Manual

LEVEL 4 SKILLS PROGRAMME

Self Study Guide

Introduction

1

Purpose

1

Linked Unit Standards

1

Notes to the Learner

2

Introduction to Long Term Insurance Category B

3

Module 1

The Income Tax Act

4

Learning Outcomes

4

Introduction

5

An Overview of Personal Income Tax

6

Definitions of Retirement Funds

10

Exemptions

13

Deductions

16

Definition of a Retirement Annuity Fund

19

Tax Deductibility of Retirement Fund Contributions

23

Normal Tax Rebates

26

The Second Schedule to the Income Tax Act

27

Taxation of Insurers

31

Tax Tables

33

Important Factors from the 2003 Budget Speech

34

Income Tax: Companies

36

The Tax Advantages of Endowment Policies and Retirement Benefits39

Knowledge Self Assessment Module 1

40

Model Answers to Knowledge Self Assessment Module 1

45

Module 2

The Long Term Insurance Act

50

Learning Outcomes

50

Introduction

51

The Long Term Insurance Act

51

General Applications of the Act

54

Part VII Business Practice, Policies and Policyholder Protection

56

Regulations to the Long Term Insurance Act

62

Other Related Matters

69

Underwriting

72

The Policyholder Protection Rules

76

Knowledge Self Assessment Module 2

87

Model Answers to Knowledge Self Assessment Module 2

97

Module 3

The Role of Risk Management

98

Learning Outcomes

98

Risk Management Today

99

The Risk Management Statement

100

The Risk Manager and his Department

101

Post Loss Action and Disaster Planning

104

Knowledge Self Assessment Module 3

106

Model Answers to Knowledge Self Assessment Module 3

108

Module 4

Risk Identification

109

Learning Outcomes

109

Macro Identification

110

Micro Identification

112

Systems Audits

113

Safety Audits

113

Hazard and Operability Study

114

Knowledge Self Assessment Module 4

115

Model Answers to Knowledge Self Assessment Module 4

116

Module 5

Risk Evaluation

117

Learning Outcomes

117

Planning

118

Ranking Risks

118

Kinds of Risks

119

Probability Theory

122

Knowledge Self Assessment Module 5

126

Model Answers to Knowledge Self Assessment Module 5

131

Module 6

Risk and Loss Control

133

Learning Outcomes

133

Prevention and Minimisation

134

Employees

135

Contingency Plans

137

Main Risk Classes

139

Knowledge Self Assessment Module 6

149

Model Answers to Knowledge Self Assessment Module 6

151

Module 7

Financing Risk

153

Learning Outcomes

153

The Cost of Risk

154

Loss Cost Distribution

156

Methods of Financing Loss

157

Risk and Reward

159

Risk Retention

159

Knowledge Self Assessment Module 7

161

Model Answers to Knowledge Self Assessment Module 7

163

Module 8

Transferring Risk

164

Learning Outcomes

164

The Role of Insurance

165

Sharing Risk with Insurers

167

Non-Insurance Transfers

168

Captive Insurers

171

Knowledge Self Assessment Module 8

174

Model Answers to the Knowledge Self Assessment Module 8

176

Module 9

Alternative Risk Transfer (ART)

178

Learning Outcomes

178

Securitisation

179

Finite Risk Insurance

180

Business Risks

181

Knowledge Self Assessment Module 9

183

Model Answers to Knowledge Self Assessment Module 9

184

Module 10

Personal Risk Management

185

Learning Outcomes

185

Introduction to Personal Risk Management

186

Management of the Investment Risk

187

Management of the Death/Disability Risk

192

Management of the Health Risk

193

Management of Personal Risks in the Business Environment

195

Application of Risk Management Theory in Personal Risk Management196

Knowledge Self Assessment Module 10

198

Model Answers to the Knowledge Self Assessment Module 10

200

Glossary of Terms

202

Purpose

The purpose of this skills programme is to enable you, the learner, to meet the minimum requirements in terms of the FAIS legislation as stated within the Fit and Proper guidelines.

The skills programme is comprised of 10 Modules. Each of these Modules is linked to unit standards taken up in the NQF qualifications framework.

Linked Unit Standards

The following unit standards are linked to this skills programme:

Unit Standard Number

Unit Standard Title

Level

Credits

12164

Demonstrate knowledge and insight of the Financial Advisory and Intermediary Services Act (FAIS) (Act 37 of 2002)

(This unit standard will be addressed via the Awareness Training.)

4

2

14315

Demonstrate knowledge and insight into the Income Tax Act (58 of 1962) as amended as it applies to insurance and investment products

4

2

14316

Demonstrate knowledge and insight into the Long Term Insurance Act

4

2

14506

Explain the Financial Intelligence Centre Act, 38 of 2001 and the implication of this Act for client relations

(This unit standard will be addressed via the Awareness Training.)

4

2

14995

Explain the nature of risk and the risk management process

4

4

Notes to the Learner

Target Audience

This learning intervention is aimed at all banking staff, new and existing who are involved in Long Term Insurance Category B.

Delivery Method

This is a self study guide which contains all the information you require in order to meet the requirements of the unit standards linked to this programme.

Duration

It will take you approximately hours of self study to master the outcomes of this programme.

Knowledge Self Assessments

At the end of each Module you will be required to complete a knowledge self assessment. Model answers have been provided against which you can assess you answers.

Assessment Method

Once you have worked through the learning material, you will be required to answer a number of knowledge questions. These questions will be presented in the form of an Assessment Guide. You are required to achieve 100% in order to pass this assessment.

The assessment process and gathering of evidence will be discussed with you by your Assessor/Line Manager during a pre-assessment discussion.

Although most candidates attempting to prove competence in Category B will be operating at the individual policy level, the range of the Income Tax Act includes aspects of group benefits is included, while the unit standard on risk expands the field to include general risk management processes.

Module 1: The Income Tax Act

Learning Outcomes

By the end of this Module, you will be able to:

Define gross income and all the different types of earnings received by individuals that need to be included therein;

Briefly explain the concept of exempt income and how this may affect an individual taxpayer;

Explain the purpose and application of section 10(A) of the Income Tax Act;

Discuss some of the more common deductions available to individual taxpayers;

Define a retirement annuity fund in such a way that it would be acceptable to SARS;

Explain the tax deductions that may be claimed by an individual for contributions made by him or her during the year of assessment to a retirement fund or medical scheme;

Briefly describe the tax deductions that may be claimed by an employer for the contributions it makes to a registered employee benefit scheme;

Discuss, in some detail, the purpose of the Second Schedule to the Income Tax Act;

Explain how the formulas included in the Second Schedule to the Income Tax Act are applied;

Complete calculations, using the formulas included in the Second Schedule to the Income Tax Act, to determine the tax free portion of a members commuted lump sums received at retirement.

Introduction

It perhaps seems strange that long-term insurance intermediaries have such a keen interest in personal income tax when the proceeds of their policies are tax-free. However, since a professional intermediary must do a detailed need analysis for his or her clients every time s/he sees them, this is perhaps not so strange after all. Without being able to establish the clients tax liabilities the intermediary will not be able to complete an accurate analysis. Not only will a need for possible additional retirement annuity contributions be overlooked, but the real possibility of not identifying a capital gains tax and/or an estate duty liability at death could result in serious liquidity problems for the estate when the intermediarys client dies.

It is thus in the best interest of every person involved in some way with long-term insurance, be this as an intermediary or a person working with in an insurers offices, that a basic understanding of South African personal income tax is attained. Anyway, whether we like it or not, we all have to pay income tax so knowing something about how it works may even be in our own interests.

Just as in any other country the South African government relies to a large extent for its income on the taxes collected from private individuals, corporations, and other taxable entities in the country. South Africa, like most of its international trading partners, levies taxes on the basis of 'residence', which means that all taxable persons resident in the country are liable to pay tax, regardless of where the source of their income is situated. (Naturally there are always a few exceptions to every rule and we will deal with them in some detail later.) The major forms of taxation used in South Africa are:

Income tax on the income and other earnings of private individuals (i.e. natural persons) and special' trusts. ('Special' trusts are taxed at the individual tax rate but do not qualify for any rebates.)

Tax on the income of taxable trusts (other than special' trusts), which are taxed at a flat rate of 40%.

Company tax on the profits made in a registered business.

Value Added Tax (VAT), added on most goods and services at every stage that the goods go through from person to person, starting with the raw materials sourced and delivered to a manufacturer to the final product purchased by a consumer.

Customs (excise) duties and import charges, particularly special charges on various products such as petrol and diesel, and the sin taxes levied on liquor and tobacco.

Capital gains tax (CGT) which is levied whenever a taxpayer disposes of an asset for a capital profit (or loss).

Estate duty on the assets of deceased individuals with relatively large estates.

Donations tax on most transfers of assets via donations.

The Regional Services Council levy paid by employers according to the number of employees in its service.

Stamp, transfer and company duties on a range of financial transactions including banking transactions, credit agreements, leases, marketable security transactions, insurance policies, business registrations, fixed property transfers, trust registrations and legal agreements.

Other ad hoc income tax levies (sometimes as a 'loan' levy which is repaid with nominal interest in some future tax year).

Provincial governments are funded by the national government but municipalities (including greater metropolitan sub-structures) levy rates on immovable property and charge for services rendered.

An Overview of Personal Income Tax

The basis of any tax system essentially works on the assumption that all income and, more often that not, capital appreciation received by an individual is taxable. (The taxation of capital gain is dealt with as a special arrangement and does not form a part of this unit standard.) This accumulation of a persons income is called his or her gross income.

The definition of gross income, found in section 1 of the Income Tax Act, is defined as, in relation to any year or period of assessment:

(i)in the case of a resident, the total amount, in cash or otherwise, received by or accrued to or in favour of such resident,

(ii)in the case of any person other than a resident, the total amount, in cash or otherwise, received by or accrued to or in favour of such person from a source within or deemed to be within the Republic,

In order to fully understand the fundamental definition of gross income, it is perhaps best if we break it down into its component parts.

in the case of a resident

There are two main principles which underpin the basis for taxation. These are either the source of the income or the place of residence of the taxpayer. In the Minister of Finance's budget speech on the 23rd of February 2000 he announced a fundamental change in the way that South Africans are to be taxed. The South African income tax system in place at the time was primarily based on what is commonly referred to as the source plus basis of taxation. As a result, income which originated in the Republic and certain types of income which were deemed to be from a source in South Africa were taxable in terms of the Income Tax Act. As was announced in the budget review, a residence minus system was adopted with effect from 1 January 2001.

South African residents are now taxed on their world-wide income, but foreign taxes paid by a South African resident, as a result of the tax regime of the country in question are allowed as a credit against a local tax liability. Certain categories of income and activities undertaken outside South Africa are also exempt from South African tax.

in cash or otherwise

It is not necessary to receive payment in cash in order to accrue a tax liability. An example of this is the fact that tax is payable on the value of any fringe benefits received. The important criteria here is the fact that the monetary value of what is received can be determined.

received by or accrued to or in favour of

Once money becomes due to a taxpayer s/he becomes liable for tax on it. An example of this can be found in a business environment. Let us assume that an individual has purchased some furniture from a store and has arranged to pay over 24 months. The income has accrued to the furniture store and they will thus be required to pay the tax, even though the full purchase price has not yet been paid. However, the instalment payments will not again be taxed. Should the furniture store not declare the accrual the money will be taxed on receipt. General practice at SARS, however, requires that income be declared and taxed at the accrual stage.

Where a person is not resident in the Republic it is nevertheless still possible that s/he will need to pay tax here. In the (ii)nd part of the definition of gross income you will notice that, in the case of a non- resident, there is a clause which states - from a source within or deemed to be within the Republic.

As was mentioned earlier, one of the most important reasons why South Africa changed its tax basis was to bring the South African tax system more in line with international tax principles. A common practice of a residence based tax system is to allow certain categories of income and activities undertaken outside their borders to be exempt from local taxes. This is to avoid the impact of double taxation where foreign income was taxed in the hands of a resident. Foreign taxes paid by residents are allowed as a credit against a South African tax liability.

not of a capital nature

Income tax within the Republic is based on income earned and not on the capital (or income producing machine). It is thus important to be able to clearly distinguish between the two.

Let us assume that you own a block of flats. Each of your ten flats has been let out to a tenant at a reasonable monthly rental. The rental paid to you is income in your hands and you are required to declare this as such and pay tax thereon. Should you decide to sell the block of flats after a number of years, the profit that you would make would be a capital gain. South Africa does tax capital gains (this will be explained later in this module) but the rate of tax levied is far lower than that levied on income. The onus of proof as to whether money earned is of an income or a capital nature rests with the taxpayer.

In the definition of gross income mention is made of amounts so received or accrued. While the definition of gross income does appear to be extremely broad, there are certain specific sources of income that need to be spelt out to ensure that they are taxed and so these are included in the definition of gross income as additional sources of income. (Only those that possibly need to be considered when a professional service is being provided to a policyholder have been included here.)

(a)any amount received or accrued by way of annuity, including any amount contemplated in the definition of annuity amount in section 10A(1);

While the meaning of an annuity is not defined in the Income Tax Act the Special Court for Income Tax Cases has, over the years come up with a general description.

If one where to thus refer to ITC 761 the following definition can be accepted as being the main characteristics of an annuity:

i)provision is made for a fixed annual payment (payments may be divided into instalments);

ii)payments are repetitive in that they are payable from year to year for a given period or until a stated happening;

iii) payment of the annuity is chargeable against a person (either natural or juristic).

This definition thus means that all annuities, including those paid by a life office, are included (totally) in the gross income of the recipient. Where a capital amount is paid over to a life office for a voluntary purchase annuity the total income (including the capital repayment) must be included in the recipient's gross income. Any capital exemption in terms of section 10A will be removed from the taxpayer's income at a later stage of the process used to determine his or her taxable income. (Section 10A will be dealt with in some detail later.)

(d)any amount, including any voluntary award, received or accrued in respect of the relinquishment, termination, loss, repudiation, cancellation or variation of any office or employment. Provided that -

i)the provisions of this paragraph shall not apply to any lump sum award from any pension fund, provident fund or retirement annuity fund;

ii)where any such amount becomes payable in consequence of or following upon the death of any person the amount shall be deemed to have accrued to such person immediately prior to his death;

This is the paragraph that includes gratuities (such as those created by a deferred compensation scheme) into the gross income of the employee. Note that lump sums received from pension, provident or retirement annuity funds are specifically NOT included here. It must also be noted that where an amount is paid on the death of an employee it is considered to have been received immediately prior to his or her death. It is thus the responsibility of the executor of the estate of the deceased to settle any tax liability before s/he can start winding up the estate. The deceaseds beneficiaries are NOT liable for the payment of the tax.

(e)any amount determined in accordance with the provisions of the Second Schedule in respect of lump sum benefits received by or accrued to a person from an approved pension, provident and/or retirement annuity fund;

The proceeds of approved group life schemes that are part of a pension or provident fund will also be included in the calculations in terms of the Second Schedule. (Whilst these are often seen as the proceeds of an insurance scheme (as they are approved schemes) they are an integral part of the retirement fund.)

(eA)This section was included into the definition as a result of the large number of conversions taking place where pension funds were changed to provident funds (many as a result of pressure from organised labour). Where any fund is changed so that more than one third of the lump sum value can be taken as cash, now or in the future, the full fund value will, at the time that the change takes place, form part of the gross income of the taxpayer and will be taxed (at the taxpayer's average rate of tax).

Where any portion of a lump sum from a retirement fund has to be paid by a member on receipt to a former spouse as a result of a court order granting a decree of divorce (as provided for in section 7(8) of the Divorce Act, 1979), the full value of the lump sum will be deemed to have accrued to the member for the purposes of any tax liability. (Any recovery of the tax from the former spouse will have to be a private arrangement between the couple concerned and cannot involve the tax authorities of the retirement fund.)

(i)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;

The Seventh Schedule of the Income Tax Act deals with the valuation of any fringe benefits (e.g. a company car or bond subsidy) granted to an employee by his or her employer. Once the value has been determined this is included in the employees gross income in terms of this paragraph.

(m)any amount received or accrued under or upon the surrender or disposal of, any policy of insurance upon the life of any person who, at any time while the policy was in force, was an employee of the taxpayer, if any premium paid in respect of such policy is or was deductible from the taxpayer's income, whether in the current or any previous year of assessment, under the provisions of section 11:

This will also apply to any loan or advance granted on or after 1 July 1982 by the insurer concerned under or upon the security of any such policy.

Where a deferred compensation scheme is set up by an employer for his or her employees the proceeds of any policies effected to create the lump sum gratuity will be payable to the employer. The employer will have been able to claim the premiums paid as a deduction against its income in terms of section 11(w) of the Income Tax Act (provided conforming policies were used). The proceeds of the policy are then included (in total) in the employers gross income in terms of this paragraph. This will be the case whether the employer claimed the permitted deductions of the premiums or not.

Definitions of Retirement Funds

Approval of the rules of a retirement fund must be obtained from the Registrar of Pension Funds who will use the basis of the Pension Funds Act as the guiding principles for approval. However, the Pension Funds Act makes no distinction between a pension, a provident, and a retirement annuity fund. To find these definitions we therefore need to seek elsewhere.

Once a fund has been approved and registered by the registrar the deductibility of contributions made by the member and his or her employer are not automatic. This must be separately requested from the Commissioner for Inland Revenue (SARS). Approval of the permitted tax deductibility of contributions will now depend on the type of fund that has been submitted to the Commissioner. The Income Tax Act contains separate definitions for pension, provident, and retirement annuity funds respectively. These definitions are included in section 1 of the Income Tax Act.

Pension Funds

The Commissioner may approve a fund subject to such limitations as he may determine, and shall not approve a fund in respect of any year of assessment unless he is satisfied that the funis a permanent fund bona fide established for the purpose of providing annuities for employees on retirement from employment. The fund may also include a provision to provide annuities for dependants or nominees of deceased members.

A further stipulation of the Income Tax Act is that the rules of the fund must provide -

(aa)that all annual contributions of a recurrent nature to the fund shall be in accordance with specified scales;

Fund rules contain details of the contribution rates that members will pay. This is usually indicated as a percentage of remuneration and, unless an amendment of the rules is negotiated, remains constant for the duration of the members participation in the fund. Employer contribution levels will also be indicated in the fund rules. However, as the employer is usually liable for the cost of administration and risk premiums, as well as the correction of any shortfall that may become apparent when a valuation is undertaken (particularly with defined benefit funds), the employers contribution rate may vary slightly from year to year. The Commissioner will nevertheless still accept that the rules abide by this condition if the overall structure, as described herein, is in place.

(bb)that membership of the fund throughout the period of employment shall be a condition of the employment by the employer of all persons of the class or classes specified therein who enter his employment on or after the date upon which the fund comes into operation;

Mandatory membership for all employees who enter the employ of a participating employer after the fund has been implemented is non-negotiable for all new employees that qualify in terms of the conditions included in the rules. Should this not be a condition of employment the Commissioner will not approve the fund and therefore any contributions paid will not be tax deductible.

(cc)that persons who immediately prior to the said date were employed by the employer and who on the said date fall within the said class or classes may, on application made within a period of not more than 12 months as from the said date, be permitted to become members of the fund on such conditions as may be specified in the rules;

It would be unfair to force existing employees to join a retirement fund set up within an employers organisation. Most of these employees will, more than likely, have already made their own retirement provisions in the light of the fact that their employer did not provide a scheme. Changing to the new pension fund set up for employees may thus be to their detriment. However, it would also be unfair if existing employees were not granted the opportunity to join the fund if they wished to do so. A compromise must therefore be included in the rules, allowing existing employees the option to join. Note that the maximum time period of twelve months should not necessarily be seen as an incentive for the existing employees to join. The fact that a fund invariably offers risk benefits such as, for example, group life and disability, on an underwriting free basis (within limits), means that an employee who has an unrestricted future option to join the fund may well only choose to do so once a life threatening ailment comes to light. This form of anti-selection against the fund could result in a substantial increase in the risk premiums, which would be to the ultimate detriment of the other members of the fund.

(dd)that not more than one-third of the total value of the annuity or annuities to which any employee becomes entitled, may be commuted for a single payment, except where the annual amount of such annuity or annuities does not exceed R1 800 or such other amount as the Minister of Finance may from time to time fix by notice in the Gazette;

This is a clause that all people familiar with pension funds is very aware of. The fact that only 1/3rd of the amount available at retirement may be taken in cash, and that the balance must be used to provide a pension or annuity be this paid monthly, quarterly, half-yearly, or annually.

A lot of confusion has arisen over the years around the part of this clause which states except where the annual amount of such annuity does not exceed R1 800 - (which is currently the amount stipulated by the Minister of Finance). The Commissioner for Inland Revenue thus issued a government notice (GN 16) on the 15th of September 1997 to clarify his decision on the commutation of small annuities, and the position is as follows:

Where the rules of an approved pension or retirement annuity fund prescribe the annuity factor the prescribed factor must be used to determine the annuity that the member is entitled to at retirement. Should the rules of the fund not prescribe an annuity factor then an annuity factor of not greater than 12,5 must be used on the full value of the retirement benefit to establish what that annuity may be.

Should the use of the annuity factor (either the factor prescribed in the rules or 12,5) result in an annuity of less than R 1 800 per annum the full retirement benefit may be taken as a single lump sum.

Where the annuity is, however, greater than R1 800, then only 1/3rd of the retirement benefit may be taken as a single lump sum. Take note that, when using the prescribed factor or 12,5 (as the case may be) to establish whether the value can be paid out in cash or not the calculation of the annual annuity must be done before the retiree has received the 1/3rd commutation of the lump sum to which s/he is entitled.

(ee)for the administration of the fund in such a manner as to preclude the employer from controlling the management or assets of the fund and from deriving any monetary advantage from monies paid into or out of the fund, except that where the employer is a partnership, a member of the partnership may be permitted to derive such monetary advantage if he was previously an employee and, on becoming a partner, was permitted to retain his membership of the fund as though he had not ceased to be an employee, his contributions being based upon his pensionable emoluments during the 12 months which ended on the day on which he ceased to be an employee and his benefits from the fund being calculated accordingly;

A retirement fund, once registered, becomes a separate legal entity. However, as a legal entity it needs to be managed and controlled. In the Pension Funds Act provision is made for this by the requirement that every registered fund must have a management board on which the employer may have no more than a 50% representation. This requirement imposed by the Pension Funds Act however only became a part of the Act in 1996. Prior to this amendment to the Pension Funds Act the Act had been silent on this issue and it had thus been up to the Income Tax Act to ensure the impartiality of the management of the fund.

This clause should however not be interpreted as meaning that the administration of a fund by a participating employer is unacceptable. This is certainly not its intent. It is in the management and control arenas that an employer is to be excluded from any measure of control. As you will note the exclusion of the control and management of the fund also includes the funds assets, and an employer can therefore not enjoy any financial benefit from having a fund for its employees. However, there is one exception.

In the structure of a partnership the partners are the employers as there is no clearly defined legal entity. As a partnership grows it would certainly not be strange for them to employ staff and, as an incentive to the staff to remain, it is very likely that a retirement fund be set up for the employees. The promotion of senior staff members within a partnership very often results in the employee being offered a partnership in the organisation. Should the employee accept the partnership s/he ceases to be an employee and becomes one of the employers. Under these exceptional circumstances the former employee is permitted to remain a member of the pension fund. However his or her membership is restricted in that future contribution levels may not exceed the contributions levels applicable in the twelve month period immediately before s/he became a partner. A further restriction is that the partners eventual retirement benefits must be based on his or hers income in the twelve months before s/he became a partner in the case of a defined benefit fund. (With a defined contribution fund benefits will automatically be limited as a result of the restrictive contribution levels.)

(ff)that the Commissioner shall be notified of all amendments of the rules; and

(gg)that no portion of any annuity payable to the widow, child, dependant or nominee of a deceased member shall be commuted later than six months from the date of the death of such member;

This clause seems fairly straightforward any commutation of a portion of a benefit due on the death of a member must be commuted within six months of his or her death. Where the application of this clause gets interesting is when the stipulations of section 37C of the Pension Funds Act have to be applied. This is particularly so where the benefit has not been left to a dependant of the deceased and therefore, in theory, a period of twelve months may transpire before a decision can be made by the trustees on the eventual recipient of the benefits. In practice the revenue authorities are prepared to take the stipulations of section 37C into consideration if a situation as highlighted herein arises.

Provident Funds

The Commissioner may approve a fund subject to such limitations as he may determine, and shall not approve a fund in respect of any year of assessment unless he is satisfied that the fund is a permanent fund bona fide established for the purpose of providing benefits for employees on retirement from employment. The fund may also include a provision to provide benefits for dependants or nominees of deceased members.

A further stipulation of the Income Tax Act is that the rules of the fund must contain provisions similar in all respects to those required to be contained in the rules of a pension funds in terms of subparagraphs (aa), (bb), (cc), (ee) and (ff) of paragraph (ii) of the proviso to paragraph (c) of the definition of pension fund.

We have already investigated the definition of pension fund as included in section 1 of the Income Tax Act and therefore the provisos of these sections should be familiar to us. However, it is not the similarity of the provisos that is important but rather the omission of certain of the provisos that must be met for an approved pension fund that are important. These omissions are notably sections (dd) and (gg).

Section (dd) deals with the stipulation that not more than one-third of the total value of the annuity or annuities to which any employee becomes entitled, may be commuted for a single payment. As this section no longer is relevant it means that the full retirement benefit can be taken as a lump sum the fundamental difference between a pension and a provident fund. (The omission of section (dd) makes the inclusion of section (gg) irrelevant, and it is thus omitted in the definition of provident fund.)

SEQ CHAPTER \h \r 1Exemptions

Once a taxpayers gross income has been determined it must be established what portion of it, if any, is exempt from tax. It is only once the exemptions have been deducted that the taxpayers income, from which deductions can be made, will have been established.

Income is defined in section 1 of the Income Tax Act as:

the amount remaining of the gross income of any person for any year or period of assessment after deducting there from any amounts exempt from normal tax;

Broadly speaking exemptions are applicable to a particular source of income (e.g. dividends from a close corporation) or to a select body (e.g. religious organisations). Exemptions are dealt with in the Income Tax Act by section 10. Briefly, there shall be exempt from tax:-

(a)the revenues of the Government, any provincial administration or of any other state;

All government departments, such as Home affairs or the Treasury, as well as the different provincial administrations are exempt from paying any tax. Reference to any other state is purely a legality in order to avoid any taxation of the income of a foreign country.

(b)the revenues of local authorities;

(d)the receipts and accruals of any

(a)pension, provident, retirement annuity fund;

(b)benefit fund; as well as

(c)a trade union, a chamber of commerce or industry or a local publicity association, etc.;

Medical schemes are defined in section 1 of the Income Tax Act as benefit funds. In terms of this section of the Act the receipts and accruals of any medical scheme are thus exempt from tax.

Pension, provident and retirement annuity funds are exempt from the payment of income tax in as far as the Income Tax Act does not apply to them. However, they are taxed in accordance with the Tax on Retirement Funds Act, 1996 (Act no. 38 of 1996). (Dealt with in summary in the unit standard 10393 Demonstrate knowledge and understanding of the primary legislation that impacts on retirement funds.

(g)war pensions or amounts received as compensation in respect of diseases contracted by persons employed in mining operations;

(gA)any disability pension paid under section 2 of the Social Assistance Act, 1992 (Act 59 of 1992);

(gB)any disability pension paid under section 39(1)(c) or (d) of the Workmen's Compensation Act, 1941 (Act 30 of 1941), or the Compensation for Occupational Injuries and Diseases Act, 1993 (Act no. 130 of 1993);

(i)(xv)where the taxpayer is a natural person, and over the age of 65, the first R15 000 of any interest earned. Where the taxpayer is a natural person but under the age of 65 the exemption applies to the first R10 000 of interest earned. However, should the interest income be from a source outside the Republic the exemption is limited to R1 000.

(k)dividends received by any person;

People who invest in normal collective investment schemes (i.e. those linked mainly to ordinary shares) therefore are unlikely to need to pay tax on their annual income from the scheme as the bulk of the income that they may receive will be dividends passed on to them from the management company.

This exemption does not apply to any dividends earned by a person from a fixed property company or where the company is registered in terms of the Collective Investment Schemes Control Act and the person has received the dividends on shares in a unit portfolio made up of property shares. This exemption does also not apply to the interest portion of any unit trust distribution. [Section 10(1)(i)(xv) (see the previous exemption) could however apply to this]

(mB)any benefit or allowance payable in terms of the Unemployment Insurance Act, 1966 (Act 30 of 1966).

(x)In terms of section 10(1)(x) a lump sum amount received, or to be received in respect of the relinquishment, termination, loss, repudiation, cancellation or variation of office or employment as does not exceed R 30 000 is exempt from tax. Any other amounts previously excluded from tax as a result of this section (in the current or any previous year of assessment) will be used to reduce the amount of the exemption allowed in the current year of assessment.

No exemption under this section will apply in respect of the amount received, or to be received in respect of the relinquishment, termination, loss, repudiation, cancellation or variation of office or employment, unless:

i)the person receiving the amount has attained the age of fifty-five years; or

ii)the employee is relinquishing, terminating, losing, repudiating, cancelling, or varying his/her office or employment as a result of superannuation, ill-health or other infirmity; or

iv)the termination of the employee's services are as a result of the employer ceasing to carry on with his/her business or where the employee is made redundant. This concession is subject to the employee at no time having been a director of the company or having owned more than 5% of the issued share capital. In a close corporation this concession will also not apply to a member who at any time held more than 5% of the interest in the CC.

Section 10(A)

Section 10(A) deals specifically with the exemption if the capital elements of voluntary purchased annuities. For the sake of clarity some definitions have been set out in this section of the Act. (Some of these have been included in these notes as they apply to our investigation of this section.)

annuity amount

means an amount payable by way of annuity under an annuity contract;

annuity contract

means an agreement concluded between an insurer and a natural person in terms of which:

(a)the insurer agrees to pay to the purchaser or his spouse (or surviving spouse) an annuity until the death of the annuitant or the expiry of a specified term;

(b)the purchaser agrees to pay the insurer a lump sum cash consideration for the annuity;

(c)the insurer will at no time pay any amount to the purchaser or any person other that the amounts payable by way of the annuity,

Note that this means that this particular exemption of the capital element of a purchased annuity is only applicable to a voluntary purchased annuity. Where the annuitant buys an annuity with the portion of a pension or retirement annuity maturity value the annuity, being a compulsory purchase, will have no capital exemption. However, the rd cash commutation can be used to purchase a section 10A annuity (and s/he will receive the capital portion exemption).

Under a voluntary purchase annuity the capital element of the annuity amount will be exempt from tax as long as the annuity is payable to the purchaser, his/her spouse, or surviving spouse. In order to establish the exempt capital element of an annuity in any tax year of assessment a formula is provided in section 10A. Where the insurer and purchaser have agreed on an escalating annuity, or where the annuity is a life' annuity (i.e. it will continue at least until the death of the annuitant), it will be necessary to use the formula, which is set out here:

C

B

A

Y

=

Where:

i) 'Y'is the value of the capital element of the annuity to be determined for the current year of assessment;

ii) 'A'is the value of the initial lump sum cash amount paid by the purchaser to the insurer for the purchase of the annuity;

iii) 'B'is the total value of all the annuity amounts that are expected to be paid by the insurer to the purchaser or his or her spouse (or surviving spouse) during the term of the annuity contract;

iv) 'C'represents the value of the annuity payable by the insurer to the purchaser or his or her spouse (or surviving spouse) during the current year of assessment.

A simplified version of the formula above is provided in section 10A if the value of the annuity remains constant for the term of the contract and the term to expiry is known. This formula is:

N

A

Z

as

written

commonly

more

,

or

A

N

1

Z

=

=

Where:

I) 'Z'is the value of the capital element of the annuity to be determined for the current year of assessment

ii) 'A'is the value of the initial lump sum cash amount paid by the purchaser to the insurer for the purchase of the annuity

iii) 'N'represents the number of years during which payments will be received by the purchaser or his or her spouse (or surviving spouse).

Deductions

Once a taxpayer's income has been established any deductions that s/he may be allowed to claim have to be determined. It is only once the deductions allowed have been claimed that the taxpayers taxable income will have been established.

Taxable Income is defined in section 1 of the Income Tax Act as:

the amount remaining after deducting from the income of any person all the amounts allowed to be deducted from or set off against such income;

The bulk of the deductions are to be found in section 11.

For the purposes of determining the taxable income of any person carrying on a trade within the Republic, there shall be allowed as a deduction against the income of such person:

(a)expenditure and losses actually incurred in the production of the income, provided such expenditure and losses are not of a capital nature;

Section 11(a), commonly known as the general deduction, allows all taxpayers who are required to spend money in the production of their income to claim their expenses. Where a taxpayer earns a fixed income (e.g. salary) it is unusual for him or her to be able to claim under this section. The reason is that any expenses that s/he may incur would normally have no influence on his or her income. His or her salary would be paid based on the conditions of employment, and the taxpayer would normally not be required to incur any expenses in order to earn this salary. Taxpayers who rely on commission earnings based on production will naturally be in a position to claim expenses actually incurred in the production of their income. However, the onus of proof always rests with the taxpayer. Where a deduction is disallowed or queried it is the taxpayer who must prove that the expense was actually incurred in the production of income. SARS is not required to prove that the opposite is in fact true. Where deductions are to be made under section 11(a) it is important to be aware of the restriction imposed by section 23.

Section 23 states that -

No deduction shall in any case be made in respect of the following matters, namely -

(a)the cost incurred in the maintenance of any taxpayer, his family or establishment;

(b)domestic or private expenses, including the rent of or cost of repairs of any premises not occupied for the purposes of trade. Included herein are also any expenses incurred on any dwelling house with the exception of that part that may be occupied for the purposes of trade;

Where a taxpayer wishes to claim a part of his or her home for the purposes of trade s/he can thus be asked to prove that the part in question has been specifically equipped for the purposes of trade. It is also required that regular and exclusive use is made of the premises for the purposes of the trade of the taxpayer.

(f)any expenses incurred in respect of any amounts received or accrued which do not constitute income (as defined in section 1);

(g)any moneys claimed as a deduction from income derived from trade, which are not wholly or exclusively laid out or expended for the purposes of trade;

It is particularly with the wording of section 23(g) that most taxpayers are not allowed section 11(a) deductions. Unless it can be shown to the satisfaction of SARS that the expense was wholly and exclusively' for the purpose of trade, the deduction will not be allowed.

One of the many expenses that can be claimed under section 11(a), and which is often overlooked, is the cost of short-term insurance incurred by a commissioned or self-employed earner. As the protection of assets used in the production of income can be best undertaken with short-term insurance policy SARS is happy to consider this to be a valid expense. An interesting aspect to claiming this deduction is the fact that the payment received for a claim does not have to be included in the gross income of the taxpayer. As a short-term insurance policy is a policy of indemnity the claimant is not enriched by the receipt of the claim proceeds. S/he is simply being recompensed for a loss and will thus not have made a taxable profit.

This same ruling also applies to any business, be it the small corner grocer or a large multi-national corporation, which uses short-term insurance policies to protect its assets. However, as most individuals are salaried people it will not apply to them. As their salaries are fixed and so not linked to the earning capacity generated by the persons assets SARS will not allow the deduction of the premiums paid. As the payment of a claim is also simply the replacement of a lost asset there will also be no tax advantage or disadvantage when a claim is paid. Anyway, most people would find it very difficult to state and prove that their household assets were used wholly and exclusively for trade, and so the limits imposed by section 23(g) would become a factor.

Continuing with section 11,

(d)expenditure actually incurred on repairs to property occupied for the purposes of trade or in respect of which rental income is received;

Rental income received from tenants occupying property owned by a taxpayer must be declared as part of his or her gross income. However, in accordance with this section the cost of maintenance and repairs that are required and carried out during the year of assessment be offset against this income.

SEQ CHAPTER \h \r 1(u)so much of the entertainment expenditure (including club subscriptions) incurred by any taxpayer who is a natural person during the year of assessment as the Commissioner is satisfied was so incurred directly in connection with the taxpayer's trade and which is not such expenditure as is referred to in paragraph (a): Provided that:

i)the deduction under this paragraph is restricted to an amount equal to the lesser of

(aa) R2 500; or

(ab) R 300 plus 5% of the taxpayer's taxable income as exceeds R 6 000

ii)no deduction will be allowed for any expenditure incurred in connection with any trade for which the taxpayer receives remuneration unless the person is an agent or representative whose remuneration is normally earned mainly as commission based on sales or turnover that can be traced back to the taxpayer.

SEQ CHAPTER \h \r 1(w)there will be allowed as a deduction an allowance in respect of any premium which was actually paid by the taxpayer under any policy of insurance taken out upon the life of a employee of the taxpayer. In the case of a company the deduction will also apply if the policy is on the life of a director. Provided that-

(aa)no deduction will be allowed in respect of any premium paid while the policy was not the property of the employer;

(bb)no deduction will be allowed if :

(A)any person other than the employer was entitled to a benefit under the policy during the year of assessment; or

(B)

a loan was made to any person, using the policy as collateral, and the loan was still outstanding, unless the loan was made by the taxpayer in order to obtain funds needed because the employee is in ill-health, infirmity, incapacity or has retired or left. [A loan made by the insurer to the taxpayer (the employer) will have to be included in its gross income (section 1 paragraph (m) of the definition of gross income) but will not cancel the allowable deduction.]

(dd)no deduction will be allowed unless :

(B)the policy is a term insurance policy; or

(C)the policy conforms to the regulations as set out in Regulation GN R2408 in the Government Gazette 8442 of 12 November 1982.

(ee)the deduction will be limited-

(B)in the case of a policy that abides by the terms and conditions of regulation R 2408 (known as a conforming policy), to an amount equal to 10% of the remuneration of the employee or director.

Definition of a Retirement Annuity Fund

Before we can go any further with the deductions it is important that we clearly understand the terms and conditions that must be met before a fund will be accepted by the Commissioner at SARS as a bona fide retirement annuity fund. It is in the Income Tax Act that the definitions of the different retirement annuity funds viz. pension, provident and retirement annuity funds, is to be found and not in the Pension Funds Act.

Some investments enjoy special recognition of their role as retirement planning tools. An extremely important retirement tool that falls into this category is the retirement annuity fund. This is especially so where the individual who becomes a member of the fund is self-employed and so does not belong to an employee benefit retirement fund, i.e. a pension or provident fund. However, this does not stop an employee from supplementing his or her retirement benefits by purchasing a membership to a retirement annuity fund in addition to his or her membership of the employee benefit fund to which s/he belongs. Any person, whether self-employed or not and whether a member of any other fund may become a member of a retirement annuity fund. Retirement annuity funds are also just as important for individuals working for Small, Medium or Micro Enterprises (SMME's) where a retirement fund is not available.

From the point of view of the individual the basic difference between a pension, provident or retirement annuity fund is the way in which they join the fund. Pension and provident fund membership must, in terms of the rules of the fund that were approved by the Registrar of Pension Funds and SARS, be a condition of employment for all new, qualifying employees starting to work for the employer after the fund has been implemented. On the other hand, with a retirement annuity fund there is no employer/employee relationship with regards the conditions for membership. Even if an employer should choose to pay contributions for a member of a retirement annuity fund, the membership of the fund is an individual contract between the member and the fund, with the employer unable to take any part in it.

A retirement annuity fund is defined in section 1 of the Income Tax Act as any fund (other than a pension fund, provident fund or benefit fund) which is approved by the Commissioner in respect of the year of assessment. The Commissioner may approve a fund subject to such limitations and conditions as s/he may determine but must not approve a fund unless s/he is satisfied -

(a)that the fund is a permanent fund bona fide established for the sole purpose of providing life annuities for the members of the fund or annuities for the dependants or nominees of deceased members; and

It is perhaps interesting to note that the Act specifically states that annuities to members must be life annuities and yet does not appear to impose the same requirement for dependants or nominees. While annuities for surviving spouses are usually life annuities those for minor children invariably make use of this concession.

(b)that the rules of the fund provide -

i)for contributions by the members, including contributions made by way of transfer of members interests in approved pension funds or other retirement annuity funds;

Retirement annuities were, until the advent of preservation funds, the preferred destination of any withdrawal benefits due to members as a result of the termination of their services with an employer before normal retirement age. When we say preferred we are referring to the wishes of the State, as it is a well known fact that unless such benefits are preserved they will be spent, with the resultant shortfall in final retirement funding. Retirement annuity funds are therefore specifically required to accept any transfers of a members interest from a pension fund on the members termination of service with his or her employer before retirement. (As will be seen later there are important tax concessions applicable where the transfer is arranged.)

ii)that not more than one-third of the total value of any annuities to which any person becomes entitled, may be commuted for a single payment, except where the annual amount of such annuities does not exceed R1 800 or such other amount as the Minister of Finance may from time to time fix by notice in the Gazette;

There has been much debate in the long-term and retirement fund industries on exactly how the size of a single payment that would have resulted in an annuity of less that R1 800 per annum was to be determined. SARS resolved this dilemma by issuing circular GN 16/97. However, one point that still creates some confusion is where a retirement annuity is sold with life cover. Many people are unaware that, in the case of the member dying, the dependants/nominees will only be entitled to receive 1/3 of the proceeds in cash (with a few adjustments to be dealt with later). The balance must be used to purchase an annuity.

This has, on occasion, led to some ill-feeling and consternation where the life cover element had been included as an integral part of a needs analysis completed to determine the members liquidity needs on death.

iii)that no portion of any annuity payable to the dependant or nominee of a deceased member may be commuted later than six months from the date of death of such member;

The wording of this clause would appear, at first glance, to be fairly simple and straightforward. Where a member dies before retirement, the proceeds of the fund are to be distributed to his or her dependants or nominees as an annuity or annuities. We are all well aware that the recipient of such an annuity can receive one third as a commuted lump sum. In terms of this clause the commutation must occur not later than six months after the death of the member.

It is in what is not said in this clause that can lead to much confusion. In terms of section 37C of the Pension Funds Act the distribution of the benefits due to the dependants or nominees of a member who died before retirement are to be finally decided by the members of the board of management. Where the nominee is not a dependant the board is expected to wait for a period of up to 12 months to allow a dependant to lodge a claim before they finally decide to allocate the benefits to the nominee.

Publications dealing with retirement funds and the legislation under which they operate are silent as to the correct interpretation of this clause if this situation should arise. Whilst it is likely that the revenue authorities would be amenable to an adjustment to the timing, based on the particular circumstances of the case, this should not be taken for granted and care should thus be taken to request a ruling on a case by case basis.

iv)adequate security to safeguard the interests of persons who may become entitled to annuities;

It is naturally important that some measure of control is maintained over retirement funds and that the interests of annuitants are safeguarded. An insurer marketing retirement annuities will thus have to give an indication of the precautions it has taken to provide these safeguards whenever requested to do so by the Registrar of Pension Funds. It is at this point perhaps interesting to take note of the fact that retirement annuities are approved by the Commissioner (at SARS) for the year of assessment in question. It is thus necessary, within a strict interpretation of the definition of a retirement annuity fund, that approval be re-applied for on an annual basis. In practice re-approval is automatic, but SARS does reserve the right to withdraw a retirement funds approval at any time.

v)that no member shall become entitled to the payment of any annuity after he reaches the age of seventy years or, except in the case of a member who becomes permanently incapable through infirmity of mind or body of carrying on his occupation, before he reaches the age of fifty-five years;

This subparagraph also falls into the category of those that cause consternation when they are invoked. While the stipulations are perfectly clear there are many members of retirement annuity funds who are unaware of their implications. They tend to assume that, as their retirement annuity has been purchased from an insurer, they will be able to take early retirement at any stage that they may wish. This is clearly not so. Unless the member is permanently disabled s/he will not be able to receive any benefit whatsoever from the fund. There is also a stipulation included in this subparagraph, not found in the definition of a pension fund, that a member must retire from the retirement annuity fund before s/he reaches the age of 70. This is so even where the member is still gainfully employed.

vi)that where a member dies before he becomes entitled to the payment of an annuity, the benefits shall not exceed a refund to his estate or to his dependants or nominees of the sum of the amounts (with or without reasonable interest thereon) contributed by him and an annuity or annuities to his dependants or nominees;

This subparagraph simply reiterates the conditions stipulated in subparagraph (ii). However, as was mentioned with that subparagraph the permitted commutated value is not simply 1/3 of the value in the fund. Before the 1/3 value is determined the dependants, nominees or estate of the deceased are entitled to a refund of contributions paid to the fund. Whether interest is paid on the refund value is at the discretion of the trustees of the fund. This will, however, not in any way diminish the members fund value. The 1/3 commutation must now be determined with the balance being used to purchase an annuity or annuities as the case may be.

vii)that where a member dies after he has become entitled to an annuity no further benefit shall be payable other than an annuity or annuities to his dependants or nominees;

This subparagraph ensures that no annuity is commuted into a cash lump sum on the death of a member at the insistence of any dependants or nominees. All that can be arranged at the time that an annuitant retires is to continue the payment of the annuity at the same or a reduced rate to a co-annuitant nominated by the annuitant at retirement.

viii)this sub-paragraph deleted by section 4(a) of Act no. 103 of 1976;

ix)this sub-paragraph deleted by section 4(a) of Act no. 103 of 1976;

x)that a member who discontinues his contributions prematurely shall be entitled either to an annuity (payable from the date on which he would have become entitled to the payment of an annuity if he had continued his contributions) determined in relation to his actual contributions or to be reinstated as a full member under conditions prescribed in the rules of the fund;

Retirement annuities cannot be surrendered (see subparagraph (xii)) but they do build up a cash value as the contributions accumulate for the benefit of a member. Should a member stop paying contributions to the fund for any reason whatsoever the contract will be made paid-up. A paid-up contract is a contract to which no future contributions are paid, but the investment component that has built up until that stage still continues to enjoy the growth enjoyed by the portfolio in which it is invested. The member may resume the payment of contributions as and when s/he can afford to do so if the rules of the fund allow this. Recommencing contribution payments will result in the contract being fully reinstated, with the member once again being a full member of the fund.

xi)that upon the winding up of the fund a members interest therein must either be used to purchase a policy of insurance which the Commissioner is satisfied provides benefits similar to those provided by such fund or be paid for the members benefit into another approved retirement annuity fund;

The revenue authorities wish to ensure that, if a retirement annuity is wound up, the benefits that have been accumulated for members, and on which they have enjoyed tax relief on contributions, are transferred to an investment mechanism that will provide the same, or very similar, benefits.

xii)that save as is contemplated in sub-paragraph (ii), no members rights to benefits shall be capable of surrender, commutation or assignment or of being pledged as security for any loan;

Other than under the circumstances explained earlier no members right can be converted into cash for any reason whatsoever. This includes being surrendered at any stage during the lifetime of the contract. Benefits can further not be pledged (ceded) as a security for a loan, as is possible with a life insurance policy. Should the member be declared insolvent the benefits are also protected from attachment by the liquidator for the benefit of creditors. (While this is the rule there are always a few exceptions. However, for current purposes these need not be addressed.)

xiii)that the Commissioner shall be notified of all amendments of the rules; and

This subparagraph (and the following paragraph) are self-explanatory and thus need no further explanation.

(c)that the rules of the fund have been complied with.

Tax Deductibility of Retirement Fund Contributions

In accordance with section 11(k)(i) of the Income Tax Act there may be claimed as a deduction before the determination of tax liability -

any sum contributed during the year of assessment to any pension fund by way of current contributions by any person who holds any office or employment, or

Where contributing to the fund is a condition of employment it may be claimed as a deduction against an employees taxable income (subject to certain maximum limitations that will be dealt with shortly). It is important to note that specific mention is made of a pension fund and that contributions to any other fund (including, in particular, a provident fund) will not be allowed as a deduction.

by any person who is a partner referred to in paragraph (ii)(ee) of the proviso to paragraph (c) of the definition of pension fund in section 1:

Where an employee of a partnership, as a member of the retirement fund, is offered a partnership in the organisation, s/he ceases to be an employee and becomes one of the employers. This would thus, under normal circumstances, preclude him or her from further membership of the fund and yet it would be unfair to discriminate against the member purely on the basis that s/he has done a good job and been rewarded accordingly. The authorities, in the drafting of the legislation, therefore recognised that an exception was justified. However, to avoid any possible abuse of the concession, the membership of the new partner is restricted to his or her benefit entitlement in the 12 months immediately before his or her promotion. The deductions of contributions are thus pegged at those contributed in the designated period, and benefits are restricted to those s/he would have been entitled to if his or her circumstances had not changed.

Provided that the total deduction to be allowed in respect of any contributions by such person to any one or more pension fund or funds shall not in the year of assessment exceed the greater of R1 750 or 7,5% of the remuneration (being the income or part thereof referred to in the definition of retirement-funding employment in section 1) derived by such person during such year in respect of his retirement-funding employment;

Retirement-funding employment is defined in section 1 of the Income Tax Act as:

(a)in relation to any employee -

i)any income constituting remuneration which is derived in respect of his/her employment and where he/she is a member of or, as an employee contributes to a pension fund established for the benefit of employees of the employer from whom such income is derived.

All persons who contribute to a pension fund are restricted as to the size of their allowable deduction. Based on the remuneration earned by a person, s/he will be permitted as a deduction, the greater of an amount of R1 750 or 7,5% of his or her remuneration from retirement-funding employment. A person can thus always claim, at least, R1 750 provided, of course, that s/he in fact pays that, or more, to the fund.

In accordance with section 11(k)(ii) of the Income Tax Act any sum contributed by way of arrear contributions to any pension fund by an employee may also be claimed as a deduction, provided that:

(aa)the deduction to be allowed shall not, in the year of assessment, exceed the sum ofR1 800;

(bb)any amount which is disallowed as a result of the fact that it exceeds the allowable deduction will be carried forward and can be claimed in the next succeeding year of assessment;

Contributions to a Retirement Annuity Fund

Allowable deductions to a retirement annuity fund are dealt with in section 11(n) of the Income Tax Act. In accordance with section 11(n) there may be claimed as a deduction before the determination of tax liability -

(aa)so much of the total current contributions to any retirement annuity fund or funds made during the year of assessment by any person as a member of such fund or funds as does not in the case of the taxpayer exceed the greatest of-

(A)15 per cent of an amount equal to the amount remaining after deducting from, or setting off against, the income derived by the taxpayer during the year of assessment (excluding income derived from any retirement-funding employment) the deductions or assessed losses admissible against such income under this Act, excluding (the deductions for):

sections 11(n)(this deductions for retirement annuities)

17A

(farm land soil erosion work)

18

(medical & dental expenses)

18A

(donations to universities etc.)

19(3)

(the "1/3rd" dividend deduction)

and paragraph 12(1)(c) to (i) inclusive of the 1st Schedule (certain farming

expenses.)

(One must be cautious when including dividends in the determination of the amount of non-retirement funding income of the taxpayer. As section 10(1)(k) now exempts from tax most dividends received by a person these dividends cannot be included in the income of the taxpayer and so must be ignored here.)

or

(B)the amount, if any, by which the amount of R3 500 exceeds the amount of any deduction to which the taxpayer is entitled under section 11(k)(i) in respect of the current year of assessment; (the amount permitted as a deduction for current contributions to a pension fund)

or

(C)the amount of R1 750.

The taxpayer may also, in terms of section 11(n)(bb), claim as a deduction the total of any contributions to any retirement annuity fund made during the year of assessment as does not exceed R1 800, where such contributions are made by a member who has prematurely discontinued his or her contributions and now wishes to be reinstated as a full member (subject to the rules of the fund). This allowance for the payment of arrear premiums will only arise where the retirement annuity is in fact in arrears and where current contributions have been paid in full.

While there are a number of additional provisos stipulated where a person wishes to claim contributions to a retirement annuity fund as tax deductions, the following are of particular relevance -

no deduction will be permitted if the contribution made to the retirement annuity fund is made with money received as a withdrawal benefit from a pension, provident or retirement annuity fund and this money has already been allowed as a deduction from the members gross income in terms of the Second Schedule;

any amount which is disallowed as a result of the fact that it exceeds the maximum allowable deduction will be carried forward and can be claimed in the next succeeding year of assessment;

where any contribution is permitted as a deduction to a person his or her spouse will not be able to claim the same contribution as a deduction on his or her assessment form.

Employer Contributions to a Retirement Fund

In accordance with section 11(l), employers may claim any sum contributed during the year of assessment to any pension fund, provident fund or benefit fund as a deduction. What is perhaps not so clear is the fact that the employers deduction is an accumulation of deductions claimed for these different types of staff benefits and thus include all contributions made to a -

pension fund;

provident fund; and

medical aid scheme.

The amount paid by the employer and permitted as a deduction is based on a percentage of the approved remuneration of the employee in question. The Commissioner must approve any deduction of an amount that is equal to, or less than, 10% of the approved remuneration of the employee. The Commissioner does, however, have the discretion to approve deductions that are greater that 10%. It has now become common practice for the Commissioner to approve deductions made by the employer of up to 20% of the approved remuneration of the employee. Where the Commissioner can be convinced that the deduction needs to be higher (e.g. where a negative valuation requires additional contributions by the employer) deductions of as high as 25 to 30% of the total cost to the employer of employee's remuneration have been known.

The Tax Deductibility of an Individuals Medical Expenses

As you will have seen in the previous sub-section, an employer is entitled to claim as an expense contributions made to a medical aid scheme on behalf of its members. This deduction falls into the same category as contributions to pension and provident funds and we can therefore safely assume that medical aid schemes are considered employee benefits. The question that must be asked, however, is whether the deduction to the employer is allowed because the State wishes to encourage people to arrange for their own private medical care. If this is the case (something that we can all safely assume is so) it seems logical that a similar incentive should extend to the individual. The deduction of medical expenses incurred by an individual is allowed but it is limited as defined in section 18 of the Income Tax Act.

SEQ CHAPTER \h \r 1(1)There shall be allowed to be deducted from the income of any taxpayer who is a natural person an allowance in respect of -

(a)any contribution made by him during the year of assessment to any medical scheme registered under the provisions of the Medical Schemes Act; and

(b)any amounts (other than amounts recoverable by the taxpayer or his spouse) which were paid by the taxpayer during the year of assessment to any duly registered

i medical practitioner, dentist, optometrist, homeopath, naturopath, osteopath, herbalist, physiotherapist, chiropractor or orthoptist for professional services rendered or medicines supplied to; or

ii nursing home or hospital or any duly registered or enrolled nurse, midwife or nursing assistant (or to any nursing agency in respect of the services of such a nurse, midwife or nursing assistant) in respect of the illness or confinement of; or

iii pharmacist for medicines supplied on the prescription of any person mentioned subparagraph (i) for,

the taxpayer or his spouse or his children or stepchild; and

(c)medical expenses of a similar nature incurred outside the Republic; and

(d)any expenditure (other than expenditure recoverable by the taxpayer or his spouse) necessarily incurred and paid by the taxpayer in consequence of any physical disability suffered by the taxpayer, his spouse or child or stepchild:

(While we will not elaborate on this here as it is unnecessary for our purposes there are restrictions imposed on what constitutes a child or stepchild of the taxpayer.)

(2)Taxpayers are divided into three categories for the purpose of determining the allowable deduction.

(a)Those persons who are allowed an additional rebate in terms of section 6(3)(f) are permitted to claim their total expenses. This additional rebate is only applicable to taxpayers who are over the age of 65 on the last day of the year of assessment.

(b)Where the taxpayer or his spouse, child or stepchild is defined as a "handicapped person" and the taxpayer is not entitled to a rebate under section 6(3)(f) then all expenses as exceed R500 may be claimed.

(c)For all other taxpayers the deduction is restricted in that the taxpayer is only permitted to claim any expenses that exceed an amount equal to 5% of the taxpayer's taxable income.

(3)For the purposes of this section a "handicapped person" means-

(a)a blind person;

(b)a deaf person;

(c)a person who, as a result of a permanent disability, requires a wheelchair, calliper or crutch to assist him or her to move from one place to another;

(d)a person who requires an artificial limb;

(e)a person who suffers from a mental illness as defined in section 1 of the Mental Health Act, 1973.

Normal Tax Rebates

SEQ CHAPTER \h \r 1Once the allowable deductions have been deducted from the taxpayer's income the taxpayer is left with his or her taxable income. It is on this amount that the tax liability of an individual (i.e. before rebates are taken into account) is determined. Tax tables are provided by the South African Revenue Services and are usually amended annually.

Once the tax tables have been applied to a taxpayer's taxable income it only remains to deduct any applicable rebates before the final tax due for the year of assessment has been established. Note that it is only natural persons who qualify for tax rebates.

There are two rebates applicable to natural persons:

the primary rebate (section 6(2)(a) ); and

a secondary rebate, if the taxpayer was or, had he lived, would have been over the age of 65 on the last day of the year of assessment (section(2)(b) )

Where the period assessed for tax is less than 12 months the amounts allowed by way of rebates must be reduced in the same proportion as the assessed period bears to 12 months. Should the reduced period of assessment however be as a result of the death of the taxpayer, or the taxpayers spouse, the Commissioner can allow the full rebate to be claimed. (Section 6(4))

The Second Schedule to the Income Tax Act

SEQ CHAPTER \h \r 1When a person retires there are certain benefits made available to them from the retirement fund of which they have been a member. These benefits are usually also made available to them, in some form or another, if they should have to retire early as a result of ill-health. Should the member die there is also, normally, a benefit made available from the retirement fund to their dependants and/or nominated beneficiaries. Should benefits be paid as a monthly income (e.g. a pension or an annuity) this will be treated as if it was a salary being paid by the retirement fund or insurer that is providing the benefit.

The retirement fund or insurer will then be seen as having taken the place of the employer of the recipient and will have to deduct normal tax in accordance with the Standard Income Tax on Employees (SITE) and/or Pay-As-You-Earn (PAYE) tax tables issued, from time to time, by the revenue authorities.

It is an unfortunate fact of life that amongst the average South Africans many will have to survive on an inadequate income once they retire. Most people therefore attempt to reduce their monthly liabilities when they retire in order to be able to survive on their reduced income. As a result it is normal for the average retiree to cash in what amounts of their pensions or retirement annuities that they can. (Provident fund moneys are usually paid out as a lump sum.) The unfortunate side effect of this is that lump sums withdrawn from pension, provident and retirement annuity funds are subject to tax. There are, however, certain tax concessions (included in the Second Schedule of the Income Tax Act). It is possible that a portion, or all, of the first amounts received are exempt from tax, but these are subject to certain maxima. The taxpayer can determine what these tax amounts are by applying the formulae that are provided in the Second Schedule. (It is policy at SARS that, where the individual has made an incorrect calculation, the amounts will automatically be re-calculated and the best result used for the benefit of the individual.)

The amounts cannot be treated in isolation as all lumps sums received are cumulative and must be considered as a whole. This also includes lumps sums received in previous years of assessment from an approved retirement fund. There are two basic formulas, with a third formula only applicable to members of funds to which the state contributes, that need to be used in order to establish the tax free portion of any lump sums received.

The Second Schedule Formulas

FORMULA A

salary

Average

3

1

30

N

1

15

Y

=

Where:

Y=the amount to be determined (this will form part or all of C in formula B);

N =the number of completed years of service (not exceeding 50) taken into account when determining the benefits from the fund; and

Average salary=the highest annual average salary (not exceeding R 60 000) actually earned during any 5 consecutive years in the service of the employer during membership of the fund.

NBFormula A is only used for pension and / or provident funds and NOT for retirement annuity funds.

FORMULA B

Z =C+ED

Where:

Z =the amount to be determined, (ie. the tax free portion of the lump sum which is not to be included in the members gross income);

C =i)the sum of the amounts determined under formula A in respect of the different pension and provident funds from which the taxpayer has retired or will retire and from which lump sum benefits were or may be received;

ii)the sum of any lump sums received from any retirement annuity funds;

iii)C cannot exceed the greater of R120 000 or R4 500 years of membership of any one of the pension, provident or retirement annuity funds.

(Where a taxpayer has retired from a provident fund only, the amount as determined by formula A will always be at least R24 000, unless, of course, the amount actually received is less than R24 000.)

E =the sum total of any contributions that were paid by the taxpayer that were not allowed as a deduction under sections 11(k) (pension funds) and 11(n) (retirement annuity funds) while s/he was a member of the fund(s); Note that the taxpayer's own contributions to a provident fund are not deductible and will thus always be a factor in determining E.

D =the sum total of any amounts received from a pension, provident or retirement annuity fund as lump sums in any previous years of assessment and which were tax exempt.

FORMULA C

D

C

B

A

=

Where:

A=the amount to be determined (this will form part or all of C in formula B);

B=the number of completed years of membership of the fund after 1 March 1998;

C=the total number of years of membership of the fund; and

D=the lump sum that the taxpayer receives at retirement.

NOTE:The value of any lump sum that is deemed to have been received before1 March 1998 (i.e. D A) will be tax exempt in the hands of the recipient.

Once an answer has been arrived at with formula C it must be used in formula B to establish what portion of the lump sum deemed to have been received after 1 March 1998 will be tax exempt.

(The origins of Formula C are to be found in the change to the law from 1 March 1998, when the tax exempt status of the proceeds of funds to which the state contributed changed. While any lump sum benefits that are deemed to have accrued prior to this date will remain tax exempt, any lump sum benefits that are deemed to have accumulated after this date will be subject to the general limitations imposed by the Second Schedule.)

Death before Retirement

The lump sums from the particular funds are deemed to have accrued on the day immediately before the date of death. The executor, as the representative taxpayer of the estate of the deceased, is responsible for the payment of the tax before s/he can even start the winding up of the estate of the deceased.

Note that, as the money is deemed to have been received by the deceased on the day before death, the dependants and/or beneficiaries of the retirement benefits payable will NOT be required to pay the tax thereon. This MUST be paid out of the estate of the deceased before any other liabilities can be settled.

The calculations to be applied in determining the tax exempt portion are the same as for retirement, except that C in formula B has additional factors that need to be taken into account. Nevertheless it must clearly understand that, regardless of the outcome of the calculations, in ALL cases the upper limit of the GREATER of R120 000 or R4 500 years of membership will still apply to C.

SEQ CHAPTER \h \r 1

Pension and provident funds

Retirement annuity funds

C shall not be less than the greater of:

(i)R60 000 or

(ii)2 x actual salary earned in the 12 months immediately before death provided that the actual salary earned does not exceed R60000 (ie. this amount may not exceed R120000).

C shall be the lesser of (i) or (ii) below.

(i) =the actual lump sum death benefit received.

(ii) =the greatest of

(a)R60 000; or

(b)the amount the member could have received as a lump sum (ie. the commutation of one-third of the annuities available) if he/she had retired on the day immediately before he/she had died; or

(c)one-third of the members own contributions to the fund together with reasonable interest (this has been accepted as being a compound interest rate of 7% pa).

Withdrawal from a Fund

Where a taxpayer withdraws from a fund, either as a result of resignation from the fund, or due to the fact that the fund is wound up, the proceeds of the fund payable to the member will be taxable. It is, however, possible for the taxpayer to eliminate the tax implications on the money due to him or her if the money is re-invested in one of the following ways (set out in paragraph 6 of the Second Schedule) by transferring any amount received by the taxpayer from:

(a)an approved pension fund into another approved pension or a retirement annuity fund. (This would also include transfer to an approved pension preservation fund.);

(b)an approved provident fund into another approved provident, pension or retirement annuity fund. (This would also include transfer to an approved pension or provident preservation fund.);

(c)a retirement annuity fund to another retirement annuity fund.

Should the taxpayer not choose to transfer the money as explained above then the first R1 800 received by him or her will be tax exempt. (Note that this R1 800 applies in any year that the taxpayer may receive a lump sum as a withdrawal benefit from a pension, provident or retirement annuity fund.)

Rate of Taxation

Under paragraph 7 of the Second Schedule, any income which is to be taxed as a result of inclusion by the Second Schedule will be taxed at the taxpayers highest average rate of tax in the current or previous year of assessment. (Section 5(10))

Taxation of Insurers

The very nature of the differences between the business conducted by short-term and long-term insurers must inevitably result in them being taxed by completely different means. The concept of the long-term insurer as the trustee of its policyholder funds has gained general acceptance and therefore the taxing of a long-term insurer as an ordinary company would be to the detriment of those very policyholders. For this reason long-term insurers find themselves in a unique position with regards their tax regime.

Short-term insurers, on the other hand, tend to be generally considered (for income tax purposes) as ordinary companies with but a few anomalies that need to be taken into account when their tax liabilities are determined. These special considerations are addressed in section 28 of the Income Tax Act.

Short Term Insurers

In the same way as with any other taxpayer the taxable income of a short-term insurer doing business in the Republic (whether as a mutual association or otherwise) is determined by deducting such allowable deductions as are permitted from its income. However, the definitions of deductions and income are unique to short-term insurance business, and this is where section 28 of the Income Tax Act comes in.

Income is defined as the sum of all premiums (including reinsurance premiums) received by or ac