CARMEN VENTER WORKSHOPS FOR CFP EXAMINATIONS 2014

Transcription

1 CARMEN VENTER WORKSHOPS FOR CFP EXAMINATIONS 2014 BUSINESS ASSURANCE Page 1

2 BUSINESS ASSURANCE MAKES REFERENCE TO THE BUSINESS ARRANGEMENTS THAT ARE NORMALLY FUNDED WITH LIFE INSURANCE POLICIES. THESE RANGE FROM FOR PURPOSES OF YOUR EXAMS ONLY: BUY AND SELL DEFERRED AND OR PREFERRED COMPENSATION KEYMAN CONTINGENT LIABILITIES RESTRAINT OF TRADE INCOME PROTECTION POLICIES [ INCOME PROTECTION POLICIES - IS NORMALLY DISCUSSED UNDER EMPLOYEE BENEFITS. YOUR EXAM GUIDELINES MAKE REFERENCE TO THIS UNDER BUSINESS ASSURANCE I WILL COVER IT HERE FROM AN INDIVIDUAL PERSPECTIVE AND THEN, WE WILL COVER UNDER EMPLOYEE BENEFITS FROM EMPLOYER/ EMPLOYEE PERSPECTIVE.] Page 2

3 BUY AND SELL What is the purpose of buy and sell agreements? In the event of one of the partners/shareholder/member s death what happens and or who receives their share of the business? They can bequeath it to family members who may have no clue on how to run a business, or have the necessary skills! The Executor may sell to a total 3 rd party who may just come and destroy the business. Credibility with clients can go out the window! Entering into a buy and sell arrangement provides certainty of who will be taking over. This can be whomever it need not be the remaining partners/shareholders/ members etc. This can be an employee of the business or someone who has nothing to do with the business but you and any surviving partner will know who this person will be. A buy and sell arrangement will prevent competitors from taking over the business as well as leaving management in competent hands without interference. A buy and sell arrangement will also facilitate the winding up of the deceased estate as the executor need not find a buyer and dependants will at least be compensated in full. Also more liquidity. Is it imperative that a buy and sell arrangement be funded by life insurance policies? No it need not be funded by life insurance policies! But, if life insurance policies are implemented for this purpose, then: Provides immediate funds to allow the successor to purchase the deceased s partnership/ members interest or shareholding. Prevents arrangements being made to repay the capital over periods of time which may be subject to tax...and with accumulated interest! Avoids the withdrawing of large capital amounts from the business which can be used more productively Successor may be flush for cash...bank may refuse loan facilities... yet the agreement obligates the purchase.! Are buy and sell arrangements only for the event of a death of one of the partners/ shareholders and or members? No arrangements can be introduced to cover any event it can be for a disability, retirement, resignation from the business and even for a dread disease. This is up to the individual /s to decide if an arrangement should be in place for a particular event. Page 3

4 In all instances you should look at funding these events with some form of life insurance and or investment. If buy and sell arrangements are implemented without life insurance policies funding the arrangement, what effect does this have on Estate Duty? In Property you will always record the deceased s value of his partnership / member s interest and or shareholding this is an asset whether a buy and sell arrangement has been funded with or without life insurance. The only difference really being that there will be no life insurance policies to account for and, no life insurance policies to determine whether exempt or Estate Dutiable. If life insurance policies are implemented to fund a buy and sell arrangements.. Firstly, remember that the value of the deceased s partnership / member s interest and or shareholding is still a value for Property. Secondly, the mere fact that the deceased is a LIFE ASSURED on a domestic policy and, that the amount is due and payable on his death makes the policy a value for Deemed Property! However! Section 3(3)(a) may provide an exemption on these policies. If the policy meets the requirements of this exemption then the policy is exempt and therefore DOES NOT FORM PART of deemed property AT ALL!... You cannot include the value and then deduct the value as no deduction exists for this event... THE WHOLE POLICY IS EXEMPT AND THEREFORE NOT INCLUDED AT ALL! The requirements in Section 3(3)(a) (ia) in the Estate Duty Act is : the commission is satisfied that the policy was taken out or acquired by a person who on the DATE OF DEATH of the deceased was a PARTNER/ held any SHARE or LIKE INTEREST in a company in which the DECEASED on the date HELD any share or like interest, for the PURPOSE of enabling that person to acquires the whole or part of: The deceased s interest in the partnership concerned or The deceased s share or like interest in that company and any CLAIM by the deceased against that company And that NO premium was BORNE by the DECEASED. Page 4

5 Notes to the above highlighted references: DATE OF DEATH: partnership / membership and or shareholding must be in existence at the time of death. PARTNER / SHARE / LIKE INTEREST: so if you are a sole trader and enter into a buy and sell arrangement funded by life insurance with a successor does not qualify... and if you are an employer entering into an arrangement funded by life insurance policies with your employee does not qualify etc etc PREMIUM: the deceased cannot have paid any of the premiums on the policy in which he was the life insured. This presents a problem in that if an existing policy is used for the arrangement...this requirement may not be met. One also needs to be aware if the company pays this premium on behalf of the shareholder as this can be seen to have been paid by the shareholder himself which will make the policy estate dutiable.! Also the shareholder will be facing a deemed dividend distribution and incur 15% withholding tax! If the person involved in the buy and sell arrangement is the employee of the employer and the employer contributed the premium to the policy then the employee has a fringe benefit consequence. PURPOSE : the purpose must be to purchase the deceased s share and or loan account in a company. When would purpose present a problem? Well clearly if the purpose is not to purchase the shares but for something else...! But, difficulties can be presented if the value of the policy is clearly overvalued with no commercial/ financial justification. Not only will the FULL value of the policy be dutiable but, the surviving partners would have to pay donations tax which was not originally catered for AND potential CGT consequences may arise for the surviving partners! DECEASED HELD ANY SHARE: clearly the purpose of the arrangement is to buy the DECEASED s share. Note that the buy and sell arrangement can include the loan account of the deceased but, only with regards to a company. If the arrangement is for a Partnership the policy will not meet the requirements if it includes the loan account. Important to note here is that the purpose is to buy the deceased s share. How do you think this will work if an arrangement includes a Trust and or a Company? Page 5

6 Let us look at some scenarios: Scenario 1 NATURAL PERSON A PRIVATE COMPANY B HOLDS SHARES HOLDS SHARES PRIVATE COMPANY D A and B own shares in Company D and Company B took out a policy on the life of A to enable company B to purchase A s shares in Company D when A dies. Assume all other requirements are met. Discuss whether this policy will be exempt from estate duty or not. Page 6

7 Scenario 2 TRUSTEE OF FAMILY TRUST A TRUSTEE OF FAMILY TRUST B FAMILY TRUST A FAMILY TRUST B HOLDS SHARES PRIVATE COMPANY D HOLDS SHARES Trustee B take out a policy on Trustee A and Vice Versa. Discuss whether these policies will be exempt from Estate Duty. Page 7

8 Scenario 3 TRUSTEE B OF FAMILY TRUST FAMILY TRUST B NATURAL PERSON A HOLDS SHARES HOLDS SHARES COMPANY D Trustee B takes out policy on life of A to purchase his shares and Natural Person A takes out a policy on the life of Trustee B to pay the Trust s shares. Discuss whether these policies will be exempt or not. Capital Gains tax on buy and sell policies. Para 55(1) of the 8 th Schedule refers: a person must disregard any capital gain or capital loss in respect of a disposal that resulted in the receipt/accrual..of an amount...: (c) (e) (a) same requirements as that of the Estate Duty Act or a risk policy with no cash /surrender value or is the original beneficial owner So if the policy you dealing with meets any of the above then the policy will be free of capital gain / loss if it is disposed of. Page 8

9 However, note that the requirement for (e) being that the policy cannot have a cash/ surrender value! So, what if it does? Then you have to rely on section (c) and or section (a). It is very important for us to discuss here the impact of CGT on the TERMINATION of the partnership/ shareholding/ membership as, para 55 has a special exemptions for buy and sell under (c) of the para of the 8 th schedule BUT, it could have a subsequent impact should a NEW partnership/shareholding etc take place using the same life insurance policies. The question of: is it payable to the original beneficial owner (assume policy has a cash value) becomes important to understand! Let us summarise the effect of buy and sell arrangements funded by life insurance: 1. If a buy and sell policy meets ALL the requirements in Section 3 (3)(a)(iA) then the policy is exempt and therefore EXCLUDED from deemed property. 2. If a buy and sell policy does NOT meet ANY of the requirements in S3(3)(a)(iA) then the policy is NOT exempt and the FULL amount [not part!] is included in Deemed Property for Estate Duty purposes. This is for calculations purposes only this does not mean that the Insurance company now needs to pay the proceeds to the Deceased Estate! The Policy proceeds will still be paid directly to the surviving partners by the life insurance company. a) Note that because the policy has a beneficiary the Executor does not handle and can therefore not charge executor fees. b) The value that is included in Deemed Property is: Value of proceeds LESS premiums plus 6% (SARS allows compound). Note that you need to remove the premiums + 6% from the value of the policy and only the NET is included in Deemed Property. c) The estate duty that the policy attracts will be paid by the surviving partners. 3. Premiums payable on a buy and sell policy are NEVER deductible for income tax purposes and the proceeds are NOT income for income tax purposes. All capital in nature! Buying shares! If I enter into a buy and sell arrangement with life insurance policies funding the arrangement and, I bequeath the shares to someone else in my Will and Testament. What do you think will happen? What advantages and or disadvantages can you think of if I decide to BEQUEATH my shares instead of SELLING it via a buy and sell arrangement? Page 9

10 So how does one actually set this up and how do we work out who pays what premium and or who is covered for what amount? Let us look at this scenario: Dan, Fred & Tom are shareholders in ABC Pty Ltd. A total of 100 shares have been issued by the company and they each own the following number: Dan Fred Tom 40 shares 35 shares 25 shares The total value of the company is R To fund the agreement they must take out 3 separate life insurance policy and structure as follows: Policy on the life of Dan: Sum assured R assume premium of R500 Owners, beneficiary and payors: Fred and Tom. Payment: Fred 35/60 x 500 = R Tom - 25/60 x 500 = R Ratio: of their respective shareholding in relation to the other Policy on the life of Fred Sum assured R assume premium R450 Owners, beneficiary and payors: Dan and Tom. Payment: Dan 40/65 x 450 = R Tom - 25/65 x 450 = R Policy on the life of Tom Sum assured R (assume premium R350) Owners, beneficiary and payors: Dan and Fred. Payment: Dan - 40/75 x 350 = R Fred 35/75 x 350 = R Page 10

11 The other insurance that we will be studying now, is essentially company owned...let s look.. Keyman? Owner is the company on the life of a VIP employee Deferred? Owner is the company on the life of the employee Contingent liability? Unless this is outside of employment it would generally be the company taking out a policy on the life of the employee / director that has stood surety or provided the loan to the company. Restraint of Trade? Owned by the company for the benefit of the employee on resignation Unapproved Group Life and or income protection again owned by the company on the life of it s employees. The only policy that we will be discussing as well that is not OWNED by the employer will be a Preferred Compensation...but we will get there. It is FIRST essential then to understand ALL the income tax implications of COMPANY OWNED POLICIES in a whole before we discuss each type of arrangement! Company Owned Policies When a Company implements a life insurance or investment policy the distinction between whether the company or whether the employee (and or his deceased estate, dependants etc) will benefit, is imperative. PREMIUMS PAID ON THE LIFE INSURANCE POLICY Firstly the company needs to make a choice on whether the premiums that the company pays should be deductible for income tax or not. This used to be called either CONFORMING or NON- CONFORMING. Although the principles have remained the same the term now used is DEDUCTIBLE or NON-DEDUCTIBLE. If DEDUCTIBLE, the premiums will be deducted under Section 11(w) either (i) or (ii) See below: Page 11

12 Section 11(w) of the Income Tax Act provides some guidance. Does the employee benefit? Does the employer/company benefit? 11(w) (i) (aa) the policy relates to the death/ disablement Or severe illness of an employee / director AND (bb) the amount paid by the employer is a FRINGE BENEFIT for the employee [S2(k) of the 7 th Schedule. 11(w)(ii) (aa) the employer is insured against any loss by reason of death /disability/ severe illness of employee or director (bb) the policy is a risk policy with no cash value (cc) the policy is at all times the property of the employer/ company at the time of payment of premium... [note cessions do not affect the deductibility of the premium] (dd) (A) after march 2012 state that you want it to be deductible! Else automatically not deductible (deadline was 31/08/2012) IF ALL REQUIREMENTS ARE MET AS PER ABOVE THE EMPLOYER CAN DEDUCT PREMIUMS FROM INCOME TAX. IF ONE OF THE REQUIREMENTS ARE NOT MET THEN EMPLOYER CANNOT DEDUCT PREMIUMS EVEN IF HE WANTS TO! IF EMPLOYER WANTS TO DEDUCT PREMIUMS (ONLY IF ALL REQUIREMENTS ARE MET) THEN HE HAS TO ELECT THIS ON THE APPLICATION. IF HE DOES NOT INDICATE THIS ON THE APPLICATION THE POLICY WILL AUTOMATICALLY BE NON-DEDUCTIBLE. From here let us differentiate between policies / arrangements that benefit the employee and those that benefit the employer. We will start with Employer Benefits first: Page 12

13 COMPANY OWNED POLICIES WHERE THE EMPLOYER/ COMPANY BENEFITS KEYMAN POLICIES A Keyman policy is beneficial to the employer if the employer identifies any one of his staff member as vital to the business. If this employee meets with an untimely death, disability and or even a severe illness, the employer is fully aware and acknowledges that it will have a negative financial impact on the business. Taking out a life policy on the life of this employee referred to as a keyman policy ensures that the employer has immediate funding available to either replace the employee, uplift an existing one, buy another skilled employee etc etc How would one place a value on the employee? The following valuation methods are common in the workplace: 7 x annual salary of the employee or The actual cost of replacing the keyperson or Number of years it will take for a replacement to reach the same levels of profitability x loss in profits due to the replacement How is the policy structured? The policy would be OWNED by the employer On the LIFE of the employee Employer is the BENEFICIARY as well as the PAYOR of the policy. On the death / disability / sever illness of the employee the proceeds are paid directly to the employer. Can the employer deduct the premiums paid on the policy and will proceeds be taxable or not? The employer can elect to deduct the premiums from income tax if he so wishes. If the Keyman policy is correctly structured, it will meet section 11(w)(ii) requirements. Contributions can ONLY be deductible under S11(w)(ii) if the requirements are not met, the employer will NOT be able to utilise S11(a) to deduct the premium When the proceeds become payable, IT WILL form part of gross income for the employer under section (m) of the definition of Gross Income. This is whether the premiums were deductible or not!!!! Page 13

14 However, if the premiums were not deductible under S11(w)(ii) as from 1/3/2012 then the proceeds will have a full exemption under Section 10(1)(gH). Example: policy A implemented for R1 million rand and employer did not deduct premiums from 1/3/2012. R1 mil is gross income and under the exemptions R1 mil is exempt. It is important to note the section (m) of gross income includes in GROSS INCOME of the EMPLOYER any loans and or advances that may have been made on the policy while active. Of course then, when the proceeds pay out eventually, the amount in gross income will be the proceeds LESS the loan/advance that was previously taxed. Once the employer then utilises the proceeds for the purpose meant the employer will be able to deduct the proceeds under Section 11(a) the general deduction provision...note that it must be used in the production of trade! What are the implications for the Employee on his death in terms of Estate Duty? Again, the mere fact that the deceased is a LIFE ASSURED on a domestic policy and, that the amount is due and payable on his death makes the policy a value for Deemed Property! However! Section 3(3)(a) may provide an exemption on these policies. If the policy meets the requirements of this exemption then the policy is exempt and therefore DOES NOT FORM PART of deemed property AT ALL!... You cannot include the value and then deduct the value as no deduction exists for this event... THE WHOLE POLICY IS EXEMPT AND THEREFORE NOT INCLUDED AT ALL! The requirements for exemption under Section 3(3)(a)(ii) are: The Commissioner is satisfied that Policy was not affected or at the instance of the deceased No premium borne by the deceased No amount will be paid into the estate of the deceased, or paid to / utilized for the benefit of any relative/ person/ dependent of the deceased AND Any company that was at ANY time a family company IN RELATION TO THE DECEASED! Family Company definition: any company (other than one listed on a recognized stock exchange) which at any relevant time was controlled or capable of being controlled, directly or indirectly, whether through a majority of shares/ interest or in any other manner whatsoever, by the deceased or by the deceased and one or more of his relatives. If the policy meets the above requirements : THEN TOTALLY EXEMPT AND YOU DO NOT INCLUDE INTO DEEMED PROPERTY AT ALL!! Page 14

15 However, if the policy DOES NOT meet the above requirements then: Let s explain this in the form of an example. Bob and Ben not related at all to one another each have 50% member s interest in ABC Stores CC. Bob had started this company totally on his own 15 years ago. The Company is valued at R10 million rand. Ben recognised that Bob was vital to the business and a keyman policy was implemented to the value of R 6 Million Rand. On Bob s death: 1. The company will now be valued at R16 million rand as the policy proceeds have been paid to the company increasing the asset value. 2. Under PROPERTY in Bob s deceased Estate for estate duty calculations you will include 50% of R16 million which is R 8 million. 3. Under DEEMED PROPERTY, because the policy is not exempt due to it being a family company in relation to Bob, THE FULL VALUE of the policy at R6 million has to be included. Can you see that as a result of the policy not being exempt a total amount of R8 million as well as R6 million = R14 mill is estate dutiable?? Double Estate Duty? It should only be on R11 million.. 4. Now this is where it is imperative to remember Section 4(p) deduction for estate duty calculations. S4(p) really says..because the value of the policy was already taken into account in the valuation of the members interest/ shares etc in PROPERTY then we will allow a deduction of the value of the life insurance in relation to the shareholding / member s interest. So we deduct under Section 4 (p) 50% of R6 million = R3 million deduction. Now let us see what is left to levy a duty on:: Property R 8 million Deemed property R 6 million 4(p) deduction ( R 3 million) Net estate R 11 million Can you see that Section 4(p) reduced the value of the company back to R5mil? IS IT POSSIBLE FOR THE EMPLOYER TO CEDE THE POLICY TO THE EMPLOYEE? You may find that the employee ends up resigning and or Retiring long before he dies! In terms of resignation there are other arrangements that can be put in place like a restraint of trade if applicable etc that we will be talking about a little later. But yes of course! Should the employee resign and or retire there may be a great possibility that the employee may want the policy to be ceded to him he is the life assured after all and there may Page 15

16 be factors such as age and or health which may make it difficult for the employee to purchase new cover. The employer can cede this policy to the employee! The question is...will there be any capital gains consequences for the employee? After all he has GAINED a capital amount that he has not paid for. This is where we again look at the requirements in Para 55 of the 8 th Schedule to determine whether there will be any exemptions: Para 55(1) of the 8 th Schedule refers: a person must disregard any capital gain or capital loss in respect of a disposal that resulted in the receipt/accrual..of an amount...: (b) (e) iro any policy where that person is/ or was an employee/director whose life was insured in terms of that policy and any premiums paid by that person s employer WERE DEDUCTED in terms of section 11(w) a risk policy with no cash /surrender value or (f) if the amount received/ accrued constitutes an amount contemplated in Section 10 (1) (gg) or (gh) [remember your exempt amounts?] So if the policy you dealing with meets any of the above then the policy will be free of capital gain / loss if it is disposed of. Can the employer deduct the value of the policy when ceded? Unfortunately for the Employer the value of the policy upon ceding it over to the Employee cannot be a deduction for income tax purposes as Section 23(p) prohibits a deduction in these caseswhether ceded to the employee, his dependents and or ceded to a Retirement Fund for the benefit of the employee not allowed as a deduction! The recommendation of life insurance: Remember that when one recommends Life Insurance for the Keyman, one needs to take into account whether the proceeds will be taxable or not, whether the proceeds will be estate dutiable or not. So how does one cater for this? The table below should assist. Remember that if a policy is both income taxable and estate dutiable SARS allows the INCOME tax to be deducted first before duty at 20% is applied. Page 16

17 Income tax free Inc Tax payable Income Tax free Income Tax & Estate Duty free Estate Duty Free Estate Duty payable Estate Duty payable Not 11w deductible 11w deductible Not 11w deductible 11w deductible NOT a family Company NOT a family Company Family Company Family Company Divide by 0.72 Divide by 0.80 Divide by CONTINGENT LIABILITY This is a policy implemented on the life of the director/shareholder / employee to cover perhaps a loan account in the favour of the director or, perhaps director signed surety on behalf of the company etc. Especially in the event of death, it may be a problem for the employer/ company if they have no immediate capital to settle the debt and, to prevent the company having to either sell off assets, or dip into reserves and or even having to re-raise a bank loan... a policy is implemented to provide the company with immediate cash. Are premiums deductible by the company? As much as one can apply section 11(w)(ii)...policy for the benefit of the employer the difficulty being this: what is the purpose of this policy? Is it for trade or is it to settle capital? You see this is to settle capital (a loan account / suretyship etc) and can therefore not be a deduction for revenue. The intention is to repay capital. When proceeds are paid is this gross income? As per above this is capital so should not come into gross income Would this be seen as a fringe benefit for the employee? Although yes the company is paying the premiums, this would not be for the benefit of the employee and not seen as a fringe benefit as per section 12(k) of the 7 th schedule. Page 17

18 What would the implications be in terms of Estate Duty. As always, one looks at the fact that the director / shareholder etc is the life assured of a domestic policy and it is due and payable on death and hence Deemed Property for estate duty purposes. Would there be any exemptions? If we look at the exemptions afforded as per previous readings above, one could think that perhaps the keyman exemption 3(3)(a)(ii) may apply. The problem in my mind is this: although the policy itself is not paid to the deceased/ it s estate and or dependants...is the mere fact that a liability does not exist in the estate as a result of the proceeds of the policy is this not an indirect benefit to the deceased and his estate? I do not think any exceptions apply. Remember the company would have to pay the estate duty that this policy would attract. Would there be any capital gains tax implications should the company cede this policy to the shareholder / director etc? Para 55(1) of the 8 th Schedule refers: a person must disregard any capital gain or capital loss in respect of a disposal that resulted in the receipt/accrual..of an amount...: (a) (e) original beneficial owner a risk policy with no cash /surrender value RESTRAINT OF TRADE Some companies may want to protect themselves from loss of business and or information should a key individual/s resign from the company. Normally on the onset of employment, a contract is negotiated between employer and employee which spells out the conditions in which the employee may trade should he resign from employment. This could be anything from not working in the same trade within a 50km range, not being able to contact the employer s clients for business for the next 5 years etc. The contract however cannot place the employee in a situation where he is unable to make a living. This is a restraint of trade. More often than not a restraint of trade arrangement comes with a payment to the employee by the employer. Of course there is opportunity lost if the employee agrees to a restraint of trade and he is therefore compensated for this by the employer. This can be funded with assurance like a sinking fund policy. Page 18

19 Taxation For the employee When the employee resigns, the payment made by the employer to the employee whether from an insurance policy or not is Gross income for the employee in ca of the definition. All though this is capital in nature it is a special inclusion in gross income and therefore taxed as such. The above applies if: You are a natural person or Labour broker as defined but not if exempt Personal service provider For the employer When the employer pays the employee the lump sum upon resignation this is a deduction for the employer under Section 11(cA). This deduction says: Firstly it must be income for the employee and Secondly, the amount being deducted, MAY NOT exceed in any one year the lessor of: 3 years OR The term of the restraint of trade. So effectively it is saying that the longer the period the better but never less than 3 years OR you can look at it this way : use the longest period of the restraint or 3 years! How do we apply this? Let us look at an example: Ian received a restraint of trade payment of R ensuring that he not open another store within a 50km range in the next 5 years. Which one is longest...3 years or 5 years? 5 years So employer can deduct R over the next 5 years. If the example was R for a restraint of 1 year... which is longer? the term of the restraint or 3 years? 3 years! So employer can deduct R over the next 3 years. Page 19

20 Life Insurance and taxation As mentioned a sinking fund type policy is implemented which has no life assured. These policies will not meet the requirements of section11 (w)(i) or (ii)! because it has no life assured one cannot say that this policy was to benefit the employer as a result of the death / disability and or severe illness of the employee.! Also if you think about it there will be no Estate Duty implications either...the employee should he die while employed..can you say he was a life insured and it becomes due and payable? NO! Would there be any CGT consequences? Well would we cede a sinking fund policy? Now let us look at policies that would benefit the employee and could therefore be deductible under section 11 w(i). UN APPROVED GROUP LIFE AND INCOME PROTECTOR When an employer decides to make available some incentives to it s employees they have choices between the introduction of a Retirement Fund with group life or a Retirement Fund without Group Life or Group Life alone or a Retirement Fund alone or a Retirement Fund with a separate Group Life Scheme amongst other choices. Where the employer decides to introduce a Group Life Scheme separate from a Retirement Fund this is seen as an Un-approved fund..ie it is not at all regulated by the Pension Fund Act. Taxation Income Tax of premiums and proceeds Up until 28 February 2012 these Life Schemes were pretty tax free.. ie the premium to the scheme was not a fringe benefit to the employee and was not taxed as Income Tax..with the EXCEPTION OF ESTATE DUTY! Unlike an approved scheme which does not form part of Estate Duty calculations at all...with an unapproved fund it was INCOME TAX FREE but Estate Dutiable. This all changed as from 1/3/2012 and these are the changes we will discuss. Page 20

21 Firstly, the premium paid to the Group Life Scheme by the employer MUST be a fringe benefit to the employee from the date of 1/3/2013 When the proceeds are paid out on death / disability /severe illness the value IS GROSS INCOME in the hands of the employee in (d) of the definition of Gross Income. However.. Exemptions apply and we will look at only the exemptions for un-approved group life for now... and this is: Section 10(1)(gG) will exempt (i) If a policy is a RISK only policy with no cash and or surrender value, if the amount of premiums paid iro that policy by the employer has been deemed to be a taxable fringe benefit SINCE the later of: The date on which the employer became the policyholder OR 1/3/2012 If the proceeds do not meet the above it will be TAXABLE as Gross income without exemptions! Note that the value of these group life values remains Estate dutiable on the death of the deceased! The value is deemed property for estate duty calculations. On death is this included in Deemed Property? Because this does not form part of a approved fund, ie it is seen as individual underwritten policies the value on death of the policy IS Estate dutiable! However, should a beneficiary be nominated then you will at least save on executor fees!! Deductions of premiums for the employer The Employer can deduct premiums under Section 11(w)(i) BUT ONLY if the premiums are a fringe benefit for the employee AND the policy is for the death / disablement and or severe illness of the employee! whether RISK only or NOT. Can the policy be ceded to the employee by the employer? Many arrangements have a continuation option. This means that when the employee resigns / retires from employment the employee can decide to take over the policy and continue as individually owned and or by a cession from the employer. When the cession takes place it is a disposal for capital gains and we have to determine again whether para 55 of the 8 th schedule provides any form of exemption. Page 21

22 Para 55(1) of the 8 th Schedule refers: a person must disregard any capital gain or capital loss in respect of a disposal that resulted in the receipt/accrual..of an amount...: (b) (e) iro any policy where that person is/ or was an employee/director whose life was insured in terms of that policy and any premiums paid by that person s employer WERE DEDUCTED in terms of section 11(w) a risk policy with no cash /surrender value or (f) if the amount received/ accrued constitutes an amount contemplated in Section 10 (1) (gg) or (gh) [remember your exempt amounts?] So if the policy you dealing with meets any of the above then the policy will be free of capital gain / loss if it is disposed of. What is the difference between the above Group Life and Income Protection cover? The above principles are all the same from premium deductibility, fringe benefit tax etc... some differences: 1. No estate duty on death as what is deemed property value with an income protector? 2. However, due to the premiums being a fringe benefit the premiums are deemed to be paid by the employee and therefore the employee can apply for a deduction from tax under s11(a). THIS CHANGES FROM 1/3/2015 NO DEDUCTION UNDER 11a WILL BE ALLOWED. 3. When proceeds are paid...remember we are protecting INCOME so when it pays out it is INCOME and taxed as per the marginal rates. However, an exemption could apply under Section 10(1)(gG) IF the employee did not use the premiums for a section 11(a) deduction. but it must have been a fringe benefit! THIS ALSO FALLS AWAY FROM 1/3/2015 AS FROM THEN, PREMIUMS TO INCOME PROTECTORS WILL NOT LONGER BE DEDUCTIBLE. Deferred Compensation / Endowments SARS has not been happy with these arrangements for a while and when the Act was changed these were the schemes that they were aiming at stopping. All a deferred compensation really is, is a scheme to incentivise employees to remain in employment until a specified date..could have been 10 years or 30 years or until retirement. This was up to the employer and employee contract. The schemes were aimed at high income earners in their 40% bracket instead of receiving an increase in salary where 40% would go towards tax the increase would be paid into an endowment for the benefit of the employee who, would receive monies at the end of the arranged term. Page 22

23 It is structured where: Owner is the employer Life Assured the employee Payor and Beneficary the employer There were many tax benefits to this but the majority of the benefits stopped by the end of 28/02/2012. This is what happens as from 1/3/2012. Can the employer deduct the premium? Note that the 11(w)(i) requirement being that if it is for the benefit of the employee which it is AND as long as it is a fringe benefit then the employer can deduct the premiums. When the proceeds are paid out? The proceeds are paid out to the Employer who in turn then pays to the employee. When the employer receives the proceeds it forms part of gross income under (m) of gross income but then, when the proceeds are paid to the employee it will be deductible under 11(a) so the employer will be in a tax neutral position. The employee then receives the proceeds from the employer which is included in gross income under section (d) of the definition of gross income. HOWEVER, will it be exempt? Section 10(1)(gG) will exempt the proceeds of a life insurance policy if it is NOT RISK ONLY..ie it has a cash component to it - IF IT WAS A FRINGE BENEFIT TAX FROM THE DATE OF INCEPTION! Really what it is saying is... if it is risk only then it is fine if the fringe benefits commenced on the latest of commencement of the arrangement or 1/3/2012 BUT!!! If the policy has a cash component to it [which a deferred compensation does have] then it better have been a fringe benefit from the ORIGINAL DATE OF COMMENCEMENT!! How many policies will meet this requirement?? So INCOME and taxed as per the Marginal rates...!!! What if the employer cedes the policy to the employee instead of paying it out? The cession value at time of cession is GROSS income in the hands of the Employee and taxed as income. However, Treasury has come to understand that in many instances these arrangements were used to fund retirement planning and, by taxing them now will render the arrangement useless. Page 23

24 So the following cession will be allowed without attracting tax: If a policy with a cash component is ceded to an occupational Retirement Fund. If ceded to the employers fund - then we are happy! The employer is also allowed to cede to an individual Retirement Annuity fund but there are some tax consequences. The amount ceded has to be included in the employee s income as a fringe benefit tax. The cession value will then be deemed to be that of the employee and, the employee will then be allowed contribution deductions as per the formula in Section 11(n) REMEMBER THOUGH THAT EMPLOYER CANNOT DEDUCT THE CESSION VALUE AS SECTION 23 (P) PROHIBITS THE DEDUCTION. On death of the employee what are the Estate Duty implications? The mere fact that the deceased is a LIFE ASSURED on a domestic policy and, that the amount is due and payable on his death makes the policy a value for Deemed Property as this is a cash value! Section 3(3)(a) has no exemptions whatsoever for these policies so there is no way out! Remember that the beneficiary in the first instance is the Employer and therefore he would be responsible for the estate duty payable. Then as per the service agreement, the employer would pay the policy into the estate. No executor fees on the policy value as there will be a beneficiary. Are there any CGT consequences upon cession to employee? Para 55(1) of the 8 th Schedule refers: a person must disregard any capital gain or capital loss in respect of a disposal that resulted in the receipt/accrual..of an amount...: (a) (b) is the original beneficial owner iro any policy where that person is/ or was an employee/director whose life was insured in terms of that policy and any premiums paid by that person s employer WERE DEDUCTED in terms of section 11(w) (f) if the amount received/ accrued constitutes an amount contemplated in Section 10 (1) (gg) or (gh) [remember your exempt amounts?] So if the policy you dealing with meets any of the above then the policy will be free of capital gain / loss if it is disposed of. Page 24

25 Is there another alternative to Deferred Compensation? PREFERRED COMPENSATION As you would have noted from above and from the discussions we will be having, there is NO MORE place for Deferred Compensation. But there still is place for incentive arrangements for staff. This is really what this arrangement is about. You want your staff to remain in your employment for as long as is possible and having some form of incentive is ideal. So how do we structure this? With a preferred compensation arrangement written in the employment contract will have: Owner : employee Life Assured: employee Beneficiary : employee Payor : employee HOWEVER VERY IMPORTANT THIS IS THE ORIGINAL STRUCTURE! In the arrangement it is agreed that the employer will increase the employee s salary by the premium amount. The amount is increased to take the tax into account. Employee agrees that they will implement an endowment type policy with the specified amount and then once active, CEDE the policy to the employer as a collateral cession. This way the employer OWNS the policy while employee is in employment. When the employment is terminated, the employer cancels the cession and the ownership reverts back the employee who can do with it what they wish. So let see how it looks when implemented: Tom is employed by BBC Stores and, as per the employment agreement, a Preferred compensation is to be implemented with a monthly premium of R1 500 pm. Tom will be in the 40% income tax bracket. Page 25

26 Employer increases Tom s salary with 1500 / 0.60 = R This means that when Tom gets his salary he will forfeit 40% tax and his net income will be R R % tax = R Tom makes an endowment policy active and cedes the policy to BBC STORES. BBC Stores deducts the amount of R2 500 under S11(a) general deduction as a salary an expense in the production of trade. So employer is not disadvantaged. When the policy pays out... it is paid out tax free as it was paid with after tax money. Of course it would have been taxed in the fund (four fund approach) but proceeds are tax free in the hands of the employee Estate Duty implications for the Employee I think we can say this with our eyes closed by now...life assured on a policy due and payable..so yes there will be estate duty implications. Does S3(3)(a) afford any exemptions? Do not think so! The proceeds are payable to the deceased estate so the employer will not incur estate duty liability. Capital Gains Tax implication When the employer cancels a security (collateral) session this is not a cgt event and therefore no capital gains tax consequences. That is BUSINESS ASSURANCE FOR YOUR EXAMS LADIES AND GENTS!!! See additional documentation for examples to work on! Page 26