Major tax law changes
The government is pressing ahead with significant reforms to the country’s retirement-funding system to improve competition, thereby reducing the cost of retirement products. It is also changing how contributions to retirement funds will be taxed.
The changes are detailed in the omnibus Taxation Laws Amendment Bill, released this week, which contains other proposals that could result in your having to rethink your financial plan. The affected products include:
Dividend income funds
The days of tax-free dividend income funds are numbered. The Taxation Laws Amendment Bill puts a stop to dividend income unit trusts by declaring that the returns are in effect interest payments and will be subject to income tax. In effect, this will convert the existing dividend income funds into money market funds but with poorer after-tax returns than normal money market funds.
There are four dividend income funds, with about R45 billion in assets under management, that cost the fiscus billions of rands in unpaid tax.
In an explanatory memorandum to the Bill, the National Treasury says that dividend income funds use various strategies “to disguise otherwise taxable interest as tax-free dividend income”.
The strategies include the creation of preference shares, dividend cessions or banks merely providing guarantees of one sort or another through special purpose vehicles/companies. The types of special purpose vehicles that are used to switch what should be taxable interest income into tax-free dividend income vary, but all of them are unacceptable, Keith Engel, the chief director of legal tax design at the National Treasury, says.
Consultations with the collective investment schemes industry over the future of dividend income funds are still under way, Engel says. “We are aware the issue needs very careful consideration.”
Engel gave the assurance that there will be no retrospective tax on the returns earned by investors in dividend income funds. The treatment of the income flows on dividend income funds is due to take effect on April 1 next year, simultaneously with the introduction of dividends tax.
Deductions for medical expenses
The Taxation Laws Amendment Bill proposes changing the tax deductions that you can claim for contributing to a medical scheme to a tax credit – an amount by which you reduce the tax you pay rather than your taxable income.
The credit will be equal to between 30 and 33 percent of the rand amounts that you are currently allowed to deduct from your taxable income for medical scheme contributions. The Bill proposes that the change be made effective from next year.
If approved, the effect on scheme members is that higher-income earners who are on a tax rate above about 30 percent will pay more tax, whereas lower-income earners on tax rates lower than about 30 percent should see a tax benefit.
The Bill proposes increasing the maximum amounts that you can deduct from your taxable income for medical scheme contributions for the 2011/12 tax year to R720 a month each for the member and the first dependant you register and R440 a month for each additional dependant.
The explanatory memorandum to the Bill says that if the proposed tax credit system had been introduced in this tax year (2010/11), the tax credit allowed would be R216 a month each for the member and the first dependant and R144 a month for each additional dependant.
The memorandum says there will be a supplementary credit for taxpayers over the age of 65, who can currently claim all their medical expenses against tax.
The National Treasury says that it will issue a discussion document next week that will clarify the policy on deductions for medical expenses, including out-of-pocket medical expenses.
Risk life assurance policies
The Bill establishes in law the basic principles for how the benefits paid on risk life assurance products – for example, death and disability cover – will be taxed in the hands of beneficiaries.
Peter Stephan, the senior legal adviser at the Association for Savings & Investment SA, says that, in the past, practice notes issued by the South African Revenue Service determined whether the proceeds of a risk policy benefit would be taxable or non-taxable in the hands of the beneficiary. Now, the taxation of risk policy benefits will be included in the Income Tax Act.
The underlying principles are that if premiums are paid with:
* After-tax money, then the proceeds will be tax-free in the hands of the beneficiary; and
* Pre-tax money, then the proceeds will be taxable in the hands of the beneficiary. This applies mainly to policies such as unapproved group life schemes, key man policies and other employer/employee contracts where an employer has paid the premiums and has claimed them as a deduction against taxable income.
Other changes in the Bill
* Foreign dividends, which are currently taxable except for the R3 700 of the annual interest exemption that you can apply against these dividends, will become subject to tax at 10 percent once dividends tax becomes effective on April 1 next year.
* Tax concessions for those receiving annual payments from the Road Accident Fund (as the fund moves away from lump sum payments) from March next year.
* An extension of the tax breaks for murabaha financing and provision for the government to issue a sukuk – a government bond that is shariah-compliant.
* Turnover tax for small businesses will be made more attractive.
