Legally arrange your taxes to reduce your liability

Johannes Visser, PPS Wealth Manager

Why tax planning is an important part of your financial plan

When thinking about tax, I always recall a scene in the movie The Shawshank Redemption. For those who have watched it, it is where Andy is working on the rooftop and asks Captain Hadley if he trusts his wife. Andy was almost thrown off the rooftop for asking this. But then, he provides the captain with tax advice. By donating the funds to his wife, the captain would be able to legally structure his affairs where he would pay the least amount of tax. In this particular case, he would pay no tax.

Tax is – for the most part – a grudge payment. The marginal tax rate for a natural person on his/her taxable income is 45% , while the corporate tax rate is 28% on net profits. To put this into context, countries like Portugal’s marginal tax rate is 59%, Canada’s is 54%, the USA’s is 50% and the UK’s is 47%. This being said – generally speaking – these country’s corporate tax rates are lower compared to that of South Africa.

The South African Revenue Service (SARS) has made it clear that it expects every taxpayer to meet their tax obligations and pay their fair share of taxes or face serious consequences. It is illegal not to pay tax (tax evasion) while tax avoidance – where people or companies pay less tax than what SARS would like them to pay – is frowned upon. SARS has put in place specific General Anti-Avoidance Rules to curb the latter. Tax planning, therefore, plays an important role in legally arranging one’s affairs to reduce one’s tax liability. South Africa has a self-assessment tax system based on worldwide income, that places the responsibility on the taxpayer to prepare and submit income tax returns

Part of our tax planning discussions with clients normally involves taking advantage of certain tax deductions/benefits of investment products. There are a few main types of products to consider including a retirement annuity, a tax-free savings account or an endowment/sinking fund. Each of these have different benefits and tax considerations should you wish to access your funds including:

• Retirement annuity: This is a great way to save for your future while also taking advantage of the allowable annual tax deduction. Interest, dividends and capital gains earned will be tax-free in your hands annually.
   - In a tax year, your contributions are tax deductible at 27.5% or a maximum of R350 000 (of the greater amount of PAYE or taxable income (excluding retirement fund and severance benefits).
   - If your contributions exceed R350 000, it will be carried forward to the next tax year and reviewed as if you had contributed to this within the new tax year.
   - Unclaimed contributions? This may help to reduce the taxable amount of a lump sum taken at withdrawal, retirement or death, and will reduce the taxable amount of the annuity income on retirement.
   - To access your funds before retirement or after retirement, the following should be kept in mind:
   - Pre-retirement: If your fund value is below R15 000, you may draw this in full before the age of 55. If above R15 000, withdrawal is allowed only due to permanent disability, divorce order, death, formal emigration or departing from South Africa on expiry of a work or visiting visa.
   - Post-retirement: Accessible only from the age of 55, you can take up to a third as a lump sum. The remainder will provide a post-retirement annuity income. If the total retirement benefit is R247 500 or less, you may commute the total capital as a lump-sum benefit.

• Tax-free Savings Account: Interest, dividends and capital gains earned will be tax-free in your hands even if you decide to withdraw from your account. You have unrestricted access to your funds with a 48-hour notice period. Underlying investments are made up from a combination of financial products such as unit trusts (excludes performance fees from portfolio selection list), bank savings accounts, fixed deposits, bonds, etc.

Contribution limits are capped at R36 000 per annum or R500 000 over one’s lifetime. Withdrawals cannot be replenished. If you exceed the annual contribution limit per tax year, this will lead to a penalty tax of 40% on the over-contributed amounts. This penalty tax applies to the over-contributed amounts of lifetime contributions at the end of the tax year.

• The Endowment/Sinking Fund: These both have cash values. The only difference is that an endowment normally has a life policy, whereas a sinking fund is a pure investment policy with no life assured.
     - Investors who have a marginal tax rate above 30% and do not require access to their savings within five years and are comfortable with limited insolvency protection, receive benefits that are paid below their marginal tax rate (and paid to them after tax). Savings will be taxed on net realised capital gains at 12% and interest at 30% within the product. Local dividends are taxed at 20% and withheld before distributions are reinvested.
    - Contributions can be made in a lump sum, recurring or ad hoc payments over a period of time. Income may be withdrawn after five years (restriction period) or the full capital amount taken in cash at that point. To reduce executor’s fees, you can nominate a natural person/trust as beneficiary.
   - An endowment policy provides protection against claims of certain creditors up to three years after the policy started and up to five years after maturity subject to Section 63 of the Long-Term Insurance Act No. 52 of 1998.
   - You are allowed one withdrawal AND one loan during the five-year restriction period. This is limited to no more than premiums received plus 5% compound interest. Where the surrender value is less than the restricted value, the full surrender value may be accessed.
  - A restriction on premiums exists. If after 12 months you contribute 120% or more of the larger of the previous two years’ contributions, you will enter a new five-year restriction period.

Careful consideration should be taken when selecting any of the products. In addition, remember that when investing in one’s personal capacity, there are interest and capital gains tax abatements applicable. These might be lost when opting, for example, into an endowment or sinking fund.

Other careful considerations should be taken on underlying investment funds as tax on growth on different asset classes varies greatly. High equity portfolios mostly incur capital gains tax and dividends withholding tax whereas investments in cash and bonds incur mainly income tax via interest earned. Therefore, one should always, consider not only the individual investor’s tax rate but also the type of underlying assets in the investment before one considers the investment wrappers.

As a parent, you can open a tax-free savings account for your minor child(ren), but you need to be aware that any contributions you make to this account on their behalf count towards their annual and lifetime contribution limits. Taxpayers are permitted to donate R100 000 per year, tax free . Donations tax will be levied at 20% on donations that do not exceed R30 million and 25% that exceeds R30 million.

Additional considerations
• Medical aid scheme
If you work for an employer who pays your medical aid (on your behalf), this will form part of your remuneration package and your tax due will be reduced by the applicable medical aid tax credits allowed by SARS each month. However, if you are self-employed and contribute towards a medical aid, your tax due will be reduced by the applicable medical aid tax credits allowed by SARS on assessment. The fixed monthly tax credits for the year 2021/2022 are R332 for you as the primary member, a further R332 for your first dependent and R224 for each of your additional dependents. SARS calls this rebate the Medical Schemes Fees Tax Credit . For example, if you are paying medical aid contributions for a partner, two children and yourself – you can decrease your tax liability by R1 112 per month or R13 344 per annum.

• Donating to a SARS-registered charity (Why?)
An option is to donate to a Section 18A5-registered Public Benefit Organisation (PBO), approved by SARS. These contributions are tax-deductible up to a limit of 10% of your taxable income, before the donation. Any donations exceeding this limit are carried forward and can be claimed as a deduction in the following tax year. You must ensure you obtain a Section 18A tax certificate from the registered PBO to successfully claim this deduction. It is a great way to donate to a good cause while also taking advantage of the tax benefit available to you as a taxpayer.

Other considerations when submitting your annual tax return

• Self-employed or employed and working from home ?
Self-employed individuals have always been allowed to deduct business-related expenses against their business income. These are all expenses incurred to earn an income. Since the outbreak of COVID-19, SARS states4 that: “If you are an employee who works from home and has set aside a room to be occupied for ‘trade’, you may be allowed to deduct certain home office expenses for tax purposes calculated on a pro-rata basis, provided that you meet the requirements as set out in the Income Tax Act.”5

Examples of such expenditure are rent, cost of repairs to your home office and/or expenses in connection with the premises i.e., rates and taxes. In addition to this, other types of business-related expenses are also allowed like phones, internet, stationery, cleaning, office equipment and wear-and-tear. You need to keep a record of these invoices together with the proof of payment so that you can take advantage of this deduction.

It is worth noting that when you sell a primary residence, the first R2 capital gain will be excluded from capital gains tax. However, there is a snag. Should you use part of the residence for trade, e.g. 25% of the home, then 25% of the full capital gain will be taxable.

As we approach the end of another tax year, remember that it is essential to walk the path with a professional. It is always useful consulting with an expert who can assist you in navigating this landscape and present you with options to suit your specific set of circumstances.