Employer contributions now taxable

In his budget speech of the 23^rd of February 2011, Finance Minister Pravin Gordhan announced that with effect from March 2012, employer contributions in respect of employees’ retirement would be treated as a taxable fringe benefit and an employee would be entitled to claim as a deduction, an amount of up to 22.5% of their taxable income for all contributions to pension, provident and retirement annuity funds. Deduction limits of a minimum of R12000 and a maximum of R200000 have been set.

At first glance, a deduction of R200000 sounds significant, but is it really beneficial to all taxpayers?

Currently, provident fund contributions made by an employer to a non-contributory fund are not taxable in the employee’s hands and such contributions are normally made on a salary sacrifice basis. The employee normally also contributes directly to a pension fund and such pension fund contributions can be claimed as a deduction limited to 7.5% of his taxable income. A further deduction for contributions to retirement annuity funds of the greater of 15% of non-retirement funding employment income or R3500 less pension fund contributions, or R1 750 will be allowed from taxable income.

It is common practice for the employer to contribute 15% to a non-contributory provident fund and for the employee to contribute 7.5% to a pension fund, thus the 22.5% limit referred to in the budget. Receipts from the funds upon retirement however, would be taxed in the employee’s hands.

Under the proposed legislation, the contributions made by the employer to the non-contributory provident fund will be included in the employee’s taxable income as a taxable fringe benefit and will be taxed in full. A deduction of up to 22.5% of the employee’s taxable income can be claimed in respect of contributions to pension, provident and retirement annuity funds, however, it is limited to the maximum deduction of R200000.

High income earners will be negatively affected by the limit of R200000, as their deductions, which were previously only based on a % of their taxable income, are now limited to the maximum of R200000.

This is illustrated in the example below:

An individual earns R1 500 000 per annum, his employer contributes 15% (R195 652) of his retirement-funding employment income to a provident fund and he contributes 7.5% (R97 826) to a pension fund.

The taxable income under the proposed legislation is significantly higher than that under the current legislation and although a total contribution of 22.5% (7.5% to the pension fund, 15% to the provident fund) of his earnings is being made to the pension and provident fund, the individual cannot claim the full R285 326 contributed as a deduction because of the new deduction limit of R200000.

This proposal will have a negative tax effect on the higher income earning individuals and goes against the idea of promoting “saving for retirement”.

For the lower earners, it is not all doom and gloom as it is not clear what the deduction would be for an individual contributing less than R12 000 per annum to a retirement fund. It seems possible that they may be entitled to benefit from the minimum deduction of R12000, despite their actual contributions being less than R12000.