SEPTEMBER 2008 – ISSUE 109 CONTENTS …...Integritax Issue 109 – September, 2008 ©SAICA, 2008...

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.


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.


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


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


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)


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.


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)


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


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)


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.


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


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”


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.


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”


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.


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:


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


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


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.


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


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


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.

SEPTEMBER 2008 – ISSUE 109 CONTENTS …...Integritax Issue 109 – September, 2008 ©SAICA, 2008...

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