Currently, employer contributions to pension and provident funds are not taxed as a fringe benefit, whilst individuals are afforded a deduction for contributions to pension funds and retirement annuity funds (RAFs). The tax-free contribution by employers is effectively unlimited, although the tax deduction for the employer is limited to 20 percent of ‘approved remuneration’ per annum. The employee’s pension deduction is limited to 7.5 percent of pensionable earnings, and the RAF deduction is limited to 15 percent of non-pensionable earnings.
Once contributions are in the funds, all income, gains and growth are effectively tax-free.
When lump sums are paid out from these funds, concessional tax tables then apply, rather than the standard income tax table. Contributions to the fund for which the taxpayer did not receive a tax deduction (for example Provident Fund contributions, or pension contributions over the prescribed limit) will reduce the taxable amount of the lump sum received. Withdrawals prior to retirement are afforded a R22 000 exemption, thereafter the tax rate starts at 18 percent, rising to 36 percent once cumulative lump sum receipts exceed R900 000.
Retirement withdrawals receive more generous exemptions, with a nil tax rate up to R315 000, and the 36 percent rate kicking in at R945 000. It should be remembered, however, that these tables are cumulative during a person’s lifetime with respect to all withdrawal, retirement and severance lump sums. Annuities however are taxed at normal marginal rates (currently topped at 40 percent on taxable income over R617 000 per annum).
From an employee’s perspective, the predicted reforms largely concern the tax concessions currently applicable to employer and employee contributions.
National Treasury has proposed to include all employer contributions to all fund types as a taxable fringe benefit in the relevant employee’s taxable income. To neutralise the tax impact of this, however, the employee shall be allowed a deduction of up to 22.5 percent of remuneration or taxable income (i.e. the combination of the current 7.5 percent and 15 percent caps, but applied to all earnings, with no distinction between pensionable and non-pensionable portions. The cap will increase to 27.5 percent for taxpayers 45 years or older). In calculating this deduction, the employee may treat the employer’s contributions as their own, so that the employer contribution fringe benefit and deemed deduction for that contribution will cancel each other out, and the employee’s contribution will remain tax deductible.
Note that this means employee contributions to Provident Funds will become tax deductible. The employer shall be afforded an unlimited tax deduction for its contributions.
If the reforms stopped there, it would be a much welcomed simplification of the rules. The reforms will go further however, and propose that a monetary cap be placed on tax deductible contributions, in addition to the 22.5 percent cap. For taxpayers up to 45 years of age, the proposed cap is R250 000 per annum, with a R300 000 per annum cap for older taxpayers. In effect, taxpayers under 46 with taxable income in excess of R1.1 million per annum will not be able to use their entire 22.5 percent pension contribution limit. Contributions in excess of the limits, for which the taxpayer received no tax deduction, will reduce the taxable lump sum and/or annuity on withdrawal/retirement. While this is sensible, it ignores the time value of that money and may become a disincentive to invest in retirement funds once the caps are reached.
Despite lobbying on the issue, Treasury appears fixed in its intention to retain the proposed monetary caps. The apparent disincentive for higher-earners has been dismissed as only impacting a few thousand individuals. That may be so, but those few thousand individuals pay a disproportionate amount of the tax collected in South Africa, and also contribute substantially to the country’s savings pool.
Therefore, it is possible that the level of the proposed monetary caps may be reconsidered in the Budget. We could also see the effective date being moved forward to 1 March 2013, as this legislation has been on the cards for two years already.
With regards to foreign pensions, there is good and bad news. The exemption available to foreign retirement annuities earned from past foreign employment is likely to be extended to foreign retirement lump sums. Furthermore, whilst non-residents will be permitted the same deduction for their local pension contributions as is afforded to residents (a recent change in policy), any contributions to foreign schemes will be non-deductible for tax purposes. This will mean that employers contributing to foreign schemes, for example on behalf of their expatriate employees (who typically remain in their home employer’s pension scheme), will see this become a taxable benefit with no tax relief, unless a Double Tax Agreement applies, for example the respective double taxation agreements with the US and UK.
If the expatriates are tax equalised, as is often the case, this will potentially be a massive additional gross-up cost to employers, and effectively a tax on bringing foreign skilled workers to South Africa. This may not have been the Minister’s intention and it is hoped that the Minister will reconsider this aspect of the proposed legislative changes.
On the subject of encouraging non-retirement savings, National Treasury has also been busy. The most significant proposal is the introduction of tax-free savings products, very similar to the hugely popular Individual Savings Accounts (ISAs) in the UK. Individuals will be permitted to invest up to R30 000 after-tax per annum in these accounts. The growth and income accruing on the accounts will be exempt from income tax and capital gains tax, as will any withdrawals from the account, however, amounts withdrawn cannot be replaced in addition to the R30 000 per annum. Two types of tax-free account will be approved; interest-bearing, for example cash and bonds, and equity-based, for example unit trusts. A lifetime contribution limit of R500 000 is also proposed.
While this is good news, it comes at a cost. The current interest exemption up to R22 800 per annum is proposed to be phased out to make way for the new accounts. Consequently, anyone earning interest outside of one of the approved accounts will be subjected to income tax on that amount. The tax-free interest exempted on the new accounts will likely never compensate for the loss of the current exemption. For example, even once a person has contributed their maximum R500 000 (which will take over 16 years at R30 000 pa), the tax-free interest earned at, say, five percent will be only R25 000 per annum. When combined with the recent dividends tax, it is unwelcome news for many investors. It remains unclear how older investors will be able to move their current savings into the new accounts.
While government’s focus on encouraging savings is welcome and needed, we hope to see the current proposals tweaked to better achieve their aims when the Minister hands down his Budget on 27 February 2013.
Ultimately, the objective is to encourage taxpayers to save so that they can support themselves in retirement, rather than rely on the state, leaving more money in the pot for government to use on the various spending initiatives in the National Development Plan.