Variable Remuneration Section 7B
10 October 2013
Posted by: Author: Rob Stretch & Trusha Ichharam
Author: Rob Stretch & Trusha Ichharam (EY)
Many employers in South Africa have, in relation to variable remuneration, previously experienced a variance between the employees’ tax reported on the employees’ tax certificates issued, and the employees’ tax declared in the monthly EMP201 returns.
The new section 7B of the Income Tax Act No. 58, of 1962, ("the Act”) provides for the tax treatment of "variable remuneration” and came into effect on 1 March 2013. Amounts accrued or expenditure incurred on or after this date will be subject to the new taxation regime. It follows that, depending on an employer’s tax year, the new regime may become effective during the course of a tax year.
For something to constitute gross income the following elements must be present:
Consequently, gross income includes all income received or accrued to an individual relating to employment, in particular, "remuneration” paid by an employer to an employee. The definition of "remuneration” per paragraph 1 of the fourth schedule of the Act, is expansive and includes basic salary, overtime pay, leave pay, commission and bonuses, benefits-in-kind, and other employment- related benefits.
- There must be an amount;
- In cash or otherwise;
- Received by or accrued to;
- Not of a capital nature; and
- From a source within the Republic in the case of a person other than a resident.
According to section 11(a) of the Act (the general deduction formula), any employer carrying on a trade is entitled to a deduction in respect of "remuneration” expenditure incurred by that employer in the production of income. Section 23E of the Act (repealed with the effect from 1 March 2013) limited the deduction for the employer under section 11(a) in respect of leave pay. The amounts allowed as deductions were limited to the extent that the amounts were actually paid or became due and payable by the employer.
The new section 7B deems the expenditure incurred in respect of variable remuneration to be incurred by the employer (and consequently accrued to the employee) on the date during the tax year on which the amount is paid (see below) to the employee by the employer. Variable remuneration per section 7B is defined as:
- Overtime pay, bonus or commission;
- An allowance or advance paid in respect of transport expenses; and
- Any amount which an employer has become liable to pay to an employee, in a particular year of assessment, in consequence of the employee having become entitled to any leave, in that year of assessment, which has not been taken during that year.
Whereas section 23E of the Act previously provided a similar "payment” regime in respect of leave pay, this principal has now been extended to overtime pay, bonuses, commissions, and transport expenses. The authorities’ stated reason for restricting the payment regime to only these forms of remuneration was as follows: "Rather than adjust core principles and create unintended and unnecessary consequences, this alignment will be required only for items that have a history of causing recurring problems, namely: Leave pay, over-time pay, commission, bonuses and travel reimbursement” (Explanatory Memorandum on the Taxation Laws Amendment Bill, 2012).
The new section 7B addresses the situation where there is a timing difference between the accrual and the actual payment of the amount. For example, where an employee has an unconditional right to receive a bonus at the end of the employer’s financial year (tax year), the deduction/accrual date may be at the employer’s financial year-end, but the employee may only receive payment of the bonus in the following financial year. Whereas the employer would have been able to deduct the bonus in the tax year it was incurred (but not paid), the employer will now only be able to deduct the bonus when paid to the employee, that is, in its subsequent financial year.
Under the so-called general deduction formula (section 11(a), read with section 23(g), of the Act), no direct link exists between most employer deductions and employee income, and , as such, it would appear that this has lead to a beneficial mismatching by employers and employees or genuine problems of interpretation. The new legislation addresses these potential timing benefit/ interpretation issues and matches the withholding tax obligation of the employer with the employer’s income tax deduction in respect of the renumerated employee income types.
Unfortunately section 7B of the Act does not provide any guidance as to when the variable remuneration will be regarded as "paid” – unlike the position with dividends tax (section 64D(2) of the Act). Problems of interpretation in this regard can be illustrated by way of a simple example: A bonus accrues to Employee A on 1 February 2013, but instead of paying this out to the employee, the employee is credited with the amount owing by the employer (a loan account is created in favour of Employee A). The loan account is paid by the employer on 30 March 2013. When was the bonus "paid” for purposes of the new section 7B of the Act – 1 February or 30 March? It has recently been held by the South African Revenue service ("SARS”) in the context of VAT that the crediting of a loan account constitutes payment, but we are not convinced that this is indeed the case. In our view the crediting of the loan account is merely an acknowledgement of the amount owing to the employee in respect of the bonus, which is only "paid’ when an amount is transferred to the employee or set off takes place – which cancels the indebtedness.
Section 7B will have a major impact for corporate taxpayers who historically claimed a deduction of their bonus provisions. That is, taxpayers will not be able to deduct inter alia their bonus expense on the "accrual basis” from 1 March 2013 as they will not have paid the relevant bonuses. They will only be entitled to a deduction when payment is made, which in all likelihood will be after the end of their tax year.
From a business income tax compliance perspective, any provisional tax calculation should take into account the new legislation by treating any forms of variable remuneration not yet paid as provisions instead of accruals in their tax computations. This may have significant cash tax consequences for companies that applied the accrual principle to variable payments in the past.
Furthermore, employers will now have to change their payroll systems such that variable remuneration is only reported in the month in which it is actually paid to the employees. This will eliminate any debate around when the amount has been accrued or not for tax purposes. Employers will also no longer be faced with the unnecessary penalties and interest charges in their PAYE accounts, due to a variance between the accrual of income, on the one hand, and the payment of employees’ tax on the other. A deferred tax implication will also arise due to a timing difference between the accounting treatment and the tax treatment of the expense. In addition, this could give rise to a cash flow disadvantage for the employer in that the tax payable for the year of incurral (of the expense) will now be higher.
This article was first published in TaxTalk magazine (September/October Edition)