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Fat Cat Executive Pay Packages and the General Tax Deduction Formula

Friday, 06 January 2006   (0 Comments)
Posted by: TaxFind ™
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Fat Cat Executive Pay Packages and the General Tax Deduction Formula


Bosses pay has moved inexorably upwards, especially in America. In 1980, the average pay for the CEO's of America's biggest companies was about 40 times that of the average production worker.In 1990, it was about 85 times.Now this ratio is thought to be about 400.Profits of big firms fell last year and shares are still down on their record high, but the average remuneration of the heads of America's companies rose by 6%. A recent poll in Britain found that 80% of people believe that top directors are overpaid.' (Editorial `Where's the Stick?' 11 Oct 2003 The Economist at 13).

Directors' pay packages have recently been under scrutiny for what has been referred to as `gluttonous corporate ethics' in the business press.As more and more companies collapse or show poor returns, executive pay packages are not correspondingly adapted (see, e.g, (2003) 8 Fortune Magazine (Euro Ed) 22).South Africa has not escaped this affliction.For instance, Didata executives still earned in excess of the equivalent of R37m in the 2001 financial year despite a loss of R451,2m for the year (7 Jun 2002 Sunday Times).Its shares were trading at above R60 at the beginning of that period but were below R10 a year later and were selling at R3,89 towards the end 2003 (20 Nov 2003 Sake Beeld).

Concerns resulting from these perceived practices lead to the recommendation in the King Report on Corporate Governance for South Africa (2002) (`King II') that South African companies listed on the Johannesburg Stock Exchange, banks, financial and insurance entities, and certain public sector enterprises are to be compelled to disclose directors' remuneration individually when reporting their annual results, while all other companies are to be urged to give due consideration to the application of the Code insofar as the principles are applicable (see par 1.1-1.2).

This became effective in March 2002. Sensational business press reports seldom touch upon the tax deductibility of large executive and employee pay packets.The more fact that an amount is payable as remuneration does not imply that the taxpayer will automatically be allowed to deduct that payment from his income (see EB Broomberg & D Kruger Tax Strategy 3 (1998) at 173).

The expenditure will have to comply with all the elements of the general deduction formula before qualifying for deduction.It consequently has to be actually incurred in the production of income, should not be of a capital nature, and will be deductible only to the extent that it has been incurred for purposes of trade (ss 11(a) and 23(g) of the Income Tax Act58 of 1962; this Act does not contain any specific provisions dealing with excessive remuneration other than s 11(l) which pertains to pension contributions).

However, when considering excessive expenses, only two of these elements are `under attack', namely the requirement that the expense has to be in the production of income, and incurred for trade purposes.This note will briefly consider these two elements and the role that the excessiveness of an expense will play in determining whether a deduction complies with the applicable provisions.It will also examine the guidelines provided by case law and the practices of the Commissioner for the South African Revenue Services (`the Commissioner').The effect of business principles and the recommendations of the King II Report (supra) concerning managerial remuneration will also be considered.

Source: By Muthundinne Sigwadiba, BA Van Der Merwe - University of South Africa (SA Merc LJ)

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