopholes used by trusts to avoid tax. This year is no different, and earlier in the year we saw the budget increase the effective capital gains tax rate for trusts to 32.8%.
Trusts are established without any capital of their own. Founders don’t usually just transfer assets into a trust as this will trigger capital gains tax (CGT). A loan account is usually set up in favour of the trust. Often no interest is charged by the lender and repayments are set off against the R100 000 donations tax allowance. Not only does the founder/lender avoid CGT, income tax and donations tax but the transferred asset no longer forms part of the estate of the lender upon death. Any amount outstanding on the loan account does however form part of the lenders estate upon death.
It is for these reasons that National Treasury intends to introduce Section 7C to the Income Tax Act. Effectively, Section 7C will entail the following:
- Lender to trust must charge interest at a market rate. In the Amendment Bill, National Treasury indicated that any interest not charged below the market rate should still be taxed in the name of the lender as deemed interest. This was challenged in industries’ comment on the Bill and the Second Batch of the Taxation Laws Amendment Bill released on the 23 September 2016 indicates that National Treasury accepts that an income tax instrument should not be used to address the avoidance of estate duty and donations tax.
They have therefore changed this proposal to indicate that any interest foregone will be treated as an ongoing donation and taxed accordingly on the last day of the year of assessment of the lender. The latest Bill also seeks to exclude certain types of trusts from Section 7C. Special trusts (set up for minors with a disability), vesting trusts, PBO trusts and certain other trusts will be excluded.
- The first Bill also indicated that the lender will not be able to use the annual R100 000 donations tax exemption to write down the loan. The second draft however does not include this provision.
- Sec 7C is proposed to be effective from 1 March 2017 but will apply to loans made prior to that date if there is still an outstanding amount.
Excess contributions to a retirement fund
Excess contributions to an RA for tax purposes could always be rolled over to the following tax year. With the 2016 tax changes - introduced by harmonisation of tax - pension fund members could for the first time also roll over contributions made after 1 March 2016 that didn’t qualify for a tax deduction to the following tax year. Another unintended consequence of the introduction of these tax changes meant that excess contributions made prior to 1 March 2016 to an RA or pension fund would not be allowed to roll over to the following tax year. The Amendment Bill seeks to address this by proposing that excess contributions to both of these funds before 1 March 2016 should be allowed to be rolled over and deducted in the following tax year. National Treasury has indicated that the roll-over relief for excess contributions will not apply to provident funds as provident fund members are not as yet required to purchase an annuity with two thirds of their fund value. We will probably see this align when annuitisation requirements are applied to provident funds which is currently scheduled for 2018.