TLAA changes affecting retirement funds
Important changes to the TLAA which affect retirement funds:
- Widespread amendments to the tax deductibility of employer owned policy premiums
- Taxation of divorce benefits
- Accrual of lump sum benefits.
Employer owned insurance policies
Section 11(w) of the Income Tax Act, provides for tax deductions in respect of policies owned by an employer, outside of a registered pension or provident fund. This provision is substantially amended in the TLAA. The 2010 Budget Review indicated Treasury’s concerns that tax leakage is occurring in the area of unapproved Group Life Insurance (“GLA”) policies where the payment of policy proceeds results in employees or their dependents receiving benefits on which no tax has been paid. The changes ensure that if the employer seeks to claim a deduction regarding a policy which ultimately benefits their employees, these premiums are taxed in the relevant employees’ hands as a fringe benefit.
Policies which are affected by the TLAA versus those which are not affected:
- Retirement fund owned “GLA” insurance policies are not affected by the TLAA
- The following policies which previously enjoyed tax deductions in terms of section 11(w) of the Income Tax Act are affected by the TLAA changes:
- Unapproved GLA policies
- Group income replacement policies / permanent health insurance policies (called “PHI” policies) and unapproved GLA insurance polices; and
- “Key Man” employer owned policies
- Dread Disease (employer owned) policies.
Tax deductions for group PHI / unapproved group life & key man policies:
In future, a tax deduction under s11(w) will only be allowed in two situations:
- Where premiums due are paid by the employer to the insurer and these premiums are included in the taxable income of such employee; or
- In respect of key man policies: where an employer has a policy on the life of an employee and this policy has no cash or surrender value; provided that the policy benefits are not paid to the employee’s estate or beneficiaries.
Tax implications for employees:
Unapproved GLA; dread disease; income replacement / PHI and key man policy premiums are now all to be added to employees’ taxable income and taxed as fringe benefits. Funeral premiums do not fall under the Long Term Insurance Act.
Date of application of changes to the TLAA:
The effective date of the above changes is 1 January 2011. However, the amendments apply for each employer from the start of the employer’s new financial year commencing on or after 1 January 2011. As an example: if the employer’s financial year end is 30 September, the changes will only apply to the employer from 1 October 2011.
Uncertain provisions in the TLAA: clarity to be obtained
Some employers may currently be claiming a deduction for premiums paid on unapproved GLA policies / PHI under section 11(a) of the Income Tax Act. It is unclear whether the deduction must now be claimed under s11(w) instead or whether s11(w) prevents a deduction under section 11(a). (Section 23B(3) forbids a deduction under section 11(a) where a specific provision already exists in the Income Tax Act.)
There are a number of interpretational issues of concern in the amendments. The industry has made submissions to National Treasury in this respect and clarity is being sought, including the intended application of the new s11(w) to unapproved GLA and income replacement / PHI policies. It may be prudent for employers to discuss these matters with their tax advisors or auditors to ensure that premiums are being treated correctly in terms of the TLAA.
Pension interest payable on / after 13 September 2007 which accrues on / after 1 March 2009
The TLAA now provides for pension interest granted in terms of a divorce order on or after 13 September 2007, which accrues on or after 1 March 2009, to be taxed in the hands of the non-member spouse.
Pension interest granted before 13 September 2007 which accrues on /after 1 March 2009
Pension interest granted prior to 13 September 2007 which are taxed on or after 1 March 2009 are not taxable.
The TLAA has not dealt with a situation where the non-member spouse lodges a claim after the member’s benefit accrues. Therefore in this situation, the pension interest will be taxed in the member’s hands.
The above provisions are deemed to have come into operation on 1 March 2009 and apply in respect of amounts deducted on or after that date, including public sector funds.
The accrual of lump sum benefits
Previously, a lump sum benefit from a retirement fund was considered to have accrued when the member elected to have the benefit paid, or on the actual payment of such benefit. This provision created difficulties for funds which had to redeem housing loans / housing loan guarantees from fund benefits. In the past, if a housing loan became payable prior to the date of the member’s election, funds were not able to apply for a tax directive because such tax was not yet payable.
To correct this matter, the TLAA now provides that, with effect from 1 March 2011, a lump sum will now accrue on the earliest of:
- the member electing to have their benefit paid in cash; or
- an amount being deducted from the benefit to pay out a housing loan balance / balance of the guarantee on a housing loan; or
- the benefit being transferred to another fund;
- or the member dying.
Taxation Laws Amendment Act, 2010 (“TLAA”) – summary of main provisions
Other changes in the TLAA:
- Tax free transfers to approved funds on retrenchment are now allowed
- Retrenchment / severance benefits with effect from 1 March 2011: the tax free amount of R30 000 and average rate concession for employees currently allowed on retrenchment is removed. There is a new definition of “severance benefit” in the TLAA, excluding lump sums paid from policies paid to employees or directors. Tax treatment of these benefits is now unclear. Industry bodies have requested clarification from National Treasury. If this is not received, these benefits must be taxed at marginal rates with effect from 1 March 2011
- Transfers to preservation funds on partial winding up of an umbrella fund: employees will now be entitled to transfer to a preservation fund tax free
- Commutation (encashing) of small living annuities and living annuities after retirement when the value falls below R75 000 or R50 000: all such commutations will now be taxed according to the table applicable to the retirement/death. However, if the commutation occurs during the member’s life or death, aggregation will occur in respect of the member. If commutation occurs during the successor’s life or death, aggregation will occur in respect of the successor
- The date by which all “old generation” preservation funds have to submit their rules for approval as “new generation” preservation funds is extended to 30 September 2010, failing which their status as an approved fund will be revoked
- Islamic financing rules: provisions are to be added to the various tax acts so this is placed on an equal tax footing with western finance
- SITE tax will be phased out over a period of three years from 1 March 2011
- Interest rate on fringe benefits: Interest free loans are fringe benefits. The official rate of interest will now be prime plus 1%. The deemed interest is deemed non-retirement funding income for retirement annuity contributions
- Tax rates and tables for the 2010/11 tax year are included in the TLAA
- Estate duty rebate for deaths after 1 January 2010: if spouses die simultaneously, the spouse with the smaller estate is deemed to have died first. This shifts the unused R3,5 million abatement to the other deceased spouse
- Motor vehicle fringe benefit tax provisions are amended.
Latest Draft of Regulation 28 The second version of draft Regulation 28 was released by National Treasury on 2 December 2010 for comments before 28 January 2011.