Tax Flash!

It was reported in Business Day on 14 March 2007 that far-reaching changes to the taxation of lump sum benefits from pension funds on retirement which strongly favour low and middle income earners are due to come into effect from October 1 this year.

The complex calculations of the tax liability for lump sum benefits are to be replaced by a much simpler, quantum-based flat rate, treasury chief director of legal tax design, Keith Engel told Parliament's finance committee yesterday. The tax-free portion of lump sum benefits is set to more than double under the new system, from R120 000 to R300 000. The proposals were welcomed by the South African Chamber of Business/Business Unity SA retirement fund spokesman Abri Meiring, who said they represented a "major concession" for low and middle income earners. He also applauded the scrapping of the highly complex formulas, which had been a burden for all concerned. One of the effects of the new regime will be that the rich will no longer be able to manipulate their income in the two years before they retire by using preference shares to reduce their tax charge. The proposed amendment is one of a raft of pending reforms to retirement fund taxation. Finance Minister Trevor Manuel announced the abolition of the very unpopular tax on the interest and rental income of retirement funds as from March 1 this year in his 2007-08 Budget Speech.

In terms of the proposals for lump sum benefits, the first R300 000 of the lump sum would be tax-free as well as (and not including) the accumulated non-deductible retirement fund contributions made by taxpayers over their working lives. This compares with the current tax-free amount of R120 000, after which the lump sum is taxed at the individual's average tax rate for the prior two years. The second R301 000 portion of the lump sum will be taxed at 18% and the rest at 36%. Meiring said this in effect meant that a tax rate of only 9% would be applied to the first R600 000 — a significant concession. Meiring believed the tax concessions to low and middle income earners would to some extent compensate them for retirement tax on the build up of investments within funds that was introduced in 1996.

Engel noted the proposed lump sum tax regime would be slanted in favour of lower and middle income earners. The current tax regime required complex calculations based on the individual's average tax rate in the two years before retirement, with a minimum rate of 18%, he said. The total amount that could be taken as a lump sum was presently determined by length of service, which would be replaced by a straight one- third of the total amount. "Wealthy taxpayers reduced their lump sums to an 18% rate by relying on tax-free preference dividends," Engel said. The treasury had decided that length of service was no longer relevant to determine the level of lump sum taxation. The lump sum formulas would apply on a cumulative basis over a taxpayer's lifetime and apply to all lump sum benefits. The only existing formula that would remain related to the tax exemption on pensions accumulated by civil servants prior to 1998.

Engel said the proposals would be included in tax amendment legislation and be refined again in Parliament in September. Meiring noted that the wealthy might argue that the new system would interfere with their vested rights, but questioned whether aggressive tax planning to reduce one's tax liability constituted a vested right. He said he expected that some wealthy individuals might decide to retire early ahead of the October introduction of the new regime. Currently, the law provided that lump sum benefits from pension and individual retirement annuity funds must be equal to the greater of one third of the total value of the money accruing to the policyholder, or equal to an amount bearing an annuity of less than R1 800. Provident funds could be fully withdrawn. In terms of the new proposal, the R1800 would be replaced by an annuity- bearing amount of R50 000. Engel said administrative fees often eroded growth of small annuity funds. To prevent this, it was proposed that the full amount of small annuities could be withdrawn.

Ken Silke
E-mail: ken@silke.co.za