Clampdown on corporate tax dodgers may hurt you
The taxman is slamming the door on corporates and their employees who inappropriately use business assurance structures to dodge tax – but in the process many thousands of innocent policyholders or beneficiaries may be “collateral damage”.
Innocents caught in the firing line include employees whose group life risk and disability benefits have been structured outside retirement funds through the use of employer-owned assurance policies.
If you are the beneficiary of a deferred compensation policy, a key person assurance policy or even certain types of group life assurance, you may find your pay packet reduced in the new year because your premiums will be subject to tax.
The financial services industry is in confusion, saying that some of the latest amendments to the tax laws contained in the Taxation Laws Amendment Act are unclear and in some cases are retrospective, creating tax liabilities that did not exist when the policies were bought by policyholders.
Industry bodies the Association for Savings & Investment SA (Asisa) and the Institute of Retirement Funds are urgently seeking clarity on this issue from the National Treasury and the South African Revenue Service.
In the meantime, industry associations are warning both employers and employees to seek proper advice before these provisions in the Amendment Act, which was gazetted last week, come into effect on January 1 next year.
Peter Stephan, a senior policy adviser at Asisa, says the amendments to the Act introduce radical changes to the regulation of the deductibility of premiums on employer-owned policies from the taxable income of the employer.
He says companies that have long-term assurance cover to protect their profit margins against the loss of key employees and directors due to death, illness or disability should seek urgent tax advice to ensure they comply with the Act.
If a key person policy has a cash value, the premiums will no longer be tax deductible unless the employer-paid premium is added to the employee’s remuneration.
Stephan says that many employers use key person assurance to legitimately protect the business against loss of profits.
At the core of the problem is that despite anti-tax-avoidance measures already in place, some deferred compensation policies are still inappropriately used as a tax dodge by giving employees vested rights to the policy benefits under all possible circumstances but not accounting for fringe-benefit tax on the premiums.
But in the process of closing off the last loopholes, the amendments completely revise the requirements for the deductibility of premiums paid by an employer on a deferred compensation policy, Stephan says.
“The legislation will have a big impact on deferred compensation schemes, as they will no longer be tax deductible for an employer after January 1, unless the employee pays tax on the premiums,” he says.
Lower tax rates that applied to the benefits paid to employees on deferred compensation policies also fall away.
Stephan says also potentially affected are group life and disability schemes provided by employers to employees outside the approved retirement fund environment.
Group life cover
Stephan says group life cover comes in two forms, namely:
Group life and disability cover provided by a retirement fund. In this case, a portion of the retirement fund contributions (by employer and employee) goes towards investment and a portion funds life and disability cover. The tax treatment of this type of cover has not changed.
Group life or disability cover provided by the employer outside of a retirement fund. In this case the employer funds the premiums on policies it owns and deducts them from its tax.
Stephan says the impact of the tax law changes is that the premium contributions on group policies outside a fund by the employer will constitute a taxable fringe benefit in the hands of the employee.
In other words, the premiums on these group policies will be taxable in the hands of the employee when the employer, who pays the premiums, claims them as a tax deduction.
He says the new measures have an impact on what are legitimate assurance practices.
Derek Smorenburg, the chairman of a business-oriented financial planning association, the Professional Business Risk Analysis Council, says the industry is concerned about the millions of rands paid every year in premiums on the affected policies, the accumulated assets (cash values) and the life policies in place that will need to be cancelled, restructured or replaced.
Smorenburg says employers should consider diverting current deferred compensation premiums towards an umbrella provident fund, thereby retaining the company contribution and employee tax deduction and at the same time ensuring the continued building of retirement capital with the tax benefits at retirement.
He says such a transaction will possibly include transferring the deferred compensation policies into the provident fund.
But he warns that these transactions will require careful analysis and salary restructuring advice that should include accountants, tax advisers, labour experts and employee benefit specialists.
THE TYPES OF ASSURANCE USED BY BUSINESSES
The main types of business assurance policies, according to Peter Dempsey, the deputy chief executive of the Association for Savings & Investment SA, are:
Policies that companies use to provide for some future event. An example is mining companies taking out endowment policies that are used to cover future environmental clean-up costs.
Key person assurance policies, which can have death, disability and cash benefits. These are used to cover the loss and replacement costs of a key individual, who can be a senior executive or someone with special skills.
Deferred compensation policies, which are used by employers primarily to top up retirement benefits. These policies can also have death, disability and cash benefits. At present, employers pay the contributions; the contributions are tax deductible; the contributions are, in fact, in most cases paid indirectly by the employee on a salary-sacrifice basis; and the employee receives the benefits, either via the cession of the policy by the employer on death, disability or retirement or when the policy matures. Such lump-sum payments are favourably taxed. However, these policies are no longer often sold because of adverse tax implications and their lack of popularity among employees. There are, however, many thousands of existing policies under legitimate schemes that will be affected.
ASSURANCE INDUSTRY AGGRESSIVELY STROVE TO OUTSMART US, SAYS SARS
The South African Revenue Service (SARS) has come out fighting over the changes to business assurance legislation, saying that its hand was forced by an industry that unabatedly cancelled its moves to make the rich pay their fair share with ever more tax-aggressive products.
And Vlok Symington, SARS’s executive of legislative research and product development, says “the apparent confusion in the industry is surprising, given the intensive and detailed consultation that preceded every aspect of the change”.
He accuses the industry of being “mischievous” in saying that a company that has legitimately insured itself against a business loss as a result of the loss of a key person will be negatively affected by the provisions.
Says Symington: “The precise opposite is true. The revised provisions reaffirm the tax deductible nature of premiums towards legitimate insurance cover.”
He says the original purpose of section 11(w) of the Income Tax Act was to allow a deduction to a business for insuring itself against a loss in consequence of the death of a key employee.
“Despite this, ‘insurance’ products were developed that abused these provisions by allowing upper-income earners to defer income tax that would otherwise have been payable on their salary and bonuses,” he says.
“Attempts over the years to tighten the provisions of this section, on the one hand, and increase the attractiveness of approved savings vehicles such as retirement funds, were unabatedly met by even more aggressive tax-driven products coupled with illegitimate salary sacrifice arrangements.
“The latest attempt to tighten these provisions should therefore not come as a surprise to either the promoters of these schemes or the employees, who both knowingly deprived the state of revenue.”
Symington says that, in essence, the revised provisions of section 11(w) deal with two totally separate issues, namely:
Employer-paid long-term insurance policies for employees. He says there is a match between allowing a tax deduction to the company that makes a contribution on behalf of an employee to an insurance policy and the employee who enjoys the benefit of being covered by the insurance policy, by allowing the tax deduction in the hands of the company to the extent that the employee is taxed on the premium.
“The rationale for taxing the employee is clear: if the employee was to acquire the benefits of the policy from his or her own pocket, it would have been from after-tax money.
“Thus, where someone else is paying the premium on behalf of the employee in the context of an insurance policy, equity demands that the employee should be taxed on it to put them on par,” Symington says.
Insurance against the loss of a key employee. Symington says this is where the abuse occurred.
He says: “The tightening-up attempts to ensure once again that a tax deduction in the hands of a business is only allowed where the business insures itself against a loss of a key person.
“The schemes developed in the past did so on the face of it, but were then supplemented by a separate agreement between the company and the employee that any insurance payout to the company would be passed to the employee when the employee terminated services.”
Symington says these products negated the intention of the legislator and avoided the payment of tax.
All material subject to our Legal Disclaimers.