According to the recently published Old Mutual Savings Monitor households in South Africa are saving less each year owing to a number of factors such as increased living costs, availability of easy credit and the youth not regarding saving for the future as an immediate priority. The poor savings culture in South Africa has resulted in many not being able to retire on their pension or retirement annuity payments alone and have been forced to continue working to support a specific lifestyle.
This article explores the potential cash flow impact from an income tax perspective on pensioners deriving income from two or more sources and provides solutions to avoid being hunted by SARS for a substantial tax bill on assessment.
To best explain the potential problem facing pensioners the following example is used as a basis to address the income tax pitfalls -
On 1 March 2008 Mr Smith retired at the age of 55 after 20 years of service for a company. Based on the pension fund contributions made during his years of service he is entitled to a monthly payment of R5,000. Because Mr Smith had no other savings products to draw from and owing to him retiring at a relatively young age, he was forced to supplement his income with a full time job from which he earned R25,000 per month. On assessment of his 2009 income tax return Mr Smith is informed by SARS that he owes R18,480. The question that arises is whether SARS made a correct assessment, and if so why the shortfall if Pay-As-You-Earn (PAYE) was deducted monthly by both the employer and pension fund administrator?
Liability to withhold PAYE
As a general rule, South African residents are subject to income tax on their worldwide gross income, subject to the certain exclusions and exemptions. The final income tax liability, after deducting PAYE and provisional tax, is determined annually, which in the case of an individual is at the end of February.
Where an individual receives "remuneration" an obligation is placed on the employer, unless directed otherwise, to withhold PAYE on a monthly basis and pay it over to SARS. The PAYE withheld by an employer is made towards the employee's liability for normal income tax, making the employer a collecting agent acting on behalf of SARS. For purposes of the Fourth Schedule to the Income Tax Act a fund administrator is regarded as a employer, meaning that if, for example, a pension payment is made to a former employee PAYE must be deducted and remitted to SARS within seven days after the end of the relevant month in which it was deducted or withheld.
In the example above the pension fund administrator correctly deducted PAYE for the 2009 tax year amounting to R2,520 on income of R60,000. The supplementary income of R300,000 was also correctly subject to PAYE deductions of R64,930. In total, Mr. Smith paid PAYE of R67,450 to SARS during the 2009 tax year.
By applying the principle of South African residents being subject to income tax on total gross income earned during a particular tax year, the result is that the actual tax liability on Mr. Smith's combined income of R360,000 is in fact R85,930 (based on 2009 tax tables and assuming he claimed no deductions) and not the R 67,450 deducted as PAYE. The blame for the shortfall cannot be placed on either the employer or pension fund administrator as they are only obliged to withhold PAYE in relation the "remuneration" actually paid by them without any regard to another source of income the employee may have.
Mr Smith's problem arises due to the fact that the R60,000 pension payment is taxed at a much lower effective rate (4%) compared to the rate relating to employment income of R300,000 (22%). When the two sources are combined on assessment as R360,000 it results in a leap to a higher effective tax rate of 24%, meaning that SARS is correct in demanding the shortfall from Mr Smith.
To the extent that the PAYE deducted during the 2009 tax year is not sufficient to offset the final tax liability as determined by SARS on assessment, the balance becomes due and payable. In many instances taxpayers faced with a large shortfall on assessment have no choice but to enter into some form of interest bearing payment arrangement with SARS.
There are essentially two methods for Mr Smith, or anybody faced with a similar problem, to ensure that cash flow is not negatively impacted on assessment each year. This can be done either by voluntary over deduction of PAYE or registration as a provisional taxpayer.
Registration as a provisional taxpayer places a significant compliance obligation on a taxpayer in terms of bi-annual returns and is therefore not recommended, unless of course SARS requires such registration to be effected. The simplest and less costly method is to make a written request for voluntary over deduction of PAYE under the provisions of paragraph 2(2) of the Fourth Schedule. The written request for voluntary over deduction of PAYE could be directed to either the employer or the pension fund administrator or both.
The purpose of the voluntary over deduction is to ensure that sufficient PAYE is deducted throughout the year of assessment to at least equal the effective tax rate of all income sources combined. Although there is no tax saving as such, it does assist in spreading the cash flow impact of the tax over a year and avoids the situation where SARS demands a lump sum payment on assessment.
Ruaan van Eeden
Senior Associate, Tax