Tag Archives: Income Tax

Personal service companies

Natural person taxpayers who earns a salary have very few items of expenditure available to them which they may deduct for income tax purposes (section 23(m) of the Income Tax Act, 58 of 1962). Generally, the deductions which salaried individuals may claim for income tax purposes are limited to amongst others contributions to retirement type funds, donations to approved public benefit organisations, medical aid contributions and expenditure linked to distances travelled which may be set off against a travel allowance earned.

To escape this restraint, employee taxpayers would arrange with employers not to be directly employed, but that a company (which would typically be owned by the taxpayer) will be contracted to provide the services which the employee taxpayer otherwise would have provided directly in an employment capacity. The employee will now perform these services as employee of the contracted company to the employer indirectly. In this manner, many other expense items also become potentially deductible by the taxpayer’s company which would not be limited by the provisions of section 23(m) since the company does not stand in an employment relationship with its client which would otherwise have been the natural person’s employer. A further potential advantage to be achieved by interposing a company in an employment relationship is that the income tax payable by high income earners is effectively capped at the corporate income tax rate of 28%.

To counter these instances of avoidance, the “personal service provider” regime was created. The deductions available to “personal service providers” for income tax purposes are similarly restricted as is the case for salaried individuals (section 23(k)). A “personal service provider” is defined as a company or trust on which behalf services are rendered to a client of the company or trust personally by an individual who is a connected person in relation to the company or trust, and any one of the following three criteria are also met:

• The individual would be regarded as an employee of the client if the services were rendered by the individual directly to the client;
• The duties linked to the services are required to be performed mainly at the premises of the client, or the individual, company or trust is subject to the control or supervision of the client as to the manner in which the duties to be performed; or
• More than 80% of the income of the company or trust during the tax year from services rendered consists of amounts received directly or indirectly from any one client of the company or trust.

(See paragraph 1 of the Fourth Schedule to the Income Tax Act.)

Considering what would normally be required by an employment relationship of an employee, it would be difficult to escape the above anti-avoidance provisions. One exception which exists though is if the company or trust employs at least 3 employees on a full time basis (and other than employees which are connected persons in relation to that company or trust).

The above anti-avoidance provision is important to take note of for individuals attempting to make use of companies to gain access to increased income tax deductions, or to limited their margin tax rate. It is however similarly applicable to small companies which operate in the services industry, as it may very well be that these companies too are also inadvertently caught by these anti-avoidance provisions.

This article is a general information sheet and should not be used or relied upon as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice. Errors and omissions excepted (E&OE)

The general Anti-Avoidance rules

A2The Income Tax Act, 58 of 1962 (‘Income Tax Act’) contains various specific anti-avoidance rules aimed at preventing the abuse of certain specific sections in the Income Tax Act. However, over and above these specific anti-abuse provisions, the general anti-avoidance rules (‘the GAAR’) would also find application to cover further potential and unforeseen loopholes, or abuse of beneficial tax regimes, which exist nonetheless and are exploited by taxpayers.

The GAAR is contained in sections 80A to 80L of the Income Tax Act. Its provisions supersede any other contained in the Income Tax Act. Broadly speaking, the GAAR consists of 4 elements, all of which must be present in order for SARS to be able to successfully invoke the GAAR against a taxpayer:

  1. an arrangement (which includes any transaction, scheme, agreement or understanding) must have been entered into,
  2. with the sole or main purpose to obtain,
  3. a tax benefit (defined as including any avoidance, postponement or reduction of any liability for tax), and
  4. this arrangement must exhibit signs of ‘abnormality’.

‘Abnormality’ is to be determined, in terms of section 80B, depending on the context within which the arrangement or transaction in question has been entered into. For example, a transaction entered into in a business context would be regarded as being abnormal if it lacks commercial substance (dealt with in detail in section 80C), whilst in a context outside of business, a transaction would be considered ‘abnormal’ if it is entered into based on terms not normally employed for bona fide purposes.

It is significant that the onus to prove that the GAAR should not apply generally rests on the taxpayer. In this regard, section 80G makes it quite clear that a taxpayer is presumed to have entered into a transaction with the sole or main purpose to obtain a tax benefit, until the taxpayer is able to prove otherwise.

The GAAR can be applied to a single transaction, a multi-stepped scheme viewed holistically, or it can even subject a single step (which may have been inserted for only tax purposes only) to scrutiny.

Once it has been determined that SARS may invoke the GAAR in relation to any such ‘impermissible avoidance arrangements’, SARS is afforded wide-ranging powers including:

l disregarding, combining, or recharacterising any steps in or parts of the impermissible avoidance arrangement;

l deeming persons who are connected persons in relation to each other to be one and the same person for purposes of determining the tax treatment of any amount;

l reallocating any gross income, receipt or accrual of a capital nature, expenditure or rebate amongst the parties;

l recharacterising any gross income, receipt or accrual of a capital nature or expenditure; or

l treating the impermissible avoidance arrangement as if it had not been entered into or carried out, or in such other manner as in the circumstances of the case SARS deems appropriate for the prevention or diminution of the relevant tax benefit.

It may seem at first as though the GAAR requirements are extremely onerous and weighted in SARS’ favour. If one remembers though that all 4 the elements discussed above must be present before SARS can invoke the GAAR, some balance is restored. When subject to a GAAR dispute with SARS therefore, it is advisable to focus on those elements which the taxpayer is able to defend. Proving the absence of merely one of the 4 prerequisite elements destroys SARS’ attack.

This article is a general information sheet and should not be used or relied upon as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice. Errors and omissions excepted (E&OE).

Transactions required to be reported to SARS in terms of the Tax Administration Act

Tax1_bCertain transactions are required to be reported to the South African Revenue Service (‘SARS’) as and when entered into (section 37 of the Tax Administration Act, 28 of 2011 (‘the Admin Act’)). These are referred to as ‘reportable arrangements’, and qualify as such when an ‘arrangement’ (defined as including any transaction, agreement, scheme or understanding) either meets one of the criteria set out in section 35(1)(a) to (e), or if specifically listed in a public notice issued by the Commissioner for SARS. This article is concerned only with the former.

Failure to report a ‘reportable arrangement’ will result in a monthly penalty being levied against non-compliant taxpayers ranging from between R50,000 to R300,000 per month (section 212), for up to 12 months. The purpose for requiring taxpayers to report certain transactions is obvious: to allow SARS to monitor transactions on an ongoing basis which it considers to exhibit potential traits of tax avoidance.

Section 35(1) determines that arrangements which exhibit any one of the below criteria qualify as a reportable arrangement. These are arrangements which:

(a) contain provisions in terms of which the calculation of interest, finance costs, fees or any other charges is wholly or partly dependent on the tax treatment of that arrangement;

(b) have any of the characteristics contemplated in section 80C(2)(b) of the Income Tax Act, 58 of 1962, or substantially similar characteristics (which include round trip financing, involving an accommodating or tax indifferent party in the arrangement or if the arrangement contains elements which offset or cancel each other);

(c) give rise to an amount that is or will be disclosed by any participant as:

  1. a deduction for purposes of the Income Tax Act but not as an expense for accounting purposes; or
  2.  revenue for accounting purposes, but not as gross income for purposes of the Income Tax Act;

(d) do not result in a reasonable expectation of an accounting pre-tax profit for any participant; or

(e) result in a reasonable expectation of an accounting pre-tax profit for any participant, but which is less than the value of the tax benefit to that participant if both are discounted to present value at the end of the first year of assessment when the tax benefit is created.

Irrespective of the above, even if an arrangement would qualify as a reportable arrangement in terms of the above, section 36 of the Admin Act lists various criteria which, if met, would render an arrangement an ‘excluded arrangement’ whereby such transactions need not be reported to SARS. Moreover, in terms of the public notice issued by the Commissioner on 16 March 2015 in Government Gazette no. 38569 as Notice 212, a transaction would not be reportable in terms of the above criteria only if the tax benefit arising from the arrangement for all persons involved would not exceed R5 million.

This article is a general information sheet and should not be used or relied upon as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice. Errors and omissions excepted (E&OE)

I stole money: Must I pay income tax on it?

A3Ever heard of a thief declaring stolen money for income tax purposes? Do you think thieves should declare stolen money as part of their taxable income? According to numerous court cases on this issue, stolen money obtained by way of theft, embezzlement or fraud is taxable in the hands of the thief. Another question: can costs incurred for the purpose of stealing and any refunds of the stolen money be deducted from the stolen income?

There are four requirements that must be met for stolen money (whether obtained by way of theft, embezzlement, fraud or any other illegal means) to be taxable in the hands of a thief:

  1. The money must have been “received by or accrued to” the thief.

The phrase “received by” has been interpreted by the courts to mean that the money has been “received by a taxpayer on his own behalf for his own benefit” while the words “accrued to” has been interpreted to mean “to which the taxpayer has become entitled”. For a person to be entitled to an amount of money, does not require the person to have received that amount, but it does require that the person has an unconditional right to receive it. As a thief is not entitled to the money he/she steals, the requirement of “accrued to” is not complied with. However, as the money has been received, the first requirement is met and the stolen money must be included in the taxable income of the thief.

  1. The money received by the thief must be of an “income nature” (as opposed to being of a “capital nature”).

Because the act of stealing money requires intention, active and purposeful planning and organisation, as well as execution by the thief, the stolen money has been actively worked for and is deemed to be of an income nature.

  1. Normally a taxpayer is taxed on income in the tax year in which he/she received the income.

However, there is no time limitation on the period during which SARS may issue an assessment if SARS finds out that a thief neglected to declare stolen income for income tax purposes in the past.

  1. An amount/monetary value must be determined at which the stolen money can be included in the taxable income of the thief.

The method to determine an amount depends on the unique circumstances of each case. Two of the methods that SARS can use are:

  • Tracing the amount of money that has been paid into the thief’s bank account.
  • Comparing the net amount of the growth of the thief’s assets with the income declared by the thief. To arrive at a net growth amount, SARS takes into account the value of income, tax-deductible expenses, and assets and liabilities declared by the thief. If the declared income does not justify the net growth in assets, SARS will reassign a value to the income which can justify the net growth in asset value.

The courts have determined that neither expenses incurred by a thief for the purpose of stealing money nor any refunds of stolen money are deductible from the taxable amount of the stolen “income” when calculating the thief’s income tax liability

Does it pay to earn income by stealing? A thief has a legal obligation to declare “income earned” by way of stealing and is liable to pay income tax on the full amount of the stolen income. No deduction for costs incurred in the production of stolen income nor any stolen amounts refunded will be allowed as deductions for income tax purposes. Include other potential costs like legal fees and stress medication, and the profitability of stealing as a means of generating income becomes considerably less attractive – if the thief gets caught out by SARS. Otherwise, stealing might still be a profitable career choice.

Reference List:

  • Accessed on 21 June 2015:
  • l SARS Interpretation Note: No. 88, Section 5

This article is a general information sheet and should not be used or relied upon as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice. Errors and omissions excepted (E&OE)

The link between CGT and Income Tax

A7The name “Capital Gains Tax” (CGT) can create the impression that CGT stands on its own as a seperate tax from the rest of the taxes but this is not the case. CGT forms part of the Income Tax system and capital gains and capital losses must be declared in the annual Income Tax return of a taxpayer.

If a taxpayer is not registered for Income Tax

If a natural person is not registered for Income Tax and his/her taxable income consists only of a taxable capital gain or a deductible capital loss, the amount of which is more than R30 000, the person will have to register as a taxpayer with SARS. In addition, the new taxpayer will have to submit an Income Tax return for that tax year.

If a taxpayer is already registered for Income Tax, they don’t have to register for CGT seperately as CGT forms part of Income Tax.

Tax treatment of capital gains in three steps

The first step is to calculate the capital gain according to the provisions of the CGT Act. A discussion of the formulas to calculate the amount of capital gains and capital losses fall outside the scope of this article.

The second step is to reduce the capital gain with any exclusions which might be applicable. Please contact your tax advisor to find out if you qualify for any CGT exclusions.

Step three will be to include the taxable amount of the capital gain in the taxable income of the taxpayer. There are different inclusion rates for the following categories of taxpayers:

  • For natural persons, deceased or insolvent estates, and special trusts the taxable inclusion rate is 33,3%. In other words, 33,3% of the capital gain will be added to the taxable income of the taxpayer and the taxpayer will have to pay more income tax.
  • Companies, close corporations and trusts (excluding special trusts) have a taxable inclusion rate of 66,6%. This means that 66,6% of the capital gain will be added to the taxable income and taxed at the normal income tax rate of the taxpayer.

As a taxable capital gain will be added to the taxable income of a taxpayer, it will have an effect on certain deductions in the income tax calculation while other deductions will not be affected.

The following tax deductions for individual taxpayers will not be affected by the inclusion of a taxable capital gain in the taxable income of the taxpayer:

  • Pension fund contributions
  • Retirement annuity fund contributions

Tax deductions that will be affected by the inclusion of a taxable capital gain in an income tax calculation are the following:

  • Medical expenses (only applicable to individual taxpayers)

If a taxpayer’s medical deduction is subject to the 7,5% of taxable income-limitation, the deductible amount for medical expenses will become smaller if a taxable capital gain is included in the taxable income.

  • Section 18(A) donations

A taxpayer can include the taxable capital gain in taxable income before calculating the 10%-limit for the tax deduction of Section 18(A) donations. The allowable tax deduction of these donations will then increase by 10% of the amount of the taxable capital gain.

Tax treatment of capital losses

Capital losses may not be deducted from taxable income but must be set off against current or future capital gains. If there is insufficient capital gains to offset the full capital loss in the current tax year, the unclaimed balance of the capital loss is carried forward to the next tax year(s) until it has been fully offset against future capital gains.

As a capital gain/loss can have a material effect on a taxpayer’s liability for Income Tax, it is crucial to calculate these amounts accurately and take advantage of all the exclusions that might be applicable to the taxpayer. For further assistance regarding any aspect of capital gains/losses, please contact your tax advisor.

Reference List:

This article is a general information sheet and should not be used or relied upon as professional advice. No liability can be accepted for any errors or ommissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice.