september 2008 – issue 109 contents …...integritax issue 109 – september, 2008 ©saica, 2008...
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Integritax Issue 109 – September, 2008 ©SAICA, 2008 page 1
SEPTEMBER 2008 – ISSUE 109
CONTENTS
CAPITAL GAINS TAX
1656. Recent amendments
INDIVIDUALS
1661. Definition of spouse
DEDUCTIONS
1657. Interest on replacement loan
RETIREMENT FUNDS
1662. New reforms
EXEMPTIONS
1658. “Any Law” means South African statute
law
VAT
1663. Fines and penalties
FRINGE BENEFITS
1659. Travel Allowance: pros and cons
SARS NEWS
1664. Interpretation notes, media
releases and other documents
GROSS INCOME
1660. Declaring more income than received
CAPITAL GAINS TAX
1656. Recent amendments
Various amendments have been introduced to the Eighth Schedule to the Income Tax Act No. 58 of
1962 (the Act), which deals with capital gains tax (CGT).
Events treated as disposals and acquisitions for CGT purposes
Relief is granted from a deemed disposal for a debt reduction in respect of intra-group debt
forgiveness. In certain circumstances the relief would not apply if the debt was acquired from a
person who was not a member of the group or the parties became members of the group after the debt
arose and the transactions were part of a scheme to avoid the tax imposed by the paragraph.
This exclusion from the relief is now extended to include transactions which are part of a scheme to
avoid any tax otherwise imposed “by virtue of this Act”. The same amendment is made to the relief
provided for debts reduced or discharged between connected persons on liquidation.
This amendment will come into operation as from the commencement of years of assessment ending
on or after 1 January 2009.
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Currently, the relief provided on liquidation will only apply if certain prescribed steps are taken for
the liquidation, winding-up or deregistration of the company within 6 months of the reduction or
discharge. An amendment extends this period to 18 months or such further period as SARS may
allow. This period is now in line with the period allowed for liquidation distributions under section 47
of the Act in terms of the Corporate Rules. This extension is deemed to have come into operation on
1 January 2008.
Base cost of CFCs
The base cost of an interest held by a resident in a CFC is the sum of the amount paid to acquire the
interest in the CFC and the proportional amount of the net income of the CFC which was included in
the income of the resident, less the amount of the foreign dividend distributed to the resident which
was exempt from tax i.e. dividends declared out of the net income of the CFC which have been taxed
in the hands of the resident under section 9D.
An amendment has been made to correct the wording of the section which provided an incorrect result
when shares in a CFC were held through another CFC.
Short-term disposals and acquisitions of identical financial instruments
Paragraph 42 deals with so-called “wash sales” or “bed and breakfasting” whereby a taxpayer
disposes of a financial instrument, usually shares, at a loss and the taxpayer or a connected person in
relation to the taxpayer acquires a financial instrument of the same kind and same or equivalent
quality within a period of 45 days prior to or after the disposal.
In these circumstances, the capital loss is disregarded by the taxpayer which disposes of the shares
and is added to the base cost of the acquiring taxpayer. Previously the acquisition date was rolled over
from the disposing taxpayer to the acquiring taxpayer. However, this rule has now been deleted;
therefore the period of holding by the disposing taxpayer is disregarded by the acquiring taxpayer.
Editorial Comment: It is interesting to note that this same restriction does not apply in regard to
trading stock held and sold prior to the year end at a loss and repurchased in the new year.
Disposal of interest in equity share capital of foreign company
Certain changes have been made to the provisions of paragraph 64B of the Eighth Schedule, which
deals with the disposal of an interest in the equity share capital of a foreign company. Currently, the
paragraph provides that, where a person holds at least 20% of the equity shares in a foreign company,
it held those shares for at least 18 months (subject to certain exceptions), and disposed of the shares to
a non-resident or on the person ceasing to be a resident, any gain or loss from the disposal of the
shares must be disregarded.
An amendment provides that the person must hold at least 20% of the equity share capital “and voting
rights” in the foreign company. This amendment brings the provision in line with the exemption
applicable to foreign dividends.
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The requirement that the shares should have been disposed of to a non-resident or on the person
ceasing to be resident, has been changed and the paragraph now requires that the shares should be
disposed of:
i. to any person other than a resident or a CFC;
ii. on commencing or ceasing to be a resident or CFC, where the circumstances arose directly or
indirectly as a result of a disposal to a person contemplated in (i) above; or
iii. by any person to a CFC in relation to that person or to any other CFC that forms part of the
same group of companies as that person.
There is a provision for a claw-back of gains previously disregarded under this paragraph in certain
circumstances. An amendment extends the claw back to include gains disregarded which resulted
from capital distributions from certain foreign companies. Presumably the inclusion in the claw back
rules was an omission in the 2007 amendments.
The above amendments are deemed to have come into operation on 21 February 2008 and apply in
respect of an interest disposed of on or after that date, unless that disposal is the subject of an
application for an advance tax ruling that was accepted by the Commissioner before that date.
It is interesting to note the comments made in a SARS media statement regarding paragraph 64B,
released on 21 February 2008. According to SARS, the provision is being abused to undermine the
South African tax base (for example, paragraph 64B is, in SARS’ view, being used to shift South
African-owned foreign companies outside the South African tax system, thereby limiting the South
African global tax reach). In view of this perceived misuse and in light of the easing of Exchange
Control, SARS is considering proposing to the legislature the possible repeal of paragraph 64B.
Deloitte
IT Act: s 9D, s 47, Eighth schedule par 42, 64B
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DEDUCTIONS
1657. Interest on replacement loan
On several occasions over the past year, the tax court has awarded costs against SARS on the punitive
attorney and client basis as a sign of its disapproval of the treatment of a taxpayer. This happened
again in Tax case No 11691, judgment in which was delivered by Claassen J in the Johannesburg tax
court on 24 April 2007.
The appellant was an incorporated medical practice consisting of three partners. They had decided on
incorporation for three reasons, which were not challenged in evidence:
• the goodwill, which resided in the approximately 8 000 patients of the practice, would appear
on the balance sheet of the company, which was not the case with the partnership. This would
facilitate the raising of loans and the sale of shares to incoming practitioners;
• the resignation and acquisition of new partners would be facilitated by the ability to buy and
sell shares in the company;
• the income tax payable by the company would be less than that payable by individual
practitioners;
• they were led to believe that, as employees of the company, they would be eligible for UIF
benefits.
As a result of the sale, the partners had loan accounts with the company, on which interest at 15% in
1998 and 21% in 1999 and 2000 was charged.
About four months after the incorporation, one of the partners was in financial difficulties and
required repayment of his loan account. They arranged with a bank to advance the sum of R1 350 000
to the company, which was used to repay loans to the extent of R450 000 to each partner. This bank
loan bore interest at 19.5% in 1998, 21% in 1999, and 14.5% in 2000 and 2001. In anticipation of
receiving the advance, the company went into overdraft in order to pay the amounts to the partners
immediately.
CSARS refused to allow the deduction of this interest, giving three reasons for its decision:
1. the interest had not been incurred in the production of income, as required by section 11(a),
the “positive” side of the general deduction formula;
2. it had not been laid out or expended for the purposes of trade as required by section 23(g), the
“negative” side of the formula; and
3. the interest incurred was capital in nature.
As to the first reason, the court referred to the dictum that expenditure is said to be incurred in the
production of income when it is closely related to the act that produces the income. In deciding
whether the act is closely connected, the court will determine whether “it would be proper, natural
and reasonable to regard the expenses as part of the cost of performing the operation”. After citing
several judgments and referring to an article by Professor R C Williams in which he refuted any
suggestion that interest paid could be capital in nature, the court found that the interest had been
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incurred in consequence of a revenue producing machine and was therefore deductible. The
subsequent bank loan was a “replacement loan” and bore the same characteristics as its predecessor
loans from the directors. All the interest had therefore been incurred in the production of income.
As to the second reason, it would appear that counsel for CSARS did not stress this argument, which
was hardly surprising. The court found that there was no basis in fact or in law for CSARS to argue
that the appellant was not conducting a trade or was paying debt outside the conduct of its trade.
As to the third reason, counsel submitted that the purpose of the appellant in making the loan was not
to produce income but to reduce its bank overdraft, which the payment to the directors had caused to
increase extensively. The court rightly rejected this argument; the overdraft had increased because the
directors had demanded repayment of their loans, which they were entitled to do. The loan from the
bank was obtained to liquidate the overdraft. Counsel for CSARS had cited CIR v Drakensberg
Garden Hotel (Pty) Ltd 23 SATC(1960) 251 and ITC 1126 31 SATC (1968) 111 in support of her
submission, but the court correctly pointed out that these cases had not found that interest paid on
money borrowed to buy shares was of a capital nature.
Therefore the appeal was upheld, whereupon counsel for the appellant asked for a punitive costs order
on the grounds that the reasons advanced by CSARS were unreasonable. In considering this
application the court drew attention to the weight of authority cited by the appellant and the fact that
counsel for CSARS had never seriously disputed the facts in the case nor had she tendered rebutting
evidence. The facts were relatively simple and the arguments of CSARS were without substance.
Consequently, the punitive award was made against CSARS.
Deneys Reitz
IT Act: s 11(a), s 23(g)
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EXEMPTIONS
1658. “Any Law” means South African statute law
“A body established under foreign law cannot qualify for tax exemption under section 10(1)(cA) of
the Income Tax Act No. 58 of 1962 (the Act).
Exemption from income tax is a prize, highly sought-after. The Act lays down detailed criteria for
gaining tax-exempt status.
The recent decision of the Pretoria Tax Court in case 10849 (2007) which has just been released in
electronic format, concerned a non-profit organisation that had enjoyed tax-exempt status in South
Africa from 1970 to 1987 in terms of the Double Tax Convention between the Republic and the USA.
That convention was abrogated in 1987, and the taxpayer’s claim for tax-exemption thereafter
depended on its falling within one of the categories for tax-exemption in the Act.
The decision in this case clarifies an important aspect of section 10(1)(cA) of the Act, namely whether
the reference in that provision to an institution, board or body, other than a company, which is
“established by or under any law” means South African statute law, or whether establishment under a
statute of another country would suffice.
The taxpayer was a non-profit organisation formed in New York
The taxpayer in this case was a non-profit organisation, founded in New York and formed in terms of
a special Act of the New York legislature.
It was a non-profit organisation carrying on the activities of an independent classification society, that
is to say, an organisation that sets and maintains standards of safety and reliability by establishing
rules for the design, construction and maintenance of merchant ships.
It seems that the taxpayer would have met the criteria for tax-exemption laid down in section 10(1)
(cA) if it had been incorporated under a law enacted in the Republic. However, it was merely a branch
of the New York-based organisation which carried on the aforementioned services for the benefit of
the South African maritime community.
The case — and the taxpayer’s claim for tax-exempt status — turned on the interpretation of the
phrase “institution, board or body ... established by or under any law”.
SARS argued that the word “any” in the phrase “any law”, though potentially of wide scope, meant in
this context, South African law, and in particular South Africa’s statute law.
Support for this interpretation is found in the Interpretation Act 33 of 1957 which defines “law” as
“any law, proclamation, ordinance, Act of Parliament ... having the force of law.”
Bell’s South African Law Dictionary defines “any law” as “an enactment having legislative authority
in the Union”, and cites in support of this proposition the decision in R v Adams 1946 CPD 288 which
held that the word “law” in the Criminal Procedure and Evidence Act of 1917 referred to “any law
enacted by a body having legislative authority in the Union or any other law especially made
applicable to in the Union”.
The decision in R v Detody (1926) AD 201 was to the same effect.
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The taxpayer argued that the phrase “any law” must include the legislative enactments of foreign
countries.
The court ruled that “any law” refers only to South African statute law
In the result, the Tax Court held that, in enacting section 10(1)(cA), the South African legislature
must have intended the phrase “any law” to refer only to South African statutes, for the entire purpose
of the Act is to control the revenue accruing to the state from taxes levied on the income of its
citizens.
The court said that—
“To give recognition to creatures created by foreign statutes without any qualification or
definition, might seriously endanger the entire object of the Income Tax Act.”
The court accordingly ruled that the taxpayer in this case did not qualify as a body to which
section 10 (1) (cA) of the Act applies.
The definition of the word “law” was crucial in this matter, as the body could not have enjoyed
exemption by incorporating a subsidiary or registering as an external company (that is, a branch of the
New York company), as the particular exemption specifically excludes companies incorporated or
deemed to be incorporated under the Companies Act.
The difficulty for this particular taxpayer was that it had applied for tax-exemption in 1997, believing
that it qualified for such exemption, and that it apparently took some eleven years for the matter to be
concluded by the Tax Court.
PricewaterhouseCoopers
IT Act: s 10(1)(cA)
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FRINGE BENEFITS
1659. Travel Allowance: pros and cons
A travel allowance should be paid only to an employee where that employee is required to use his (or
her) own private motor vehicle for the purposes of his employer’s business. It is risky for travel
allowances to be granted to employees not for commercial reasons, but only for tax reasons.
For the purpose of calculating employees’ tax, 60% of the travel allowance must be included in the
employee’s monthly remuneration.
If an employee receives a monthly travel allowance from his employer and that employee does
undertake a reasonable or substantial amount of business travel, the employee should realize a benefit
on assessment if his or her business travel deduction is greater than 40% of the travel allowance. In
those circumstances PAYE will have been over-deducted and a refund will be due. It should be noted
that the deduction for business travel expenses is limited to the travel allowance received.
There are two options available to determine the business travel deduction on assessment. The first
option is where an employee has kept an accurate logbook of the business kilometres travelled during
the tax year (travelling between home and work being regarded as private travelling). The second
option is where an employee does not keep records of actual business travelling. Here, the first 18 000
kilometers traveled in the tax year will be deemed to be private travel, with the next 14 000 kilometers
deemed to be business travel. Kilometers traveled in excess of 32 000 will be deemed to be private.
Where is the benefit and where is the danger?
Where the employee keeps an accurate logbook of business travel (and actually does a fair amount of
business travel) or where the employee does substantial traveling (i.e. around 32 000 kilometers) in a
tax year, then the employee should benefit from receiving a travel allowance.
Where the employee does not keep an accurate logbook or total kilometers traveled in a tax year do
not exceed 18 000 by any meaningful amount, that employee could potentially find himself with an
unwanted tax liability on assessment.
As only 60% of a travel allowance is subjected to employees’ tax during the tax year, essentially the
employee has received 40% of that travel allowance “tax-free” during the year. The justification of
this 40% being tax-free becomes the issue on assessment and the business travel deduction (as
discussed above) would then determine the extent of the travel allowance that is subjected to income
tax on assessment.
Thus, where an employee receives a travel allowance, whilst he will enjoy the benefit of 40% of that
travel allowance being tax-free during the year, when it comes to determining the business travel
deduction for the purposes of his assessment, the employee may suffer the consequences of not being
able to justify the 40% tax-free component. This will result in the employee being faced with a tax
liability on assessment which results in him having to pay the tax that was not deducted during the tax
year.
In summary, if an employee is in receipt of a travel allowance and does not use a vehicle for business
purposes, the employee should request that the allowance be adjusted (through a reallocation to
salary), so that he does not find himself with an unwanted tax liability on assessment.
Is the travel allowance then a benefit or a lurking danger? The answer to this depends on the
circumstances of each employee. There is no one solution that fits all. Employees should perform a
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calculation based on the quantum of business travel they expect to do in a tax year. In this way they
can ensure that they then receive a travel allowance that is commensurate with travel and does not
cause them to have a tax liability on assessment.
As the deduction for a taxpayer’s business travel expenses may not exceed his travel allowance, once
the business travel is estimated, the optimal travel allowance should build in some element of margin
so as to avoid the situation where business travel expenses exceed the travel allowance and the
deduction for that excess is forfeited on assessment.
Ernst & Young
Editorial Comment: Specimen logbooks are available as a download from the SARS website. Refer
item 1641.
IT Act: s 8(1)(a)(i)(aa)
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GROSS INCOME
1660. Declaring more income than received.
This was the principal issue before the Pretoria Tax Court in ITC 1824 (2008) 70 SATC 27 in which
the judgment was handed down on 3 April 2007 but which has only just been published.
Following hard on the heels of the Brummeria Renaissance judgment on the tax consequences of an
interest-free loan, the shock-waves from which are still rocking the business world — comes a
decision of the Pretoria Tax Court, also dealing with fundamental aspects of the concept of “accrual”
in terms of the Income Tax Act No. 58 of 1962 (the Act).
This new judgment, happily, resonates with common sense, business practicality and is soundly based
in legal principle.
Gross income includes both receipts and accruals
In terms of the Act, a taxpayer must disclose to SARS the total amount of income that has either been
“received” by him or which has “accrued” to him during the tax year.
The meaning of “received” in this context has not proved troublesome, but the concept of “accrual” is
more complex.
The fundamental principle is, however, not in doubt — an amount “accrues” to a taxpayer when he
becomes “entitled” to it, in other words, when he acquires a legal right, even if the amount has not yet
been paid to him. This cardinal principle was laid down in Lategan v CIR (1926) CPD 203 at 208 and
affirmed in CIR v People’s Stores (Walvis Bay) (Pty) Ltd (1990) (2) SA 353 (A), SATC 9.
But what happens where the taxpayer thinks that he was entitled to a certain item of income (although
he has not yet received it) and dutifully discloses it to SARS in his tax return, and then — after he has
been assessed to tax on that income - learns that he was not, in fact, entitled to it? Clearly, he has paid
more tax than he ought to have, but how does he get his tax affairs set right?
The facts
In this case, the taxpayer had, in the year 2000, entered into a written agreement with its client, in
terms of which the taxpayer was to provide the latter with “financial risk management services” in
return for specified performance-related fees.
Thereafter, the taxpayer introduced an “electronic cash sweeping statement” for its client and
rendered so-called “liquidity risk management” (LRM) services to the client, for which the taxpayer
claimed to be entitled to a fee of some R19 million, which it duly invoiced. At the time of the hearing
before the Tax Court, this invoice had not been paid.
The taxpayer claimed that it had also arranged for a contingent insurance policy to replace a general
insurance fund (GIF). For this service, the taxpayer claimed that it was entitled to a fee of some R13
million, for which it also invoiced the client. The client paid this invoice.
Thereafter, the client disputed its liability for both of these fees, and claimed repayment of the R13
million that it had already paid the taxpayer.
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The dispute went to arbitration. The arbitrator made his award in July 2004, holding that the taxpayer
was not entitled to the amount it had claimed for the LRM claim or the GIF claim. The arbitrator also
held that the client was entitled to be refunded the R13 million it had paid in respect of the latter.
In the meantime, the taxpayer had included the R19 million in respect of the LRM claim and the R13
million in respect of the GIF claim in its tax return for 2001. In June 2002, the SARS had assessed the
taxpayer on a taxable income of some R30 million for that tax year, which included the two amounts
that were the subject of the arbitrator’s ruling.
The taxpayer did not lodge an objection because, at this time, it believed that it was indeed “entitled”
to these amounts, and that the amounts had therefore “accrued” to it, and must therefore be included
in its gross income for income tax purposes.
After the arbitrator gave his ruling in July 2004, both the taxpayer and the client agreed that the
arbitrator’s ruling was correct.
The issues
The issues before the Tax Court centred on whether there had been an accrual to the taxpayer in
respect of the invoiced amounts of R19 million and R13 million.
The court held that the factual findings of the arbitrator provided a basis on which the relevant legal
principles could be applied, but that it was for the court to determine the law and apply the law to the
facts.
The court said that whether a person was “entitled” to an amount is a question of law; the subjective
belief of that person that he was entitled to the amount was not the test.
The court ruled that the effect of the arbitrator’s award was not to novate the taxpayer’s rights (in
other words, the award did not extinguish the original rights of the taxpayer and replace them with the
terms of the arbitrator’s award) but merely confirmed and reinforced those original rights.
The court held that, on the facts found by the arbitrator and agreed by the parties as being correct, the
contractual amounts in question had never become “due” to the taxpayer by the client.
It followed, said the court that those debts could not become “bad debts”; the debts had never existed,
so there was nothing to go bad. Hence, it was not open to the taxpayer to put matters right by claiming
a deduction under the bad debts allowance provided for in section 11(j) of the Act.
The relief to which the taxpayer was entitled therefore had to take the form of an order that the
amounts in question had never “accrued” to the taxpayer, and that the amounts in question must
therefore be excluded from the assessment for the 2001 tax year.
In effect, therefore SARS would have to reissue a revised assessment for that year.
Is the judgement correct?
While this approach is to be welcomed, it should be compared with the approach of the Supreme
Court of Appeal in MP Finance Group CC (in liquidation) v CSARS 69 SATC 141(2007) . In that
matter, the CC was a vehicle for an illegal pyramid scheme, and its operators had duped gullible
investors into parting with considerable amounts of money. The SCA held that the relationship
between the victims and the operators was irrelevant. The matter was between the scheme and the
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fiscus and the sole question was whether the amounts were accepted by the operators for their own
benefit.
Notwithstanding that the operators must have known that the amounts were fraudulently obtained, the
SCA held that they fell within the requirements of gross income and were taxable.
In principle, the issue of an invoice would indicate that the taxpayer considered that it was entitled to
be remunerated for its services. It only subsequently conceded that it was not so entitled. In principle,
it is in a worse position than the fraudsters in the SCA matter, who knew from the outset that they
were not legally entitled to the money for their own benefit.
Editorial Comment: The Draft Revenue Laws Amendment Bill 2008 proposes a new s23(iiA) to
address this problem by allowing a deduction.
PricewaterhouseCoopers
IT Act: s 1 definition of “gross income”
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INDIVIDUALS
1661. Definition of spouse
In 2001 a definition of “spouse” was introduced into the Income Tax Act No. 58 of 1962 (the Act),
the Estate Duty Act, and the Transfer Duty Act. This seemingly innocuous and politically correct
definition has implications that are perhaps not readily apparent to the taxpayer. In terms of this
definition, “spouse” means, in relation to any other person, a person who is the partner of that person:
a) in a marriage or customary union recognized in terms of the laws of the Republic;
b) in a union recognized as a marriage in accordance with the tenets of any religion; or
c) in a same sex or heterosexual union which the Commissioner is satisfied is intended to be
permanent.
The definition then provides that any marriage or union contemplated in either paragraph (b) or (c)
will, in the absence of proof to the contrary, be deemed to be a marriage or union without community
of property.
Say two people have been co-habiting for 10 years and do not intend to get married. In terms of the
fiscal Acts there is a strong suggestion that they are spouses in terms of the definition, with the
implications that accompany that status. This status could be invoked by them or by the
Commissioner, but in practice is more likely to be initiated by them because of the fiscal benefits that
flow from such status, which include, apart from the obvious social benefits that arise from the
recognition of parties to such relationships as spouses, and in particular the protection for partners:
• Donations tax is not payable on donations between spouses.
• Transfer duty is not payable on the transfer of property between spouses on termination of the
union, whether by death or break-up.
• Estate duty is not payable on any asset bequeathed to a spouse.
• Capital gains tax is not payable on the disposal of an asset, by whatever means, from one
spouse to the other. The recipient spouse is deemed to have acquired the asset at a base cost
equal to that of the disposing spouse.
Editorial Comment: There may also be other Acts which would be relevant.
In general, the definition raises several important implications which need to be taken into account by
people who, as is increasingly the case nowadays, choose to co-habit without undergoing a formal
union in terms of the marriage laws or the Civil Union Act. Since the introduction of the definition it
would be advisable for persons who are co-habiting and who, for whatever reason, do not wish to be
considered each other’s spouses, to record that fact in some sort of agreement. They might not want,
for example the laws of intestacy to apply to them. Neither might they wish to be treated as spouses in
the event of the termination of the relationship. The point is that the parties should decide on the
nature of their relationship and not merely drift along until they are faced with a possible dispute
when things turn sour.
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If two people are co-habiting and consider themselves to be spouses in terms of the fiscal Acts, it is
important that they draft wills reflecting that fact and bequeathing their estates accordingly. Failure to
do so might leave a bereaved partner fighting with blood relatives of the deceased partner seeking to
apply the law of intestacy to disinherit the surviving partner, as happened in a case that reached the
Constitutional Court (Gory v Kolver NO & Others (2006) 4 (SA) 97 CC)— where the parents of a
person who died young and intestate are seeking to take possession of his fixed property, arguing that
he and his partner were not spouses. In terms of the law of intestacy, if a spouse dies intestate and
there are no children, the estate devolves upon the surviving spouse. If there is no spouse, the estate
devolves upon the parents of the deceased.
Finally, any people acquiring a property jointly should draw up an agreement setting out what should
happen to the respective share of each of them in the event of death.
Deneys Reitz
IT Act: s1 definition of “spouse”
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RETIREMENT FUNDS
1662. New reforms In terms of the Explanatory Memorandum to the Taxation Laws Second Amendment Bill (2008), a
number of the proposed retirement fund-related changes are aimed at facilitating the future movement
of the definitions of different types of retirement funds, currently defined in the Income Tax Act No.
58 of 1962 (the Act), to the Pension Funds Act.
Currently, there are two systems of registration for retirement funds. Retirement funds have to register
with the Financial Services Board in terms of the requirements of the Pension Funds Act. These funds
also then have to be approved by the Commissioner as either a pension, provident or retirement
annuity fund in terms of the Act. Two sets of qualifying and regulatory criteria have thus to be
complied with.
Due to the administrative burden which this dual registration imposes, it has been decided that certain
regulatory definitions would be moved from the Income Tax Act to the Pension Funds Act, with the
aim of streamlining the registration and regulation process. In anticipation of this move various
definitions are being amended to ensure the synchronisation between the Income Tax Act and the
Pension Funds Act. The following amendments have accordingly been proposed:
Definition of “living annuity”
In order to remove any uncertainty as to whether the term annuity includes a “living annuity”, the
latter term has now been specifically defined in the Act, and the references to annuity have been
expanded to refer to a “living annuity”.
Editorial Comment: This new definition overrules the decision in this regard in the case of CSARS v
Higgo 68 SATC 278 (2006).
Certain proposed amendments which arise as a result of the specific inclusion of this definition,
include amendments to make it clear that two thirds of the fund value for pension and retirement
annuity funds may be taken in the form of a living annuity, and that payments from living annuities
are included in gross income.
Partners and Pension Funds
The pension fund definition has been amended to ensure that partners who were not previous
employees of the partnership may now also join a pension fund. The current definition only allows a
partner to join if he or she was previously an employee of the partnership and, on becoming a partner,
was permitted to retain his or her membership as though he or she had not ceased to be an employee.
The proposed legislation will now allow all partners to join irrespective of previous employment.
Amendments which arise as a result of this expansion include the amendment to the definition of
“retirement-funding employment” and amendments relating to the deduction for contributions, from
both an employee and an employer point of view.
The formal introduction of provident preservation funds and pension preservation funds
In terms of the Explanatory Memorandum, preservation funds are currently dealt with in terms of the
definitions of pension fund and provident fund.
As the requirements are closely linked to the approval requirements for these funds, this is creating
difficulties for persons who wish to preserve savings for purposes of their retirement.
Integritax Issue 109 – September, 2008 ©SAICA, 2008 page 16
Difficulties which are being experienced include:
• Where employment is terminated, there is a limited choice of preservation funds;
• Transferability between preservation funds is difficult and funds can become trapped in a fund
once transferred.
Two new definitions of “pension preservation fund” and “provident preservation fund” are
accordingly being introduced. These will provide flexibility and choice for those wishing to retain
their retirement savings within a tax-free retirement vehicle.
In terms of the Explanatory Memorandum, what the new definitions do is to “untie” a preservation
fund from the employment relationship. It will be possible for:
• An employee to choose his or her own pension or provident preservation fund on termination;
• Transfer between the same types of preservation fund;
• A divorcee who receives a settlement from the former spouse’s pension to be able to transfer
funds to a preservation fund; and
• Preservation funds to be set up to hold benefits which have not been paid within 24 months of
becoming due.
Pension and provident preservation funds will differ (mainly) in that:
• Pension preservation funds may only receive amounts transferred from pension funds and
provident preservation funds from provident funds.
• Pension preservation funds will contain the same compulsory annuity provision as pension
funds (i.e. 1/3rd
lump sum; 2/3rds annuity).
Transfers to these funds will be tax-free and payments from these funds will be determined on the
same basis as payment from other funds.
A number of specific proposed amendments have arisen as a result of the inclusion of these two new
definitions. These include changes to the “gross income” definition, changes to provisions which deal
with the taxation of long-term insurers, the inclusion of the funds for purposes of determining the
liability of representative employers, amendments relating to objections and appeals and amendments
in relation to the furnishing of information.
“Retirement date”
A new definition of “retirement date” has been inserted, which makes reference to the date of
entitlement to an annuity or a lump sum benefit contemplated in the Second Schedule, on or
subsequent to death or attaining normal retirement age.
“Normal retirement age”
The definition section now also includes a definition of “normal retirement age”, which means:
Integritax Issue 109 – September, 2008 ©SAICA, 2008 page 17
a) in the case of a pension/provident fund member, the date on which that member becomes
entitled to retire for reasons other than illness, injury, incapacity etc; or
b) in the case of a retirement annuity fund/pension preservation fund/provident preservation
fund, the date on which the member attains 55 years; or
c) in the case of any fund mentioned, the date on which the member becomes permanently
incapable of carrying on his occupation due to illness, injury, incapacity etc.
Definition of “retirement fund lump sum withdrawal benefit” and “retirement interest”
A new definition of “retirement fund lump sum withdrawal benefit” has been added, and its meaning
has been determined with reference to the Second Schedule.
Also defined is the term “retirement interest”, which means a member’s share of the value of a fund,
as determined in terms of the fund’s rules upon his or her retirement date.
Changes to the “pension fund” definition
In addition to amendments which arise as a result of the various definitional changes, the definition
has also been amended to delete the timing limitation on the payment of a lump sum following the
death of a member.
The definition currently disallows the commutation of an annuity payable to a dependant or nominee
of a deceased member six months after date of death. The full amount could be received as a lump
sum if the election for this is made within the six months after death. It was found that there were
many occasions when trustees did not find all the dependants within 6 months and this proviso
prevented these individuals from electing a lump sum payment. The section limiting the months for
commutation is now deleted.
Changes to the “retirement annuity fund” definition
The concomitant provision from the pension fund definition, which limited the commutation of an
annuity to within six months of death, has also been removed from the retirement annuity fund
definition.
The definition currently refers to the fact that the rules of the fund have to provide that no member
will become entitled to the payment of any annuity before age 55 years and after age 70 years. It is
proposed that this is removed and replaced with a reference to the entitlement contemplated in the
Second Schedule (which deals with the amount to be included in gross income on retirement or death)
and with reference to the definition of “normal retirement age”.
In the case of a retirement annuity fund the normal retirement age is the date on which the member
attains 55 years. The upper age limit of 70 years has now been removed and the rules will accordingly
no longer need to provide that members are forced to retire from the fund by this age. The rules of the
fund will now determine the retirement date.
In terms of the current legislation, annuities can only be paid to a member’s dependants on the
member’s death, which, in terms of the Explanatory Memorandum, resulted in a problem where there
were no dependants. An amendment now removes the prohibition of payment of amounts on death
otherwise than by way of annuity to dependants and nominees.
Under the current legislation, members of a retirement annuity fund are not able to withdraw their
funds except in instances where the amount is small. In terms of the Explanatory Memorandum, an
Integritax Issue 109 – September, 2008 ©SAICA, 2008 page 18
exception is now made so that members who formally emigrate may withdraw their funds, subject to
the payment of tax.
Second Schedule amendments
The majority of the amendments in the Second Schedule arise as the result of the introduction of the
pension preservation fund and provident preservation fund and other definitions and to correct
drafting errors in the 2007 amendments.
Another Second Schedule amendment is to clarify that the amount to be included in gross income, as
determined in the Second Schedule, is now subject to the provisions of section 9(1)(g), which deems a
pension to be from a South African source if the services were performed in South Africa for at least
two years during the ten years preceding the date the pension first became due.
Only the portion relating to the period of service in South Africa will be of a South African source
(i.e. there will be an apportionment in respect of years of service in and years of service outside South
Africa). This merely confirms the practice of applying apportionment to lump sums as well as
pensions where services were rendered partly outside of South Africa.
Retirement-related provisional tax amendment
Paragraph 19 of the Fourth Schedule which deals with estimates of taxable income for provisional tax
purposes has been amended. Lump sum amounts, contemplated in paragraph (e) of the gross income
definition, are excluded for purposes of the basic amount. This gives effect to the fact that provisional
tax was designed to cover recurring income.
Deloitte
IT Act: s 9(1)(g), Second schedule, Fourth schedule par 19
Integritax Issue 109 – September, 2008 ©SAICA, 2008 page 19
VAT
1663. Fines and penalties
When an association or organization imposes a fine or penalty, the question often arises whether it is
required to charge VAT on the fine or penalty. A fine or penalty can either take the form of a
monetary payment, or it could comprise the suspension of privileges, or both.
The South African Revenue Service (SARS) issued a ruling (general written ruling 439) with regard
to non-statutory fines or penalties in which it states that usually the fine or penalty is due to the action
or lack of action by the person who must pay the fine or penalty, and as such, the fine or penalty
relates to a supply made and is subject to VAT at the standard rate. SARS therefore simply assumes
that such a fine or penalty is paid as consideration for a supply of some sort and is therefore subject to
VAT. It also seems that by implication statutory fines or penalties are not subject to VAT.
The issue is unfortunately not as simple as stated in VAT ruling 439. For a payment to attract VAT, it
must comprise consideration for the supply of goods or services supplied by a vendor in the course or
furtherance of an enterprise carried on by the vendor. Therefore, even if the association or
organization that imposes the fine is a vendor, it will only be subject to VAT if the fine relates to a
supply of goods or services.
For example, if a video club hires out videos to members for a fee, and according to its rules charges
members a fine if a video is returned late, such fine is directly attributable to the hire of the video. The
fine comprises additional consideration for the hire of the video, and is subject to VAT.
Similarly, if a local authority imposes a penalty for the excessive use of water or electricity in the
form of an additional charge for such usage, the penalty relates directly to the supply of the water or
electricity, and as such attracts VAT.
However, if the fine or penalty is not paid in respect of goods or services supplied, it does not attract
any VAT.
In a New Zealand case, Case S65 (1996) 17 NZTC 7408, the court considered whether two law
societies which imposed penalties against a solicitor rendered any services to the solicitor. The case
involved a solicitor who was a member of the New Zealand Law Society and the District Law
Society, which both imposed certain penalties payable by the solicitor to them. The solicitor sought to
claim input tax thereon on the basis that the penalties were subject to VAT and that he was entitled to
a tax invoice to enable him to claim input tax. In his judgment Willy DJ stated that: “One would have
thought that to prosecute somebody is the opposite of doing them a service. It is the doing of a
disservice”. He concluded that the penalties were not consideration for any service supplied by the
societies, that the societies were not liable for VAT or to issue tax invoices, and that the solicitor was
not entitled to any input tax deduction.
In an unreported United Kingdom VAT Tribunal Case, Northamptonshire Football Association
(NFA) (BVC Tribunal, 1996) 2128 the court considered whether the imposition of fines or penalties
was part of the business of the NFA. In this case the Tribunal Chairman concluded that the
enforcement of the rules to which the fines and penalties relate is provided in consideration for the
payment of the membership subscriptions and not in consideration of the fines and penalties imposed.
The fines and penalties are the sanctions accepted by the members for breach of the rules, and are not
consideration for the enforcement activity in any contractual sense.
Integritax Issue 109 – September, 2008 ©SAICA, 2008 page 20
The Australian Tax Authority (ATO) determined that the payment of a fine or penalty is not
consideration for any supply if it is imposed because of a breach of membership rules of an
association and is primarily intended as punishment or to act as a deterrent. It is therefore not an
additional amount of consideration for the supply of membership by the association to the member;
upon payment of the fine or penalty the member receives no additional rights, benefits or privileges to
those which the member was not already entitled immediately prior to the imposition of the fine or
penalty.
The ATO determined further that in accepting the payment of the fine or penalty, the association does
not enter into an obligation with the member to tolerate the misconduct, but it is rather fulfilling its
obligation to all members to enforce the rules. The association can therefore not be said to make a
supply where it already has a pre-existing obligation to continue providing the benefits of membership
to all members.
The VAT implications of fines and penalties imposed by associations or organizations should
therefore be carefully considered in view of the services supplied by that association or organization.
If no additional services or benefits are provided to members, the fine or penalty imposed does not
attract VAT.
Edward Nathan Sonnenbergs Inc.
General written ruling 439
Integritax Issue 109 – September, 2008 ©SAICA, 2008 page 21
SARS NEWS
1664. Interpretation notes, media releases and other documents
15 September 2008 - Legal & Policy: Diamond Export Levy. Your comments are kindly invited on
the attached draft legislation to be sent to [email protected] before or on 06 October 2008
15 September 2008 - Average exchange rates: Table A lists the average exchange rates of selected
foreign currencies as from December 2003; Table B lists monthly average exchange rates.
11 September 2008 - Tariff Amendments: 12 September 2008
01 September 2008 - Legal & Policy: Income Tax Act (58/1962): Appointment and re-appointment of
chairpersons to the Tax Board for the hearing of income tax appeals (GG 31381 - 29 August 2008)
01 September 2008 - Legal & Policy: Income Tax Act: Determination of interest rate for purposes of
paragraph (a) of the definition of "official rate" (GG 31381 - 29 August 2008)
01 September 2008 - Legal & Policy: Taxation Laws Second Amendment Act (4/2008):
Determination of a date upon which section 22 (1) (b) of the Taxation Laws Second Amendment Act,
2008,shall come into operation (GG 31381 - 29 August 2008)
29 August 2008 - Trade Statistics for July 2008
29 August 2008 - Media Release: South African Trade Statistics for July 2008
28 August 2008 - Rule Amendment: 29 August 2008
26 August 2008 - Publication: Practitioners Guide to engaging with SARS August 2008
26 August 2008 - Publication: Comprehensive Guide to Advance Tax Rulings
25 August 2008 - Media Release: One week left to reconcile!
22 August 2008 - Legal & Policy: Draft interpretation note. Income tax: Section 24: Instalment credit
agreements and debtors’ allowance – send your comments to [email protected] by 12
September 2008
21 August 2008 - Tariff Amendments: 22 August 2008
21 August 2008 - Legal & Policy: Media Statement: Revenue Laws Amendment Bills, 2008:
Miscellaneous Additions - 20 August 2008
21 August 2008 - Legal & Policy: Third batch of the draft Revenue laws Amendment Bills, 2008
19 August 2008 - Publication: Guide on the employers' tax responsibilities with regard to
artists/models/crew in the film industry
Readers are reminded that the latest developments at SARS can be accessed on their website
http://www.sars.gov.za
Integritax Issue 109 – September, 2008 ©SAICA, 2008 page 22
Editor: Mr M E Hassan
Editorial Panel: Mr KG Karro (Chairman), Dr BJ Croome, Mr MA Khan, Prof KI Mitchell,
Prof L Olivier, Prof JJ Roeleveld, Prof PG Surtees.
The Integritax Newsletter is published as a service to members and associates of the South African
Institute of Chartered Accountants (SAICA) and includes items selected from the newsletters of firms
in public practice and commerce and industry, as well as other contributors. The information
contained herein is for general guidance only and should not be used as a basis for action without
further research or specialist advice. The views of the authors are not necessarily the views of
SAICA.
All rights reserved. No part of this Newsletter covered by copyright may be reproduced or copied in
any form or by any means (including graphic, electronic or mechanical, photocopying, recording,
recorded, taping or retrieval information systems) without written permission of the copyright holders.