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Saving rands now makes tax sense

27 January 2015   (0 Comments)
Posted by: Author: Di Seccombe
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 Author: Di Seccombe (Mazars)

A discussion on the introduction of section 12T into the Taxation Laws Amendment Bill which creates a tax free savings vehicle

Taxpayer’s will welcome the introduction of section 12T (effective 1 March 2015) into the Taxation Laws Amendment Bill 2014 (TLAB 2014), as released by Treasury on the 30 October 2014.

Section 12T creates a tax free savings vehicle, aimed at incentivising taxpayers to save, in an attempt to increase the level of household savings in South Africa. Although the incentive is predominantly aimed at middle to low income earners, the proposed tax benefits may be enjoyed by and must be a consideration for all taxpayers. 

Envisaged in section 12T are qualifying service providers that will be able to offer tax free savings accounts comprising only of selected qualifying products ("tax free investments”).When a person makes a contribution into a tax free savings account; this will be regarded as a contribution into the underlying tax free investment. More than one tax free savings account will be possible, and thereby investments into a host of underlying tax free investments can be made?

A government gazette will be published setting out the service providers permitted to provide tax free savings accounts. Further regulations to be drafted by the Minister of Finance (the Minister) will prescribe the requirements to which any financial instrument or policy as defined in terms of section 29A (taxation of long-term insurers) must conform in order for the financial instrument or section 29A policy to be regarded as a tax free investment for the purposes of section 12T. 

Although neither the gazette nor regulations were available at the time of writing, the Explanatory Memorandum (EM) on the TLAB 2014 cites as examples of qualifying service providers, "JSE authorised users,banks,long term insurers, collective investment scheme companies, linked investment services providers and national government”. When tax free investments are described in the EM it is envisaged that "eligible products will include exposure to money market instruments, equities and property investments”. The returns from these investments will most likely include dividends and interest, and any capital gains from the disposal of a qualifying tax free investment. At this stage it is uncertain whether returns will be limited to local returns, or include foreign interest and foreign dividends.

The effectiveness and tax efficiency of section 12T will only be measurable once taxpayers have had sight of the regulations, and the tax free investments that they will be able to invest in.

The tax free element of the investment is set out in sections 12T(2) and 12T(3). Once a tax free savings account has been created, and a taxpayer has contributed into the account, any amount that is received by or accrues to the taxpayer from the underlying tax free investment will be exempt from normal tax (section 12T(2)). In determining the aggregate capital gain or aggregate capital loss for any year of assessment, the taxpayer will disregard any capital gain or capital loss from the disposal of a tax free investment (section 12T(3)).  

The section 12T incentive is only applicable to natural persons including the deceased or insolvent estate of a natural person and contributions to a tax free investment must be in the form of cash. In terms of section 12T(4) contributions made are subject to two limits. The first being an annual limit of R30 000 in aggregate during a year of assessment and the second a lifetime limit of R500 000 in aggregate. The contribution limits apply per person contributing and not per tax free savings account contributed to.

In reply to public comment raised in respect of the effect of inflation and the prescribed contribution limits, SARS and Treasury have indicated that while the annual limits will be increased on a regular basis to take inflation into account, and in the future the annual limit may be adjusted for persons 65 years and older, the lifetime limit of R500 000 will not be adjusted.

In the EM taxpayers are warned that although an amount can be withdrawn from a tax free investment at any time, should the amount be returned to a tax free investment, this will count towards the annual and lifetime contribution limits.

In terms of section 12T(7) a punitive penalty will be levied on contributions that exceed the prescribed contribution limits. If during a year of assessment a person contributes in excess of R30 000, an amount equal to 40 percent of that excess will be deemed to be an amount of normal tax payable by that person in the relevant year of assessment. If a person contributes in excess of R500 000, any excess that has not already been subjected to the 40 percent penalty will be deemed to be an amount of normal tax payable in respect of the year of assessment in which the excess is contributed by that person. As an example, if in a year of assessment an individual were to contribute R38 000 to a tax free investment, this would result in an amount of normal tax payable of R3 200, being 40 percent of the R8 000 excess contribution.

In the EM it is stated that taxpayers may transfer between tax free investments offered by different service providers and that these transfers will not be considered when determining the annual or lifetime contribution limits. Section 12T(6) which gives effect to this described relief is not as straightforward. Section 12T(6) permits a taxpayer to transfer an amount from one tax free investment to another tax free investment, and that the amount so transferred will not be regarded as contributions in excess of the pre-determined contribution limits. The result being that although the transferred amount will be considered towards the prescribed contribution limits, should the contribution limits be exceeded, the 40 percent penalty will not be triggered.

Similar relief is created by Section 12T(5). The section states that any exempt amounts that have been received by or accrued to a taxpayer from a tax free investment (section 12T(2)), that are reinvested will not be regarded as excess contributions for the purpose of the 40 percent penalty. This too seems to suggest that tax free receipts and accruals can be re-invested into a tax free investment and, although they will be considered towards the annual and lifetime contributions, they will not trigger the 40 percent penalty, if in excess of the prescribed contributions. 

The subsequent tax consequences of income produced by excess contributions are not specifically dealt with in section 12T. In the draft "Standing Committee on Finance (SCOF): Report-Back Hearings” dated 15 October 2014, in response to concerns raised by commentators on section 12T and particularly the severity of the 40 percent penalty, SARS and National Treasury state (on page 9) that at the request of potential service providers and in order to keep the penalty system simple, "all future returns on contributions above the limit would be tax free (so that providers are not required to implement any reversals or transfers)”. From the SCOF report back it would seem that once an excess contribution to a tax free investment has been subjected to the 40 percent penalty, subsequent income produced from the tax free investment as a result of the excess contributions will fall within the parameters of sections 12T(2) and 12T(3) and not be subject to tax.

The EM states that returns from the tax free investments earned by a taxpayer prior to their date of death will be regarded as "property” in terms of the Estate Duty Act, and therefore potentially subject to Estate Duty. Returns earned from the tax free investment after the date of death will however not be subject to Estate Duty. On the death of a taxpayer, any amounts within the tax free investment that are transferred to a natural person heir or beneficiary will be regarded as a deemed contribution in the hands of the heir or beneficiary and be subject to their annual and lifetime contribution limits. Treasury has made it clear that the benefit of the tax free investments, are only meant to apply per individual and are not meant to act as an intergenerational tax incentive.

In order that local dividends are not subject to the required 15 percent withholding tax section 64F(1)(o) has been introduced. In terms of section 64F(1)(o), when a natural person is paid a dividend in respect of a tax free investment, the dividend paid will be exempt from the 15 percent withholding tax.

Section 10(1)(i) of the Income Tax Act (the Act) contains what is commonly referred to as the local interest exemption that is available to natural person taxpayers. Each year of assessment a taxpayer under 65 is entitled to an exemption of R23 800 in respect of local interest received or accrued and a taxpayer aged 65 and over has the benefit of an exemption of R34 500. Section 10(1)(i) has been specifically amended to exclude interest received or accrued from a tax free investment. Treasury has given the assurance that while the exemption limits will not be increased, section 10(1)(i) will not be repealed.

To ensure that current and proposed tax savings are fully utilised, it is important that taxpayers consider both sections 10(1)(i) and 12T when deciding between investment options. From 1 March 2015 taxpayers investing in an interest bearing investment, must ensure that until they have earned interest equal to the applicable section 10(1)(i) exemption, the interest bearing investment is not regarded as a tax free investment asset in terms of section 12T. By doing so taxpayers will ensure they get the full benefit of the section 10(1)(i) exemption without deposits into the interest bearing investment being considered as section 12T contributions.

Taxpayers investing in a tax free investment producing local dividends will benefit in terms of section 12T as dividends from the tax free investment will not be subject to the 15 percent withholding tax, and there will be no capital gains tax on the disposal of the investment asset. Taxpayers currently investing directly in equities or into collective investment scheme in securities are afforded no such relief. 

It will be of great interest to see if the regulated tax free investment products will include the relatively new Real Estate Investment Trusts (REITS). Despite the name, a REIT is regarded as a company for income tax purposes, and all distributions paid out by a REIT are regarded as dividends. However, resident shareholders of a REIT are excluded from benefiting from the local dividend exemption and as a result a dividend paid by a REIT is fully taxed as normal income. Due to the REIT dividend being subject to normal tax, the dividend is not subjected to dividend tax. Should a REIT be regarded as a qualifying investment asset the dividends paid by a REIT to a local shareholder would effectively be tax free. The shareholder would also not be subject to capital gains tax on disposal as would ordinarily be the case. REITs would therefore be an immensely tax efficient section 12T investment option.

The reference to a "policy as defined in section 29A”, as a section 12T tax free investment must also not be overlooked. Proceeds from endowment policies taken out with long term insurers are essentially taxed in the insurer’s hands on behalf of the investor. The effect of section 29A is that via the insurer an individual is effectively taxed at 30% on income earned by the insurer and at an effective rate of 9,9% on any capital gains. In terms of section 12T an individual contributing into a section 12T qualifying section 29A policy, may be subject to neither of these taxes.

 Section 12T may well have limitations, but as can be seen it is a savings incentive well worth taxpayer’s consideration, and a welcome introduction into the Act. 

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This article first appeared on the January/February edition on Tax Talk.


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