PREMIUMS & PROBLEMS Edition No. 105 July 2012

Transcription

1 PREMIUMS & PROBLEMS Edition No. 105 July 2012 A journal to provide an information service and a forum for the discussion of problems and new developments in financial planning. The opinions expressed by contributors are not necessarily those of Old Mutual Life Assurance Company (SA) Ltd, a Licensed Financial Services Provider. FSP License Number 26/10/703. Calculations and illustrations should under no circumstances be used in quotations. Copyright reserved. Kindly note that this edition has been updated in accordance with the Budget Speech delivered in February Certain interpretations are based on the editors understanding of the Budget Speech and correspondence with the Commissioner for Inland Revenue. Contributions and enquiries are welcome and must be sent to: The Editors Premiums & Problems Personal Financial Advice Human Resources Legal Department Old Mutual PO Box 66 Cape Town premiums&[email protected]

2 Editors David Hands B Comm, LLB, LLM (Tax), CFP Jim Dawson BA (Hons), LLB, ICMQ, CFP Soré Cloete B Com LLB, CFP H Dip Tax Tristan Naidoo LLB (UWC) Adv. PG Dip in Fin. Plan CFP Julia le Roux B.A. LLB, CFP Carl Muller BLC LLB LLM (Tax Law) Adv. PG Dip. in Fin Plan CFP Gerald Peter LLB, CFP Adv. PG Dip. in Fin Plan The Editors wish to thank the following persons for their contributions to the Business Assurance chapter: Jean-Louis Fourie FIA Mostafa Abdou BCom (Accounting) Robert Spiers FIA Angus Lawrie BCom LLB, CFP, H Dip Tax (UNISA) Published by Old Mutual Personal Financial Advice Human Resources Legal Department Design and layout: Proofreading: Reproduction, printing and binding: Debbie Sampson Tristan Naidoo Creda Communications

3 Disclaimer: The information contained in this publication is provided for reference purposes only and is not intended to constitute advice of any nature. Old Mutual or any of its subsidiaries shall in no circumstances be liable or responsible and disclaims all liability for any loss, damage (whether direct or consequential) or expense of any nature whatsoever, which may be suffered as a result of, or which may be attributable, directly or indirectly, to the use of or reliance upon the information contained in this publication

4 Personal Financial Advice Old Mutual Offices BLOEMFONTEIN Tel: (051) PHG Building Fax:(051) Nelson Mandela Road BLOEMFONTEIN 9300 CAPE TOWN Tel: (021) nd Floor, Southgate Fax:(021) Carl Cronje Drive Tygerwaterfront BELLVILLE 7530 DURBAN Tel: (031) P.O. Box 2139 Fax:(031) WESTVILLE 3630 PORT ELIZABETH Tel: (041) P.O. Box 386 Fax:(041) PORT ELIZABETH 6001 PRETORIA Tel: (012) Menlyn Office Park 2 Fax:(012) Gobie Street Menlyn 0181 JOHANNESBURG Tel: (011) st Floor Fax:(011) Nicol Grove Office Park Cnr Leslie Avenue East & William Nicol Drive Fourways 2091

5 Old Mutual Offices Brokers WINELANDS Tel: (021) P.O. Box 399 Fax: (021) SOMERSET WEST 7137 BLOEMFONTEIN Tel: (051) P.O. Box 214 Fax: (051) BLOEMFONTEIN 9300 PRETORIA MENLYN Tel: (012) PO Box 34 Fax: (012) Umtata 5099 KZN SERVICE CENTRE Tel: (031) P.O. Box 2552 Fax:(031) DURBAN 4000 JOHANNESBURG Tel: (011) P.O. Box 91 Fax:(011) PARKLANDS, 2121 PORT ELIZABETH Tel: (041) P.O. Box 386 Fax:(041) PORT ELIZABETH 6000 GAUTENG BANKS Tel: (011) P.O. Box 91 Fax:(011) PARKLANDS 2121 EGOLI BANKS Tel: (012) Private Bag X573 Fax:(012) MENLYN 0063

6 (i) Table of Contents A - Income & Capital Gains Tax Table of Contents General notes... A1 1. Introduction... A1 2. Residence-based tax... A1 3. The taxpayer... A3 4. Employee s Tax and Provisional Tax... A3 5. The steps in calculating the tax liability of a natural person... A5 6. Gross income... A6 7. Exempt income... A20 8. Deductions... A27 9. Calculating the tax liability... A31 Income tax rates for natural persons & special trusts... A31 Income Tax Calculation Sheet... A35 Provisions relating to persons who are married... A36 1. Income deemed to have accrued to the spouse - s.7(2)... A36 2. Spouses married in community of property... A37 Dividends Withholding Tax... A38 1. Regulated Intermediary (RI)... A39 2. Exemptions (s 64F, read with s 64FA(2), 64G(2), & s64h(2)(a), Income Tax Act)... A40 3. Generic Product Examples... A43 4. Impact of DWT on allowable deduction for retirement annuity contributions... A44 5. Impact of DWT on companies and shareholders... A44

7 Table of Contents (ii) Capital Gains Tax... A45 1. Who is liable for CGT?.... A45 2. What is capital gain?.... A45 3. Assets... A46 4. Disposals... A46 5. Exclusions from capital gains tax... A47 6. Determining the base cost... A50 7. Attribution of capital gains... A52 8. Aggregate capital gain or aggregate capital loss... A53 9. Capital losses... A Record-keeping... A54 Summary of capital gains tax liability calculation... A56 B - Investment Planning General notes... B1 What is investment planning?... B1 The investment planning process... B1 Main factors affecting client s investment strategy... B4 1. Risk... B4 2. Liquidity... B10 3. Taxation... B10 4. Inflation.... B13 Miscellaneous Investment Formulae... B14 1. Bank acceptances... B14 2. Values of gilts (e.g. Eskom stock) in phases of rising and falling interest rates... B14 3. Calculation to determine return on redemption of existing debt (e.g. bond on house or motor vehicle lease).. B15 4. A guide to interest rate calculations using basic interest tables... B19

8 (iii) Table of Contents Bond Redemption Table... B22 Bond Redemption Table... B23 Bond Redemption Table... B24 Investment Planning Worksheet... B26 1. Step 1: Financial data.... B27 2. Step 2: Income growth objective... B30 3. Step 3: Determine investor s marginal rate of tax... B30 4. Step 4: Determine whether debt should be repaid from capital available... B32 5. Step 5: Invest the capital required for emergency purposes at the best available call rate... B33 6. Step 6: Provide for future capital needs... B33 7. Step 7: Determine income deficit in year 6... B33 8. Step 8: Determine the amount to be invested in an income portfolio... B34 9. Step 9: Determine future cash flows... B Step 10: Determine total annual income from income portfolio... B Step 11: Incorporating the figures determined in steps 7 to 10 do a comprehensive cash flow analysis... B Step 12: Investment of balance of capital... B38 Investment comparison... B39 Collective Investment Scheme... B45 1. What is a collective investment scheme?... B45 2. Benefits of collective investment schemes... B45 3. Classification of collective investment schemes... B46 4. Funds not specifically categorised... B49 5. Factors to consider when investing in unit trusts... B49 6. Categories of unitised investment products... B50

9 Table of Contents (iv) Offshore investments... B54 1. Introduction... B54 2. Diversifying risk.... B54 3. Exploiting international markets and enhancing returns... B54 4. Selecting an offshore centre... B54 5. Offshore Investment Options for SA Residence... B57 6. Estate Planning & Tax implications... B60 7. Exchange Control Odds & Ends... B63 C - Retirement Planning Retirement Planning Worksheet... C1 Notes to Retirement Planning Worksheet... C2 Table A: Capital preservation... C4 Table B: Annuity rates... C6 Retirement planning vehicles: A comparison... C8 Preservation Funds... C20 Severance benefits... C23 Comparison between defined benefit and defined contribution funds... C24 Retirement Annuity Calculation Sheet... C25 Calculating the tax payable where the taxpayer retires from more than one retirement fund (after 1 October 2007)... C26 Calculating the tax payable where the taxpayer retires from a retirement fund after having withdrawn or retired from another fund previously and/or receiving a severance benefit... C28

10 (v) Table of Contents Techniques to reduce income tax at retirement... C29 Introduction... C29 1. Investment of capital in investments generating tax-free returns... C29 2. Limiting lump sums to tax-free amount... C29 3. Preserve retirement fund benefits upon withdrawal... C29 4. Retire later from Retirement Annuities... C29 Divorce Order Awards from Retirement Funds... C30 Divorce Orders and the Government Employees Pension Fund (GEPF)... C32 D - Business Assurance Business entities: A comparison... D1 Business entities - Advantages and Disadvantages... D10 1. Sole proprietorship... D10 2. Partnership... D12 3. Close corporation... D13 4. Company... D15 Company Act 71 of 2008 New structure of companies...d16 Company-owned policies - Summary of tax implications... D18 1. Paragraph (m) of the definition of gross income... D18 2. Paragraph (d) of the definitions of gross income... D18 3. Deductibility of premiums - Section 11(w)... D20 4. Exemptions... D22 5. Summary of developments... D26 Deferred compensation... D30 1. Definition... D30 2. Income tax implications... D30

11 Table of Contents (vi) 3. Estate duty implications... D33 4. Capital gains tax implications... D33 Keyperson assurance... D34 1. Definition... D34 2. Income tax implications... D34 3. Estate duty implications... D34 4. Capital gains tax implications... D35 5. Keyperson valuation... D35 6. Keyperson valuation guideline... D37 7. Calculation of cover required where policies are owned by third parties... D38 Preferred compensation... D42 1. Definition... D42 2. How the plan works... D42 3. Income tax implications... D42 4. Estate duty consequences... D43 5. Important considerations... D43 6. Capital Gains Tax Implications... D43 Buy-and-sell agreement... D45 1. Definition... D45 2. The elements of a buy-and-sell agreement... D45 3. How the plan works... D46 4. Income tax implications... D47 5. Estate duty implications (s.3(3)(a)(ia))... D47 6. Capital gains tax implications... D48 Income tax implications of restraint of trade payments... D49 1. Implications for the company... D49 2. Implications for the employee... D50

12 (vii) Table of Contents Loan account cover... D51 1. Debit loan accounts... D51 2. Credit loan accounts.... D51 Loan account redemption plan... D53 1. Introduction... D53 2. Income tax implications... D54 3. Estate duty implications... D54 4. Capital gains tax implications... D54 Business contingency plan... D55 1. Introduction... D55 2. Working of the plan... D55 3. Income tax implications... D55 4. Estate duty implications... D56 5. Capital gains tax implications... D56 The balance sheet: Business assurance leads... D57 Introduction... D57 Assurance leads... D57 Valuing business interests... D61 1. Introduction... D61 2. Assumptions used in Business Valuations... D61 3. Valuation Method... D62 4. Earnings Yield Method... D64 5. Dividend Yield Method... D65 6. Super Profits Method... D66

13 Table of Contents (viii) Financial ratios... D70 Introduction... D70 1. Liquidity ratios... D70 2. Solvency ratios... D72 3. Profitability ratios... D72 E - Estate Planning Introduction... E1 Methods to save Estate Duty... E2 Ways to limit growth in the estate... E2 Capital Gains Tax and Estate Planning... E3 Disposals by the deceased... E3 Disposals by the estate... E4 Taxation of trusts... E5 Donations Tax: Exemptions... E6 Estate Pegging Worksheet Comparison of costs and benefits... E7 Costs involved in transferring assets... E8 Costs involved in the setting up and administration of trusts... E9 The taxation of trust income... E10 Tax rates... E11 Interest-free loans... E14 1. Income tax considerations... E14 2. Donations tax considerations... E15 3. CGT Consequences... E15

14 (ix) Table of Contents Anti-tax avoidance measures... E16 1. Section 7... E16 2. Sections (Donations tax)... E16 3. Section 80A... E16 4. Section 103(5) (Cession of interest)... E17 Tax implications of retaining control in estate planning.... E19 1. Trusts... E19 2. Companies: Unquoted shares... E19 Limited interests... E21 1. Tax implications... E21 2. Valuing limited interests for estate duty purposes: Deaths before and after 1 April E23 3. Valuation of limited interests: Examples... E24 Tables for valuation of limited interests.e28 - E33 Estate duty: Rebate of duty on successive deaths... E34 How to calculate the estate duty that may be apportioned to policies owned by third parties/ where there is a thirdparty beneficiary... E35 ANC marriage - Estate Duty Worksheet... E37 ANC marriage and residue is bequeathed to surviving spouse - Estate Duty Worksheet... E38 Community marriage - Estate Duty Worksheet... E40 Community marriage and residue is bequeathed to surviving spouse - Estate Duty Worksheet... E42 Calculation of residue which accrues to the surviving spouse... E44 Estate planning - Liquidity analysis... E45 Capital Needs Analysis Worksheet... E46 Trust Worksheet - Income tax saving... E47

15 Table of Contents (x) Calculation of accrual in terms of the accrual system... E48 Life assurance and estate planning... E49 Retirement fund lump sums... E51 Intestate succession... E53 1. The surviving spouse... E53 2. Descendants... E54 The Wills Act, No. 7 of The signing of wills... E56 1. Wills in respect of which the testator has died before 1 October E56 2. Wills in respect of which the testator has died after 1 October E57 F - General Report writing... F1 1. Introduction/Background... F1 2. Areas of concern... F1 3. Objectives... F1 4. Possible courses of action and their appraisal and evaluation... F2 5. Conclusion/Recommendations... F2 Exchange control guidelines... F3 1. Capital Transactions... F3 2. Portfolio Investments by South African Institutional Investors... F3 3. Emigration... F4 4. The Single Discretionary Allowance... F5 5. Credit and/or Debit Cards... F6 6. Estates and transfers to beneficiaries... F6

16 (xi) Table of Contents Section S54 of the Long-term Insurance Act... F8 Definitions... F8 Provisions relating to policies (excluding annuities)... F10 Provisions relating specifically to annuities... F11 Basic interest calculations on a financial calculator... F14 Valuation of market value of long-term gilts (e.g. Eskom stock)... F17 Nominal and effective rate of interest... F18 Simple vs compound interest... F18 Simple vs compound interest.... F19 Debt repayments... F19 Resultant Rate... F20 Life Expectancy Tables... F21 Compound Interest Tables...F23 - F34 Present Value Tables... F35 - F41 Medical Schemes... F42 1. Introduction... F42 2. Purpose of the Act... F42 3. Role-players... F42 4. Medical Schemes... F49 5. Duties and obligations of the broker... F56 6. Penalties... F61

17 Table of Contents (xii) Money Laundering.... F62 1. Introduction... F62 2. Prevention of Organised Crime Act 121 of 1988 (POCA)... F62 3. Financial Intelligence Centre Act 38 of 2001 (FICA)... F64 Compliance in terms of the Policyholder Protection Rules (Long-term Insurance Act 52/1998)... F77 The Financial Advisory and Intermediary Services Act.... F78 1. Introduction... F78 2. Pertinent definitions... F78 3. Licensing... F80 4. Key Individuals... F80 5. Representatives... F81 6. Fit and Proper requirements... F82 7. Compliance Officer... F85 8. General Code of Conduct for FSP s and Representatives... F86 9. Record Keeping... F Offences & Penalties... F97

18 (xiii) Table of Contents

19 Income, Capital Gains & Dividends Withholding Tax Income Tax, Capital Gains Tax & Dividends Withholding Tax

20 Income, Capital Gains & Dividends Withholding Tax

21 Income, Capital Gains & Dividends Withholding Tax A1 General notes 1. Introduction In South Africa income tax is levied in terms of the Income Tax Act No. 58 of 1962 (as amended). This Act contains provisions for the levying of four different types of tax, i.e. income tax, dividends withholding tax (DWT), donations tax and capital gains tax (CGT). In these notes we will deal only with income tax, CGT, and DWT. Income Tax and CGT are taxes levied on all persons who have a taxable income and/or capital gains. The word "person" in this context does not only refer to natural persons, but also to companies, close corporations, estates of deceased persons, clubs, trusts and any other legal entity subject to tax. In these notes the focus is on the normal tax payable by a natural person and, more specifically, the employed person earning a salary. 2. Residence-based tax A residence minus tax system became effective on 1 January 2001 and South African residents have since been taxed on their world-wide income. To avoid double taxation all foreign taxes paid by these residents will, however, be allowed as a credit against the South African tax liability (subject to certain limitations). Certain categories of income and activities undertaken outside South Africa will be exempt from South African tax. A Double Taxation Agreement may also apply. All non-residents will be taxed on their South African sourced income. Who is a resident? Individuals A resident is defined as either: A person who is ordinarily resident (namely, whether that person s permanent home in South Africa is the home to which he or she will return). This is the subjective part of the definition, or A person who is in the Republic for more than 91 days in aggregate during the year of assessment; and was in total, during the preceding five years of assessment, physically present in the Republic for a period exceeding 915 days; and physically present in the Republic for a period exceeding 91 days, in aggregate, in each of such five preceding years.

22 A2 Income, Capital Gains & Dividends Withholding Tax (This is the more objective part of the definition known as the physical presence test.) It should also be noted that where a person who is a resident, in terms of the above definition, is physically outside South Africa for a continuous period of 330 full days, such a person shall be deemed not to be a SA resident from the day on which such a person left the RSA. This does, however, not apply to persons who are resident in the Republic because of the ordinary resident test. In summary, then, a person may be a resident in terms of either the physical presence test or the ordinarily resident test. However, where the person is a resident in terms of the physical presence test only, but is physically outside of South Africa for a continuous period of 330 days, that person is deemed not to be an SA resident. Companies A company is a resident if it is incorporated, formed or established in South Africa, or has its place of effective management is in South Africa. Certain specific exclusions How will the income of a controlled foreign entity (CFE) be taxed? A CFE is a foreign entity which is controlled by South African residents as defined in Section 9D. Control means where South African residents hold more than 50 per cent of the participation rights or votes in the entity or control the entity. Such income, whether active or passive, will be taxed in the hands of the residents controlling the CFE. Note that there are exceptions to this general principle. How will foreign losses be treated? Foreign losses of a CFE will be ring-fenced in the CFE and not taken into consideration in determining the tax liability of the South African resident controlling the CFE.

23 Income, Capital Gains & Dividends Withholding Tax A3 3. The taxpayer The term "taxpayer" means any person chargeable with any tax levied in terms of the Act (s.1 "taxpayer"). All taxpayers (other than companies, close corporations and trusts) are taxed according to one tax table. Note: For income tax purposes, a minor is taxed in his/her own right unless the provisions of section 7 apply. A deceased estate is regarded as a taxpayer (represented by the executor) and is taxed according to the tables applicable to natural persons. If the taxpayer dies during the year that he/she would have turned 65, the deduction of the secondary rebate is allowed s.6(1) and 6(2). However, the rebate will be apportioned, depending on how far into the year of assessment death occurs. 4. Employee s Tax and Provisional Tax Tax is collected by way of employees tax and provisional tax. (Fourth Schedule) Employees tax refers to the tax deducted by an employer from remuneration paid or payable to any employee. This method of collecting tax is also referred to as the pay-as-youearn system (PAYE). Provisional tax refers to the estimated amounts of tax that are paid at periodic intervals. The First Period (at half year) o Half of the total tax for the full year; o Less the employee s tax deducted for this period (6 months); o Less any allowable foreign tax credits for this period (6 months). The Second Period (at year end) o o o o The total estimated tax for the full year; Less the employee s tax paid for the full year; Less any allowable foreign tax credits for the full year; Less the amount paid for the first period.

24 A4 Income, Capital Gains & Dividends Withholding Tax The Third Period: (voluntary top up six months after year end unless year end is February in which case seven months after year end). o o o o The total tax payable for the full year; Less the employee s tax paid for the full year; Less any allowable foreign tax credits for the full year; Less the amount paid for the 1st and 2nd provisional tax periods. A provisional taxpayer is: Any person (other than a company) who derives income, other than remuneration or an allowance or advance as contemplated in section 8(1). Any Company excluding Public Benefit Organisations and Recreational Clubs. Any person who is notified by the Commissioner that he is a provisional taxpayer. As from the 2007 year of assessment, directors of private companies and members of close corporations are not required to register as provisional taxpayers. The following persons / natural persons are not required to pay provisional tax: Any person whose income is derived solely from remuneration. Any person who does not carry on a business and whose income does not exceed the tax threshold: 2011/2012 Tax Year 2012/2013 Tax Year Below age 65 R R Age 65 and over R R Age 75 and over R R

25 Income, Capital Gains & Dividends Withholding Tax A5 The taxable income of any person which is derived from interests, dividends, and rental from the letting of fixed property will not exceed R Any person, who apart from income derived from remuneration, receives investment income which does not exceed R for persons under 65 or R for persons over 65. Any person 65 years or older is exempt from the payment of provisional tax if: the taxable income for the tax year does not exceed R and consists of remuneration, pension, interest, dividends or rental income from the letting of fixed property; and he /she do not carry on any business. Non-resident ship and aircraft owners that are required to make payment under section 33 of the Act are exempt from paying provisional tax. When any taxpayer s liability for normal tax for the year of assessment is calculated by the South African Revenue Service (SARS), these amounts of employees tax and provisional tax payments are then set off against the taxpayer s final liability for tax. If the sum of the tax paid the taxpayer s total liability for tax, the excess is refunded, but if the amount of tax paid is insufficient, the taxpayer must pay in the shortfall. It has previously been proposed that SITE be repealed given that the personal income tax threshold for taxpayer s younger than 65 is approaching the SITE ceiling of R The steps in calculating the tax liability of a natural person The following steps are used to determine the liability for normal tax of a natural person: Determine gross income Less exemptions = Income Less deductions Plus taxable capital gains = Taxable income Apply normal tax rates = Tax per scale Less rebates = Tax payable. We will now look at each of these steps individually.

26 A6 Income, Capital Gains & Dividends Withholding Tax 6. Gross income 6.1 General formula Gross income means, in relation to any year or period of assessment: in the case of any resident: the total amount, in cash or otherwise, received by or accrued to or in favour of such resident and in the case of any person other than a resident: the total amount in cash or otherwise received by or accrued to or in favour of such person from a source within or deemed to be within the Republic during such year of assessment, but excluding receipts or accruals of a capital nature. Although the definition refers to amounts received by or accrued to the taxpayer, there are certain provisions which deem amounts received by persons other than the taxpayer, to have been received by the taxpayer. These include: income received in certain circumstances by a married person from his or her spouse (s.7(2)); income received in certain circumstances by a minor child (s.7(3) and s.7(4)); income flowing from a donation, settlement or other disposition (s.7(5), s.7(6), s.7(7))and s.7(8)); lump sums payable by approved funds after the death of the taxpayer (Second Schedule par. 5(1)); certain types of investment income (s.9d). Trade income Trade includes every profession, trade, business, employment, calling, occupation or venture, including the letting of any property and the use of any patent, design, trademark or copyright or any property which is of a similar nature (s.1 "trade"). 6.2 Shares and Tax Section 9C All qualifying shares that have been held for a continuous period of three years or more, are regarded as capital in nature, and are

27 Income, Capital Gains & Dividends Withholding Tax A7 automatically subject to capital gains tax. Whereas previously it was necessary to look into the facts and circumstances of each case, including the intention of the holder of the shares, now only the length of time for which those shares are held is relevant. Where the shares are acquired on different dates, the taxpayer is deemed to have disposed of the shares held for the longest period of time. Note, however, that a share held for under three years may still be regarded as capital, depending on the intention of the holder thereof. The definition of a qualifying share includes listed and unlisted shares, shares in private companies, interests in close corporations, and certain collective investment schemes (unit trusts). Among the exclusions are interests in share block schemes, former rollover schemes, hybrid equity investments, shares that are not equity shares (for example non-participating preference shares) and shares in unlisted foreign companies. There is no election to be able to treat shares as either capital or revenue in nature. The amendments are favourable to taxpayers who hold onto shares for more than 3 years; in that the highest effective rate of CGT for individuals of 10% is lower than the marginal rates of income tax applicable to taxable income. In respect of the sale of shares held for more than three years, the taxpayer must, however, include in his income any expenditure in respect of the shares which the taxpayer previously enjoyed a deduction for in that year or previous years. 6.3 Off-shore investment income Section 9D This section introduces certain anti-avoidance measures in relation to the income of controlled foreign entities (CFE), as well as investment income arising from certain donations, settlements or other dispositions. The important definitions in section 9D are the following: Controlled foreign company means a foreign company in which any resident/residents, individually or jointly, directly or indirectly, have more than 50 per cent of the participation rights or are

28 A8 Income, Capital Gains & Dividends Withholding Tax entitled to exercise more than 50 per cent of the votes, i.e. control the entity. Foreign company means any association, corporation, company arrangement or scheme (excluding a CC or public benefit organisation (PBO)) which is not a resident. Participation rights means the right to participate directly or indirectly in the share capital, share premium, current or accumulated profits or reserves of the foreign company, whether of a capital nature or not. There will be included in the income of affected residents a proportional amount of the net income of the foreign entity, which is attributable to the participation rights of the resident in such entity. This provision will not apply to a resident who, together with connected persons, holds less than 10% (in aggregate at all times during the tax year) of participation rights and voting rights in the CFE. Section 9D(9) sets out various amounts that are exempt from the provisions of section 9D, e.g. if the net income of the CFE is subject to income tax in South Africa, the provisions of section 9D will not be applicable. 6.4 Specific inclusions The definition of gross income lists certain specific amounts that are included in gross income, e.g. annuities (including commuted annuities), rewards for services, lump-sum benefits, pension fund benefits, fringe benefits, dividends, restraint of trade payments, pension and provident fund surpluses and the proceeds of certain policies. 6.5 Fringe benefits The cash equivalent of the value of all fringe benefits, as determined under the provisions of the Seventh Schedule, granted in respect of employment or to the holder of any office must be included in gross income. In terms of the Seventh Schedule the following perks give rise to a taxable benefit if they are provided to the employee or holder of office for consideration which is less than the actual value or cost:

29 Income, Capital Gains & Dividends Withholding Tax A9 the acquisition of an asset; the right of use of any asset (other than residential accommodation and motor vehicles); private use of an employer-owned motor vehicle (company car); meals and refreshments or a voucher for such meals or refreshments; the use of residential accommodation; free or cheap services; interest-free or low-interest loans; housing loans or subsidies; payment of an employee s debt or release from obligation to pay a debt; contributions to a medical aid fund. Note: It has been proposed that employer contributions to retirement funds be fringe benefit taxed. [Proposed effective date: 1 March 2014] Employee in relation to any employer is defined in the Seventh Schedule as any person who is an employee in relation to such employer for purposes of the Fourth Schedule, i.e. for purposes of employees tax, including a person who was previously employed by, or was a director of, a private company if such person is or was the sole shareholder or one of the controlling shareholders in such company. Also included are persons who were released by their employer from an obligation which arose before retirement to reimburse the employer for an amount paid by the employer on their behalf or to pay any amount which became owing by them to the employer before their retirement. 6.6 Subsistence allowances (section 8(1)(c)) A subsistence allowance is not regarded as taxable provided that it does not exceed a set daily rate (See Government Gazette 35044):

30 A10 Income, Capital Gains & Dividends Withholding Tax (i) (ii) (iii) (iv) (v) R303 per day (previously R286), inside the RSA (if the allowance is paid to defray cost of meals and other incidental subsistence expenses). R93 per day (previously R88), if the allowance is paid to defray cost of incidental subsistence expenses. Where the accommodation to which the allowance or advance relates is outside the RSA and is paid to defray the cost of meals and incidental costs, the amount per day is determined in accordance with a table for the country in which the accommodation is located (among them: Angola: US$340, Australia: Aus$188, Botswana: Pula518, Canada: Can$157, Democratic Republic of Congo: US$288, Egypt: US$118, France: EUR141, Germany: EUR107, India: 4791 Indian Rupees, Pakistan 5775 Pakistani Rupees, Mozambique: US$69, United Kingdom: GBP124, USA: US$142, Zimbabwe: US$120). The employee may be entitled to a larger allowance if he/she can prove that such larger amount was actually expended. These amounts apply in respect of year of assessment commencing 1 March Travelling allowances (section 8(1)(b)) (i) (ii) (iii) (iv) Any portion of a travelling allowance received which is not expended on business travel is included in the employee s taxable income. Travel between the employee s place of residence and his/her place of work is not business travel. Where the taxpayer receives a travelling allowance, the amount of the deduction to be claimed for business travel may be based on the actual cost incurred or on a kilometre rate established in accordance with the tariffs set out in a notice published by the Minister of Finance in the Government Gazette. Where a travel allowance has been given to an employee who has also been granted the use of an employer-owned vehicle, that portion of the travel allowance which is not subject to tax in the employee s hands is based on the

31 Income, Capital Gains & Dividends Withholding Tax A11 employee s actual business travelling expenditure and not the deemed expenditure determined according to the statutory rate per kilometre scale. (v) The following formulae may be used in calculating the amount expended on business travel: actual business km actual costs (a) x total km travelled 1 (b) actual business km x km rate An accurate log book must have been kept. (vi) (vii) In determining the rate per kilometre, a distinction is drawn between the fixed-cost element (which includes depreciation, licence fees, registration fees, etc.), the fuel element and the maintenance element. These elements are based on the determined value of the vehicle. Determined value in relation to a motor vehicle means: o o o where the vehicle was acquired under a bona fide agreement of sale or exchange concluded by parties dealing at arm s length, the original cost thereof, including sales tax or VAT, but excluding any finance charges or interest payable; or where the vehicle is/was held under a financial lease the cost to the lessor or the selling price of the vehicle plus any sales tax or VAT paid; or in any other case the market value of the vehicle at the time when the taxpayer first obtained the vehicle or the right of use thereof plus any sales tax or VAT which would have been payable had it been purchased. (viii) Where any motor vehicle which is owned or leased by an employee, his/her spouse or child, whether directly or indirectly, by virtue of an interest in a company or trust or otherwise, has been let to the employer or any associated institution in relation to the employer, the sum of the rental paid and any expenditure defrayed in respect of the vehicle, shall be deemed to be an allowance paid to the employee in respect of transport expenses.

32 A12 Income, Capital Gains & Dividends Withholding Tax (ix) (x) (xi) The fixed-cost element (which includes depreciation, licence fees, registration fees, etc.) allowed in any year is a fixed amount ascertained according to the determined value of the vehicle in accordance with the gazetted table. The rate per kilometre will be the fixed amount divided by the total number of actual kilometres travelled, whether for business or private purposes. A separate rate per kilometre is provided in respect of the fuel element and the maintenance element. The scale setting out the three components of the gazetted rates per kilometre (see Government Gazette 35064) which may be used in determining the allowable deduction for business travel, where no records are kept (effective 1 March 2012) is as follows: Where the value of the vehicle (including VAT) Fixed cost (R p.a.) Fuel cost (c/km) Maintenance (c/km) R0 R R R R R R R R R R R R R R R R and above Note: The fixed cost must be reduced on a pro-rata basis if the vehicle is used for business purposes for less than a full year. Where the allowance is based on the actual distance travelled on business or the recipient can prove the actual distance and the distance travelled in the vehicle for actual business purposes during the year of assessment does not exceed kilometres, the rate per kilometre shall, at the option of the recipient, and provided that no other compensation in the form of an allowance or reimbursement is payable by the employer to the employee in respect of such vehicle, be determined in accordance with a scale of 316 cents per kilometre.

33 Income, Capital Gains & Dividends Withholding Tax A13 (xii) The steps in calculating the deductible travel expenses are as follows: Step 1: List: (a) total km actually travelled:. (b) determined value:. Step 2: Use the amount in Step 1 and the fixed cost amount from the above table to work out the fixed cost: = fixed cost / total kilometres) x (y/365)=... y: If the motor vehicle was used for business purposes for less than 365 days, the fixed cost must be apportioned accordingly. Step 3: Obtain the fuel and maintenance costs per km from the above table: Fuel costs =. cents per km Maintenance costs =. cents per km Note: The fixed cost amount is a rand amount so convert the fuel and maintenance amount (in cents) into a rand amount for step 4. Step 4: Add Step 1 and Step 3 amounts together to get the total cost per km: Fixed cost + fuel costs + maintenance costs =. total R costs/km Step 5: Now work out the deduction allowable against allowance: Business kilometres (per logbook) x total cost per kilometre (step 4) = R Note: The deduction may not exceed the amount received as a travel allowance. To ensure that the correct amount of income tax is collated through the PAYE system during the year, 80% of a person s monthly vehicle allowance will be subjected to tax.

34 A14 Income, Capital Gains & Dividends Withholding Tax 6.8 Private use of employer-owned motor vehicles (company cars) - Paragraph 7 of Seventh Schedule (i) (ii) (iii) The value of the taxable benefit is calculated according to a scale based on the determined value of the vehicle. The exclusion from the determined value of the VAT paid on the acquisition of the vehicle changed from 1 March With effect from this date the determined value must now include the VAT paid on the acquisition of the vehicle. The determined value is based on the original cost (to the employer) excluding finance charges and interest but including VAT and any maintenance plan purchased (excluding extended maintenance plans). (iv) The monthly benefit is calculated by multiplying the determined value of the vehicle by: o 3.5% where the vehicle was the subject of a maintenance plan, or o 3.25% where the vehicle was the subject of a maintenance plan at the time the employer acquired the vehicle. (v) (vi) (vii) With effect from 1 March 2011, only 80% of the taxable value of this benefit is subject to the deduction of employees tax. Where the employer is satisfied that at least 80% of the use of motor vehicle will, during the year of assessment be for business purposes, then 20% of the taxable value of the benefit is subject to the deduction of employees tax. On assessment, the fringe benefit for the tax year is reduced by the ratio of distance travelled for business purposes (substantiated by a logbook) divided by the actual business travelled during the tax year. Further relief may also be available on assessment in respect of the cost of licence, insurance, maintenance, and fuel for private travel (where the full cost is borne by the employee and if the distance travelled for private purposes is substantiated by a logbook.)

35 Income, Capital Gains & Dividends Withholding Tax A15 Exemptions: Pool vehicle A vehicle available to and used by other employees; and the private use is of an infrequent nature or merely incidental to its business use; and the vehicle is not kept at or near the employee s residence outside of business hours. Restricted use Where the nature of the employee s duties requires the use of the vehicle out of business hours and the only private use permitted is travel between his/her residence and work. 6.9 Residential accommodation - Paragraph 9 and 10A of the Seventh Schedule (i) (ii) No taxable benefit arises where the employee is provided with accommodation away from his/her normal place of residence for purposes of performing his/her duties. The benefit is taxed on the basis of the employee s level of remuneration and not on the actual value of the housing provided. (iii) The value of accommodation provided to expatriate employees is taxable to the extent that it exceeds an amount equal to R multiplied by the number of months for which the benefit will apply. (Para 9(7B)(ii)(B) of Seventh Schedule). The employee is exempt from fringe benefits for a maximum of two years from date of first arrival in the RSA. Fringe benefits tax will apply where the employee was present in the RSA for a period exceeding 90 days during the year of assessment prior to arrival. (iv) The taxable benefit that is derived, may be the rental value of such accommodation calculated in terms of the formula in (v) below, less any rental actually paid by the employee for the accommodation or any rental consideration paid by the employee for household goods supplied and any charge made to the employee by the employer in respect of power or fuel provided with the accommodation.

36 A16 Income, Capital Gains & Dividends Withholding Tax (v) The rental value to be placed on any accommodation provided to an employee is calculated in terms of the formula: (A - B) x C 100 x D 12 A = A remuneration factor representing remuneration derived by the employee from his/her employer during the preceding year of assessment, in terms of which the remuneration received is deemed to be grossed up to an annual amount where the employee worked for the current employer for part of the previous year, or is an amount equal to the employees monthly salary divided by the amount of days in that month and multiplied by 365 where the employee worked for a different employer in the previous year. Remuneration includes directors fees but excludes (amongst others): the benefit derived from residential accommodation; the benefit derived from the private use of any motor vehicle; B = an abatement of 2012). R (from 1 March The abatement is not available where: the employer is a private company and the employee or his/her spouse controls the company or is one of the persons controlling the company. the employee, his/her spouse or minor child owns or has some right to acquire the property. C = a factor which determines the value to be placed on the accommodation and varies

37 Income, Capital Gains & Dividends Withholding Tax A17 depending on the size of the accommodation and facilities supplied: 17, if less than four rooms, or more than four, but unfurnished and without power; 18, if four or more rooms with either furnishing or power supplied; 19, if four or more rooms with both furnishing and power supplied. D = the number of months in the year of assessment during which the employee was entitled to occupation of the accommodation. (vi) (vii) Where the employee is provided with two or more residential units the cash equivalent will be that of the unit with the highest rental value over the full period during which the employee was entitled to occupy more than one unit. Where accommodation which is provided as a benefit to an employee is not owned by the employer or an associated person in relation to the employer, or where the employee has an interest in the particular accommodation, said employee will be taxed on the amount equal to the greater of: o o the value determined or total amount of rentals and other expenditure paid by employer. Rental payable is not taxable in the hands of the employee or connected person in order to avoid double taxation. An employee will be deemed to have an interest in the accommodation if: such accommodation is owned by the employee, his/her spouse or child, or by a company in which the employee, his/her spouse or child has a substantial shareholding, or by a trust in which the employee, his/her spouse or child is a beneficiary; or any increase in the value of the accommodation in any manner whatsoever, directly or indirectly, accrues for the benefit of the employee, his/her spouse or child; or

38 A18 Income, Capital Gains & Dividends Withholding Tax such employee, or a connected person in relation to such employee, has a right to acquire the accommodation from the employer. The following criteria apply: The formula above will not apply, where it is customary for an employer in the industry concerned to provide free or subsidised accommodation to its employees, and It is necessary for the particular employer to provide free or subsidised accommodation to its employees: o o for the proper performance of their duties; or as a result of the frequent movement of employees; or o as a result of the lack of employer-owned accommodation. The benefit is provided solely for bona fide business purposes. The formula method in (v) above will, however, still apply Subsidies - Paragraph 2 and 12 of the Seventh Schedule (i) (ii) (iii) Taxable benefit arises when an employer pays a subsidy in respect of capital or interest payments due by the employee on any loan. Cash equivalent of the taxable benefit in all cases is equal to the full amount of the subsidy. Where a financial institution or other body grants a loan to an employee of any employer at a low rate of interest subject to an additional payment by the employer to compensate the financial institution for the consequent loss of interest income, the additional payment will be regarded as a taxable subsidy in the hands of the employee, if the payment by the employer - the amount calculated using the official rate of interest. If it does not exceed this amount, the benefit will be taxed as a low-interest loan.

39 Income, Capital Gains & Dividends Withholding Tax A Housing and other loans - Paragraph 11 of the Seventh Schedule (i) (ii) (iii) A low or no-interest loan to an employee gives rise to a taxable benefit calculated with reference to the difference between the interest charged at the official rate (7% pa with effect from 1 October 2010) and the interest which the employee actually pays. The value of the taxable benefit is the difference between the amount of interest, which would be payable on the loan at the official rate of interest and the amount of interest actually paid by the employee on the loan. No taxable benefit arises from: o any casual loans which in aggregate do not exceed R (Para 11(4)(a) of Seventh Schedule) o a loan granted to enable an employee to further his own studies Payment of employee s debt or release from obligation to pay a debt - Paragraph 13 of the Seventh Schedule (i) (ii) (iii) Where an employer pays any amount owing by the employee or releases him/her from the obligation to repay any debt, a taxable benefit accrues to the employee. The employee will be taxed on the amount of the debt he/she is released from paying. If an employer pays an employee s subscriptions to a professional body, membership of which is a condition of employment, it is not regarded as a taxable benefit Free or cheap services - Paragraph 10 of the Seventh Schedule Travel facility (i) The general rule is that travel facilities paid for by an employer for an employee s private use will be taxable at cost to the employer.

40 A20 Income, Capital Gains & Dividends Withholding Tax (ii) (iii) No taxable benefit is attached to a transport service rendered by an employer to convey employees from home to work. In certain circumstances employees of airlines, railways, etc. will not be taxed on the benefit of free travel. Other services All other services are taxable at cost to the employer unless: the services are rendered at the employer s place of work to enable employees to perform their services more effectively or (in the case of recreational facilities) are rendered at a place set aside for employee s recreation in general Contributions to a medical aid fund The full amount of any contribution made by the employer to a medical scheme for the benefit of any employee or the employee s dependants is deemed to be a medical aid contribution made by the employee and is a taxable fringe benefit, irrespective of the employee s age. (Effective 1 March 2012). The value of the benefit is equal to the value of the monthly employer contribution. Where a lump sum contribution is made by the employer, a formula is used to determine the fringe benefit based on an apportionment amongst all affected employees. The fringe benefit has no value where the contribution is in respect of either: An employee retired due to superannuation (reaches normal retirement age according to the rules of the employer s superannuation fund) or ill-health; or Dependants of a deceased employee. However, the amount of contributions paid by the employer on behalf of an employee who is 65 years and older AND HAS NOT RETIRED from that employer, will still be a taxable fringe benefit. 7. Exempt income Gross income less exemptions equals income. Some of the more common exemptions are:

41 Income, Capital Gains & Dividends Withholding Tax A The basic interest and foreign dividend exemption s.10(1)(i)(xv) and (xvi) The interest and foreign dividend exemption threshold has not been revised. The domestic interest income exemption for the tax year 2012/2013 remains unchanged at: R per annum for taxpayers under the age of 65, R per annum for taxpayers aged 65 years and older, Interest includes distributions from property unit trusts and foreign interest and dividends. As from 1 March 2012, the foreign interest and dividend exemption falls away. Example If it is assumed that an investor can earn interest of 4.5% on a money market investment: Taxpayers younger than 65 can invest up to R before paying tax. Taxpayers 65 and older can invest up to R before paying tax. Note: The current exemptions for interest will possibly be phased out. To encourage greater savings, tax-preferred savings and investment accounts are proposed to be introduced by April 2014, as alternatives to the current tax-free interest-income caps as above. This will encourage a new generation of savings products. Whilst returns generated within these savings and investment vehicles (including interest, capital gains and dividends) and withdrawals will be tax exempt, it is unclear what the impact will be on interest earned in other investment vehicles, given the review of the above mentioned tax-free interest income caps. It is proposed that a cap of R per year (with a lifetime limit of R ) per taxpayer be placed on aggregate annual contributions, to ensure that high net-worth individuals do not benefit disproportionately. The design and costs of these savings and investment vehicles may be regulated to help lower-income earners to participate.

42 A22 Income, Capital Gains & Dividends Withholding Tax 7.2 Dividends - s.10(1)(k) The exemption for South African dividends has been retained despite the introduction of a dividends withholding tax (DWT) from 1 April 2012, as DWT is a separate tax and withheld and paid to SARS on behalf of the beneficial owner. Dividends are therefore included in gross income but don t affect taxable income as they remain exempt. (See section 3 on page A38 for more detail on DWT). 7.3 The tax-free portion of voluntary purchase annuities - s.10a The capital element of a voluntary purchase annuity is exempt from tax in the hands of the purchaser or his/her spouse or surviving spouse or deceased/insolvent estate of purchaser spouse. The capital element includes the capital element of a purchased annuity where the purchaser of the annuity has died or has been sequestrated and where the final payment under the annuity contract becomes payable to the purchaser s deceased or insolvent estate. The following requirements must be met before this exemption applies: There must be an agreement between an insurer and a natural person. The annuity must be payable until the death of the annuitant or the expiry of a specified term. The annuity must be payable to the purchaser or his/her deceased or insolvent estate or spouse or surviving spouse. It must not be an annuity payable by the insurer under the rules of a pension, provident or retirement annuity fund. The capital element of the annuity is determined in accordance with the following formula: Capital element A B x C where: A = the amount of the total cash consideration given by the annuity purchaser.

43 Income, Capital Gains & Dividends Withholding Tax A23 B = C = the total expected return of all the annuities to be paid (where the annuity is a temporary life annuity the total expected return must be calculated using the life expectancy tables based on age last birthday). the amount of the annuity. Example A male aged 66 buys a temporary life annuity for R He receives an annuity of R8 000 per annum. His life expectancy is years. The total expected return of all the annuities is R8 000 x = R Capital element R R x R8 000 = R5 331 The taxable portion of the annuity: R R5 331 = R2 669 If the annuitant is required to render a return, a copy must be attached to the tax return. Commutation of voluntary purchase annuity - s.10a(3)(c) The commuted value of a voluntary purchase annuity is now taxable as gross income less an exempt amount determined in accordance with the following formula: Example X = A - D, in which formula: X = the exempt amount; A = the amount of the total cash consideration given by the purchaser under the annuity contract; and D = the sum of the capital elements of all annuity amounts payable under the annuity contract prior to the commutation. A taxpayer purchases a temporary life annuity for R The annual annuity is R7 000 of which the capital element is R4 000.

44 A24 Income, Capital Gains & Dividends Withholding Tax After three years the taxpayer commutes the annuity and receives a commuted value of R What amount will form part of gross income? Exemption = X = A - D = R R = R Taxable portion = commuted value - exemption = R R = R Transfer costs - s.10(1)(nb) Where an employer bears certain expenses of transfer of any employee: on taking up employment; on transfer from one place of employment to another; on termination of employment; no taxable benefit accrues to the employee. The exempt expenses are: transport of the employee, his/her household and his/her possessions; settling-in expenditure at the new place of residence; the hiring of temporary accommodation (up to a maximum of 183 days) pending the obtaining of permanent residential accommodation. 7.5 Share incentive schemes - s.10(1)(ne) An amount (including any taxable fringe benefits) received by or accrued to an employee under a share incentive scheme operated for the benefit of employees which was derived - upon the cancellation of a transaction under which the employee purchased the shares under the scheme; or upon repurchase from the employee at a price not exceeding the selling price to him/her of the shares under the scheme,

45 Income, Capital Gains & Dividends Withholding Tax A25 is exempt from tax, if the employee does not receive compensation or a consideration in excess of the purchase price he/she actually paid for the shares. 7.6 Employment outside South Africa s.10(1)(o) Income earned by a resident from employment outside South Africa on behalf of any employer, resident or non-resident, will be exempt if services are rendered outside South Africa and the taxpayer was outside South Africa for periods exceeding 183 days (in aggregate) during any 12-month period commencing or ending during the year of assessment and for a continuous period exceeding 60 full days during such 12-month period. Such service must have been rendered during such periods.

46 A26 Income, Capital Gains & Dividends Withholding Tax Basic steps to be followed in determining the exemption: See also SARS Interpretation Note March Is the taxpayer a person referred to in a 9(1)(e) of the Income Tax Act? Yes No Was remuneration received or did it accrue in respect of services rendered outside the Republic during the year of assessment? No Yes Was the taxpayer outside the Republic for more than 183 days in total during a twelve-month period that commences or ends during the above mentioned year of assessment? No Yes Was the taxpayer s absence continuous for more than 60 days during the same twelve-month period above? No Yes Were the services rendered during the 183-day and 60-day period? No Yes No exemption Exemption

47 Income, Capital Gains & Dividends Withholding Tax A Foreign pensions Foreign pensions received by or accrued to any resident are not at present taxable s.10(1)(gc). 7.8 Bursaries - s.10(1)(q) Bona fide scholarships or bursaries granted to any person to enable or assist that person to study at a recognised educational or research institute are exempt from tax. If the scholarship or bursary is granted by an employer or any associated institution in relation to the employer to an employee or to a relative of an employee, the amount will be taxable in the following circumstances: if the bursary is received by means of a current or future salary sacrifice ; or if the bursary is received by a relative of an employee who earns in excess of R per annum; and so much of the bursary contemplated in (ii) above as in the case of any such relative - R during the year of assessment. 8. Deductions 8.1 General formula - s.11(a) read with s.23(g) The general formula allows the deduction of: expenditure and losses actually incurred during the year of assessment in the production of income not of a capital nature laid out or expended for the purposes of trade. The general formula provides for the deduction of those expenses not covered in the list of special deductions. Included hereunder would be travelling expenses, recurring business expenses, advertising, legal costs, salaries, interest paid on money borrowed to produce income, etc.

48 A28 Income, Capital Gains & Dividends Withholding Tax The Income Tax Act specifies various special deductions allowable against income. These deductions are generally meant to expand the general deduction formula. 8.2 Entertainment expenditure Self-employed taxpayers can deduct entertainment expenses under the general deduction formula, (sec.11(a) and sec.23(g)). Note: Where an agent or representative derives an income mainly in the form of commissions, qualifying expenditure may be deducted. The word mainly has been interpreted to mean that more than 50% of the agents total remuneration is made up of commission payments. See also SARS interpretation note Medical Aid Contribution and Expenses Deduction Effective 1 March 2012, the medical tax credit regime replaces the previous medical aid contribution deduction for taxpayers under the age of 65. The new tax credit system aims to bring about greater equality across income levels in terms of tax relief for medical aid contributions. This tax credit system will only apply to taxpayers under the age of 65. Taxpayers who are 65 years and older will, for the time being, continue to enjoy a full deduction for all their medical related expenses. As it stands, the tax credit (applied in the same way as the rebates to the final tax liability) for the taxpayer and the first dependent is R230 and R 154 for each additional dependent. In addition to this: taxpayers under the age of 65 may deduct their out of pocket medical expenses plus the amount of their medical scheme contributions that exceed four times the medical tax credit to which they are due, as, in aggregate, exceed 7.5% of the taxpayers taxable income. taxpayers with disabilities (including their spouses or children with disabilities) may deduct their full out of pocket

49 Income, Capital Gains & Dividends Withholding Tax A29 Note: expenses as well as the amount of their medical scheme contributions that exceed four times the medical tax credits to which they are due. The list of illnesses qualifying as mental illnesses exceed 200 and includes for example depression, anorexia, ADD, ADHD, anxiety, bereavement, etc. Qualifying expenses consist of: Contributions paid to a registered medical scheme (Note: where contributions are paid by an employer of a taxpayer, they are deemed to have been paid by the taxpayer to the extent that such amount had already been included in the income of the taxpayer as a taxable benefit). Expenses paid in respect of medical services and prescribed medical supplies not recovered from a medical scheme; and Other expenditure necessarily incurred and paid in consequence of any physical disability. Example Taxpayer 1 has a taxable income of R per year (before the medical aid deduction), attracting a marginal rate of 40%. He has a wife and 3 children who are dependants on his medical aid. Previously, his allowable deduction was: (R720 + R720 + R440 + R440 + R440) x 12 = R This reduced his annual taxable income by R (equating to a tax saving of R13 248). Taxpayer 2 has a taxable income of R per year (before the medical aid deduction) with a marginal tax rate of 18%. He also has a wife and 3 children who are dependants on his medical aid. Previously, his allowable deduction was R This equated to a tax saving of R Higher income earners were seen to derive a larger benefit from the previous regime as opposed to lower income earners. Under the medical tax credits regime: Taxpayer 1 has a tax liability of R before medical tax credits. He qualifies for a credit of R11 064, and his final liability will be R

50 A30 Income, Capital Gains & Dividends Withholding Tax Taxpayer 2 has a tax liability of R As he has the same number of dependents, he will have the same medical credit of R11 064, and his final liability will be R Donations to public benefit organisations (PBO s) - s.18a Bona fide donations to any approved public benefit organisation may be claimed as a deduction by a taxpayer. The deduction is limited to 10% of the taxpayer s taxable income before the deduction of a claim in respect of any donation or medical expenditure, but inclusive of any taxable capital gains. Donations to transfrontier parks are deductable if the donation equals, or is less than, the amount of R1 million with effect from 1 March Deductions in respect of current and arrear pension fund contributions - s.11(k) See Retirement Planning. 8.6 Deductions in respect of current and arrear retirement annuity fund contributions - s.11(n) See Retirement Planning.

51 Income, Capital Gains & Dividends Withholding Tax A31 9. Calculating the tax liability 9.1 The tax tables Different income tax rates apply to natural persons, non-natural taxpayers and trusts. See section E for the tax rates applicable to trusts. The tables that follow contain the income tax rates applicable to natural persons for the current and previous two years of assessment. Income tax rates for natural persons and special trusts Year of assessment ending Taxable Income (R) R0 - R % of taxable income Rate of tax R R R % of taxable income above R R R R % of taxable income above R R R R % of taxable income above R R R R % of taxable income above R R R % of taxable income above R Year of assessment ending Taxable income (R) Rate of tax % of each R R % of the amount above R R % of the amount above R R % of the amount above R R % of the amount above R and above R % of the amount above R

52 A32 Income, Capital Gains & Dividends Withholding Tax Year of assessment ending Taxable income (R) Rate of tax % of each R R % of the amount above R R % of the amount above R R % of the amount above R R % of the amount above R and above R % of the amount above R Deceased estates, special trusts (set up for the benefit of persons suffering from mental or physical disabilities) and testamentary trusts established for the benefit of minor children will also be taxed at these rates. All other trusts are taxed at a flat rate of 40%. Trusts do not qualify for any rebates or for the exemption on interest granted to natural persons. 9.2 Tax Thresholds 2011/2012 Tax Year 2012/2013 Tax Year Below age 65 R R Age 65 and over R R Age 75 and over R R This means that a taxpayer younger than 65 and earning a taxable income of R or less per annum, or a taxpayer older than 65 but younger than 75 and earning a taxable income of R or less per annum, or a taxpayer of 75 years and older and earning a taxable income of R or less per annum, will not pay any income tax in the 2012/2013 tax year.

53 Income, Capital Gains & Dividends Withholding Tax A Tax rebates Taxpayers who are natural persons are entitled to certain rebates. These rebates are determined by the age of the taxpayer (section 7). The rebates are as follows: 2011/2012 Tax Year 2012/2013 Tax Year Primary Rebate R R Secondary Rebate (applicable only to taxpayers aged 65 and over) R6 012 R6 390 Tertiary Rebate (applicable only to taxpayers aged 75 and over) R2 000 R2 130 The secondary and third rebate will also be available if the taxpayer dies during the tax year in which he/she would have turned 65 or 75 respectively. Where the period of assessment is less than 12 months, the rebate is reduced proportionately. 9.4 Small business: tax stimulus (Section 12E(4)(a)(i)) The tax rates applicable to Small Business Corporations (gross income under R14 million) for financial years ending on any date between 1 April 2012 and 31 March 2013 are: Taxable Income (R) Rate of Tax R0 - R % R R % of the amount above R but less than R R and above R % of the amount above R

54 A34 Income, Capital Gains & Dividends Withholding Tax To qualify as a small business corporation: in addition to the turnover requirement: all the shares must be held by individuals (none of whom hold shares in any other company other than listed shares, unit trusts, and shares in certain tax exempt entities. A shareholding or members interest in an inactive close corporation/company with assets less than R5000, or which has taken steps to liquidate, wind-up or deregister is permitted.) not more than 20% of the gross income of the corporation may comprise of investment income and income from rendering a personal service the business must not be an employment company or personal service provider. Turnover tax rates (elective) for micro businesses (qualifying turnover does not exceed an amount of R1 million) for financial years ending 29 February 2013 are: Taxable Income (R) Rate of Tax % % of the amount above R R % of the amount above R R % the amount above R and above R % of the amount above R Note: Turnover tax is a tax based on the turnover of a business and is available to sole proprietors, partnerships, close corporations, companies and co-operations. It is a substitute for VAT, Provisional Tax, Income Tax, and Capital Gains Tax. With effect from years of assessment commencing 1 March 2012, a micro business can voluntarily exit the turnover tax system at the end of any year of assessment (but will not be permitted to re-enter). From 01 March 2012 micro businesses that register for VAT will not be barred from registering for Turnover Tax.

55 Income, Capital Gains & Dividends Withholding Tax A35 Income Tax Calculation Sheet GROSS INCOME Salary R Trade Business R Commission R Interest R Dividends (subject to DWT) R Dividends (other foreign - see note) Other. R. R Total R R EXEMPTIONS Basic Interest R Dividends (subject to DWT) R Dividends (other foreign) R Foreign employment income. R Other. R R - R INCOME R DEDUCTIONS Expenses R Pension fund contributions R Retirement annuities contributions R Donations to PBC s R Medical expenses R Other R Plus: Portion of travel allowance not expended R on business travel Plus: Taxable Capital Gain R R - R TAXABLE INCOME R Tax on R. R + % on R. + R TAX PER SCALE R REBATES Primary R 65+ R 75+ R - R MEDICAL TAX CREDITS Less: Medical Credit: Taxpayer plus dependants R R TAX PAYABLE R Note: Dividends declared from foreign companies not listed on JSE are taxed at marginal rate subject to any eligible exemptions See A41 (See page A28 (8.3) and page A30 (8.4) for calculation of medical expenses and deductions for donations to PBO).

56 A36 Income, Capital Gains & Dividends Withholding Tax Provisions relating to persons who are married 1. Income deemed to have accrued to the spouse - s.7(2) To prevent married taxpayers from splitting their income with the sole or main purpose of reducing or avoiding their liability for tax, the Income Tax Act contains certain anti-avoidance measures which deem the income of either spouse in certain circumstances to be the income of the other spouse. The circumstances in which the section applies are as follows: Where income is derived by a spouse as a result of: o o a donation, settlement or other disposition made on or after 20 March 1991 by the other spouse; or a transaction, operation or scheme entered into or carried out by that other spouse on or after that date; o AND the sole or main purpose of the donation, settlement or other disposition, transaction, operation or scheme was to reduce, postpone or avoid that other spouse s liability for tax. Where a spouse derives any income: o o o from a trade carried on by that spouse in partnership with the other spouse or which is in any way connected with any trade carried on by the other spouse; or from any partnership of which the other spouse is a member or from any private company of which the other spouse is the sole or main shareholder or one of the principal shareholders; and the amount so earned is excessive having regard to the nature of the relevant trade, the extent of the spouse s services or participation in the trade or any other relevant factor.

57 Income, Capital Gains & Dividends Withholding Tax A37 2. Spouses married in community of property In the case of spouses married in community, all rental income from fixed property and all other income derived other than from the carrying on of a trade will be deemed to have accrued to both spouses equally, irrespective of which spouse earned the income. All income derived from the carrying on of a trade will be deemed to have accrued to the spouse who is carrying on that trade. Income derived by way of both voluntary and compulsory purchase annuities is regarded as income from trade.

58 A38 Income, Capital Gains & Dividends Withholding Tax Dividends Withholding Tax With effect from 1 April 2012, the Secondary Tax on Companies (STC) regime is to be replaced by a Dividends Withholding Tax (DWT) regime. All SA residents who are natural persons, and all foreign investors will be subject to DWT. In anticipation of this, the STC rate was lowered from 12.5% to 10%. Whilst dividends withholding tax was expected to be introduced at 10%, the 2012 budget unexpectedly proposed to introduce dividends tax at 15%. Foreign dividends are also taxed at the maximum DWT rate, subject to applicable exemptions or reduced rates. A dividend for purposes of DWT is an amount transferred or applied by a company for the benefit or on behalf of any person in respect of any share in that company, whether that amount is transferred or applied by way of distribution made by or as consideration for the acquisition of the share in that company (subject to certain exclusions), that is either paid by a South African resident company, or paid by a non-resident company if the dividend is paid in respect of a listed share. For DWT purposes, a dividend is deemed to have been paid on the earlier of the date on which the dividend is paid or becomes payable by the company that declared the dividend. Share buybacks and capital distributions to shareholders are not subject to DWT. The following table compares STC to DWT: STC Liability triggered by declaration of dividend. DWT Liability triggered by payment of a dividend. A tax on the declaring company. Levied on the first distribution (with credits for subsequent distributions). A tax on the recipient ( beneficial owner /shareholder) which is withheld by the declaring company/authorised regulatory intermediary. Levied on last distribution from corporate chain to individual or nonresident.

59 Income, Capital Gains & Dividends Withholding Tax A39 Payable on top of the dividend distributed. Deducted before payment of dividend (gross dividend less DWT). Shareholder receives the net amount after DWT. Rate of 10% (subject to exemptions) previously 12.5%. Rate of 15% (subject to exemptions or reduced rate). Exemption is based on the nature/status of the company (for example s10 exempt entities, fixed property companies, certain gold miners, intra-group, registered micro companies). Exemption is based on the nature/status of the recipient (beneficial owner). 1. Regulated Intermediary (RI) A RI is essentially a withholding agent interposed between the company paying the dividend and the beneficial owner. It has the responsibility of withholding the DWT and paying the DWT across to the South African Revenue Service (SARS). What that means for a financial services company like Old Mutual is that various entities and funds in the Old Mutual group will be RIs in respect of certain of their investment products and will be required to put detailed systems in place to facilitate withholding and payment of DWT, taking into account for example clients who have notified OM in the prescribed manner that they are exempt from DWT. In relation to long term insurance products (for example endowment policies), the tax is payable by the company issuing the policy on behalf of its individual policyholders allocated to the individual policyholders fund. The result will be a decrease in the value of the assets backing those policies. Other RI s are: a portfolio of a collective investment scheme a nominee that holds investments on behalf of clients as contemplated in the Codes of Conduct for Administrative and Discretionary Financial Service Providers (i.e. a nominee company established by a Linked Investment Service Provider (LISP))

60 A40 Income, Capital Gains & Dividends Withholding Tax a central securities depository participant authorized users or approved nominees under the Securities Services Act, a transfer secretary approved by the Commissioner. 2. Exemptions (s 64F, read with s 64FA(2), 64G(2), & s 64H(2)(a), Income Tax Act) Categories of current exemptions which may be relevant for a financial adviser are: Public Benefit Organisations (PBO s) South African resident Companies/Close Corporations South African Retirement Funds (Pension, Provident, Retirement Annuity, Benefit & Beneficiary funds as well as medical schemes A shareholder in a registered micro business (currently qualifying turnover not exceeding R1 million for the financial year) paying the dividend, where the dividend does not exceed R ) Shareholders (who are natural persons) where the dividend constitutes a capital gain on a primary residence (limited to the first R gain) A non-resident shareholder where the dividend is paid by a non-resident company if the share in respect of which that dividend is paid is a listed share. (Dividends from dual-listed shares are subject to DWT). The effect of the exemption is therefore that, inter alia, South African resident companies/south African retirement funds will not pay DWT on receipt of a dividend from an SA company. Other categories currently include: Government - national, provincial & municipal administration mining rehabilitation trusts Certain tribal authorities and the Water Board SANRAL, CSIR, the Development Bank of South Africa

61 Income, Capital Gains & Dividends Withholding Tax A Declaration s 64G The onus is on the shareholder to notify the company paying the dividend (prior to payment thereof) that they are exempt from DWT. Failure to submit the required notifications (declarations and undertakings in the form prescribed by SARS) prior to payment of the dividend will result in dividends tax being withheld. Nonresidents would also need to notify the company if they qualify for a reduced rate based on an applicable DTA (see below). 2.2 Refund Of DWT s 64L and s 64M Provision is made for a refund of an amount withheld by a company or RI in respect of DWT where a declaration is not submitted by the beneficial owner in time but is submitted within a period of three years after the payment of the dividend & DWT should not have been paid. 2.3 Foreign dividends S 64D To bring parity to the system, foreign dividends will also to be taxed at 15% [effective 1 April 2012]. The foreign dividends contemplated in this section pertain to dividends distributed from foreign companies that are ALSO listed on the JSE. Therefore, distributions from companies NOT LISTED on the JSE are not subject to DWT and the exemptions in s64f (to be taxed at marginal rate subject to any eligible exemptions). 2.4 STC credits s64j DWT will not apply to dividends covered by an STC credit. As STC credits can be carried forward for a period of 5 years, no DWT is payable by the recipient/beneficial owner during this period for as long as the STC credits are carried forward. 2.5 Non-residents Reduced Rates Under the STC regime, a South African company paying dividends to a non-resident investor was not able to reduce the rate of STC regardless of whether a Double Trade Agreement (DTA) was in place between the two countries. Under the new DWT regime, it will now be possible for reduced rates to be applied to the DWT for non-resident shareholders who qualify based on an applicable DTA. Non-SA residents seeking to qualify for a reduced rate should complete SARS Form DTD(RR).

62 A42 Income, Capital Gains & Dividends Withholding Tax South Africa has a number of DTAs with its main trading partners. The withholding tax rates per SA treaties for the following countries (full list available on SARS website) are: Country Mozambique Mauritius Reduced rate of DWT 8% (minimum holding of 25% of capital by a beneficial owner which is a company) [15% for other beneficial owners] 5% (minimum holding of 10% of capital by a beneficial owner which is a company) [15% for other beneficial owners] Namibia Australia 5% (minimum holding of 25% of capital by a beneficial owner which is a company) [15% for other beneficial owners] 5% (minimum holding of 10% of capital directly by a beneficial owner which is a company) [15% for other beneficial owners] France 5% (minimum holding of 10% of capital directly by a beneficial owner which is a company) [15% for other beneficial owners] Germany India United Kingdom 7.5% (minimum holding of 25% of voting shares directly by a beneficial owner which is a company) [15% for other beneficial owners] 10% 5% (Control of at least 10% voting power by a beneficial owner which is a company). [15% for other beneficial owners] Rebates s64n If tax has been paid in another country (which cannot be recovered from the foreign tax authority), a rebate equal to the amount of foreign tax paid on the dividend may be deducted from the South African DWT (only up to the amount of the South African DWT).

63 Income, Capital Gains & Dividends Withholding Tax A43 3. GENERIC PRODUCT EXAMPLES 3.1 Direct Unit Trust portfolio A Collective Investment Scheme (CIS) is an RI. Local dividends are received from underlying equity investments and dividends distributed within 12 months are deemed to accrue directly to the unit holder (s25b(a). DWT will therefore be withheld by the CIS when the unit trust portfolio declares a distribution, unless the dividend is paid to another RI or the beneficial owner is exempt as above (for example, a retirement fund, an SA resident company, or a PBO among others) and has submitted a declaration to that effect to the CIS. 3.2 Linked Investment Service Provider (LISP) products The nominee company established by the LISP (because the LISP does not own the units which it purchases in a CIS or direct shares but acts as administrator only) will be the RI. Liability for DWT is determined based on the identity of the beneficial owner. DWT will be withheld by the RI on dividends generated within the underlying unit trust investment by the LISP, unless the dividend is paid to a RI or the beneficial owner is exempt as above (for example, a retirement fund, an SA resident company, or a PBO among others) and has submitted a declaration to that effect to the RI. 3.3 Life Assurance Endowment Policies s64i Life assurance endowment policies are governed by the Long Term Insurance Act, and as such taxation is applied according to the four-funds approach (s29a Income Tax Act). Where investors are allocated to the Individual Policyholder Fund (IPF), any dividend (for example from investment into a unit trust, fund of funds, or direct share) which is allocated to the IPF is deemed to be paid to a natural person that is a resident by the RI on the date that the dividend is paid to the insurer and DWT is payable. The tax is thus payable by the company issuing the policy on behalf of its individual policyholders allocated to the IPF. The result will be a decrease in the value of the assets backing those policies. The investments of investors allocated to the Company Policyholder Fund, Corporate Policyholder Fund, or Untaxed Policyholder Fund will not be subject to DWT.

64 A44 Income, Capital Gains & Dividends Withholding Tax 3.4 Provident Fund, Retirement Annuity, Pension Fund, Preservation Fund s 64F Where a retirement fund is the beneficial owner of a dividend, such dividend will be exempt from DWT. In order to qualify for the exemption from DWT, retirement funds will have to provide an exemption declaration to the paying entity (either the company or the RI). An exemption declaration is not required in respect of a policy issued by a life company. 3.5 Living Annuities Investment returns within a living annuity are currently tax-free. No DWT is therefore payable on dividends within a living annuity. 4. IMPACT OF DWT ON ALLOWABLE DEDUCTION FOR RETIREMENT ANNUITY CONTRIBUTIONS Dividends will not form part of Non Retirement Funding Income for the purposes of the s11(n) calculation of the allowable deduction for RA contributions. 5. IMPACT OF DWT ON COMPANIES AND SHAREHOLDERS Essentially shareholders will pay a higher rate of tax under the DWT regime than under the STC regime, as the dividend is declared exclusive of any dividends tax. However, as with STC, receipt of the dividend will not affect the taxpayer s marginal rate of tax.

65 Income, Capital Gains & Dividends Withholding Tax A45 Capital gains tax The implementation date for capital gains tax (CGT) was 1 October 2001 (the effective date) and only capital gains arising after the effective date will be subject to CGT. Capital gains are determined and then a portion thereof is included in the taxable income of a taxpayer. Capital gains are therefore included in the determination of normal tax and incorporated as part of the Income Tax Act. 1. Who is liable for CGT? 1.1 Residents All South African residents are liable for CGT, on the disposal of any asset as defined whether the disposal is made in the Republic or beyond its borders Non-residents A non-resident will be subject to CGT on the disposal of: any immovable property or any interest or right in immovable property situated in the Republic, and any asset of a permanent establishment through which a trade is carried on in the Republic. Note: Where a non-resident disposes of immovable property in South Africa for more than R , the purchaser is obliged to withhold tax (unless a directive indicates otherwise) in advance of the CGT liability at the following rates: 5% of purchase price (natural persons), 7.5% (company), 10% (trust). 2. What is capital gain? A capital gain is the proceeds (or deemed proceeds) from the disposal (or deemed disposal) of an asset less the base cost. The proceeds from the disposal will generally be the price at which the asset is sold. In certain cases, when it is not possible to determine the selling price of the asset (for example in the case of death, donations, disposal of an asset at less than market value, emigration or immigrations), the market value of the asset will be the price that could have been obtained upon the sale of the asset between a willing buyer and a willing seller dealing at arm s length in the open market. The base cost of the asset is deducted from the proceeds to arrive at the capital gain. The capital gain is then

66 A46 Income, Capital Gains & Dividends Withholding Tax multiplied by the inclusion rate to determine the taxable capital gain. 3. Assets The term asset is defined as widely as possible and basically includes any property of whatever nature and any interest in such property. It will therefore include the following: Shares; unit trusts; land; property and rights to property; large boats (more than 10 m) and aircraft (more than 450 kg); plant and machinery; mineral rights; coins made mainly from gold or platinum, e.g. Krugerrands and all other assets except those specifically excluded. The definition of asset specifically excludes any currency and the distribution of money can therefore never be subject to CGT. CGT applies to all assets disposed of after 1 October 2001, whether or not the asset was acquired before, on, or after that date. 4. Disposals A disposal for capital gains tax purposes is regarded as any event, act, forbearance or operation of law which results in the creation, variation, transfer or extinction of an asset. It is a very wide definition that covers almost every situation where there is a change of ownership of an asset. The following events, amongst others, would fall within the definition of disposal: A sale, donation or cession; expiry or abandonment of an asset; the scrapping, loss or destruction of an asset; the vesting of an interest in an asset of a trust in the hands of a beneficiary; the distribution of an asset by a company to a shareholder; the granting, renewal, extinction or exercise of an option; the decrease in value of a person s interest in a company, trust or partnership as a result of a value shifting arrangement. In addition to the list above, there are a number of events that are to be treated as disposals for the purposes of CGT (i.e. deemed disposals). The legislation deems that the asset(s) are disposed of

67 Income, Capital Gains & Dividends Withholding Tax A47 a day before the event and reacquired immediately at market value. Some of these events are the following: When a person ceases to be a resident (par 12(2)), all that person s assets are deemed to be disposed of except immovable property or rights in immovable property situated in the Republic, and assets of a permanent establishment through which that person carries on a trade in the Republic during the year of assessment. The assets of a person who is not a resident, which becomes an asset of that person s permanent establishment in the Republic other than by way of acquisition, and is withdrawn from the permanent establishment for personal or other use, par. 12(2). An asset of a person that is not held as trading stock, which becomes trading stock. A personal use asset held by a natural person, which ceases to be a personal use asset of that person without being disposed of. An asset which is not held as a personal use asset, which commences to be held as that person s personal use asset. When a person dies, all that person s assets are deemed to be disposed of, the day the person dies, at market value, par. 40(d). In determining when the capital gain or loss accrues to a person the timing of the disposal becomes important. In most cases the disposal will take place on transfer of ownership of the asset. 5. Exclusions from capital gains tax The list below contains some of the pertinent CGT exclusions Annual exclusion - Paragraph 5(1) of Eighth Schedule The first R of a natural person and a special trust s capital gains or capital losses are excluded in each year of assessment. Where a person dies during a year of assessment, such person s annual exclusion for that year of assessment is R (Paragraph 5(2), Eighth Schedule). [effective date 1 March 2012]

68 A48 Income, Capital Gains & Dividends Withholding Tax 5.2. Primary Residence Exclusion - Paragraph 5(2) of Eighth Schedule The general principle is that capital gains will be taxable on the disposal of primary residences, with the first R of a capital gain or loss being disregarded. Capital gains in excess of R will, therefore, be subject to CGT. [Effective date 1 March 2012] The size of the residential property will also be subject to certain exclusions. A primary residence includes the land upon which it is actually situated and may include land adjacent to it that is used mainly for domestic purposes. The total of all the land must not exceed two hectares in order to fall out of the CGT net. If the size of the property exceeds two hectares, a reasonable apportionment would have to be made. If the property is not mainly used for domestic purposes, that portion will not qualify for the exclusion. Absence from primary residence for certain periods Where a natural person or a special trust disposes of an interest in a primary residence, but was not ordinarily resident in such residence for the whole period prior to the disposal date, the exclusion will be determined with reference to the period(s) during which the person, beneficiary or spouse was actually ordinarily resident. Even if a person, beneficiary or spouse was not ordinarily resident in the residence for a maximum period of 2 years, he or she will still be deemed to be a resident, if the absence was due to the following reasons: The residence was being put up for sale and vacated with the intention to acquire a new primary residence. The residence was in the process of being built on land acquired for purposes of building a primary residence. The residence was accidentally rendered uninhabitable, for example, as a result of flood or fire. The death of that person Personal use assets Personal use assets are also not subject to CGT. Examples of personal use assets are cars, furniture and garden appliances.

69 Income, Capital Gains & Dividends Withholding Tax A49 The following are not regarded as personal use assets: A coin made mainly from gold or platinum, e.g. Krugerands; immovable property; an aircraft exceeding 450 kg; a boat exceeding 10 m in length; all financial instruments; a fiduciary, usufructuary or other like interest, the value of which decreases over time, a right or interest in any of the aforementioned assets and certain policy contracts Lump sums from pension, provident or retirement annuity funds Lump sums from local retirement funds or from foreign funds of a similar nature are not subject to CGT The proceeds of a long-term insurance policy Insurance policies are not subject to CGT in the hands of the owner provided that such owner is the owner of first instance (original owner) or his/her spouse, dependant or beneficiary Prizes from a South African source (gambling, games and competitions) 5.7. A gain of up to R on the sale of assets of a small business on retirement. Small business means a business of which the market value of all its assets, as at the date of disposal of the asset or interest does not exceed R (Para 57(1) of Eighth Schedule). The person must have, at the time of disposal, held for his/her own benefit that active business asset, interest in the partnership, or interest in the company for a continuous period of at least 5 years prior to disposal and must have been substantially involved in the operations of that small business during that period. The person must have attained the age of 55 years or the disposal must be in consequence of ill-health, other infirmity, superannuation or death. The sum of the amounts to be disregarded may not exceed R during that person s lifetime (Para 57(3) of Eighth Schedule).

70 A50 Income, Capital Gains & Dividends Withholding Tax 6. Determining the base cost Capital gains or losses are the difference between the base cost of the asset and the sum received on its sale or disposal. The base cost is calculated by adding up the following expenses: Acquisition costs; costs associated with the acquisition and disposal of the asset (for example legal fees, agent s commission, stamp duty, advertising costs, broker s fees and transfer duty); VAT; improvement costs and any legal costs incurred (for example, the legal costs incurred in defending a right to an asset owned by the taxpayer). Business assets: All current expenses incurred in respect of business assets can be included in the base cost. Shares and unit trusts: Up to one third of any interest incurred on a loan taken to purchase shares or unit trusts will form part of the base cost. 6.1 Assets acquired after to 1 October 2001 As mentioned earlier, CGT only applies to gains made after 1 October The base cost of an asset, purchased after that date, is simply the purchase price plus any allowable expenses (as discussed above). 6.2 Assets acquired before 1 October 2001 Before the base cost can be determined, the valuation date value (value of the asset as at 1 October 2001) has to be determined. Once this value has been determined, any allowable expenses incurred after 1 October 2001 must be added to determine the base cost. 6.3 Market value The market value of the asset at 1 October 2001 can be used as the valuation date value. Taxpayers had until 30 September 2004 to obtain the market value of the asset. Even though the valuation may occur subsequent to 1 October 2001, the valuation must be the value as at 1 October 2001.

71 Income, Capital Gains & Dividends Withholding Tax A51 For shares, bonds and other securities traded on the open market, the market value will be calculated by taking the average closing price of the asset for the five trading days before 1 October Time apportionment method This method involves looking at the total capital gain made over the period during which the asset was owned and then determining the gain made after 1 October The 20% rule In terms of this rule 20% of the proceeds received by the seller will be deemed to be the base cost in the event that an asset held before 1 October 2001 is sold thereafter. Allowable expenditure incurred after 1 October 2001 must be deducted from the proceeds before the 20% rule is calculated. A taxpayer need only inform the Commissioner of the South African Revenue Service of the option chosen once the asset is disposed of. However, where a taxpayer opts for the market value as the valuation method, proof of the valuation must be submitted with the first tax return submitted after 30 September 2004 in the following instances: Type of asset Applies Where market value exceeds Intangible assets Per asset R1 million Unlisted shares All shares held by the shareholder in the company R10 million All other assets Per asset R10 million 6.6 Roll-overs The CGT legislation provides for the roll-over of certain capital gains. In such cases a CGT liability does not arise upon disposal or transfer of ownership, but is rather deferred until a subsequent CGT event. In all cases the pre-exchange base cost is rolled over. Some pertinent roll-overs are listed below.

72 A52 Income, Capital Gains & Dividends Withholding Tax 6.7 Involuntary disposals - in the case of expropriation, loss or destruction of an asset If an amount equal to the proceeds has or will be used in replacing the asset; a contract is entered into for the replacement, reconstruction or rectification within one year; and the replacement asset has or will be brought into use within 3 years of the disposal of that asset, the roll-over may be applied. The Commissioner may extend these periods by no more than 6 months if all reasonable steps were taken by the taxpayer. In the event that this time frame is not adhered to, the gain will be taxed at the applicable rate for the year in which the asset was originally disposed of, plus interest at the prescribed rate. 6.8 Reinvestments in replacement assets where capital gains arise on the disposal of assets that qualify for capital allowances or deductions This is the case where an asset utilised in the production of income is disposed of and the proceeds are reinvested in a similar asset, provided that the base cost is no less than that of the asset disposed of. Tax on the capital gains on such assets may be deferred and paid in annual instalment as per the prescribed formula. Where the asset disposed of is a depreciable asset, the roll-over only applies to the capital gain or loss and not to any recoupment required in terms of normal income tax provisions. 6.9 Transfers of assets between spouses The base cost of an asset is transferred to a person s spouse where the asset is transferred to that person s spouse during that person s lifetime. The base cost will also be rolled over to that person s spouse as a result of that person s death, or as a consequence of a divorce order/agreement of division of assets that has been made an order of court. 7. Attribution of capital gains In certain instances capital gains will be attributed to entities other than those that have disposed of the assets. The following are examples of where capital gains will be attributed to entities other than those that made the disposal:

73 Income, Capital Gains & Dividends Withholding Tax A53 Attribution of capital gains to spouses Attribution of capital gains to parents of minor children Attribution of capital gains subject to conditional vesting Attribution of capital gains subject to revocable vesting Attribution of capital vesting in a person who is not a resident Attribution of income, as well as capital gain (These CGT attribution rules are similar to the income tax provisions contained in section 7 of the Income Tax Act.) 7.1 Rate at which the capital gains is included in taxable income (inclusion rate) Once a net capital gain for the year of assessment is determined, such amount is multiplied by the inclusion rate to determine the individual or entity s taxable gain. Inclusion rate x statutory tax rate = effective rate. Type of Taxpayer Inclusion Rate Statutory Tax Rate Effective Tax Rate Individuals 33.3% 0-40% % Unit Trusts N/A N/A N/A Other (local) Trusts 66.6% 40% 26.64% Special Trusts 33.3% 0-40% % Life Assurance Individual Policyholders Corporate Policyholders Company Policyholders Untaxed Retirement Untaxed: Other 33.3% 66.6% 66.6% N/A 0 30% 28% 28% N/A % % % N/A 0 Companies 66.6% 28% % 8. Aggregate capital gain or aggregate capital loss A capital gain or loss is first determined separately for each asset disposed of by a taxpayer during a year of assessment.

74 A54 Income, Capital Gains & Dividends Withholding Tax In determining a person s aggregate capital gain or loss, two steps need to be followed: First of all a person s capital gains and/or losses are added together; and Thereafter, the total amount of such capital gains and/or losses is reduced by the annual exclusion, R30 000, in the case of a natural person. 8.1 Determination of a net capital gain or assessed capital loss After determining a person s aggregate capital gain or aggregate capital loss, the person s assessed capital loss for the previous year of assessment, if any, must be deducted from the aggregate capital gain or added to the aggregate capital loss to determine the net capital gain or assessed capital loss for the current year of assessment. There is no limit as to the length of time that a capital loss can be carried forward. 9. Capital losses Capital gains must be included in taxable income, but capital losses can only be offset against capital gains. It is not possible to offset capital losses against income. 9.1 The limitation of capital losses Although capital losses may generally be offset against capital gains, capital losses made on the disposal of certain assets must be disregarded. These include losses made on the disposal of personal use aircraft, boats, as well as certain intangible assets acquired prior to valuation date from connected persons. The capital loss on the sale of shares will be disregarded if the share has not been held for more than 2 years before resale. The limitation above will exclude distributions from unit trusts, foreign dividends and the dividends between group companies. 10. Record-keeping It is the taxpayer s responsibility to supply proof of the base cost of an asset. As a minimum, the following records should be kept: The date the asset is acquired

75 Income, Capital Gains & Dividends Withholding Tax A55 The price paid Any money spent on the purchase (transfer fees) Any money spent improving the asset The date the asset was disposed of The profit or loss made on the disposal When an asset is disposed of, the records pertaining to the asset must be kept for at least four years after the Commissioner acknowledges receipt of the disposal.

76 A56 Income, Capital Gains & Dividends Withholding Tax Summary of capital gains tax liability calculation (Income Tax Act 8th Schedule) Disposal or deemed disposal of an asset Proceeds or deemed proceeds Deduct base cost of the asset Exclusions Sum of all capital gains and losses reduced by the annual exclusion of R (R on death) >R0 or <R0 Aggregate capital gain Aggregate capital loss Deduct previous assessed capital loss (if applicable) Net capital gain x inclusion rate Assessed capital loss carried forward Taxable gain included in taxable income

77 Income, Capital Gains & Dividends Withholding Tax A57 NOTES

78 A58 Income, Capital Gains & Dividends Withholding Tax

79 Investment Planning Investment Planning

80 Investment Planning

81 Investment Planning B1 General notes What is Investment Planning? Investment Planning is the process of identifying and implementing appropriate investment strategies to create and accumulate the financial resources for achieving financial planning goals. Investment planning seeks to accomplish two equally important goals that naturally conflict with each other. The first goal is to maximise returns on investments. The second is most often to minimise investment risk. Effective investment planning seeks to balance these two goals in all areas of the investment planning process so that the investor can achieve the desired outcomes. Broadly speaking, every investor seeks to achieve one or a combination of the following objectives: Wealth creation Wealth protection Income generation Because these objectives are usually not compatible, an investment planning exercise will often involve trying to reach the best compromise or balance. The Investment Planning Process The investment planning process must take place within the framework of the six- step financial planning process, which is the internationally recognised and preferred methodology. The steps are as follows: 1. Establishing and defining a relationship The financial planner must use this step to achieve the following: Discuss the financial planning process Manage the investor s expectations (e.g. whether the portfolio will be actively or passively managed) To clarify his/her responsibilities To establish the investor s level of financial knowledge and attitude toward investments Comply with the FICA know your client requirements

82 B2 Investment Planning Comply with the FAIS disclosure requirements 2. Gathering client data This step involves gathering as much information about the investor s assets and liabilities as possible. Without a full understanding of the client s circumstances, it is not possible to make appropriate recommendations. A financial planner should use this step to collect details (including values) of all the investor s existing: Short-term investments (e.g. bank accounts; savings accounts etc) Long-term investments (e.g. fixed deposits; bonds etc) Equity investments (e.g. shares and unit trusts) Other investments (e.g. rental, property investments etc) Insurance, retirement annuity, pension, provident fund investments Liabilities It is also at this stage that the investor s specific needs must be established. The following factors must be established at this stage: The investor s liquidity requirements The investor s current tax position The intended investment horizon (term) The measure of risk the investor is prepared to take to achieve his/her objectives. 3. Analysing Information. The financial planner should analyse the client s information to assess the investor s current situation and determine what the investor must do to achieve their objectives. This could include analysing the investor s assets, liabilities and cash flow, current insurance coverage, investments and tax strategies. Investment Policy

83 Investment Planning B3 It is at this stage that the investment policy must be established. The investment policy refers to the asset allocation decision and how the investor s wealth will be distributed between the various asset classes. Portfolio Strategy The decision must be taken whether the portfolio will be actively managed or passively managed. 4. Preparing and presenting recommendations and solutions The financial planner should offer financial planning recommendations that address the investor s goals, based on the information the investor provides. The planner should go over the recommendations with the investor to enable him/her to make informed decisions. The planner should also listen to the investor s concerns and revise the recommendations as appropriate. 5. Implementation Once the strategy has been devised and agreed to, the advisor and investor must decide on implementation. If for example money is to be invested offshore, the necessary exchange control procedures have to be followed. 6. Reviewing and monitoring The portfolio needs to be monitored on a regular basis (depending on the investment strategy chosen). The investor should be always be made aware of how his/her funds are invested and what, if any, changes have occurred in the portfolio. The investor s objectives must also be reviewed periodically to determine if any changes to the investment objectives are required, and subsequently to the investment policy and strategy.

84 B4 Investment Planning Main factors affecting client s investment strategy The main factors that affect a client s investment strategy are risk, liquidity, taxation and inflation. 1. Risk Risk refers to the uncertainty of whether an investment will earn its expected rate of return (i.e. the possibility that the actual return of an investment will deviate from the expected return). 1.1 Risk and Return It is a widely accepted principle of investing that risk increases with the potential for higher returns. Low levels of uncertainty (low risk) are associated with low potential returns. High levels of uncertainty (high risk) are associated with high potential returns. It should be noted however, that investing in high risk assets does not always equate to high returns.. The risk/return tradeoff tells us that the higher risk gives us the possibility of higher returns. There are no guarantees. Just as risk means higher potential returns, it also means higher potential losses. Art and Antiques Warrants Return Ordinary Shares Real Estate Preference Shares Corporate Bonds Government Bonds Treasury Bonds Risk

85 Investment Planning B5 1.2 Types of Risk Market or Benchmark Risk Refers to the risk that is inherent in a particular market. Market risk is indiscriminate and affects all investors in a particular market. Equity markets for example, are extremely volatile and susceptible to market crashes. Market Timing Risk The risk that an investor takes when trying to buy or sell a stock based on future price predictions. Timing risk explains the potential for missing out on beneficial movements in price due to an error in timing. This could cause harm to the value of an investor s portfolio because of purchasing too high or selling too low. Currency Risk/Exchange Control Risk This is the risk when otherwise good investment returns will be eroded by a weak currency. For example, if money must be converted into a different currency to make a certain investment, changes in the value of the currency relative to the Rand will affect the total loss or gain on the investment when the money is converted back. Geographic Risk Refers to the risk associated with the country in which your investment lies. The risk of investing in a country which is politically volatile will be greater than the risk of investing in a country that is stable. Sector Risk Sector risk refers to the danger that the stocks of many of the companies in one sector (like health care or technology) will fall in price at the same time because of an event that affects that entire sector/industry. Fund Manager Risk Fund manager risk refers to the potential loss which an investor could incur as a result of the failure of a fund manager to perform on his mandate.

86 B6 Investment Planning Liquidity Risk Liquidity risk is the risk that a given asset cannot be traded quickly enough in the market to prevent a loss (or make the required profit). Term or time horizon risk Generally speaking, the risk inherent in a growth investment tends to decrease the longer the term of the investment. Thus, for example, it is recommended that one invests in unit trusts preferably over the medium to long term (five years and longer). A time horizon for an investment does affect the investor s ability to accept risk. The longer the time horizon of the investment, then generally the lower the standard deviation and, therefore, the lower the risk the longer the term. A five-year view can therefore differ substantially from a ten-year view. It is therefore recommended that a risk analysis should be done per investment need. 1.3 Measuring Risk Risk may be measured by means of the standard deviation and the coefficient of variation. These measures are based on the expected rate of return of a particular asset. Standard Deviation Standard deviation is a statistical measure as to the volatility of an investment portfolio and is therefore a good indicator of the risk associated with that investment. Example Over a 3 year period the expected return of a portfolio is 12% per annum. If the standard deviation is 15%, this means that the range of expected returns could statistically be between -3% and 27%. Coefficient of Variation The coefficient of variation allows an investor to determine how much volatility (risk) he/she is assuming in comparison to the amount of return he/she can expect from his/her investment. Simply stated, the lower the ratio of standard deviation to mean return, the better your risk-return tradeoff.

87 Investment Planning B7 To calculate the coefficient of variation, the standard deviation is divided by the expected return. Coefficient of Variation = Standard Deviation Expected Return 1.4 Diversification Diversification refers to the spreading of a portfolio over many investments to avoid excessive exposure to any one source of risk. The prices of shares, bonds, property, precious metals and other investments often do not rise and fall in tandem. Therefore, when one type of investment is on the rise, another may be declining. Consequently, by investing in two or more types of classes of investments, the possibility is increased that when an investment in a portfolio is under-performing, then another investment in the portfolio could be performing well. These investments perform well under differing economic conditions. Diversification of investments therefore should result in a less volatile overall portfolio performance. A well-diversified portfolio should therefore, theoretically, achieve higher returns for a given level of risk. Diversification does not, however, eliminate market risk. Ways to diversify Invest across asset classes. Invest in South African as well as foreign assets. Invest in managed portfolios rather than directly in individual shares. (In principle asset managers of managed funds have a pool of funds from many investors, they are then able to buy a range of shares within an asset class, as well as investing in a number of different asset classes.) Diversifiable Risk / Unsystematic Risk The risk that is specific to an industry or firm. Examples of diversifiable risk include losses caused by labor problems or weather conditions. Because these events occur somewhat independently they can be largely diversified away so that their negative effects are offset by positive results from another firm or sector.

88 B8 Investment Planning Non- Diversifiable Risk Risk of an investment asset (bond, real estate, share) that cannot be reduced or eliminated by adding that asset to a diversified portfolio. This includes general economic conditions; the impact of monetary and fiscal policies, inflation and political events that affect all sectors of the economy. 1.5 Risk Assessment The amount of risk that an investor is prepared or can afford to accept will vary from investor to investor as well as from one investment need to another. A problem is that defining risk and tolerance is difficult, in that objective as well as subjective factors are applicable. Some of the factors that should be taken into consideration in determining an investor s risk profile are: Objective considerations Generally: the older the person the more risk averse because of the shorter term of the investment. the longer the term the higher the potential risk that can be absorbed. the larger the disposable income the higher the risk that could potentially be absorbed. Subjective considerations The investor s investment experience. (Investors who have such experience will appreciate the implications associated with high-risk investments such as equities.) The investor s reaction to market fluctuations. If the investor does not have short-term insurance this could indicate a high-risk tolerance. There are a number of risk profiles available in the market place and the majority have either a three or five-risk profile differentiation. What is important is that the risk profile of the investor indicates the risk that can be tolerated. Once established, the investor s risk profile should be aligned with the risk profile of the investment itself.

89 Investment Planning B9 The investor risk profile analysis Before any investment vehicle is recommended to the investor, the following should be determined: The investor s risk profile; The investor must understand that the higher the risk, the higher the potential return and the lower the risk, the lower the potential return; The need for diversity in investments in relation to the investor s investment needs. The term of the investment in relation to the investor s short and long-term investment needs. The appropriate type of portfolio in relation to the investor s risk profile. Typical questions contained in a risk profile analysis are: What is your current age? This investment will be required in how many years? What percentage is this investment of your investment portfolio? Have you made provision for an emergency fund, e.g. hospital, repairs to vehicle, replacement of household appliances, etc.? Do you expect your earnings to: o o o increase decrease, or remain the same over the next few years? What experience have you had in equities, i.e. what percentage of your portfolio is invested in equities? Your attitude towards investing: o o I am averse to risk and do not want to be exposed to volatile high-risk investments. I want the potential of a return higher than inflation and am prepared to invest between 55% and 75% of my investment in shares.

90 B10 Investment Planning o I want the potential of a return higher than inflation and am prepared to invest in excess of 75% of the investment in shares. What would your reaction be if there was a stock market crash and the value of your investment reduced by 50%: o o o Surrender/liquidate the investment immediately? Hold on to the investment until the market corrects itself and then surrender/liquidate the investment? Take a long-term view and remain invested until maturity date of the investment? What is your current state of health? o o Chronic illness or disability No chronic illness or disability and healthy You are participating in a TV game show and are offered a choice of the following prizes. Which one would you choose? o R5 000 cash o Risk the R5 000 on a spinning wheel with a chance of winning R o Risk the R5 000 on a spinning wheel with a 5% chance of winning R Liquidity One needs to ensure that enough cash is kept on hand to be able to meet emergency expenses (e.g. medical costs, replacement of a major appliance) and planned future expenses (e.g. new car, overseas trip). Traditionally there has been a relationship between the liquidity of an investment, and the return that the investment will yield. The general rule is that the longer the term (less liquid) the higher the yield. However, when the economy is going through periods of rapid change the reverse can be true. 3. Taxation The investment with the highest yield is not necessarily always the best investment.

91 Investment Planning B11 Tax implications will vary depending on the investment chosen by an investor and accordingly the after-tax return of an investment plays a vital role in selecting the most suitable investment. Fixed interest investments with banks are interest bearing and fully taxable subject to R for tax payers under that age of 65 and R for taxpayers of 65 years or older [Section 10 (1)(i)] There is no longer any exemption for foreign dividends and interest earned. Formula to calculate after-tax returns on fixed-interest investments Whenever financial planners have to advise prospective investors on fixed-interest investments, they are expected to recommend a portfolio that will give the investor the highest after-tax yield, i.e. the best rate on an investment after the payment of taxes. The net after-tax return can be calculated by using the following formula: Net after tax yield = gross yield x where: 100 marginal rate tax-exempt yield, gross yield is the taxable portion of the interest (applicable to the type of fixed deposit) paid by the financial institution where the funds are placed. marginal rate is the investor s marginal rate of tax, i.e. the rate the taxpayer pays on an increase in his taxable income. The marginal rate is calculated as follows: Net increase in tax as a result of increase in taxable income Increase in taxable income x 100 = marginal rate% tax-exempt yield is the percentage of the total yield the investment provides that is exempt from tax.

92 B12 Investment Planning Once the investor s marginal rate has been established, the formula is a quick and effective means of comparing the after-tax yield of different investments - whether fully or partially taxable. Example - investment fully taxable Bank fixed deposit = 12 months. Interest rate = 11%. Marginal tax rate = 35%. Note: The above calculation ignores the effect of the interest exemption (s.10(1)(i)). Step 1 Gross yield 11% Step 2 Investor s marginal rate of tax 35% Step 3 Net after-tax yield x x Example - investment partially taxable A unit trust investment where the income distribution is as follows: 7% dividends and 4 % interest. Marginal tax rate = 40%. Step 1 Gross yield 11% Step 2 Taxable portion of yield (interest) 4% Step 3 Tax-exempt portion of yield (dividends) 7% Step 4 Investor s marginal tax rate 40% Step 5 Net after-tax yield x + 7% x % 9.4% Note: The above calculation ignores the effect of the interest exemption (s.10(1)(i)).

93 Investment Planning B13 4. Inflation Inflation is a rise in the general level of prices of goods and services in an economy and the subsequent erosion of the buying power of money over a period of time. Inflation is measured by defining a basket of goods and services used by a typical" consumer and then keeping track of the cost of that basket. In the twelve months up to January 2012, the cost of that basket rose by 6.1per cent. This increase of 6.1 per cent in the so-called consumer price index is referred to as the inflation rate. From 1981 to 2010 the average inflation rate in South Africa was 10 per cent. It has been brought down to less than 10 per cent per annum since The rule of 72 is used as a guideline to determine how long it will take for the purchasing power of money to halve at a given inflation rate. 72 Present inflation rate E.g. Assume inflation rate of 8% p.a. over the period concerned: 72 = 9 years 8 In terms of this example the value of money will halve in 9 years if the inflation rate is 8%. The need to maintain, and preferably increase, the real value of an investment in times of inflation has become a major factor in investment planning. Fixed- interest deposits are subject to a steady loss in real value. An investor who wishes to protect the purchasing power of his/her income is forced to put his/her money in investments that have the possibility of growth but which carry a greater degree of risk. Inflation as well as guarantees in investments are also linked to the risk that an investor should consider. The investor should bear in mind that a guaranteed investment, while providing security of a return, could also provide the risk of providing a below inflation return. This, once again, emphasises the need for diversification of investments.

94 B14 Investment Planning Miscellaneous Investment Formulae 1. Bank acceptances Discount = The yield = Face value x days to maturity x discount rate 385 x 100 Face value x rate Purchase price 2. Values of gilts (e.g. Eskom stock) in phases of rising and falling interest rates An example An investor wishes to invest in Eskom 167 stock. Coupon rate = 12%. Market-related interest rates = 18%. Nominal value of stock is R Term to maturity is six years. Calculate the purchase price. Purchase price = present value of all future interest payments + present value of the nominal value of stock at date of redemption. Interest payments are R p.a. for six years. These payments must be discounted over the period concerned at the market-related rate: Therefore, R x 3,4976 ( Present value of R1 per period table - six years - 18%)= R41 971,20 Add: Present value of the nominal value of stock at date of redemption = R x 0, ( Present value of R1" table - six years - 18%) = R37 043,20 Purchase price = R41 971,20 + R37 043,20 = R79 014,40

95 Investment Planning B15 Assume that market rate now moves to 16%. The future interest payments, as well as the nominal value of the stock at redemption, now have to be discounted at 16%. So, R x 3,68474 ( Present value of R1 per period table - six years - 16%) = R44 216,88 Add: Present value of the nominal stock at date of redemption: R x 0, ( Present value of R1" table - six years - 16%) = R41 044,20 Total price = R44 216,88 + R41 044,20 = R85 261,08. An interest rate move from 18% to 16% caused the price of the stock to increase from R79 014,40 to R85 261,08. Conversely, an increase in market interest rates would cause the price to fall. This example clearly illustrates the inverse relationship between gilt prices and market interest rates. Note, however, that the interest payments on this type of stock is usually paid six monthly in arrears and would, therefore, also be discounted six monthly. The face value at redemption should, however, be discounted annually. This would require two separate calculations. 3. Calculation to determine return on redemption of existing debt (e.g. bond on house or motor vehicle lease) The question that often arises when an investor receives a lump sum payment is whether they should either: reduce an outstanding debt, or continue repaying the debt on a monthly basis and invest the capital. To determine the appropriate course of action in such a case, the effective cost of the debt must be compared to the taxable return of the investment. If the taxable return of the investment is higher than the cost of the debt, then it would be advisable not to repay the debt in full and to invest the available capital. It is also important to know whether the debt repayments are tax deductible, as this will have an effect on the cost of the debt. The following scenarios can be distinguished:

96 B16 Investment Planning 3.1 If the investment is fully taxable and the debt not tax deductible 1 Interest rate on debt (Marginal rate divided by 100) = x% If one could earn a taxable return of greater than x% p.a. on an alternative investment, then the debt should not be redeemed and one should rather opt for the alternative investment. If one could only earn on an alternative investment a taxable return equal to or less than x% p.a., one should rather redeem the debt. Step 1 Bond interest rate 15% Step 2 Investor s marginal rate of tax 35% Step (35 divided by 100) 23.08% Step 4 Minimum taxable return required from investments E.g. Housing bond interest = 15% Marginal rate of tax = 35% 23.08% If one cannot earn a taxable return of greater than 23,08% p.a., the debt should be redeemed. 3.2 If the investment is partially taxable and the debt is not tax deductible Step 1 Bond interest rate 15% Step 2 Investor s marginal rate of tax 35% Step 3 Investment 30% tax exempt 4.5% Step 4 Investment 70% taxable 10.5% Step 5 Step (35 divided by 100) Minimum taxable return required for investment Step 3 + Step % 20.65% If one cannot earn a taxable return of greater than 20,65% the bond should be redeemed.

97 Investment Planning B If the investment is fully taxable or partially taxable and the debt repayment is tax deductible One must take into consideration whether the debt repayments are tax deductible, for example bond or lease repayments. If the full payment is deductible, then the taxable return (inclusive of income tax due) of the investment must at least be more than the effective cost of the bond. Fully taxable investment Step 1 Bond interest rate 14% Step 2 Investor s marginal rate of tax 40% Step 3 Step 4 Effective cost of bond after deduction: 14% - (14% x 40%) Minimum taxable return of investment required: (40 divided by 100) 8.4% 14% Note: Bond repayment must be fully tax deductible. If one cannot earn an after-cost taxable return of greater than 14%, the bond should be redeemed. Partially taxable investment Step 1 Bond interest rate 14% Step 2 Investor s marginal rate of tax 40% Step 3 Effective cost of bond after deduction: 14% - (14% x 40%) 8.4% Step 4 Investment 70% taxable (8.4% x 70%) 5.88% Step 5 Investment 30% tax exempt 2.52% Step 6 Step (40 divided by 100) Minimum taxable return of investment required: Step 6 + Step 5 9.8% Note: Bond repayment must be fully tax deductible. If one cannot earn an after-cost taxable return of greater than 12,32%, the bond should be redeemed.

98 B18 Investment Planning 3.4 How does tax on fringe benefits affect the calculation? A potential investor has a bond of R at 4% p.a. His marginal tax rate is 40%. He inherits a large sum and is unsure whether to redeem the bond. Assume the prescribed interest rate is presently 13% p.a. Therefore, the investor is taxed on 13% - 4% = 9% of R Therefore, it costs him an extra R3 600 (40% x (9% x R )) per year. In total, therefore, the bond costs him R7 600 and not R4 000 (4% x ) per year In the formula, the interest rate on debt is 7,6% ( and not 4%. x 100) Step 1 Bond interest rate 7,6% Step 2 Investor s marginal rate of tax 40% Step (40 divided by 100) 12,67% Step 4 Minimum taxable return of investment required: 12,67% If one cannot earn a taxable return of greater than 12,67%, the bond should be redeemed.

99 Investment Planning B19 4. A guide to interest rate calculations using basic interest tables Basic interest calculations can be done with either a financial calculator or present value and future value tables as set out in the general sections. Interest rate calculations Future Value Present Value Recurring payment Single payment Recurring payment Single payment (Tables B and C) (Table D) (Table E) (Table F) Note: The tables referred to above can be found in Section F.

100 B20 Investment Planning 1. Examples of future value calculations using basic tables (i) Recurring payments Principle: Determine the future value of recurring payments made at the beginning of the period earning compound interest. See Table B for monthly payments and Table C for yearly payments. Example: Annual payment in advance : R2 400 Period : 20 years Interest rate : 12 % Factor : Future value : R (ii) Single payment Principle: Determine the future value of a single payment earning compound interest. See Table D. Example: Single payment : R Period : 10 years Interest rate : 12 % Factor : 3,106 Future value : R

101 Investment Planning B21 2. Examples of present value calculations using basic tables (i) Recurring payments Principle: Determine the present value of future payments in arrears. See Table E. Example: Annual payment in arrears : R1 500 Period : 15 years Interest rate : 14 % Factor : 6,14217 Present value : R (ii) Single payment Principle: Determine the present value of a single future payment. See Table F. Example: Future payment : R Period : 5 years Interest rate : 8 % Factor : 0, Present value : R

102 B22 Investment Planning Bond Redemption Table Monthly repayments to redeem a mortgage bond of R1 000 at an interest rate of % p.a. Yrs 8,5 9,0 9,5 10,0 10,5 11,0 11,5 12,0 Yrs To calculate the factor for interest rates below 12,5%, reduce the 12,5% factor by 0,24 for every 0,5%, e.g.: Year 1: 12% = 89,08-0,24 = 88,84. The reverse applies for factors for percentages in excess of 24%, i.e. 0,24 is added for each 0,5%.

103 Investment Planning B23 Bond Redemption Table Monthly repayments to redeem a mortgage bond of R1 000 at an interest rate of % p.a. Yrs 12, , ,5 15 Yrs ,08 47,30 33,45 26,58 22,49 89,31 47,54 33,69 26,82 22,75 89,55 47,77 33,93 27,07 23,01 89,78 48,01 34,17 27,32 23,26 90,02 48,24 34,42 27,57 23,52 90,25 48,48 34,66 27,83 23, ,81 17,92 16,52 15,46 14,63 20,07 18,19 16,80 15,75 14,93 20,33 18,46 17,08 16,04 15,22 20,60 18,74 17,37 16,33 15,52 20,87 19,01 17,65 16,62 15,82 21,14 19,29 17,94 16,92 16, ,97 13,43 12,99 12,63 12,32 14,27 13,74 13,31 12,95 12,65 14,58 14,05 13,63 13,27 12,98 14,88 14,37 13,95 13,60 13,31 15,19 14,68 14,27 13,93 13,65 15,50 15,00 14,60 14,27 13, ,06 11,84 11,66 11,50 11,36 12,40 12,18 12,00 11,84 11,71 12,73 12,52 12,35 12,20 12,07 13,07 12,87 12,70 12,55 12,43 13,42 13,22 13,05 12,91 12,80 13,76 13,57 13,41 13,28 13, ,24 11,13 11,04 10,97 10,90 11,60 11,50 11,41 11,34 11,27 11,96 11,86 11,78 11,71 11,65 12,33 12,23 12,16 12,09 12,03 12,69 12,61 12,53 12,47 12,42 13,07 12,98 12,91 12,85 12, ,84 10,79 10,74 10,70 10,67 11,22 11,17 11,13 11,09 11,06 11,60 11,55 11,51 11,48 11,45 11,98 11,94 11,90 11,87 11,84 12,37 12,33 12, ,24 12,76 12,72 12,69 12,66 12, To calculate the factor for interest rates below 12%, reduce the 12,5% factor by 0,24 for every 0,5%, e.g.: Year 1: 12% = 89,08-0,24 = 88,84. The reverse applies for factors for percentages in excess of 24%, i.e. 0,24 is added for each 0,5%.

104 B24 Investment Planning Bond Redemption Table Monthly repayments to redeem a mortgage bond of R1 000 at an interest rate of % p.a. Yrs 15, , ,5 18 Yrs ,49 48,72 34,91 28,08 24,05 90,73 48,96 35,15 28,34 24,31 90,96 49,20 35,40 28,59 24,58 91,20 49,44 35,65 28,85 24,85 91,44 49,68 35,90 29,11 25,12 91,68 49,92 36,15 29,37 25, ,41 19,57 18,23 17,22 16,44 21,69 19,86 18,52 17,52 16,75 21,96 20,14 18,82 17,82 17,06 22,24 20,43 19,12 18,13 17,38 22,52 20,72 19,42 18,44 17,69 22,80 21,01 19,72 18,75 18, ,82 15,33 14,93 14,60 14,34 16,14 15,65 15,26 14,94 14,68 16,46 15,98 15,60 15,29 15,03 16,78 16,31 15,94 15,63 15,39 17,11 16,65 16,29 15,98 15,74 17,44 16,99 16,63 16,33 16, ,11 13,93 13,77 13,64 13,53 14,47 14,29 14,14 14,01 13,91 14,82 14,65 14,51 14,38 14,28 15,18 15,01 14,87 14,76 14,66 15,54 15,39 15,25 15,14 15,04 15,91 15,75 15,62 15,52 15, ,44 13,36 13,30 13,24 13,19 13,82 13,75 13,68 13,63 13,58 14,20 14,13 14,07 14,02 13,98 14,58 14,52 14,46 14,41 14,37 14,97 14,90 14,85 14,81 14,77 15,36 15,30 15,25 15,20 15, ,15 13,12 13,09 13,06 13,04 13,55 13,51 13,49 13,46 13,44 13,94 13,91 13,89 13,87 13,85 14,34 14,31 14,29 14,27 14,25 14,74 14,71 14,69 14,67 14,66 15,14 15,12 15,10 15,08 15, To calculate the factor for interest rates below 12%, reduce the 12,5% factor by 0,24 for every 0,5%, e.g.: Year 1: 12% = 89,08-0,24 = 88,84. The reverse applies for factors for percentages in excess of 24%, i.e. 0,24 is added for each 0,5%.

105 Investment Planning B25 Example Assuming that the variables will remain constant over the term and payment is in arrears, i.e. at the end of the month: Bond Term Interest Monthly Instalment R % R4 424 R % R4 684 R % R5 060 R % R5 972 If the instalment in the above scenario is increased from R4 424 to R4 684, i.e. R320 more per month, then the term of repayment is reduced by 10 years.

106 B26 Investment Planning General Investment Planning Worksheet The objective of this investment planning worksheet is to give the financial adviser an understanding of the fundamental principles applicable to an investment plan where an investor requires both an income as well as capital growth. This type of worksheet is often used when an investor reaches retirement stage. The procedure, as set out in the twelve steps below, is simply a method for determining the structure for a ten-year investment plan. The purpose of the procedure is to establish the amounts to be invested in growth and income investments, respectively, without referring to specific types of investments. Further consideration must be given specifically to which growth and income investments should be chosen. Factors that will play a role in this choice between various investment vehicles are risk, term, inflation, cost, tax and liquidity. When investment planning is done at retirement, the term of the plan is vitally important. Normally the term would be the same as the life expectancy of the retiree, which can be as much as 30 years or even longer. In the investment plan, the whole term has to be taken into account. Doing a 30-year cash flow analysis manually may, however, not be practical. It is, nevertheless, necessary to calculate whether there is sufficient capital (in addition to expected future income, e.g. pension, retirement annuity) to provide the required level of income. If not, the initial required income level should be adjusted accordingly, or assets would have to be sold at some stage in order to prevent a situation in the future where the capital is exhausted and a dramatic reduction in income is experienced. Where the life expectancy is longer than ten years, a ten-year cash flow analysis does not deal with the capital adequacy properly. By assuming the rate of inflation and the rate of return on the investment to be identical over the term of the investment plan, an indication of the capital adequacy can be obtained by dividing the capital amount by the number of months in the investment plan. This will give an indication of the monthly income that can be expected to be produced by the capital amount. Example After retirement Mr A will receive no monthly income from any source. However, he has R available to invest in order to produce an income. His life expectancy is 15 years. He wants to be conservative and plan for 20 years. What level of income can he expect to receive if the income has to increase annually with the inflation rate? If the assumption is made that the rate of return on

107 Investment Planning B27 his investment and the inflation rate over the term will be identical and that the capital will be consumed, the answer will be: x 12 tax. = R2 083 p.m. before the deduction of personal income Conversely, an indication of the capital amount needed to provide a required level of income can be calculated by multiplying the required income level by the number of months in the investment plan, if the same assumptions as above apply. Once it has been established that in principle the capital amount is sufficient to produce the required level of income through the duration of the investment plan, the specific growth and income investments can be decided on. They may have varying terms (from one day to ten years) and should be reviewed periodically to assess their suitability. Income investments should be made only as and when required. Personal details Name: Age: Retirement Age Marital Status Step 1: Financial data 1.1 Capital available for plan Asset Self Spouse Policies Fixed deposits Unit Trusts Share portfolio Property portfolio Cash on call Other Total capital available

108 B28 Investment Planning 1.2 Outstanding liabilities Liability Interest Rate Instalment payment (p.a.) Outstanding amount Mortgage bond Hire purchase Lease agreements Overdraft Other Total 1.3 Income (present) (p.a.) Source Self Spouse Employment Pension Retirement annuities Interest Dividends Other income Totals 1.4 Income (future) (p.a.) Source Year due Self Spouse Employment Pension Retirement Annuities Interest Dividends Other income Total

109 Investment Planning B Deductions (present) (p.a.) Pension contributions Retirement annuity contributions Other R R R 1.6 Future capital injections Maturing endowments/retirement annuities Year Amount Note Other capital injections Year Amount Note 1.7 Capital expenditure Year Amount Note

110 B30 Investment Planning 1.8 Required income Year Amount Note 1.9 Emergency fund requirements Year Amount Note Step 2: Income growth objective At what rate does the client wish his/her annual income to increase? (Normally equal to the inflation rate.).....% Step 3: Determine investor s marginal rate of tax. The worksheet on the next page can be used.

111 Investment Planning B31 Income Tax Calculation Sheet GROSS INCOME Salary R Trade Business R Commission R Interest R Dividends (subject to DWT) R Dividends (other foreign - see note) Other. R. R Total R R EXEMPTIONS Basic Interest R Dividends (subject to DWT) R Dividends (other foreign) R Foreign employment income. R Other. R R - R INCOME R DEDUCTIONS Expenses R Pension fund contributions R Retirement annuities contributions R Donations to PBC s R Medical expenses R Other R Plus: Portion of travel allowance not expended R on business travel Plus: Taxable Capital Gain R R - R TAXABLE INCOME R Tax on R. R + % on R. + R TAX PER SCALE R REBATES Primary R 65+ R 75+ R - R MEDICAL TAX CREDITS Less: Medical Credit: Taxpayer plus dependants R R TAX PAYABLE R Note: Dividends declared from foreign companies not listed on JSE are taxed at marginal rate subject to any eligible exemptions See A41 (See page A28 (8.3) and page A30 (8.4) for calculation of medical expenses and deductions for donations to PBO).

112 B32 Investment Planning Step 4: Determine whether debt should be repaid from capital available. Fully or partially taxable investment and debt repayments not tax deductible Calculations as illustrated. Fully or partially taxable investment and debt repayments tax deductible Calculations as illustrated. If the investor can earn a taxable return of more than x%... Calculation

113 Investment Planning B33 Step 5: Invest the capital required for emergency purposes at the best available call rate. R invest at % Step 6: Provide for future capital needs. Date Investment Rate Date Investment Rate Note: The value of the future capital need must be established. Accordingly, the term, rate of return and tax must be taken into account in determining the amount that has to be invested now. If the capital need would arise in less than five years, an interestbearing investment would probably be most suited, taking cost and risk factors into account. Step 7: Determine income deficit in year 6. (a) Non-investment income available in year 6 Source Present Income Increase (per cent) Factor Value in year 6 Salary Pension Retirement Annuities Dividends Unit Trust Property Total non-investment income in year 6

114 B34 Investment Planning (b) Determine income requirements in year 6. Present actual income required (Year 0) R.... per annum Inflation rate factor for year 6 x Actual income required in year 6 R..... (c) Income deficit Note: Income deficit = Income required - total income = R R = R Therefore, the income required in year 6 from an income portfolio is R A deficit usually occurs at some point during a ten-year investment plan. Experience has shown that in calculating the size of the income investment to be made in year 0 to counter these future deficits, the deficit that would exist after 60% of the investment term had expired (year 6) usually provides a satisfactory basis for a paper-based calculation. A more tax-efficient plan can be crafted through, for example, the liquidation of certain investments at certain times. This emphasizes the importance of creating a flexible plan as well as revisiting the investor s objectives, outcomes and scenarios on an annual basis. Step 8: Determine the amount to be invested in an income portfolio. Income required from income portfolio realistic yield = capital required R / % = R

115 Investment Planning B35 Step 9: Projection of escalating income Determine future cash flows. End year 1 Salary Pension Dividends Unit Other Total Trust % % % % % %

116 B36 Investment Planning Step 10: Determine total annual income from income portfolio. Non-growth income summary Immediate annuities R Retirement annuities R Bank R Call funds R Other R TOTAL R Step 11: Incorporating the figures determined in steps 7 to 10, do a comprehensive cash flow analysis. End Escalating Fixed Total Required Surplus Income Fund year Income Income Income Income Income Shelter Value

117 Investment Planning B37 Notes: Escalating income, as calculated in step 9. Fixed income, as determined in step 10. This income will stay constant throughout the forecast period. Aggregate of (a) and (b). Income required in year 1, escalated annually at the expected inflation rate. Difference between (c) and (d). Fund value in previous year plus a return equal to the realistic yield used in step 8. Aggregate of (e) and (f). Income surplus is added to fund value. Income deficit is deducted from fund value. Notes on the cash flow analysis Investment income, non-investment income as well as required income are reflected before tax. Required income as specified in step 1.8 should be based on a monthly expense budget. Provision for income tax should also be made, the amount of which will depend on the size, term and nature of the income investment finally recommended. It should also be noted that the tax implications of income investments based on voluntary purchase annuities vary according to term, i.e. the shorter the term the more tax efficient the investment is. If the initial investment amount included an investment in an endowment policy, this endowment policy can produce tax-free withdrawals after five years. Refer to section A for capital gains tax implications. These factors should be taken into account in the cash flow analysis.

118 B38 Investment Planning Step 12: Investment of balance of capital The balance of the capital must be invested in growth investments. The balance of the capital in this case is as follows: R... (Total capital available) Less R... (Invested for emergency fund) Less R... (Invested for income) Less R... (Repayment of liabilities) Less R... (Invested for future capital expenses) = R... (Capital available for growth investments).

119 Investment Planning B39 Investment comparison Tank containers Managed portfolio Collective investments like Unit Trusts Collectables Krugerrands Term Risk Costs Long term. Risk is influenced by Approximately purchase Approximately frequency of use and price: R years fluctuations in the Management fees Refurbishment value of the rand percentage of distribution 10 years No fixed term. Medium to long term recommended. No fixed term. Medium to long term recommended. For higher return, five years or longer No fixed term. Long term recommended. Nil. Dependent on supply and demand Medium to high risk. Medium risk if managed by experienced investors. Share values move in line with stock market which is volatile. Bigger spread of shares could reduce risk. High risk depending on type of unit trust fund. Managed by experienced asset managers. Unit values move in line with stock market which is volatile. Medium risk. Unlike other investments could be stolen, destroyed by fire, etc. Risk dependent on gold price and rand/dollar exchange rate. Values are volatile. No guarantees. After deregulation brokerage charges are fully negotiable. The sliding scale used before deregulation is still used as basis. Charges apply to purchases and sales Marketable securities tax (MST) of 0,25% & is payable on all purchases. Costs generally applicable in market: Equity funds: Initial charge max. 5.7% incl. VAT. Management fee 1.14% % p.a. incl. VAT. Gilt & income funds: Initial charges max 1.14% incl. VAT. Management fee 0.86% p.a. incl. VAT. Money market funds: No compulsory or initial charges. Annual management fee 0.57% p.a. incl. VAT. Costs could be high due to high premium rates in respect of short-term insurance. Auctioneer s commission: 10% + VAT No costs unless purchases and sold through a broker.

120 B40 Investment Planning Liquidity Tax Inflation Fairly illiquid, but lucrative second-hand market exists. Tax effective 20% depreciation. Increased effectiveness through gearing. Rand hedged. Return inversely proportional to rand exchange rate. Liquidity dependent on supply and demand and on current desirability of the shares being sold. 100% liquid. However, for higher return, hold for 5 years or longer. Dividends (excluding foreign dividends) taxable at 15%. Profits on resale not income if held for less than 3 year Safe-haven option (see Section A.) Capital gains realised may be subject to CGT. Dividends (excluding foreign dividends subject to R3 700 that can be used if the full interest exemption is not utilised) are taxed at 15%. Interest fully taxable in excess of R (under 65 years) or R (65 and older). Proceeds on sale of units may be subject to CGT (no CGT on build-up). Expected to outpace inflation. Dependent on performance of particular shares on stock exchange. Historically returns exceeded inflation rate over medium to long term. Liquidity dependent on supply and demand. Proceeds on sale may be subject to CGT. Capital growth dependent on the nature of the particular asset. Liquidity dependent on supply and demand. No loan value but has a security value. Profits on sale may be taxed. Revenue practice is currently to tax profits. Historically, long-term inflation beaters. However, over past few years, performance below inflation.

121 Investment Planning B41 Zerocoupon bonds Term Risk Costs Variable. Medium Medium risk. Face value Costs minimal. term for higher guaranteed. Growth return. dependent on fluctuating Property unit trusts No fixed term. Medium to long term recommended. For higher return, five years or longer Medium risk. Over short term risk is less than in shares. Property values are more stable. Broker s Commission of about 1.5% of the value of in investment. Marketable Securities Tax of 0.25%. Property Retirement annuities No fixed term. Medium to long term recommended. Varies according to age of investor. Minimum maturity 55 a.l.b. No maximum maturity age Medium risk dependent on factors such as location, price range, supply and demand, commercial or residential use, etc. Medium risk. Could be higher risk depending on portfolio choice. Values fluctuate in line with underlying assets. Protected against creditors in event of Fairly high costs. Maintenance costs, especially where property is leased. Transfer duty: 0% up to R , 3% from R R1m, for above R1m but below R1.5m will be R % on the value above R1m, above R1.5m will be R % above R1.5m. The same will apply irrespective of the juristic nature of the acquirer of the property. VAT may be payable if seller is a registered vendor in which case, no transfer duty. In addition, cost of insurance. Costs minimal policy fees and intermediary s commission

122 B42 Investment Planning Liquidity Tax Inflation Not liquid. Cash values usually only available after 1-2 years. Loss on investment if surrendered in early years. Has loan value. Can be ceded as security. Proceeds tax-free (in investor s hands). Second-hand policies may be subject to CGT. Returns over ten years often outpace inflation. Returns exceed inflation rate over long term Liquid can be discounted on the secondary market prior to maturity. The income from property unit trusts is usually paid out every 6 months in the form of a dividend. For tax purposes this income is treated as interest and is fully taxable. Should keep pace with inflation depending on return and on whether interest taxed annually. 100% liquid. Income distributions are regarded as interest and are fully taxable (R or R interest exemption). Gains in the value of units may be subject to CGT. Dependent on property market. Not liquid until minimum maturity age. Can however be commuted on official emigration. Also accessible if the paid up value is below R7000. Contributions deductible subject to specified limits. At retirement a lump sum determined in accordance with the Second Schedule to the Income Tax Act is tax-free. Balance taxable. Compulsory annuity is fully taxed at marginal rates. Have a record of beating inflation, once tax concessions have been taken into account.

123 Investment Planning B43 Participation bonds Term Risk Costs 5-year minimum term (except on death). Medium risk. Dependent on property market and fluctuating interest rates. Risk lessened with minimum guaranteed return (floor rate). No cost to investor. Borrower charged interest. Eskom Stocks No fixed term. Medium to long term recommended. Very low risk. Government controlled. Brokerage costs.

124 B44 Investment Planning Liquidity Tax Inflation Not liquid. After 5-year term, 3 month notice period required. Interest fully taxable (R or R interest exemption) After-tax yield historically below inflation. No protection against inflation for either capital or income. Interest-bearing rather than growth investment. Fairly liquid. Can be used as loan security. Note: Interest is fully taxable (subject to R or R interest exemption). Dependent on interest rates. Highly unlikely that return would beat inflation. In all cases the effect of capital gains tax, as set out in section A, should be considered. Generally, capital assets are considered affected assets and therefore potentially subject to capital gains tax.

125 Investment Planning B45 Collective Investment Scheme 1. What is a Collective Investment Scheme? A collective investment scheme (CIS) is a trust based scheme that comprises a pool of assets that is managed by a collective investment scheme manager and is governed by the Collective Investment Schemes Control Act no 45 of The concept behind a CIS is simple: a group of investors pool their money in order to get a spread of professionally managed investments Participatory Interests Each investor has a proportional stake in the CIS portfolio based on how much money he or she contributed. The word unit is commonly used to describe the portion or part of the CIS portfolio that is owned by the investor. The funds from a group of investors are pooled or collected together to form a CIS portfolio. The investment portfolio is divided into equal parts. These are referred to as units. Each unit represents a direct proportionate interest in every asset in the portfolio. Units are notional assets (imaginary) and find their market value in the total underlying assets. With the new CISCA legislation the term unit was replaced by participatory interest in a collective investment scheme but for all purposes the industry still refers to units. 2. Benefits of Collective Investment Schemes They allow ordinary people to invest in shares that would normally be out of their financial reach if their money had not been pooled with that of other investors in the fund. They provide a means to beat inflation, as returns are normally higher than the inflation rate. CIS are a flexible form of investment, as you can either invest a lump sum or you can make a regular investment each month. CIS offers liquidity. In other words, the unit holder may choose to cash in a portion of the CIS or all of it. This means that your money is always accessible, which is not the case with all long term investments.

126 B46 Investment Planning They can also be transferred to another party, and you can even invest on somebody else s behalf. The investors can monitor the performance of their CIS on a daily basis as it appears in the newspapers business reports. Experts in the field of managing money, invest your money on your behalf. Investors may invest in markets all over the world, and reap the benefits of rand hedging. 3. Classification of Collective Investment Schemes Collective Investment Schemes are grouped into sectors to enable investors to compare the performance of portfolios with similar objectives and benchmarks. Geographic Categories The first tier in the classification process is where Collective Investment Schemes in Securities are categorised according to where they geographically invest. This could be in: Domestic markets, Worldwide, Foreign or regional. Each of the geographic categories is further subcategorised into the second tier of asset classes. They are named according to the type of investment that such a fund would make. The categories are: Equities Asset Allocation Fixed Interest Real Estate Equity Funds A minimum of 75% of the fund must be invested in equities at all times. At least 80% of this equity portion must be invested in the JSE and a maximum of 20% may be invested outside the JSE sectors provided they comply with the category definition.

127 Investment Planning B47 Asset Allocation Funds Asset Allocation funds are funds that invest in a wide spread of investments in the equity, bond, money and property markets. These funds are also known as balanced funds or managed funds. Managed funds aim to achieve medium to long-term performance by investing in a combination of markets. This is a way of decreasing the risk associated with investing in a single market. Fixed Interest These funds invest only in interest bearing assets. The level of risk for these funds is relatively low, but so is the likelihood of exceptional growth. Real Estate Funds These funds invest predominantly in listed property shares. DOMESTIC FUNDS Invest 70% or more of their assets in South African local markets Equity Funds Asset Allocation Funds Fixed-Interest Funds General funds Growth funds Value funds Large cap funds Smaller companies funds Mining & resources sector funds Financial & industrial sector funds Financial sector funds Varied specialist funds Prudential funds Flexible funds Flexible property funds Bond funds Income funds Money market funds Varied specialist funds

128 B48 Investment Planning WORLDWIDE FUNDS Invest between 15% and 50% of their assets in South African local markets and a minimum of at least 30% in foreign markets. General funds Equity Funds Other theme funds Technology sector funds Varied specialist funds Asset Allocation Funds Flexible funds Fixed-interest Funds Bond funds Money market funds FOREIGN FUNDS Invest 85% or more of their assets in foreign markets. Equity Funds Asset Allocation Funds Fixed-interest Funds General funds Flexible funds Income funds Varied specialist funds Varied specialist funds REGIONAL FUNDS Invest 85% or more of their assets in a single country or region, excluding South Africa. Equity Funds Fixed-interest Funds Varied specialist fund General Varied specialist funds

129 Investment Planning B49 4. Funds not specifically categorised Fund of funds A fund of funds is a unit trust that invests in a range of other unit trusts. Index funds Index funds are collective investment schemes that are designed to match the performance of a particular index. Their mandate is to track the performance of a benchmark index by buying the shares in that index at their respective weightings (e.g. the JSE Top 40 Companies Index). Property unit trust funds Property unit trusts enable investors to share in professionally managed property portfolios without the disadvantages of direct property ownership. They differ from other unit trust funds in that they are closed ended. This means that there are a fixed number of units and that you can only buy units if there is a seller available. Unlike other unit trusts, there is no obligation on the fund managers to repurchase units from the investor. This type of fund provides an investment in a portfolio of properties that would otherwise be unattainable by most investors because of the high costs involved. This type of investment is, therefore, more liquid than the usual type of property investment. The price of the units is not determined by the value of the underlying assets, but rather the demand and supply of the units on the JSE. Units are traded and quoted on the JSE. Dividends are usually paid out biannually and are taxable as interest in the hands of the investor. Exchange Traded Funds These are special types of tracker (index) funds which are listed on a stock exchange. ETF s are almost similar to other index funds in that they also replicate the weighted constituents of an index. 5. Factors to consider when investing in unit trusts Apart from the factors which may affect investment strategy in general the following factors should also be considered in the context of unit trusts.

130 B50 Investment Planning 5.1 Timing Timing of an investment is almost as important as choosing the right investment and should be discussed with a potential investor before the investment is made. The crucial moment is not so much when an investor starts the investment in unit trusts, but rather when he/she ends it by cashing in the units. Because of the nature of unit trusts and their dependency on stock market cycles which, based on world stock markets, last for approximately five years on average, unit trusts should be seen as a medium-term to long-term investment. As more management companies are marketing unit trusts by propagating the ease with which investors can switch between unit trusts funds, the investor should appreciate the risks associated with trying to time the market correctly. Such decisions are often made because of emotions or hunches which can result in losses for the investor. Switching costs also have to be considered. 5.2 Rand cost averaging as a method of reducing risk For the investor who invests on a regular basis, as opposed to making a lump-sum investment, the rand cost averaging method can reduce the risk and minimise the importance of investment timing. 6. Categories of unitised investment products 6.1 Specialised Funds In addition to these collective investments funds, there are specialised funds regarded as packaged products that include a number of collective investment schemes or investment portfolios in one bundle. Do not confuse them with Specialist Equity Funds, which are funds that invest in one specialised area of the JSE. They enable the investor to spread his/her investment through a range of collective investments, and are also known as split investments. These packaged products include: Funds of funds, Wrap funds and Multi-manager funds

131 Investment Planning B51 Below are the main categories and features of split investment products What is a linked product? Linked product companies also called (Linked Investment Service Providers or LISP) are administrators as they simply channel investor funds through their own umbrella investment vehicles into underlying unit trust funds of various companies. The broad categories of these umbrella investment vehicles are retirement products (e.g. retirement annuities), specialist plans (e.g. capital guarantee products) and general investments. Usually linked product companies do not give advice on investments. The investor should, therefore, work through a reputable financial adviser. The linked product company facilitates the switching of the underlying investments for a substantially reduced fee. However, overall investment costs may be higher due to the aggregate costs of the linked product company s management fees, the management fees of the underlying management company and the commission of the financial adviser. A feature of investing in a linked product company is its computer software system which provides instant report backs on what you are invested in and how your investment is performing. However, the investor should be confident that the linked product company has made adequate provision for computer failure, as well as security provisions What is a multiple-manager product? The emphasis here is on the investment strategy utilised called the multiple-manager approach. The funds are called multi-managed funds. The multiple-manager approach is not purely an administrative system as it is more active in providing the investor with a limited choice of investments to suit the risk profile of the investor. The multiple-manager fund manager is the manager of a number of independent asset managers who are selected for their skill in a particular investment type. These specialist

132 B52 Investment Planning asset managers, who have to handpick shares, take specific instructions from the multiple-manager fund manager and are closely monitored to ensure compliance with instructions. This specialist control by a wide range of asset managers is a feature of this type of investment strategy which ultimately reduces the risk of relying on the expertise and skill of one fund manager. However, the multiple-manager fund manager may not have access to the full selection of asset managers, and this could detract from the attractiveness of this investment approach. The bundled products offered by multiple-manager fund managers are essentially the traditional product types such as unit trusts, life assurance endowment policies, retirement annuities and retirement funds. 6.2 Wrap funds A wrap fund is a fund which holds all the investments of one person. A wrap fund provider company can also place the investor s money directly into the underlying investments, e.g. an endowment policy or unit trusts. A wrap fund may include a choice of unit trusts, split investment products as well as portfolios of life assurance companies. Together these products are sold to the investor using an umbrella product, e.g. a retirement preservation fund. A wrap fund provider company offers the investor guidance on aspects of risk profile and investment selection based thereon. The investor should take cognisance of his/her own risk profile and investment objectives when deciding on the mix of investments in the wrap fund. It is very important for the investor to know how his/her wrap fund is being bundled, through what umbrella product he/she is invested and also what the underlying investments are. An investment trust is as the legal structure within which the wrap fund operates. As is the case with linked products, a feature of wrap funds is the wrap fund provider company s computer software system, which provides instant report backs on what you are invested in and how your investment is performing.

133 Investment Planning B Structured funds Structured funds are a type of multiple-manager fund. Again the principle of unitisation is applicable with structured funds, where the structured fund management company is free to invest in any proportion of any investment type within the limits of the fund s mandate. The structured fund consists of underlying investment portfolios which are managed by different asset managers. The structured fund manager then manages the aggregate portfolio which now falls into the structured fund, again in terms of a specific mandate. The importance of a good computer software system is again a feature of this fund. It is important to note that, although a structured fund eliminates the need for switching, offshore asset swaps are not allowed in terms of exchange control legislation. 6.4 Fund of funds A fund of funds is a unit trust fund that invests in a range of other unit trusts. A dedicated fund manager makes the selection from any unit trust fund with specific performance objectives in mind. A fund of funds can offer reduced risk and lower volatility because of unit trust diversification. The costs of a fund of funds are higher than ordinary unit trusts, as they are invested in at least two underlying unit trusts. The investor should ideally look for a diversification of management styles of the underlying funds.

134 B54 Investment Planning 1. Introduction Offshore investments The nature of offshore investments and factors influencing the choice of these investments are becoming increasingly important with the progressive relaxation of exchange controls. The availability of offshore investments will of course place a responsibility on the financial adviser to provide investors with advice to make informed decisions on offshore investments. There are many reasons for South African investors to consider offshore investments, and many factors govern an investor s choice: 2. Diversifying risk Investing in an offshore portfolio means that the investment is not influenced by one country s political and economic stability alone. The investor is also diversifying currency risk. Should the rand drop in value the investor can actually expect a higher return on his/her investment (in rand terms). The reverse is also true of course. 3. Exploiting international markets and enhancing returns The investor is not limited to his/her local market but has the choice of investing where he/she perceives that the best possible opportunities for a good return on the investments exist. The availability of offshore investments could mean that the investor who makes careful and informed choices of offshore investments could enhance the return on his/her total investment portfolio because he/she has a wider choice of investment options. A much broader range of traditional and alternative investment strategies ( hedge funds ) is available. 4. Selecting an offshore centre South Africans may now invest in the country of their choice, and some will choose to invest in a major country, but many will seek an offshore investment centre, rather than a major nation, mainly because of the possibility that lower tax will be levied in the so-called tax havens. Since the introduction of residence-based

135 Investment Planning B55 tax in 2001 this has become less important, but using a low or zero-tax environment can certainly simplify reporting in South Africa The better known offshore centres include: Bahamas, Bermuda, Cayman Islands, Netherlands Antilles, Panama, Guernsey, Jersey, Isle of Man, Liechtenstein, Luxembourg, Monaco, Netherlands, Switzerland, Gibraltar, Cyprus and Hong Kong. The decision as to which offshore tax centre should be utilised may be influenced by one or more of the following factors (this list is by no means exhaustive): Physical situation Where is the country situated geographically? Stability How stable is the country from a political and economic perspective? How stable has the country been historically? Facilities Banking facilities? Investment facilities? Other professional facilities? Tax treatment of non-resident income Are there any taxes levied on non-resident investors? How is tax on income, inheritance, wealth and profits dealt with? Confidentiality Is there complete secrecy on investments? Offshore investments offer greater confidentiality than local investments. Local advisers should be careful when dealing with the confidentiality issues, in view of the provisions of the Prevention of Organised Crime Act (POCA) and the Financial Intelligence Centre Act (FICA). Financial advisers should avoid giving advice in situations where confidentiality may be abused for illicit purposes.

136 B56 Investment Planning Legal, language and time-zone compatibility From the perspective of a South African investor, only the Channel Islands and the Isle of Man offer all three of these. In particular their trust and company laws and regulatory environments have much in common with their South African equivalents. Offshore trusts can be attractive estate planning options for South African advisers and their clients, particularly in relation to foreign-sourced wealth such as inheritances Estate and tax planning opportunities and advantages In addition to offshore trust services, the legal systems of some tax havens, and particularly the Channel Islands and the Isle of Man also permit the use of South African branch arrangements with South African life assurers, where investment policies are issued under the laws of the offshore centre but are to a limited extent regulated in South Africa, and are nominally taxed under S29A of the Income Tax Act. Besides lower effective tax rates on the investments, proceeds can be directed via beneficiary nomination, allowing the funds to be retained offshore by SA beneficiaries as well as avoiding executors fees and the delays and costs associated with administration of the estate in SA, or obtaining a grant of probate elsewhere. Recent developments have seen growth in the use of life platforms for the holding of a wide variety of assets in addition to more traditional funds, giving investors the tax advantages and estate planning flexibility of life policies together with a wide variety of investment choices. Regulation and consumer protection Reputable offshore centres have a modern regulatory environment. This will include anti-money laundering regulation to the standard of the Financial Action Task Force countries. The international investment environment is a target area for unethical advisers and criminals. Sophisticated consumer protection regulation is a critical criterion in selecting an offshore investment. The branch arrangement also provides a degree of consumer protection and oversight by South African financial authorities

137 Investment Planning B57 5. Offshore investment options for SA residents Source of Funds An investor s choice of an offshore investment vehicle will be influenced by the source of the funds. The funds may be sourced from South Africa under an exchange control allowance (see Section F) or may already be legitimately held outside South Africa from sources such as inheritances, foreign earnings, immigrant funds, assets amnestied under the official amnesty of 2003 or the Voluntary Disclosure Programme of In broad terms foreign investments can be classified into two categories: o o Those investments available in respect of funds which have to remain under exchange control ( indirect or asset swap investments) and Direct offshore investments of funds already held or transferable offshore. Advice given in South Africa regarding foreign financial products will be subject to FAIS. Indirect or asset swap investment With the advent of relaxation of exchange control a number of options were introduced. One of these was the asset swap mechanism. Essentially this meant that certain types of local institutions were allowed to take a percentage of the value of assets under management offshore, provided they were able to secure a reciprocal investment into South Africa. This allowed South Africans to enjoy some of the benefits of offshore investment, while ensuring that there was no drain on the country s foreign exchange reserves. The asset swap mechanism was removed in 2001, and replaced by rules governing portfolio investments by South African institutional investors. Institutions are now allowed to invest client funds outside South Africa, subject to certain prudential foreign exposure limits. Currently the percentages permitted are 25% of total assets for pension funds and life assurers underwritten policies, and 35% for collective investment schemes, investment managers and

138 B58 Investment Planning the investment-linked business of long-term insurers. A further 5% may be invested in African countries. o Advantages: Currency hedging: any fall in the value of the local currency will enhance an investor s returns. Familiarity: asset swaps are available in most familiar local investment vehicles, such as unit trusts, endowment policies, retirement annuities, etc. Low entry levels: asset swaps in local investment vehicles are usually available with much lower contribution levels than direct offshore investments, and with regular monthly contributions. o Disadvantages: No political risk hedging: the investment proceeds will be paid out in South Africa regardless of the political, fiscal and exchange control regimes in effect at that time. Higher cost: often there is a double layer of management, with a local product provider and a foreign fund manager. Tax: the investment will be subject to whatever tax is applicable to the relevant local vehicle. Capping: institutions may have reached the limits imposed, meaning that they cannot accept further investment. Also, if the value of their local assets under management decreases, the offshore portion may exceed the limit. Under these circumstances, fund managers are sometimes forced to sell foreign securities, and acquire local assets, usually so-called rand-hedged shares on the JSE. Many asset swap funds have had diluted offshore exposure because of this. Limited options: choice of vehicles and funds is limited.

139 Investment Planning B59 Direct offshore investment There are two categories of assets which South African residents may legitimately hold outside South Africa, and which may be invested directly into offshore investment vehicles. Firstly, there are amounts exported from South Africa under an exchange control investment allowance concession. The principal concession allows individual SA residents to invest up to R per annum (per person) in offshore markets. The concession is available to natural persons over the age of 18 and is subject to the obtaining of a tax clearance from the Receiver of Revenue. From 2012, South African residents may also utilise the Single Discretionary Allowance for investment purposes as well as travel, gifts, maintenance etc. This totals R per annum and is not subject to a tax clearance. Residents may also now apply to the Financial Surveillance Dept of SARB to exceed these limits subject to a certificate of good standing from SARS. Secondly, South African residents may also legitimately hold certain categories of foreign-sourced assets. These would include immigrants foreign-held funds, foreign income and inheritances from non-south African residents. To these must be added assets or funds in respect of which amnesty has been granted, or which have been regularised during the 2003 exchange control and tax amnesty process or the 2011 Voluntary Disclosure Programme. There are few limitations on what the investor may do with these funds in terms of expenditure or investment, although transfer to another SA resident or investing back into South Africa may not be permissible. o Advantages: Currency hedging: any fall in the value of the local currency will enhance performance. Hedging political risk: the investment is in a stable political environment. Lower cost: direct offshore investment usually has a lower cost.

140 B60 Investment Planning Choice of currency: both the investment and the proceeds may be in the currency of the investor s choice. Freedom from exchange controls: the investment may be made, and proceeds may be paid wherever the client wishes. Income tax, estate duty and donations tax advantages, depending on circumstances. o Disadvantages: High entry levels: direct offshore investments are denominated in strong currencies, and entry levels can be high by South African standards. Tax and estate planning: specialist advice must be sought in these areas. 6. Estate planning and tax implications Estate planning and Offshore Trusts Offshore trusts have been extensively used by South African residents for estate planning purposes, asset protection and confidentiality. These can be expensive, with trust fees varying widely between different managers in various locations. Post-amnesty, South African planners need to reassess the need for a trust. They are most effective for holding foreignsourced assets, and assets acquired by immigrants before becoming resident. The benefits include freedom from probate (estate administration) costs, freedom from estate duty for current and future generations, and the usual trust benefits such as protection from creditors and on divorce. They can be used for funds transferred from South Africa, but transfers may be subject to donations tax or Section 31(2) of the Income Tax Act. SA-resident donors to foreign trusts may also be taxed in terms of Section 7(8), and beneficiaries in terms of Section 25B (2A). Corresponding sections of the 8th schedule may apply to capital gains. Planning using foreign trusts can be complex and professional assistance should be sought.

141 Investment Planning B61 o Tax implications Residence-based tax Since 2001 South Africans have been taxed on a residence basis on their worldwide income. Where offshore income is concerned this means that there is, in theory, little difference to the taxation of similar local investments. However, practical considerations make it necessary to look at the effect on some specific types of offshore investments: o Collective investment schemes: South Africa taxes unit trusts differently to most other countries. In South Africa, local dividends have been taxfree, and the interest income attributable to an individual unit holder is taxable in the unit holder s hands. The unit trust manager has issued a certificate detailing the interest portion. Most unit holders have elected to have the income reinvested, but this did not prevent the income from accruing to them. Reinvested income purchased further units in the selected fund/s. This may change with the introduction of a withholding tax on dividends in 2012, which will probably bring South Africa closer to international practice. In many other countries there is a withholding tax levied on interest and/or dividends, before payment to the investor. Thus, the income received by a fund is after-tax income. It is unnecessary to account to individual unit holders for different types of income, and income, together with intrinsic capital growth, is automatically reinvested, and simply rolled up in the funds. Hence the commonly used term, roll-up funds. The effect of automatic reinvestment in the fund is to increase the price per unit, rather than purchase additional units, as in South Africa. This practice made it difficult to levy tax on these funds in South Africa, and in many cases a withholding tax will already have been levied on the assets in the country where they are held. The way the Income Tax Act used to read, withdrawals should have been treated as foreign company dividends. There was considerable uncertainty about this, until 2007 when the uncertainty was clarified. Foreign Unit Trusts or CIS are included in the CGT net at the full rate applicable to individuals. The administrative burden of reporting gains and

142 B62 Investment Planning losses in each tax year will remain with the individual investor. o Branch-issued- or local policies with offshore funds: Some South African life assurers offer offshore investments through the medium of policies sold under the auspices of a local head office, under a branch arrangement, whereby the policy is issued by the offshore branch. Other local insurers offer locally issued policies denominated in foreign currencies. In both cases these are at least partially regulated under the Long-term Insurance Act. This has generally been permitted where the Financial Services Board is satisfied with the level of regulation in the country where the funds are managed, such as the Isle of Man, Jersey and Guernsey. Regulation of this arrangement has been formalised in FSB directive 127 B.i(LT). These are suitable for amounts exported in terms of the foreign exchange concessions and for other money held legitimately offshore. It is logical that for tax purposes they will be treated in the same way as local long-term insurance policies, that is, taxation in terms of the four-fund approach under S29A. The effect of income tax is usually minimal because of the rollup nature of the underlying funds, and other reasons, including reinsurance agreements with foreign insurers. In some circumstances capital gains tax, at the lower effective rate applicable to insurers, may be payable by the insurer. Proceeds on maturity will be free from income tax and from CGT in terms of the Eighth Schedule to the Income Tax Act. Apart from the disclosure requirements of the Act, there is no administrative burden. o Foreign policies: In the past certain foreign insurers have marketed offshore investment policies to South African residents without any form of approval. Anyone assisting in the promotion and marketing of such polices will be in contravention of the Long-term Insurance Act. Because the South African Revenue Service has no jurisdiction over the foreign issuer

143 Investment Planning B63 of the policies, or the managers of the underlying funds, there can be no income tax implications during the term of these policies. It is for precisely this reason (according to the explanatory memorandum to the 2001 Taxation Laws Amendment Act) that the CGT exclusion granted to South African policies will not be extended to foreign policies. It is also worth noting that the basis for tax-free maturity of local long-term policies is that the policyholder has already been subjected to taxation in terms of the trustee principle embodied in four-fund taxation. Intermediaries and policyholders need to be aware that there is nothing in legislation to prevent SARS from levying income tax on the entire gain of a foreign policy held by a South African resident. In addition SARS BPR 105, issued in 2011, has made it clear that portfolio assets in such unapproved policies will be regarded as being held by the policyholder and taxed accordingly. If they are not invested in roll-up funds this could mean having to account for portfolio income on an annual basis as well as capital gains on any disposal of assets. It should also be noted that there is no legal recourse against the assurer in South Africa, should anything go wrong with this type of investment. 7. Exchange Control Odds and Ends See Exchange Control Guidelines on page F3

144 B64 Investment Planning Notes

145 Retirement Planning Retirement Planning

146 Retirement Planning

147 Retirement Planning C1 Retirement Planning Worksheet 1. Retirement income required (Present Value) Monthly expenditure x 12 : R. x 12 or percentage of annual salary : R. x % R 2. Less: Income available at retirement (Present Value) If client/partner belongs to a defined benefit fund: Pension: Years service x percentage x average salary (in present value) Client :.. years x.. % x R.. Partner :.. years x.. % x R.. (R ) If client/partner belongs to a defined contribution fund Pension that could be purchased with the projected retirement benefit (in present value) Client: Partner Other income (e.g. rental) 3. Conversion of income shortfall to capital shortfall Preliminary questions: Preserve (Table A) or consume (Table B) capital Inflation rate Investment period/life expectancy at retirement Interest rate Shortfall x factor (Table A or B) INCOME SURPLUS/SHORTFALL = capital required. %. years.% R.... x R.... R 4. Add: Lump-sum expenses at retirement (present value) R Total capital required 5. Less: Present value of a defined contribution fund benefit (only if not already in step 2 above) 6. Less: Present value of future capital amounts (R..) (R..) (R ) R R (R ) Projected maturity value x factor (use discount tables to obtain factor) e.g. assurance policies (1) R x R. = R (2) R x R. = R (3) R x R. = R (R ) 7. Less: Present value of OTHER EXISITNG INVESTMENTS (e.g. unit trusts, fixed deposits) (1) = R (2) = R (3) = R (R ) CAPITAL SURPLUS/SHORTFALL 8. Monthly investment needed to eliminate shortfall Shortfall years to retirement 12 months R... years 12 months 9. Less: Contributions to other existing investments (see above) (R ) Additional monthly investment to eliminate shortfall R R

148 C2 Retirement Planning Notes to Retirement Planning Worksheet The first section in the worksheet indicates the income the investor requires at retirement. This could be based on expected monthly expenditure. If all calculations in the worksheet are done with pre-tax amounts, this monthly expenditure must make provision for income tax. The assumption is made that pension income and other income entered in section 1 will keep pace with inflation. Please note that in step 2 a distinction is made between a defined benefit and defined contribution fund member. If the client belongs to a defined benefit fund, simply use the formula in the fund rules to determine the pension. If the client belongs to a defined contribution fund his/her projected retirement benefits would normally be expressed as a lump sum. You can follow one of two routes: Draw a quote based on the projected amount that would be available to obtain an income figure that could be entered in this section. Remember to always use present values. (The income amount from the quote needs to be discounted to a present value.) or Take the defined contribution benefit expressed as a lump sum and enter this amount in Step 5 (again using present values). In section 2 of the worksheet the income shortfall is converted to a capital shortfall. The investor should indicate whether he/she wishes to preserve capital or consume the capital over the identified investment period (term of retirement). In step 6 of the worksheet, where future capital amounts are deducted, the assumption is made that all capital amounts will be available at retirement. This means that the future value of the investment at retirement date is worked back to a present value. Certain amounts might, however, not be available at the chosen retirement date, because, for example, the term of the investment extends past the chosen retirement date. The same procedure will be followed in these cases. Use the compound interest tables (Table F in the General section of this book) to work back from the future value to the present value of the capital amounts. Remember, however, to use the full term of the investment to work back to present value.

149 Retirement Planning C3 Example Retirement date is in ten years time. The investment has a 15-year term. Projected value of the investment is R Assume inflation of 8% over the term: Work back the projected value of the investment with the factor obtained from table F, over a 15-year term to a value in today s terms. R x 0, = R (Please note that the same result can be achieved by using a financial calculator.) Enter the present value (R ) under the appropriate category in the worksheet, i.e. Present value of future capital amounts. In this way the investor can see the total capital position at retirement, even though some of these amounts might not be available at retirement date. In order to plan effectively, the investor should be aware that not all capital amounts will be available at retirement. In step 9 you will see the monthly investment needed to eliminate the potential shortfall as calculated in the previous steps. The assumption is made that the monthly investment will increase annually in line with the inflation rate and the invested capital will also grow at the inflation rate. The monthly investment calculated to eliminate the shortfall, in step 9, will provide for the shortfall in Present Value terms. The shortfall at the end of step 7, could be converted to a Future Value (using the inflation rate and years to retirement) and then step 8 and step 9 could be applied to calculate the monthly requirement to achieve the future shortfall. Note that the worksheet is a very simplified capital needs analysis and the accuracy of calculated results can therefore not be guaranteed.

150 C4 Retirement Planning Table A: Capital preservation Table to calculate the capital required to: (i) provide a R1 yearly annuity payable in advance and escalating at e% p.a. for n years, and (ii) return the capital sum after n years. Assume an interest rate of i% p.a. Interest (i) 9% 9% 9% Yrs (n) Escalation rate/inflation (e) 3% 4% 5% 6% 7% 8% % 10% 10% % 11% 11% % 12% 12% % 13% 13% % 14% 14% % 15% 15% % 16% 16% % 17% 17% % 18% 18% % 19% 19% % 20% 20%

151 Retirement Planning C5 Interest (i) Yrs (n) Escalation rate/inflation (e) 9% 10% 11% 12% 13% 14% 9% 9% 9% 10% 10% 10% 11% 11% 11% 12% 12% 12% 13% 13% 13% 14% 14% 14% 15% 15% 15% 16% 16% 16% 17% 17% 17% 18% 18% 18% 19% 19% 19% 20% 20% 20%

152 C6 Retirement Planning Table B: Annuity Rates Table to calculate the capital required to: (i) Provide a R1 yearly annuity payable in advance and escalating at e% p.a. for n years, and (ii) Capital is consumed / deleted after n years. Assume an interest rate of i% p.a. Interest (i) 9% 9% 9% Yrs (n) Escalation rate/inflation (e) 3% 4% 5% 6% 7% 8% % 10% 10% % 11% 11% % 12% 12% % 13% 13% % 14% 14% % 15% 15% % 16% 16% % 17% 17% % 18% 18% % 19% 19% % 20% 20%

153 Retirement Planning C7 Interest (i) Yrs (n) Escalation rate/inflation (e) 9% 10% 11% 12% 13% 14% 9% 9% 9% 10% 10% 10% 11% 11% 11% 12% 12% 12% 13% 13% 13% 14% 14% 14% 15% 15% 15% 16% 16% 16% 17% 17% 17% 18% 18% 18% 19% 19% 19% 20% 20% 20%

154 C8 Retirement Planning ADMINISTRATIVE REQUIREMENTS Retirement planning vehicles: A Comparison Provident Fund Must be approved by the Registrar (Pension Funds Act). Pension Fund Must be approved by the Registrar (Pension Funds Act). Retirement Annuity Must be approved by the Registrar (Pension Funds Act). Must be approved by Commissioner of SARS. Must be approved by Commissioner of SARS. Must be approved by Commissioner of SARS. DEDUCTIBLE CONTRIBUTION Membership agreement between employer and employee: New fund - employee choice Existing fund - compulsory Membership agreement between employer and employee: New fund - employee choice Existing fund - compulsory No agreement between employer/employee required. Fund must be registered. Fund must be registered. Fund must be registered. Employer Employer Employer 10% of approved remuneration for pension, provident funds and medical aid schemes. In practice up to 20% is allowed if justifiable. 10% of approved remuneration for pension, provident funds and medical aid schemes. In practice up to 20% is allowed if justifiable. Contribution made by employer deemed to have been made by the employee to the extent that the contribution is included in the employee s income. (Section 11(I)) (Section 11(I)) (Section 11(n)(ii)) It has been proposed that employer contributions (with effect 1 March 2014) to approved provident, pension and retirement funds are to be included as a fringe benefit for the employee.

155 Retirement Planning C9 DEDUCTIBLE CONTRIBUTION (continued) Current Provident Fund Pension Fund Retirement Annuity Employee Employee Member/taxpayer Not tax deductible Deductible with max. of the greater of: - R1 750 or - 7,5% of pensionable remuneration. (Limit also applies to government employees.) (Section 11(k)(i)) Any disallowed excess may not be carried forward to the following year of assessment. The disallowed excess is allowed as a deduction at retirement Deductible with max. of the greater of: - 15% of nonretirement funding taxable income (excluding retirement fund lump sums or severance benefits); or - R3 500 allowable pension fund contribution; or - R (Section 11(n)(aa)) Any contribution made by an employer for the benefit of the tax payer to the extent that the amount is included in the income of the taxpayer as a taxable benefit, will be deemed to have been made by the taxpayer with effect 1 March As from 1 March 2012, preservation fund benefits may

156 C10 Retirement Planning Arrear Not tax deductible R1 800 deductible p.a. as a past period contribution. Any excess above R1800 may be carried forward to the following year of assessment. be transferred to a retirement annuity. R1 800 deductible p.a. as a reinstatement of membership. Any excess may be carried to the following year of assessment. DEDUCTIBLE CONTRIBUTIONS (continued) RETIREMENT BENEFIT (Section 11(k)(ii)(aa) & (bb)) (Section 11(n)(bb)) It has been proposed (with effect 1 March 2014) that all taxpayer contributions to approved pension, provident and retirement annuity funds are consolidated with the following caps: contribution deductions will be capped at 22.5% of the higher of employment or taxable income with a maximum rand amount of R for those younger than 45 years and 27.5% with a maximum rand value of R for those older than 45 years. These limits will include risk and administration costs as well employer contributions that have been fringe benefits taxed. A minimum annual deduction of R will apply. Provident Fund Pension Fund Retirement Annuity Cash lump sum Cash lump sum Cash lump sum Entire amount or surrender value of policy. 1/3 of total value (if 2/3 of the total value is less than R the full benefit may be paid.) (Section 1 pension fund (c)(ii)(dd)) Balance used to purchase a comp. annuity; taxed at the annuitant s marginal rate. 1/3 of total value (if 2/3 of the total value is less than R the full benefit may be paid.) (Section 1 RA fund (b)(ii)) Balance used to purchase a comp. annuity taxed; at the annuitant s marginal rate. Taxable Lump sum Taxable Lump sum Taxable Lump sum The taxable retirement fund lump sum is the benefit derived in consequences of retirement, less the following The taxable retirement fund lump sum is the benefit derived in consequences of retirement, less the following The taxable retirement fund lump sum is the benefit derived in consequences of retirement, less the following

157 Retirement Planning C11 amounts, if they have not enjoyed deductions before: Contributions; Previously taxed transfer of divorce awards to the retirement fund; Previously taxed transfer of benefits to a retirement fund; and The pre-1998 amounts transferred from public sector funds. amounts, if they have not enjoyed deductions before: Contributions; Previously taxed transfer of divorce awards to the retirement fund; Previously taxed transfer of benefits to a retirement fund; and The pre-1998 amounts transferred from public sector funds. amounts, if they have not enjoyed deductions before: Contributions; Previously taxed transfer of divorce awards to the retirement fund; Previously taxed transfer of benefits to a retirement fund; and The pre-1998 amounts transferred from public sector funds. Provident Fund, Pension Fund and Retirement Annuity The taxable retirement fund lump sum accrued from 1 Oct 2007,withdrawal benefits accrued from 1 March 2009 and severance benefits from 1 March 2011 are aggregated. The aggregated lump sum is taxed as follows at retirement: Taxable income from lump sum benefits Rate of Tax R0 - R % of taxable income R R R0 plus 18% of taxable income exceeding R R R R plus 27% of taxable income exceeding R R and above R plus 36% of taxable income exceeding R The tax is reduced by the tax calculated in accordance with the above table on such lump sum benefit accrued prior to the lump sum in respect of which the tax is being determined. (Section 1 and Appendix 1 to the Income Tax Act)

158 C12 Retirement Planning RETIREMENT BENEFIT Public Sector Funds Provident Fund Pension Fund Retirement Annuity Taxable portion Taxable portion Taxable portion Lump sum benefits paid from a public sector fund were tax-free until 1 March Thereafter parity between public and private sector fund taxation. Vested rights are protected by formula C in the Second Schedule to the Income Tax Act. If a Public Sector fund is involved, the following calculation must be done: Lump sum benefits paid from a public sector fund were tax-free until 1 March Thereafter parity between public and private sector fund taxation. Vested rights are protected by formula C in the Second Schedule to the Income Tax Act. If a Public Sector fund is involved, the following calculation must be done Not Applicable

159 Retirement Planning C13 RETIREMENT BENEFIT (continued) Public Sector Funds Provident fund 1. Apply formula C: A= B x D, where C A = the taxable portion of the lump sum to be included in gross income (subject to any further deductions allowed by paragraphs 5 and 6 of the Second Schedule). Pension fund 1. Apply formula C: A= B x D, where C A = the taxable portion of the lump sum to be included in gross income (subject to any further deductions allowed by paragraphs 5 and 6 of the Second Schedule). Retirement annuity B = the number of completed years of employment, after 1 March 1998, including previous or other periods of service approved as pensionable service after 1 March B = the number of completed years of employment, after 1 March 1998, including previous or other periods of service approved as pensionable service after 1 March C= the total number of completed years taken into consideration for the purpose of determining the amount of benefits payable to the member by the fund. C= the total number of completed years taken into consideration for the purpose of determining the amount of benefits payable to the member by the fund. D = the lump-sum benefit. D = the lump-sum benefit.

160 C14 Retirement Planning RETIREMENT BENEFIT (continued) Public Sector Funds 2. Deduct the following from the taxable portion calculated ito Formula C: Contributions previously disallowed; Previously taxed transfer of benefits to retirement funds 3. Apply table under retirement benefit to taxable amount. 2. Deduct the following from the taxable portion calculated ito Formula C: Contributions previously disallowed; Previously taxed transfer of benefits to retirement funds 3. Apply table under retirement benefit to taxable amount.

161 Retirement Planning C15 WITHDRAWAL BENEFIT Provident Fund Pension Fund Retirement Annuity Cash Lump sum Cash Lump sum Cash Lump sum Subject to the rules of the fund. A minimum benefit in terms of Section 14A of the Pension Funds Act must be paid Subject to the rules of the fund. A minimum benefit in terms of Section 14A of the Pension Funds Act must be paid No withdrawals prior to age 55; except upon death or disability or where contributions are discontinued prematurely and: The member s interest in the fund is less than R7 000; or The member emigrated from RSA and the emigration is recognised by the SARB; The following documents must be submitted to SARS upon emigration: Tax clearance certificate; Tax directive on the lump sum; Supporting documents in the tax directive application; and Proof of emigration. (Section 1 RA fund )

162 C16 Retirement Planning WITHDRAWAL BENEFIT (Continued) Provident Fund Pension Fund Retirement Annuity Taxable portion Taxable portion Taxable portion The taxable lump sum retirement fund withdrawal benefit is the lump sum benefit derived other than iro death, retirement or retrenchment/redundancy, less the following amounts: The taxable lump sum retirement fund withdrawal benefit is the lump sum benefit derived other than iro death, retirement or retrenchment/redundancy, less the following amounts: Should a withdrawal be allowed, such a withdrawal will be taxed as a withdrawal from a Provident / Pension fund. (i) If they have not enjoyed deductions before: Contributions; Previously taxed transfer of divorce awards to the retirement fund; Previously taxed transfer of benefits to the retirement funds; and Pre-1998 amounts transferred from public sector funds. (ii) Amounts transferred taxfree to another retirement fund ito par 6 of the Second Schedule to the Income Tax Act. (Par 6 of Second Schedule ) (i) If they have not enjoyed deductions before: Contributions; Previously taxed transfer of divorce awards to the retirement fund; Previously taxed transfer of benefits to the retirement funds; and Pre-1998 amounts transferred from public sector funds. (ii) Amounts transferred taxfree to another retirement fund ito par 6 of the Second Schedule to the Income Tax Act. (Par 6 of Second Schedule )

163 Retirement Planning C17 WITHDRAWAL BENEFIT (Continued) Provident Fund, Pension Fund and Retirement Annuity The taxable lump sum withdrawal benefit which accrued from 1 March 2009 and retirement lump sum benefits which accrued from 1 Oct 2007 are aggregated. This aggregated amount is taxed according to the table below: Taxable income from lump sum benefits R0 - R % of the taxable income Rate of Tax R R % of the taxable income exceeding R R R R plus 27%of the taxable income exceeding R R and above R plus 36% of the taxable income exceeding R The tax is reduced by the tax calculated in accordance with the above table on such lump sum benefit accrued prior to the lump sum in respect of which the tax is being determined. (Section 1 and Appendix 1 to the Income Tax Act).

164 C18 Retirement Planning Provident Fund Pension Fund Subject to the rules of the fund a minimum benefit in terms of section 14A of the Pension Fund Act must be paid. WITHDRAWAL AS Members who withdraw from their Members who withdraw from their A RESULT OF Provident funds as a result of Pension fund as a result of retrenchment/redundancy in the retrenchment/redundancy in the RETRENCHMENT or following instances: following instances: REDUNDANCY A member whose termination of employment is due to the employer ceasing trade or intending to do so; or Redundancy is a result of an employer effecting a general deduction in personnel in a certain class; and Member s are not shareholders with more than 5% share capital or members interest in the employer; A member whose termination of employment is due to the employer ceasing trade or intending to do so; or Redundancy is a result of an employer effecting a general deduction in personnel in a certain class; and Member s are not shareholders with more than 5% share capital or members interest in the employer; Not applicable. Retirement Annuity will be taxed in terms of the Retirement table and not the withdrawal table. The same deductions will be available as for retirement or withdrawal. will be taxed in terms of the Retirement table and not the withdrawal table. The same deductions will be available as for retirement or withdrawal. (Par 2(a) of Second Schedule) (Par 2(a) of Second Schedule)

165 Retirement Planning C19 Provident Fund Pension Fund Retirement Annuity DEATH BENEFIT Cash lump sum Cash lump sum Cash lump sum Full fund value. Full fund value. Full fund value. (Section 1 Pension Fund ) (Section 1 Retirement Annuity Fund ) Taxable portion Taxable portion Taxable portion Tax free portion is calculated as explained under Retirement Benefit above. Tax free portion is calculated as explained under Retirement Benefit above. Tax free portion is calculated as explained under Retirement Benefit above. The taxable portion will be taxed as per the table included under Retirement Benefit above. The taxable portion will be taxed as per the table included under Retirement Benefit above. The taxable portion will be taxed as per the table included under Retirement Benefit above.

166 C20 Retirement Planning Preservation Funds 1. Regulations Preservation funds are defined as pension preservation funds and provident preservation funds in the Income Tax Act. In addition to the Income Tax Act, preservation funds are also governed by Practise Note RF1/2011 (which replaced RF1/98 with effect from 30 September 2010) as well as the rules of the particular preservation fund. 2. Contributions No recurring contributions are allowed. The Income Tax Act provides for membership to a preservation fund by former members of pension and provident funds, where membership was terminated by: resignation of a member; retrenchment of a member; winding up of a fund; a transfer of a business from one employer to another in terms of S197 of the Labour Relations Act; and former members of any other preservation fund. 3. Eligibility Any person may transfer a retirement fund benefit to a preservation fund of choice. Eligibility of membership is no longer based on the employer being a participating employer of the fund. A non-member spouse may transfer a divorce award to a preservation fund. Unclaimed benefits may also be transferred to a preservation fund. Upon retrenchment, the benefits from pension- and provident funds may be transferred to a preservation fund. Pension preservation funds, may receive transfers from pension funds, other pension preservation funds or provident preservation funds.

167 Retirement Planning C21 Provident preservation funds, may receive transfers from provident funds and other provident preservation funds. 4. Translocation benefits Amounts transferred to a preservation fund may not be paid or transferred in such a way that it is split between more than one preservation fund. A split transfer between one preservation fund and one retirement annuity is allowed. The one withdrawal facility is not influenced where a member transfers to a preservation fund and retirement annuity. SARS has indicated that this practice may be amended. 1 It is not a requirement that the full fund benefit in the retirement fund must be transferred to a preservation fund. A member may take a cash withdrawal and transfer the balance to a preservation fund. The cash withdrawal or deductions prior to transfer to a preservation fund will not prevent the member from making a withdrawal after transferring to a preservation fund. (Definition of preservation fund in the Income Tax provides for any lump sum benefit to be transferred to a preservation fund.) SARS has indicated that this practice may be amended. 2 Divorce award payments made in terms of section 37D of the Pension Funds Act will not prevent transfers to a preservation fund and will not affect the one withdrawal option available to members of a preservation fund. SARS has indicated that this practice may be amended. 3 1 A draft Retirement Fund Practice Note (RF1/2012) has indicated that this practice may change; at the time of publication further submissions by the industry were still to be made in terms of such draft note. 2 id 3 id

168 C22 Retirement Planning 5. Retirement benefits A member of a preservation fund does not have to retire at the same time as he/she leaves his/her employment. In a pension preservation fund, only one third of the retirement interest may be paid as a lump sum, except where two-thirds of the total value does not exceed R There is no maximum age of retirement from a preservation fund. 6. Disability benefits If an employee is retired early due to disability, he/she may retire from the preservation fund. Self-employed persons will have to satisfy the trustees of the preservation fund that they are permanently disabled in order to receive an early retirement benefit. 7. Withdrawal benefits No more than one withdrawal may be made by a member of a preservation fund (Definition of preservation fund in the Income Tax). Take note of the following: The one withdrawal facility applies separately to each preservation fund. A withdrawal from a preservation fund will be taxed as any withdrawal from a retirement fund. A deduction from a member s benefit in a retirement fund before the balance is transferred to a preservation fund is not payment to the member during his/her membership of the preservation fund and is not regarded as the member s one withdrawal. SARS has indicated that this practice may be amended. A divorce award payment before or after transferring to a preservation fund is not regarded as the one withdrawal from a preservation fund.

169 Retirement Planning C23 Severance Benefits Severance benefits are taxable in terms of the retirement fund lump sum tables. The definition of severance benefit as per section 1 of the Income Tax Act: Any lump sum amount: other than a lump sum from a retirement fund; received by or accrued to a person; from or by arrangement with the person s employer; in respect of the relinquishment, termination, loss, repudiation, cancellation or variation of the person s office or employment or of the person s appointment (or right or claim to be appointed) to any office or employment. If one of the following applies: the person is 55 years or older; or the relinquishment or termination is due to the person being permanently incapable of holding his employment or office due to sickness, accident, injury or incapacity through infirmity of mind or body; or the termination or loss is due to: - the employer retrenching the person, due to ceasing carrying on the trade in which the person was appointed; or - the person is retrenched due to a reduction in personnel. The retrenchment provision will not apply where the person being retrenched holds more than 5% of the shareholding of the company.

170 C24 Retirement Planning Comparison between defined benefit and defined contribution funds Retirement benefits Defined Benefit Determined by a formula contained in the fund rules, e.g. 2% x years service x final salary. Early retirement penalties may apply. Employee can plan more effectively for possible shortfalls since the pension formula is fixed. Defined Contribution Retirement benefit is the total fund value ( savings account ) at retirement date consisting of: member contributions + employer contributions + investment returns. Usually no early retirement penalties. Member receives the balance in the savings account. Resignation benefits Employee contributions Employer contributions Risk Pension increases Capital preservation Usually linked to years service. A scale is used to determine benefits. See Retirement Planning Vehicles: A comparison. (No difference between defined benefit and defined contribution.) Varies according to cost for the employer to provide pensions for the members. Usually involves an actuarial calculation. See Retirement Planning Vehicles: A comparison for tax implications. Employer carries the risk of investment returns. Pensions are fixed by a formula and has to be provided regardless of fund performance. Usually at the discretion of a board of trustees. Increases may or may not keep pace with inflation No automatic preservation of retirement capital after member and dependants die. No fixed pension formula. Pension will depend largely on investment returns of the fund. Makes planning for possible shortfalls difficult. Usually no scale used. Member receives the full value in the savings account. See Retirement Planning Vehicles: A comparison. (No difference between defined benefit and defined contribution.) Employer contribution is a fixed percentage of the identified portion of the employee s remuneration. See Retirement Planning Vehicles: A comparison for tax implications Employee carries the risk of future investment returns. Member controls increases by the annuity option chosen by him/her at retirement. Depends on the annuity option chosen by the member at retirement.

171 Retirement Planning C25 Retirement Annuity Calculation Sheet GROSS INCOME Salary R Trade Business income R Commission R Interest R Unit Trust Interest R Dividends R Other dividends R Other. R. R Total R R EXEMPT Basic Interest R Dividends R Other. R R (R ) INCOME R Less: Retirement funding income (R ) R Less: Allowable deductions (only applicable to non-retirement funding income excluding the following deductions: Lessor s expenditure on soil erosion; medical, dental and physical disability expenses; donations to certain public benefit organisations; farming capital expenditure) Expenditure in the production of income R Other R R - R NON-RETIREMENT FUNDING TAXABLE INCOME R # (Lump sums received from retirement funds upon retirement or withdrawal from a retirement fund and severance benefits may not be included in Non-Retirement Funding Income) MAXIMUM DEDUCTIBLE CURRENT CONTRIBUTIONS The greater of: (A) 15% of R # OR R (A) (B) R allowable pension fund contributions R R..... OR R (B) (C) R R (C) The greater of (A), (B) or (C) R MAXIMUM (ADDITIONAL) CONTRIBUTIONS Maximum deductible current contributions R Less existing contributions (R ) MAXIMUM (ADDITIONAL) CONTRIBUTIONS R

172 C26 Retirement Planning Calculating the tax payable where the taxpayer retires from more than one retirement fund (after 1 October 2007). Step 1: Summarise the amounts Lump sum Pension fund Provident fund Retirement annuity Total Step 2: Calculate the tax-free portion from the Retirement Funds Contributions which did not previously qualify as a deduction; Previously taxed transfers of divorce awards; Previously taxed transfers of benefits to the retirement fund; and Pre amounts transferred from public sector funds. Step 3: Calculate the tax payable on the lump sum from Retirement Funds Total lump sum from pension, provident and retirement annuity funds = R... (Refer step 1) LESS: Tax-free amount (R...) (Refer step 2) Total Taxable Amount R...

173 Retirement Planning C27 Apply the following table to the taxable amount: Taxable Income from lump sum benefits R0 R R R R R R and above Lump sum 0% of the taxable income R0 + 18% of the taxable income above R R % of the taxable income above R R % of the taxable income above R

174 C28 Retirement Planning Calculating the tax payable where the taxpayer retires from a retirement fund after having withdrawn or retired from another fund previously and/or receiving a severance benefit Step 1: Calculate the taxable lump sum amount of the current retirement fund and/or the current severance amount received. Step 2: Identify and add previous amounts received: Taxable lump sums received from retirement funds upon retirement (from 1 Oct 2007) + Taxable lump sums received from retirement funds upon withdrawal (from 1 March 2009) + Severance payments (from 1 March 2011) Step 3: Add the taxable amounts in Step 1 + Step 2. Step 4: Calculate the tax payable on the total amount calculated in Step 3, applying the retirement tax table. Step 5: Calculate the tax payable on the previously taxable withdrawal / retiral lump sum amounts calculated in Step 2. Apply the retirement tax table to arrive at a hypothetical tax amount. Step 6: Tax payable = Tax calculated in Step 4 R LESS : hypothetical tax calculated in Step 5 (R ) = Tax Payable R The same aggregation method is applied upon death, withdrawal and retrenchment/redundancy where the applicable table is applied depending on the event.

175 Retirement Planning C29 Techniques to reduce income tax at retirement Introduction Prior to 1 October 2007, the taxable portion of a lump sum was taxed at the taxpayer s average rate of tax, this changed with the amendments to the Income Tax Legislation in The lowering of the average rate of tax will no longer effect the tax payable on lump sums from retirement funds, since fixed rates were introduced in October Investment of capital in investments generating tax-free returns A technique of reducing the taxpayer s taxable income is to invest income-generating capital in tax-free investments. Investments could be made in endowments or sinking funds, which could pay tax-free income after maturity. 2. Limiting lump sums to tax-free amount The tax payable on lump sums can be avoided by limiting the lump sum to an amount which may be taken tax-free. However, it should be borne in mind that the amounts which would have been taxable at a fixed rate will now be taken as a compulsory annuity and be taxed at marginal rates, such marginal rates may be higher than the fixed rates. 3. Preserve retirement fund benefits upon withdrawal Should a tax payer withdraw from a retirement fund prior retirement, the withdrawal will have an influence on the tax payable at retirement. Should a tax payer preserve retirement fund benefits upon withdrawal by transferring to a preservation fund or a retirement annuity, the tax payable will be limited at retirement. 4. Retire later from Retirement Annuities The legislation forcing a member to retire at age 70 has been amended. A large number of retirement annuity funds have made amendments to their rules to allow members to retire after the age of 70. Members may thus retire at any age after 55.

176 C30 Retirement Planning Divorce order awards from Retirement funds A portion of a member s interest in a retirement fund may be awarded to a former spouse of the member in terms of: Section 7(8) of the Divorce Act; Section 37D of the Pension Funds Act and General Financial Services Amendment Act, 2008 Pension Interest is defined as following in the Divorce Act: In the case of a Pension Fund, Provident Fund, Pension Preservation Fund and Provident Preservation fund: The benefits to which a member would have been entitled had he/she withdrawn from the fund on the date of divorce. In the case of a Retirement Annuity: The member s contributions up to the date of divorce plus annual simple interest at the rate as prescribed by the Prescribed Rate of Interest Act. The maximum interest may not be more than the fund return. The Pension Fund Act was amended in 2007, to introduce the clean break principle whereby payments may be made to non-members immediately after divorce. The non-member no longer has to wait for the member to exit the fund. Divorce Order granted before 13 September Date of deemed accrual: Accrual date is the date of deduction from the fund. Date of deduction is the date of election by non-member spouse to take cash or transfer to another fund. If no election and fund requests an election, it must be made within 120 days. 2. Tax position: Where the deduction was made between 1 November 2008 & 1 March 2009, the member was regarded as the taxpayer. The divorce award was taxed at the member s average rate of tax.

177 Retirement Planning C31 Where the deduction was made after 1 March 2009, no tax is payable. Divorce Order granted after 13 September Date of deemed accrual: Date of deduction from the fund is the date of accrual. 2. Tax position: Where the deduction was made prior to 1 March 2009, the member is the taxpayer and the award is taxed at the member s average rate of tax. Where the deductions were made after 1 March 2009, the non-member is the tax payer if deducted from the member s minimum individual reserve. If not deducted from the minimum individual reserve (e.g. former spouse makes an election after the member exits the fund or public sector funds which not governed by the Pension Funds Act), taxed in the member s hands and member may recover from former spouse. Withdrawal table applies where deductions is made after 1 March Non-member may transfer to an approved retirement fund and such a transfer is tax-free. Upon retirement or withdrawal from retirement funds by the non-member, the taxed divorce award would be aggregated with other lump sums. (Par 2(1)(b)(iA) and 2B of the Second Schedule)

178 C32 Retirement Planning Divorce Orders and the Government Employees Pension Fund (GEPF) The GEPF was amended (14 Dec 2011) to allow the clean break principles to apply to the GEPF. The amendment however does not mirror the private sector-funds, and National Treasury proposed that it should. In terms of the amendment to the GEPF; the divorce order accrues to the member with tax implications for the member, unlike the private sector-funds where the funds accrue to the non-member. It has therefore been proposed that the regime, as from 1 March 2012, should be as follows: Divorce orders issued before 13 September 2007: neither the member nor the non-member is taxed; irrespective of when the non-member claims payment. (Similar to the private sector-funds) Divorce orders issued on/after 13 September 2007: the nonmember is taxed, irrespective of when he/she claims payment of the award. (Similar to the private-sector funds). It is intended that Formula C will apply to the award to the non-member, so as to apportion the tax-free portion of the member s pensionable service accruing prior to 1 March 1998.

179 Retirement Planning C33 Notes

180 C34 Retirement Planning

181 Business Assurance Business Assurance

182 Business Assurance

183 Business Assurance D1 Business Entities: A comparison Sole proprietorship Partnership Close corporation Company 1. Nature The sole proprietorship is a business which is owned by one person in his/her own name, administered to his/her own advantage, and exclusively and fully at his/her own risk and responsibility. 2. Membership Any one individual (with the necessary contractual capacity) can be a sole proprietor. A partnership is the legal relationship which arises when at least two people and/or legal entities contribute something (be it money, skill or labour) to a business enterprise with the object of making and sharing profits. Any individual (with the necessary contractual capacity) and/or legal entity can be a partner. The maximum number of parties who can be party to a partnership is 20 (minimum two). A close corporation is a separate legal entity apart from its members which can attract rights and obligations in its own name. Only natural persons can be members of a CC. The following persons can also qualify for membership: (i) A trustee under a testamentary trust provided no juristic person is a beneficiary of the trust and if the trustee is a juristic person, it is not controlled by a beneficiary of the trust. (ii) An executor or administrator (who can be a juristic person) in the estate of a deceased member. A company is a legal entity separate from its shareholders, which can acquire legal rights and obligations in its own name. Any person, natural or juristic, may be a shareholder in a company. Thus a CC can be a shareholder in a company. A private company may have only one shareholder whereas a public company must have at least seven shareholders. A private company is restricted to a maximum of 50 shareholders, while there is no limitation in respect of the amount of shareholders n a public company.

184 D2 Business Assurance 2. Membership (cont.) Sole proprietorship Partnership Close corporation Company (iii) A trustee or curator (who can be a juristic person) of an insolvent estate of a member. A trustee of an Inter Vivos Trust can hold a member s interest in a Close Corporation provided the following requirements are met: a natural person was immediately before 13/4/87 a member of the CC for the benefit of the trust. no juristic person is a beneficiary of the trust. the member personally has all the rights and obligations of a member. the CC is not obliged to obligations of the trust. The total number of members and trust beneficiaries does not at any time exceed 10. A company or another CC cannot hold an interest in a CC. A CC can have between one and ten members.

185 Business Assurance D3 3. Creation and Organisation Sole proprietorship Partnership Close corporation Company The sole proprietorship is created by the voluntary action of the individual. There are generally no formal requirements which have to be observed before business can be commenced expect for compliance with possible licence requirements. A partnership is created by the voluntary agreement of the parties and there are generally no formalities. The agreement may be either oral or in writing or even by implication. Usually there is a written agreement to avoid and resolve disputes re the terms of the agreement. Incorporation takes place upon registration of the founding statement by the Registrar of Close Corporations. This is a document signed by or on behalf of the members of the CC and must contain various particulars as prescribed by the Act. These include: The full name of the CC. The principal business to be carried on. The postal address. The business address. The full names and ID number of each member. The size of each member s interest, expressed as a percentage. The particulars of the members contributions. The name and address of the accounting officer. The date of the end of the corporation s financial year. A company is formed according to statute. The company comes into existence when the Registrar of Companies issues a certificate of incorporation. The Memorandum of Incorporation defines the limits of the company s business activities and once registered, serves as a notice to the public of facts about the company which are of interest to those who deal with it. The board of the company may make, amend or repeal any necessary or incidental rules relating to the governance of the company in respect of matters that are not addressed in the Companies Act 7 of 2008 or the Memorandum of Incorporation.

186 D4 Business Assurance 3. Creation and Organisation (cont.) 4. Capital Structure Sole proprietorship Partnership Close corporation Company There is no limitation on the amount of capital which a sole proprietor can use in his/her business. For obvious reasons, however, capital is limited to the means of the proprietor, and may be varied at his/her will. There is no limitation on the amount of capital in a partnership, but for obvious reasons capital is restricted to what the individual partners are prepared to contribute. Capital can be increased or decreased by agreement. * Capital in this context does not only include monetary contributions but labour and skills as well. The internal organisation of a CC may be regulated by an association agreement. This could lay down the voting rights of its members, the transfer or disposal of a member s interest the participation of members in profits document and does not have to be lodged with the registrar. The members contributions constitute the capital of the corporation. When a CC is formed, each member must make an initial contribution. This contribution can be in the form of: (i) an amount of money (ii) property (corporeal or incorporeal); (iii) services rendered in connection with and for the purposes of the formation and incorporation of the CC. The capital of a company is limited to an amount authorised in the Memorandum of Incorporation. This amount can be increased or diminished only by proper amendment of the memorandum as permitted by law. Company capital is often raised by means of long-term liabilities, debenture issues and loans from directions or shareholders.

187 Business Assurance D5 4. Capital Structure (cont.) Sole proprietorship Partnership Close corporation Company There is no restriction as to the contributions of members. Note: It is not required that the size of a member s interest in the corporation be related to the value of his/her contribution. 5. Relationship Individual to Business The undertaking is not a juristic person separate from the owner. The owner and his/her business are one and the same and thus. All the rights and liabilities of the business are legally those of the proprietor himself/herself. A partnership is not a juristic person separate from the parties who constitute it. Therefore the partners can be held jointly and severally liable. However, when parties enter a partnership relationship, their contributions do go towards forming what can be called the partnership estate which is separate from the partners personal estates. All the property in this partnership estate is owned jointly by the partners in undivided shares in such proportions as they have agreed upon. The corporation and its members are separate juristic persons. Each member of the corporation stands in a fiduciary relationship to the CC. In general, this means that a member must act honestly and in good faith and avoid any material conflict between his/her own interests and those of the CC. The company is a separate juristic person from its shareholders. The shareholders own the shares in the company. The company s assets are independent from those of the shareholders.

188 D6 Business Assurance 6. Liability for Debts Sole proprietorship Partnership Close corporation Company The proprietor is personally liable for all debts. The debts of the partnership are shared by the members in such proportions as they have agreed upon. Should the partnership estate be unable to meet the claims of creditors, the partners personal estates will be liable. As a juristic person, the CC is liable for its obligations. Members can, however, become jointly and severally liable under certain circumstances. These include: (i) where transactions are entered into without using the abbreviation CC or BK in the name. (ii) by failing to make contributions as required in the founding statement. (iii) where the number of members exceeds 10 for a period of six months. (iv) where a person takes part in the management of the CC while he/she is disqualified. (v) where the office of the accounting officer is vacant for six months. (v) where a court is satisfied that the business has been carried out recklessly, with gross negligence or with intent to defraud. The liabilities of the company are binding on the company and not the shareholders. However, in practice directors/shareholders are often required by creditors to stand security for debts of the company. In certain instances, the directors can be held personally liable.

189 Business Assurance D7 6. Liability for Debts (cont.) 7. Period of Legal Existence Sole proprietorship Partnership Close corporation Company The sole proprietor can sell or liquidate his/her lifetime. If he/she is still owner of the business at his/her death, the business assets will either be sold by the executor or transferred to the heirs or successor. Any licence, goodwill or legal agreements entered into on behalf of the business ceases on the death of the sole proprietor Various circumstances can cause the dissolution of a partnership. These include: The expiry of the period for which the partnership for which the partnership was formed: The completion of the task for which it was formed. The entry of a new partner. The retirement of a partner. The insolvency of the partnership or a partner, (vii)where certain payments are made to a member, unless: After such payment the CC s assist, fairly valued, exceed all its liabilities, or The CC is able and will continue to be able to pay its debts as they become due in the ordinary course of business. A close corporation has perpetual succession in that the death, retirement, etc. of a member does not cause its dissolution. However, there are circumstances where a CC will cease to exist. These include voluntary termination by winding up or the liquidation of a CC in terms of an order of court. The life of a company is perpetual, unless limited in terms of a charter, by-laws or statute, or unless it is wound up. The death of a shareholder, therefore, does not affect the company continuity as an independent legal body.

190 D8 Business Assurance 7. Period of Legal Existence (cont.) Sole proprietorship Partnership Close corporation Company i.e. The sole proprietorship does not benefit for perpetual succession. 8. Taxation All the profits of the business belong and accrue directly to the sole proprietor. As a result, all the profits are taxable in the hands of the sole proprietor at his/her marginal rate of tax. Sole proprietors are provisional taxpayers. Inability of the partnership to perform; Dissolution by mutual agreement or court order; death of a partner. Each partner is taxed on his/her share of the partnership income whether withdrawn or not. This share is then added to the partner s other taxable income. If a loss is made by the firm, each partner may deduct his/her share of the loss from his/her other income. If a partnership receives dividend income, the dividend income is apportioned to the partners separately form the trading income. Partnerships are provisional taxpayers. A CC pays income tax at a rate of 28% on its taxable income. From 1 April 2012, a withholding tax on profits distributed is levied at a rate of 15% on dividends, which replaces STC and which is a tax liability at member level. It is required to pay provisional tax each half year during its financial year and a third topping up payment within six months after the end of the tax year, if necessary. Members of a CC are provisional taxpayers. A company pays tax at a rate of 28% on its taxable income.* From 1 April 2012, a withholding tax on profits distributed is levied at a rate of 15% on dividends, which replaces STC and which is a tax liability at shareholder level. Companies as provisional taxpayers, are required to pay tax each half year and a third topping-up payment within six months after the end of the tax year, if necessary. Shareholders are not provisional taxpayers purely by reason of being shareholders. Note : * Refer to the Income and Capital Gains Tax Section for the taxation of Small and Micro Businesses.

191 Business Assurance D9 Sole proprietorship Partnership Close corporation Company CGT Inclusion rate: 33.3% Effective rate: % 9. Estate Duty For estate duty purposes, the value of the business on the death of the sole proprietor forms part of his/her estate. Inclusion rate: 33.3% Effective rate % A partner s share in the partnership is subject to estate duty in the same manner as his/her assets. Inclusion rate: 66.6% Effective rate 18.65% A deceased member s interest is property in his/her estate for estate duty purposes. Inclusion rate: 66.6% Effective rate 18.65% A shareholder s share in a company is subject to estate duty.

192 D10 Business Assurance Business Entities: Advantages and Disadvantages 1. Sole Proprietorship Advantages 1. Income earned accrues directly to the sole proprietor. 2. Unlike companies, no dividends are declared. Unlike partnerships, the net profits earned by the business are not distributed among various people, but belong exclusively to the proprietor. This fact encourages enterprise and sound management, as the proprietor s income relates directly to the successful operation of his/her business. 3. The sole proprietor can operate the business entirely as he/she sees fit. He/she is not responsible to a board of directors or shareholders and freedom of operation is virtually unlimited. 4. The business can be restricted or expanded at will and, subject only to license requirements, the proprietor can at any time modify or add to the type of business conducted by him/her. 5. With the exception of tax returns, there are no complicated statutory returns which have to be made to government authorities. Disadvantages 1. There is no limit to the proprietor s liability for business debts and any of his/her assets are attachable to settle those debts. 2. An employer/employee relationship does not exist between the sole proprietor and his/her business. He/she is therefore prohibited from making use of those provisions of the Income Tax Act which apply between employer/employee, e.g. Pension funds, provident funds, deferred compensation plans and fringe benefits. Nothing prevents him/her, however, from implementing one or more of these schemes for his/her employees. 3. Unless some specific arrangement exists, the sole proprietor business will automatically terminate on the proprietor s death. The business assets and liabilities are regarded as falling into the sole proprietor s estate to be dealt with by his/her executor 6. Only if the sole proprietors marginal tax rate is lower than the corporate tax rate then it is better that the profits of the business are not taxable as business income, but are taxed only in the sole proprietor s hands. Capital gains are taxed in the sole proprietor s hands which could be beneficial because the effective tax rate for capital gains in the

193 Business Assurance D11 hands of individuals is less than that of companies and close corporations. Sole proprietors also qualify for the primary abatement, whereas companies and close corporations do not qualify for an annual abatement. On death of the sole proprietor he/she is deemed to have disposed of all assets, including business assets. The sole proprietor may also qualify for the R exemption on disposal of a small business. 7. The termination of a sole proprietorship is far simpler than in other cases. He/she simply ensures that all his/her business obligations are met and then ceases to conduct business; or he/she may sell the business as he/she may sell any other personal asset. No other formal requirements need to be met.

194 D12 Business Assurance 2. Partnership Advantages 1. Partnerships are cheaper and easier to form than companies or close corporations. 2. Partners are not restricted in their operations by the strict requirements of the Companies Act. 3. In terms of the Income Tax Act partners are liable for tax in their individual capacities. Each partner is therefore taxed on his/her share of the partnership profits, and the partnership itself is not taxed. This may be an advantage in that it allows the partner to structure his/her personal tax planning. 4. Partners also pay capital gains tax in their personal capacities. In terms of the 8th Schedule to the Income Tax Act a partner can disregard R of the gain on disposal of the partnership interest in the event of the death of the partner. This exemption applies in respect of small businesses and an interest in a partnership qualifies as a small business. Disadvantages 1. A partnership is automatically dissolved if a partner leaves or a new partner joins. 2. The partners are jointly and severally liable for the debts of the partnership, provided that the debs are incurred with the authority of the partnership and in its name. It is only after the dissolution of the partnership that a creditor can sue the partners of the firm individually. Until that stage he/she must proceed against the partnership. 3. A partner may not be a member of the partnership s pension fund or provident fund. One exception: In terms of an amendment to the Income Tax Act in 1978, any employee who is a member of a partnership s pension or provident fund may remain as a member when he/she is appointed as a partner, provided his/her contributions are based on his/her pensionable remuneration received during the preceding twelve months and his/her benefits from the fund are calculated accordingly.

195 Business Assurance D13 3. Close Corporation Advantages 1. The CC is a separate legal entity. 2. The main advantage is the simplicity in its registration and the relative lack of formalities. This reduces the cost of acquiring and retaining corporate status. 3. A CC is not required to hold any meetings, though these may be held if it so wishes or if requested to do so by a member. 4. As no audit is required, no audit fees are incurred. 5. Annual financial statements are relatively simple. 6. Members interests do not have to be proportionate to their contributions. These interests may be varied from time to time. 7. A CC may acquire the interest of a member or provide financial assistance to acquire a member s interest. 8. It is simple and inexpensive to change the particulars of the founding statement. 9. As there are no directors or shareholders no special resolutions are necessary for a CC to take any action it is legally entitled to take. An association agreement may provide that only certain members can be involved in the management of the business of the close corporation. Disadvantages 1. Every member is an agent for a CC and can act on its behalf and participate in its management (unless excluded from doing so by way of an association agreement.) Although each member has a fiduciary duty to the CC, outsiders are not bound by any restrictions on or disqualifications of members of which they were not aware. 2. A member can be personally liable to a CC for breach of fiduciary duty or for loss through failure to act with the skill and care that can reasonably be expected from a person with his/her skill and experience. 3. The disposal of a member s interest requires the consent of all other members of a CC. There are certain exceptions in respect of an insolvent or deceased member but, even in these instances, the CC has the right to acquire such interest in preference to any third party. 4. A CC cannot be sold to a company. It would first have to be converted to a company before it could be sold as a going concern to another company.\ 5. A CC cannot become a subsidiary of a company or another CC. Consequently, it will not be possible to include a CC in a group structure other than as the top holding body. 6. The restriction on the number of members can be an inhibiting factor in the expansion of a successful enterprise. 7. Although an audit is not a statutory requirement, banks or other financial institutions may require it before they

196 D14 Business Assurance advance funds. 8. Close corporations are subject to capital gains tax and have a higher inclusion rate and effective rate of tax on capital gains than individuals. Close corporations also do not qualify for the primary abatement applicable to individuals in respect of capital gains. 9. No new close corporations can be registered (which was effective as from 1 May 2011)

197 Business Assurance D15 4. Company Advantages 1. It is a separate legal entity. 2. Liability of shareholders is normally limited. 3. Partners are normally limited to 20 and CC s may only have 10 members whereas the shareholders of a private company can be The Companies Act and memorandum and articles of association provide clear guidelines as to the conditions under which a company can operate. 5. A company is entitled to purchase its own shares subject to the stringent requirements set out in the Companies Act. 6. Shares in a company are easily transferable: Additional shareholders can be introduced and existing shareholders bought out, without much difficulty. Valuation of shares held may be more favourable for estate duty purposes than direct holding of assets. Disadvantages 1. Inflexibility in distribution of capital. Allotment of shares cannot be revoked. Capital profits are not easily distributable. 2. Constant rate of tax regardless of income level. 3. Greater disclosure required may lead to closer scrutiny by SARS. 4. An annual audit must be performed. 5. Companies are subject to capital gains tax and have a higher inclusion and effective rate of tax on capital gains than individuals. Companies also do not qualify for the annual exclusion or the primary residence exclusion applicable to individuals in respect of capital gains. 7. Continuity of family control over a business or farm may be enhanced by company formation. Shares can be passed on to heirs. 8. A company is a separate entity for income tax purposes. 9. With a company it is relatively easy to arrange for employees to participate in the concern s profits. By taking up shares, employees participate in the company s growth. Share incentive schemes have become an accepted way of rewarding workers.

198 D16 Business Assurance Companies Act 71 of 2008 New structure of companies As from 1 May 2011, the choice of companies would be broken up into two main sections, i.e. Profit Companies and Non-profit Companies. A further explanation of the companies that may be chosen under those sub headings are explained below. 1. Non-profit companies the old section 21 companies and companies limited by guarantee their names are to end with NPC they are established for a public benefit purposes (such as welfare, arts, culture) and are exempt from various requirements only reasonable compensation for services rendered may be distributed to certain officials and incorporators, but not income and property. 2. Profit companies are state-owned companies; o o an entity registered as a company as defined in terms of this Act and falls within the definition of a state-owned enterprise in terms of the Public Finance Management Act, or is owned by a municipality in terms of the Local Government: Municipal Systems Act and is similar to an enterprise in paragraph a) the company s name must end with SOC Ltd private companies o o a company that is not a state owned company Its Memorandum of Incorporation must: prohibits the offering of its securities to the public, and restrict the transferability of its securities

199 Business Assurance D17 o o there is no longer a maximum of 50 shareholders allowed company name is to end with (Pty) Ltd personal liability companies o o o o o effectively the old section 53(b) companies a company that meets the requirements for a private company, and its memorandum of incorporation states that it is a personal liability company has the effect that the directors and past directors are jointly and severally liable with the company for any debts and liabilities company name is to end with Inc public companies; name to end with Ltd o a profit company that is not a state-owned, private or personal liability company. 3. Close Corporations In terms of paragraph 2 of the 3 rd Schedule to the Act, no new close corporations may be formed once the Act becomes enforceable. With regard to existing close corporations, paragraph 3 of the same Schedule states that businesses may continue to run their operations out of an existing close corporation if they so wish, until such time as that business is deregistered, dissolved or converted into a private company governed under the new Companies Act.

200 D18 Business Assurance Company-owned policies Summary of tax implications In this section, for the sake of convenience, a policy effected by an employer, company or close corporation on the life of an employee or director will be referred to as a company-owned policy and any reference to company will include all business undertakings where an employer/employee relationship exists. A policy owned by a company on the life of an employee or director could be subject to income tax under the Income Tax Act. Previously, this was as a result of paragraph (m) of the definition of gross income in section 1. As from 1 March 2012 however, company owned policies will also be taxed in terms of a new paragraph (d) of the definition of gross income. 1. Paragraph (m) of the definition of gross income As from 1 March 2012 paragraph (m) was replaced with the following new paragraph: (m) any amount received or accrued in respect of a policy of insurance of which the taxpayer is the policyholder, where the policy relates to the death, disablement or severe illness of an employee or director (or former employee or director) of the taxpayer, including by way of any loan or advance; Provided that (i) (ii) any amount so received or accrued shall be reduced by the amount of any such loan or advance which is or has been included in the taxpayer s gross income, to the extent that paragraph (a) or (d) of this definition applies to an amount, this paragraph does not apply to that amount. 2. Paragraph (d) of the definition of gross income Paragraph (d) is amended from 1 March 2012 and is applicable where the policy benefits are received by or accrues to the employee/director or a dependant or nominee of that employee/director. Paragraph (d) reads as follows:

201 Business Assurance D19 Any amount including a voluntary award received or accrued: (i) in respect of the relinquishment, termination, loss, repudiation, cancellation or variation of any office or employment (or right to be appointed) to any office or employment (ii) by or to a person, or dependant or nominee of the person, in respect of proceeds from a policy of insurance where the person is or was an employee or director of the policyholder (iii) by or to a person, or dependant or nominee of the person, in respect of any policy of insurance (other than a risk policy with no cash value or surrender value) that has been ceded to: aa. the person (employee/director); bb. a dependant, or cc. a pension fund, pension preservation fund, provident fund, provident or retirement annuity fund for the benefit of the person or dependant or nominee of the person by (A) the employer or former employer of the person; or (B) the company of which the person is or was a director There is also a proviso to paragraph (d) which states that the provisions of (i) and (ii) do not apply to a lump sum award from a retirement fund. It goes on to say that an amount which becomes payable in consequence of the death of the person is deemed to have accrued to the person immediately prior to his or her death and that any amount that is received by or accrues to a dependant or nominee of the employee/director of a person is deemed to be received by or accrued to that person. The important factor to take note of is how these two provisions change of the manner that of the way that the policy in treated. Under the previous methods, the proceeds of the policy would only be included in gross income if the premium ranked for tax deduction. As from 1 March 2012, the policy proceeds are included in gross income irrespective of whether the premiums ranked for tax deduction or not. Exemptions under section 10 are now used to render a policy proceeds tax-free in particular circumstances.

202 D20 Business Assurance 3. Deductibility of premiums - Section 11(w) Much like the Taxation Laws Amendment Act 2010 had introduced significant changes in respect of the deductibility of premiums paid by employers on company-owned policies, the Taxation Laws Amendment Act 2011 has replaced that section 11(w) in its entirety (which ran for years of assessment commencing as from 1 January 2011) and stipulates that a deduction will be available to employers who are the policyholders of long term insurance policies in the following two scenarios: The new section 11(w) provides for a deduction in respect of expenditure incurred by a taxpayer in respect of premiums payable under an insurance policy (but not a policy solely against an accident as defined in section 1 of the Compensation for Occupational Injuries and Diseases Act) of which the taxpayer is the policyholder. It allows for deductions in respect of two categories of policies, which are section 11(w)(i) and section 11(w)(ii). This will be referred to as (i) fringe benefit policies and (ii) key person policies and is applicable in respect of premiums paid on or after 1 March Fringe benefit policies section 11(w)(i) The first deduction allowed under section 11(w) is where the following requirements are met: (a) (b) the policy relates to the death, disablement or severe illness of an employee or director of the taxpayer; and the premium paid by the employer/company is deemed to be a taxable benefit granted to the employee/director [paragraph 2(k) of the 7 th Schedule]. 3.2 Key person policies section 11(w)(ii) The second deduction allowed under section 11(w)(ii) applies in cases where the premium is not required to be included in the gross income of the employee/director if a number of requirements under the section are met. The requirements to be met are:

203 Business Assurance D21 (a) The taxpayer is insured against any loss by reason of the death, disablement or severe illness of an employee or director of the taxpayer; (b) The policy is a risk policy with no cash or surrender value; (c) The policy is not owned by a person other than the taxpayer at the time of payment of the premium, and (d) In respect of a policy entered into: a. on or after 1 March 2012 the policy agreement states that this paragraph applies in respect of premiums payable under that policy; or b. before 1 March 2012, it is stated in an addendum to the policy agreement by no later than 31 August 2012 that this paragraph applies in respect of premiums payable under the policy. Prior to the changes in the 2011 Amendment Act, some employers were often elected to be issued with a policy that did not conform to the regulations of 11(w) i.e. a non-conforming policy. The 2010 Act however, removed the distinction between conforming and non-conforming policies and as such had left employers with the predicament in that, previously nonconforming policies had met the requirements of the then s11(w), meaning that the premiums was deductible and the proceeds taxable. The 2011 Act then repealed the 2010 Act in its entirety as from its effective date, i.e. from 1 January This means that the old pre-2010 taxation regime was reinstated and applied up until 29 February Therefore, up until 29 February 2012, the OLD section 11 (w) was applicable, bringing back the distinction between conforming and non-conforming policies. As mentioned previously, the new changes to company owned policies as discussed above applies to premiums as from 1 March As mentioned in an earlier paragraph, the deduction of the premiums does not affect whether or not the proceeds of a particular policy will be deductible or not. The proceeds of these policies are automatically included in gross income (either in

204 D22 Business Assurance terms of paragraph (m) or paragraph (d)). The next question however is to determine whether the proceeds or the policy is subject to an exemption or not, which will be discussed in the paragraphs below. 4. Exemptions The two new subparagraphs that were introduced in the Amendment Act of 2011 are sections 10(1)(gG) and 10(1)(gH) 4.1 Section 10(gG) The new section 10(1)(gG) exempts an amount that is included in the gross income of the employee/director under paragraphs (d)(ii) and (d)(iii) from tax in the following instances: (i) in the case of a policy that is a risk policy with no cash value or surrender value, if the amount of premiums paid in respect of that policy by the employer of the person has been deemed to be a taxable benefit of the person in terms of the Seventh Schedule since the later of a. the date on which the employer or company contemplated in those subparagraphs became the policyholder of that policy, or b. 1 March 2012 unless the amount of the premiums paid was deductible by the person in terms of section 11(a); (ii) in the case of any other policy, if an amount equal to the aggregate of the amount of any premiums has been included in the income of the person as a taxable benefit in terms of the Seventh Schedule since the date on which the policy was entered into; The provisions of this exemption introduce certain consequences. Firstly is that contained in paragraph (i) pertaining to group unapproved Permanent Health Insurance (PHI). Even though the premiums are included as a fringe benefit, these policies will not receive an exemption as a result of the employee being able to receive a s11(a) deduction.

205 Business Assurance D23 With regard to unapproved Group Life Assurance (GLA) however, the exemption would apply to the proceeds as no such deduction is available to the employee in terms of s11(a). Secondly, it is made quite clear that for paragraph (ii) to apply, all the premiums since the date of inception should have been included in gross income as a fringe benefit. As stipulated in the provisions, paragraph (ii) applies to policies that are NOT pure risk, therefore, Deferred Compensation policies would fall under the ambit of this paragraph. The reason for Deferred Compensation policies being dealt with in a separate sub-paragraph, is that the legislature makes a clear distinction between PURE RISK and NON- PURE RISK policies with regard to the date from which premiums must be included as a taxable fringe benefit for the employee. For PURE RISK policies, the inclusion of the premiums as a fringe benefit, merely needs to take place as from 1 March 2012 for the exemption to apply. With regard to NON-PURE RISK policies however i.e. Deferred Compensation policies, paragraph (ii) makes it quite clear that all the premiums since the date of inception of the policy must have been included as a fringe benefit for the employee before the exemption will apply. 4.2 Section 10(gH) The new section 10(1)(gH) exempts an amount: - received or accrued in respect of a policy of insurance contemplated in section 11(w)(ii), - where it is not stated that section 11(w)(ii) applies to premiums payable in respect of that policy, - as contemplated in section 11(w)(ii)(dd)(A) or (B). This is the exemption available for keyman policies. It is also quite favourable as it has the effect that the employer could have had a conforming policy for which they had claimed the deduction for the premiums up until 29 Feb 2012 and then decided not to make the s11(w)(ii)(dd) election from 1 March 2012, hence meaning that these

206 D24 Business Assurance policy proceeds would then be tax-free for any death after 1 March The wording of this exemption creates a bit of a minefield though, as a result of the words as contemplated in s11(w)(ii). This essentially means that in order for the exemption to apply, the policy still needs to comply with the rest of s11(w)(ii) (excluding s11(w)(ii)(dd) of course). The effect of this is that keyman policies with cash values are not strictly speaking as contemplated in s11(w)(ii) and so do not fall within the exemption, meaning that such policies are both non-deductible and taxable. Even though it appears that this was not an intended consequence of the exemption and there are current discussions to correct this situation, to date (of this publication) this is how the legislation stands. Other notable amendments regarding the taxation of company-owned policies include the following: Prior to the amendments, the old s11(w) contained a provision whereby a deduction for the premiums paid by an employer in respect of a company-owned policy on the life of an employee/director of the employer could only be claimed under section 11(w). The new s11(w) contains no such prohibition, but a new s23b(5), read together with s23b(3), provides that no deduction shall be allowed under s11(a) in respect of any expenditure incurred by a taxpayer in respect of any premium paid under a policy of insurance contemplated in section 11(w). The new s23(p) prohibits a deduction for the employer in instances where the employer cedes a policy to an employee/director or a dependant of either. The reason for this is that on cession of the policy no amount is included in the employer s gross income under paragraph (m) (as paragraph (d) applies). Therefore, if a deduction were to be allowed it would effectively be deducted from other trade income as there is no policy proceeds in gross income to deduct.

207 Business Assurance D25 Stipulations of the Long-term Insurance Act relating to company-owned policies Apart from the requirements regarding company-owned policies dealt with on the preceding pages, such policies are also required to comply with the provisions in the Long-term Insurance Act (section 54). A detailed discussion of the legislation can be found in Section F of this publication. Cession of a company owned policy It often happens that a company-owned policy is ceded to the employee or director when he/she leaves the company/employer s employment. As stated in the afore-mentioned paragraph, on cession of the policy the policy proceeds will not be included in the gross income of the employer due to its inclusion into the gross income of the employee under paragraph (d). As a general rule the capital gains or losses in respect of second hand policies are subject to CGT but there are certain exceptions. Paragraph 55(1)(b) of the 8th Schedule to the Income Tax Act provides for the situation where an employer has taken out a policy on the life of an employee and paid the premiums on the policy which were deductible in terms of Section 11(w). The policy is ceded to the employee when he/she leaves the services of the employer. This is technically a second hand policy but in terms of the amendment to paragraph 55(1)(b) any capital gain or loss on this disposal must be disregarded for CGT purposes. Paragraph 55(1)(c) of the 8th Schedule provides for the situation where a person takes out a policy to insure against the death, disability or severe illness of a partner, member or co-shareholder so that he or she can acquire the interest in the partnership or shares or similar interest in the company if the partner or coshareholder dies, becomes disabled or suffers of a severe illness. If the partnership is dissolved or the person is no longer a shareholder the policy may be ceded to the person whose life was insured and this paragraph provides that any capital gain is disregarded. The Amendment Act of 2011 also introduced two more additions to the afore-mentioned paragraph 55 in the form of a sub-paragraph (e) and (f), which provides that the capital gain on the following insurance policies must be disregarded.

208 D26 Business Assurance a) A risk policy with no cash or surrender value [para 55(1)(e]; and b) Policies exempt from tax under section 10(1)(gG) or 10(1)(gH) [para 55(1)(f] Buy and sell policies that are pure risk policies will therefore be exempt from capital gains tax even after the partnership has been dissolved. There is no longer a need to take out new policies if a partner/shareholder is replaced. The same would apply to key person policies which are pure risk policies, as it would no longer be necessary for the policy premiums to have been deductible under section 11(w) for the exclusion to apply. When the policy proceeds are paid to the policy owner. Under paragraph (m) of the definition of gross income, policy proceeds paid to the policy owner will be included in the company s gross income. This will of course not be the case should the proceeds be paid over to the employee. In such a case, it will not be included in the employer s gross income but instead in the employee s gross income in terms of paragraph (d) as discussed earlier. As mentioned before, it is no longer necessary to determine whether the policy premiums was deductible or not for the proceeds to be included in the company s gross income. Furthermore, there will be a disregard of any gain on any policies which were exempt from tax under sections 10(1)(gG) or (gh) (which is discussed in more detail in 4.1 and 4.2 respectively) 5. Summary of developments As from 1 January 2011, there had been numerous changes pertaining to the taxation of company owned policies through numerous changes to the definitions of gross income and section 11(w) of the Income Tax Act. This summary serves as a guide to those developments, detailing the respective position prior to the changes to the current position to date of this publication.

209 Business Assurance D27 (a) Position prior to the Taxation Laws Amendment Act 7 of 2010 (the original position): For a premium to have been deductible from income the following requirements had to be met: It had to be certain policies effected before 1 June It had to be a term policy i.e. a policy where the only benefit payable under the policy a benefit payable within a period fixed in such policy upon or by reason of death or disablement of the EE or director whose life is insured under the policy or the policy is a disability policy. It had to be a conforming policy. The requirements for a policy to have been a conforming policy: there was only one life assured and no other life assured may be substituted therefor; and the premiums were payable at regular prescribed intervals and such premiums could not be increased by more than a fixed ascertainable amount which could not exceed 15% of the preceding year s total premiums; and there was life cover on the policy totalling an amount not less than 80% x the term of the policy x lowest premium payable; and these terms and conditions were contained in the policy contract. A maximum amount equal to 10% of the EE s remuneration during that year was deductible in respect of these policies. (b) After the promulgation of the Taxation Laws Amendment Act 7 of 2010 (effective for years of assessment commencing on or after 1 January 2011 This Amendment Act introduced section 11(w)(i) and (ii). These sections stated that a premium could be deductible from income:

210 D28 Business Assurance S11(w)(i) In any case where the premiums paid by the employer had been included in the taxable income of the employee or director, or S11(w)(ii) Where: (i) the policy had been a long term insurance policy of which the taxpayer (company) was the policy holder, (ii) the taxpayer had been insured against any loss by reason of the death, disablement or severe illness of an employee or director the taxpayer (iii) the policy was a pure risk policy with no cash or surrender value (iv) at the time of paying the premium, the company had owned the policy (v) no transaction, operation or scheme existed in terms of which any amount recoverable under the policy or an amount equivalent to or in lieu of such amount would have been made over by the taxpayer to or in favour of the employee (John), or a person connected to John, John s deceased estate, a dependent of John (whether partially or wholly dependent) (c) After promulgation of the Taxation Laws Amendment Act of 2011 but prior to 1 March This Act was promulgated on 10 January 2012, which deleted the amendments introduced in the 2010 Amendment Act as discussed above. This effectively reinstated the position to what it was prior to the 2010 Act, which was effective until the new amendments came into operation as from 1 March Therefore, between 10 January 2012 and 1 March 2012, for a premium to be deductible from income, the requirements as discussed in paragraph (a) had to be met.

211 Business Assurance D29 (d) As from 1 March 2012 (to date of publication). For the premiums to be deductible, the requirements are those as earlier discussed in this publication under the respective headings of sections 11(w)(i) and (ii).

212 D30 Business Assurance 1. Definition Deferred compensation Deferred compensation is a benefit offered by employers to selected employees in order to promote a settled and contented staff and to induce the company s employees to remain in the company s employ for as long as possible. It is constituted by an agreement between the employer and employee, in terms of which the employer undertakes to pay the employee a sum of money at retirement or on the occurrence of some other specified event. The vehicle to fund the benefit normally consists of an assurance policy which the employer undertakes to effect on the life of the employee. 2. Income tax implications 2.1 Premiums (a) Employer: May deduct the amount of the premiums paid in respect of a policy on the life of the employee provided that s11(w)(i) requirements have been met. (b) Employee: The premiums will be included in the taxable income of the employee/director in terms of paragraph 2(k) of the 7 th Schedule. 2.2 Proceeds (a) Employer: At maturity or on surrender of the policy: (i) (ii) the proceeds of all policies taken out on the life of an employee or director will be included in the gross income of the employer. once the amount is paid over to the employee or director, the amount will then not fall into the gross income of the employer under paragraph (m) as it fall into the gross income of the employee in terms of paragraph

213 Business Assurance D31 (d) of gross income and paragraph (This is because paragraph (m) does not apply where paragraph (d) applies). (b) Employees: Any amount paid to the employee or his or her estate or dependants in terms of the service agreement will be included in his or her gross income in terms of paragraph (d)(ii) of the definition of gross income ). If amount equal to the aggregate of the amount of any premiums has been included in the income of the person as a taxable benefit since the date on which the policy was entered into, section 10(1)(gG) exempts an amount that is included in the gross income of the employee or director. 2.3 Cession Tax implications on cession of deferred compensation policies between employers Where an employer took out a deferred compensation policy in respect of an employee who has now been employed with a new employer, the previous employer can agree to cede the policy to the new employer. The new employer as the cessionary, will be the new owner of the policy. We will now look at the tax implications that could arise in two situations. In both examples, assume that that obligations towards the employee have passed from the cedant employer to that of the new (cessionary) employer. Situation 1 The new employer pays the cedent-employer a cash consideration for the policy. If this is the case, the consideration must be included in the cedent-employer s taxable income (without a resulting deduction because the cedent-employer has

214 D32 Business Assurance received compensation without retaining the obligation towards the employee). The new employer can claim a deduction for the payment of the consideration on maturity of the policy, if the requirements of s11(a) are met. Upon maturity of the policy, the normal method of taxation will be applicable as discussed under 2.2. It must be kept in mind though, that SARS may have a right of recoupment in terms of s8(4)(a) of the Income Tax Act with regard to any premiums that the cedent employer may have deducted in terms of the policy. The reason for this is that in the past, the employer would have had the ceded amount included in its gross income and pay tax on that amount. With the ceded amount no longer being included in the cedent employer s gross income, SARS would attempt to recover that previous benefit received, as the employer would have recouped those premiums paid via the consideration received. Situation 2 The policy is ceded for no consideration to a new employer. This would give rise to an accrual in neither the hands of the cedent-employer under paragraph (m) of gross income, nor the employee under paragraph (d) as there is no onward payment to the employee or director at that stage. Such employer may also not be able to claim the s11(a) tax deduction upon maturity of the policy as the policy proceeds would not form part of the employer s gross income since there would be an onward payment to the employee (and hence paragraph (d) would apply). If the requirements of s11(w)(i) are met, the new company may deduct any further premiums due under the policy. No tax implication arises for the employee immediately upon cession between old and new

215 Business Assurance D33 employer (provided there is no accrual in favour of the employee). Tax implications on cession of deferred compensation policies to employees See the discussions under Cession of a company-owned policy (summary of tax implications). 3. Estate duty implications In terms of section 3(3)(a) of the Estate Duty Act policies owned by other persons on the life of a deceased are deemed to be property in the estate of the deceased. The value to be included in the estate of the deceased is so much of the amount due under the policy as exceeds the premiums paid by such other person who is entitled to the proceeds plus 6% compound interest. The duty will be recoverable from the owner, i.e. the employer. It is the practice of SARS to tax only the net proceeds of the policy in terms of paragraph (m) of the definition of gross income after estate duty has been deducted. 4. Capital gains tax implications See the discussion under Cession of a company-owned policy (summary of tax implications). In terms of paragraph 55(1)(e) deferred compensation policies will not be subject to capital gains tax where an amount equal to the aggregate of the amount of any premiums has been included in the income of the person as a taxable benefit since the date on which the policy was entered into.

216 D34 Business Assurance Keyperson assurance 1. Definition Keyperson assurance refers to policies effected by an employer on the life of an employee with the purpose of compensating the business for the loss it will sustain should the employee die or become disabled prematurely. The plan guarantees that cash will be available to absorb any disruptions to the business, protect existing credit facilities and provide the necessary funds for the recruitment and training of a replacement. It is important to note that a keyperson is an individual that has an important impact on the future income and profits of the business. It s not just any employee, but someone who s absence, whether through death or disability, will severely impact the future sustainability of the business. 2. Income tax implications (a) (b) Premiums: If the requirements of s.11(w)ii) are met, the premiums will be tax deductible. Proceeds: If s11(w)(ii) was complied with and there was no election made to have section 11(w)(ii) apply to premiums payable in respect of that policy the maturity value will be exempt from tax in terms of section 10(1)(gH) 3. Estate duty implications Policies on the life of the deceased owned by a third party are deemed to be property in the estate of the deceased for estate duty purposes (s.3(3)(a) of the Estate Duty Act). However, the proceeds of a keyperson policy will not be deemed to be property in the deceased s estate if the requirements of s.3(3)(a)(ii) are met, namely: (i) (ii) (iii) the policy was not effected by or at the instance of the deceased; and no premium was paid or borne by the deceased; and no amount due or recoverable under the policy has been or will be paid into the estate of the deceased; and

217 Business Assurance D35 (iv) no amount has been or will be paid to or utilised for the benefit of: any relative of the deceased, or any person who was wholly or partially dependent on the deceased, or any company which was at any time a family company in relation to the deceased. A family company, as defined in the Estate Duty Act, means any company other than a quoted company which at any relevant time was controlled or capable of being controlled directly or indirectly, by way of majority holding of shares or any other interest or in any other manner by the deceased, or by the deceased and one or more of his/her relatives. A relative of a person, as defined in the Estate Duty Act, means the spouse of that person or anybody related to him/her or his/her spouse by blood within the third degree or any spouse of anybody so related. Parents, brothers and sisters and their spouses, and the children of brothers and sisters and their spouses thus qualify as relatives. If the policy does not qualify for this exemption, the policy proceeds less premiums plus 6% compound interest will be deemed an asset in the estate in terms of section 3(3)(a) of the Estate Duty Act. In terms of present departmental practice only the net proceeds of the policy after the estate duty has been deducted, will be subject to income tax. 4. Capital gains tax implications See the discussion under Cession of a company-owned policy (summary of tax implications). 5. Keyperson valuation How to establish the value of a keyperson Frequently, difficulty is encountered in establishing the keyperson s value to the business, and consequently, the amount of assurance that should be carried. It is always difficult to place an exact value on a human life, and the same applies to keyperson cover.

218 D36 Business Assurance However, the emphasis for keyperson cover is what the financial loss to the organisation will be on the death or disability of that specific keyperson. Various methods can be used, some approximate, others more accurate and depending on the information available, one of the following should be used: (a) A multiple of the annual salary of the keyperson. This is a relatively approximate method, and multiples of up to seven times annual salary could be used. Normally 5 times should suffice, but for very valuable keypersons, where it would take a very long time to replace them, the higher multiple could be used. It should be noted that due to the approximate nature of the calculation, a more accurate method is preferable for high cover amounts. OR (b) The number of years it will take for a replacement to reach the key employee s present level of profitability multiplied by the loss in profits due to the replacement of the keyperson. This calculation would make reference to the net profits of the business, and the keyperson s impact on those profits. OR (c) Itemising the cost of replacing the keyperson. (See worksheet.) How much would it cost to replace the keyperson? These include advertising costs, training costs, etc. How much is the keyperson worth to the business in net profits? This calculation can become quite detailed and extra information is provided in the next section. In particular, mention is made of the proceeds generated from the business s capital. What this is referring to is that if a large portion of the business s profits are from capital investments, e.g. investments in other businesses, this amount should be excluded from the profits. This is because these profits are not generated by employees of the business, and should potentially not be attributable to the keyperson.

219 Business Assurance D37 6. Keyperson valuation guideline Since the third method is more detailed, it is considered to be the recommended method. In order to determine the rand value of the keyperson, the following worksheet can be used: 1. Replacement cost Advertising for the replacement R Resettlement cost of replacement R Increase in salary package of replacement R Other R Keyperson s contribution to net profit Average profit over last five years R Less: reasonable proceeds R on invested capital Annual profit attributable to key person Keyperson s salary as percentage of key personnel s salary packages R (A) % (B) Keyperson s contribution to profit attributable to key personnel: A x B R = (C) Years it will take to replace keyperson s contribution years (D) Keyperson s contribution to profit C x D R Total value of keyperson = R If provision is made by means of life and/or disability assurance for the loss of the keyperson, the amount of life and/or disability cover on the policy will be calculated as follows: Life cover: Total value of keyperson + income tax and/or estate duty attracted by the policy.

220 D38 Business Assurance Disability cover: Total value of keyperson + income tax attracted by the policy. 7. Calculation of cover required where policies are owned by third parties Any policy on the life of an individual constitutes deemed property in his/her estate, unless it is specifically exempted in this regard, in terms of sections 3(3)(a)(iA) or (ii) of the Estate Duty Act. Should a policy not be exempted, there will be estate duty payable on the proceeds. In addition, notwithstanding any exemption as above, there could also be income tax implications. Income tax implications could arise where the premiums on the policy were tax deductible in terms of section 11(w). The policy proceeds will be taxable in terms of paragraph (m) of the definition of gross income whether it is tax deductible or not but may be subject to an exemption. The purpose of the calculations set out hereunder is to provide for a situation where the amount of cover taken out may be reduced by estate duty and/or income tax. It must be noted that:: (a) (b) (c) the calculations herewith are not the only method employed in this regard and that other methods are also used. the calculations herewith do not take the deduction of premiums plus 6% compound interest into account. This deduction is allowed in respect of premiums or consideration paid by a person other than the life assured who is also entitled to the amount due under the policy. it is assumed that the life assured has already utilised his/her R3.5 million estate duty exemption and that the policy is thus fully estate dutiable. (d) It is assumed that the employer tax rate is 28%. Different scenarios will be examined in turn. 1. Only income tax payable Where a policy meets the requirements of s11(w) with the result that the premiums were deductible, the proceeds will be taxable.

221 Business Assurance D39 If the cover required on the keyperson s life is R after tax, then the amount of cover needed will be: Initial cover required 1 Income tax rate = cover required Thus: = R Only estate duty payable (i) If the premiums were not deductible for income tax purposes in terms of section 11(w), the proceeds of the policy will not be taxable and it should, therefore, be adjusted to take only estate duty into account. Initial cover required 1 Estate Duty rate = cover required = cover required Thus = R (ii) Where the policy is estate dutiable and the amount of life cover is increased to cover the estate duty payable, the life assured s interest in the close corporation or shareholding in a company may also be increased. The situation may arise that double estate duty may be imposed: firstly, on the policy proceeds as deemed property in the life assured s estate. secondly, on the increased value on the member s interest/ shareholding as an asset in the estate. Section 4(p) of the Estate Duty Act prevents double taxation as described above by allowing a deduction equal to the value of any deemed property that has

222 D40 Business Assurance also been taken into account when valuing a member s interest or shareholding. The following formula can be used in the case of a keyperson policy or business contingency plan, where the owner of the policy is a family company in relation to the life assured: lnitial cover required divided by 100 (100 % membership interest) x estate duty rate) 100 If we assume a membership interest of 60%: 100 (100 60) x 20%) Thus: R divided by 100 = R ,26 3. Income tax and estate duty payable If in scenario (ii) (above) the premiums were also deductible in terms of section 11(w), income tax and estate duty will be payable. In terms of present departmental practice, only the net proceeds of the policy after the estate duty has been deducted, will be subject to income tax. The cover is, therefore, firstly adjusted for purposes of Estate Duty and thereafter for Income Tax purposes. Step 1 Initial cover required 1 Estate Duty rate Thus: ,2 = R

223 Business Assurance D41 Step 2 Adjusted cover 1 0,28 (Income Tax rate) Thus: ,72 = R R represents total cover required for Income Tax and Estate Duty purposes.

224 D42 Business Assurance 1. Definition Preferred Compensation Preferred Compensation is an arrangement whereby the employer pays an amount on a monthly basis to establish a fund that is awarded to the employee after he or she has been in the service of the employer for a specified period, such as 5 or 10 years. 2. How the plan works The employer increases the employee s salary to place him in a position to take out a policy on his/her own life. The employer normally pays the premiums directly to the life office and the parties agree that the employee will remain in the service of the employer usually for a minimum period of 5 years. The employee cedes the policy to the employer by way of a security cession, as security for the fulfilment of his/her obligations in terms of the agreement viz. to remain in the employ of his/her employer for the specified period. Upon expiry of the agreed period, the employer cancels the security cession, thus restoring ownership in the policy to the employee. 3. Income tax implications 3.1 For the employer The salary increase (contributions) forms part of the remuneration package of the employee and is therefore a tax-deductible expense for the employer. (Expense incurred in the production of income under Section 11(a) of the Income Tax Act provided the amount is reasonable in relation to the employee s function and that the provisions of the section are complied with.) The employer does not receive the benefits, neither do they accrue to the employer because these are paid directly to the employee by the life assurer. Should the employee not fulfil the service requirements laid down in the agreement, the employer can claim the proceeds and use them to fund similar benefits for another employee, should it wish to do so.

225 Business Assurance D For the employee The salary increase (contributions) forms part of the remuneration of the employee and is taxed in his/her hands (paragraph (c) of the definition of gross income in the Income Tax Act). The figure which is paid over by the employer must be adjusted to take account of the income tax burden. Calculation of salary increase: Premium 100 marginal tax rate (employee) Once the security cession has been cancelled, the employee receives the proceeds from the policy tax-free. Such payment will therefore not be included in the gross income of the employee. 4. Estate duty consequences The policy on the life of the employee is deemed to be property in the estate of the employee in terms of section 3(3)(a) whether the employee dies before or after the security cession is cancelled. None of the exclusions in section 3 of the Estate Duty Act are applicable in these circumstances. 5. Important considerations The use of preferred compensation is often opposed on the grounds that an employee very often would rather receive an increase in take-home pay than the promise of some benefit in the future. For this reason it is unlikely that preferred compensation can be sold on a salary sacrifice basis. If it is to be funded exclusively by the employer, the implementation of the scheme is likely to be more successful. 6. Capital gains tax implications If the employee remains with the employer for the agreed period, no CGT will be payable in respect of the proceeds of the policy in the hands of the employee as original

226 D44 Business Assurance policyholder upon disposal of the policy. (A security cession does not give rise to a disposal) If the employee breaches the agreement and the policy is ceded to the employer, there will be CGT payable on any gains made on the policy in the employer s hands. Should the employee first elect that employer as a beneficiary to the policy, the gains will then be disregarded in the employer s hands in terms of paragraph 55(1)(a)(ii), which states that a capital gain must be disregarded by a person who is a nominee of the original beneficial owner of the policy.

227 Business Assurance D45 Buy-and-sell agreement For the purposes of this section, where the word member is used, the words partner and shareholder will also be appropriate, depending on the type of entity involved. Likewise, the member s interest may be interchanged with share or shares as appropriate. 1. Definition A buy-and-sell agreement is an agreement between the members of a business entity, obligating themselves to sell on their deaths (or disability) their interest to the survivors and likewise obligating the survivors to purchase the deceased member s interest. 2. The elements of a buy-and-sell agreement A buy-and-sell agreement usually comprises the following: 1. An undertaking by the co-owners that the survivors will purchase the interest of the first-dying of the co-owners. 2. An undertaking that the first-dying will sell, on death, his/her interest in the business to the survivors. 3. The purchase price or a method of determining the purchase price of a co-owner s interest in the business. 4. Agreement as to the funding method of the buy-and-sell agreement, usually through life policies and the correct way of taking out the policies. 5. Provision for the cession for value of policies held by the executor of the first-dying s estate on the lives of the surviving co-owners. 6. An agreement as to the procedure to be followed in the event of all co-owners dying simultaneously or within 30 days of each other. Normally the estates of the owners of the policies will receive the full proceeds of the policies. 7. Provision can also be made for co-owners to purchase a disabled co-owner s interests in the business.

228 D46 Business Assurance 3. How the plan works The partners/members/shareholders enter into a contract in terms of which they effect policies on each other s lives, e.g. A and B effect a policy on C s life, B and C effect a policy on A s life and A and C effect a policy on B s life. The premium payer in the case of each policy under the plan should be the partner/member/shareholder(s) who will purchase the deceased s share. The premiums for each policy should, therefore, be paid by the co-owners other than the assured, and such premium payments should be contributed by these other coowners in the same ratio in which the interest of the assurer will be purchased and shared between them upon the assured s death. Example: Bob, James and Dylan are shareholders in Upmarket (Pty) Ltd, with a value of R2m. Bob owns 40%, James 35% and Dylan 25% of the shares. Policies taken out: Policy Owners Life Assured Life Cover Premium James & Dylan Bob R R450 per month Bob & Dylan James R R400 per month Bob & James Dylan R R300 per month Premiums payable by each shareholder: Policy on Bob s life: James will pay: x R450 = R262,50 Dylan will pay: x R450 = R187,50 Policy on James life: Bob will pay: x R400 = R246,15 Dylan will pay: x R400 = R153,85

229 Business Assurance D47 Policy on Dylan s life: Bob will pay: x R300 = R160,00 James will pay: Income tax implications x R300 = R140,00 There is no tax deduction for the premiums paid by each partner/member/ shareholder. In terms of the Close Corporation Act, a CC may assist financially in the purchase of an interest in itself (s.40). It is, therefore, possible that a buy-and-sell agreement can be entered into between the members and the CC, in terms of which the CC will buy a deceased member s interest. The CC would then be the proposer on the policy on the member s life. Provided that the requirements of s.11(w) are met, the premiums paid under such a policy will be deductible. As previously mentioned, whether or not the premiums are deductible or not, the proceeds of such a policy will be included in the CC s gross income in terms of paragraph (m) of the gross income. It may however be subject to a possible exemption. The Companies Act makes it possible for companies to fund the purchase of their own shares. The circumstances in which this may be done are limited and stringent financial governance requirements mean that this route will often not present the solution to the problem faced by the company on the death or permanent disability of a shareholder. 5. Estate duty implications (s.3(3)(a)(ia)) In terms of the Estate Duty Act, policies on the life of the deceased owned by a third party are deemed property in his/her estate. However, an exception is made in respect of policies effected to fund buy-and-sell agreements. Provided such a policy meets the following requirements, it will not be deemed property in the estate of the deceased: (i) the policy is taken out or acquired by a person who, on the date of the death of the deceased, was a partner of the deceased, or held a share or like interest in a company in

230 D48 Business Assurance which the deceased, on that date, held a share or like interest, and (ii) (iii) the policy was taken out or acquired with the purpose of acquiring the deceased s interest in the partnership, or with the purpose of acquiring the whole or a part of the deceased s share or like interest in the company or close corporation and any claim by the deceased against the company or close corporation, and no premium on the policy was paid or borne by the deceased. This concession is not available if a CC or company is the owner of the policy. A buy-and-sell agreement can also be used in the sole proprietor context. The sole proprietor can enter into an agreement with another party (e.g. an employee). If a policy is used to fund this agreement, it will not qualify for the s.3(3)(a)(ia)) exclusion. The reason for this is that there is no adherence to requirement (i), as mentioned above. 6. Capital gains tax implications See the discussion under Cession of a company-owned policy (summary of tax implications).

231 Business Assurance D49 Income tax implications of restraint of trade payments Restraint of trade agreements are frequently used by companies to protect themselves against employees who may want to leave and set up in competition. The agreement sometimes provides for a sum of money to be paid to the employee as consideration for an undertaking by the employee to restrain his/her income-earning activities. What follows is a brief discussion of the tax implications for the company and the employee of restraint payments funded by life assurance. 1. Implications for the company (refer to Companyowned policies) 1.1 Premiums See the discussions under Company-owned policies summary of tax consequences. 1.2 Proceeds See the discussions under Company-owned policies summary of tax consequences. 1.3 Restraint payment (received or accrued before 23 February 2000) This payment made in consideration of a restraint of trade agreement is a capital payment (ITC 1338). Therefore, the company will not be allowed to claim an income tax deduction based on the amount of the payment (s.11(a)). (a) Death before retirement The employee s estate or dependants would not be entitled to the restraint payment as such because the company would not be bound to nor would it have any interest in paying them. The company may, however, pay the proceeds over in the form of an ex gratia payment. Such a payment is not deductible since it is not incurred in the production of income and it is of a capital nature.

232 D50 Business Assurance (b) Disability or retirement If the employee is still a potential threat despite his/her disability or age, the restraint payment may still be justified. If not, an ex gratia payment may be substituted. In neither case will the payment be tax deductible. 1.4 Restraint of payment (received or accrued on or after 23 February 2000) Restraint of trade payments received or accrued on or after 23 February 2000 by natural persons or employment companies are tax deductible for the payer (employer). The deduction of such payment must be made over the period of the restraint or three years, whichever the longer. Such payments will be included in the gross income of the recipient. 2. Implications for the employee 2.1 Premiums Policies taken out to fund restraint payments are generally owned by the company. The employee, therefore, does not pay any premiums. However, due to the new paragraph 2(k) of the 7 th Schedule, the premiums will, have to be included in his/her taxable income. 2.2 Restraint of trade (received or accrued on or after 23 February 2000) Restraint of trade payments are included in the gross income of the recipient where such recipient is a natural person or employment company.

233 Business Assurance D51 1. Debit loan accounts Loan account cover Loans are made by the company to shareholders, directors or employees (e.g. instead of receiving dividends or increases in salary). Clearing debit loan accounts: (i) (ii) (iii) (iv) Bequeath the estate or portion of it to a beneficiary provided he/she takes over the debit loan account. Bequeath shares to a testamentary trust provided the trust takes over the debit loan account. Bequeath shares to a charitable institution provided it takes over the debit loan account. Cover with life assurance to ensure liquidity in the estate to settle the outstanding debt. Capital gains tax implications: There will be no capital gains tax implications on debit loan accounts provided it is a bona fide loan specifically excluded as a disposal as defined. 2. Credit loan accounts Loans are made by shareholders to the company. This makes it easier to withdraw funds from the company. The loan account ranks as a concurrent claim on liquidation. (a) Tax implications Any interest payable on the loans is taxable in the hands of the holder of the loan account and deductible as an expense for the company. (NB: Interest payments will only be deductible for the company if the loan was made for trade purposes.) (b) Capital gains tax implication There will be no capital gains tax implications on credit loan accounts provided it is a bona fide loan specifically excluded as a disposal as defined.

234 D52 Business Assurance (c) Clearing of credit loan accounts (i) (ii) The company can effect a policy on the shareholder s life. Note that the value of the life assurance will not be exempt from estate duty in terms of s.3(3)(a) of the Estate Duty Act. The shareholders can include the credit loan account in their buy-and-sell agreements. The value of life assurance used to fund the buy-and-sell agreements would be exempt from estate duty in terms of s.3(3)(a)(ia).

235 Business Assurance D53 1. Introduction Loan account redemption plan This plan is used to release funds to the shareholder/director/ member (hereinafter referred to as shareholder ) who has lent money to the company/close corporation (hereinafter referred to as company ). The funds are released in such a way that the company s capital requirements are not affected. Working of the plan: The company approaches a financial institution for a loan equal to the amount owing to the shareholder. The minimum loan period is five years and, during this period, only the interest on the loan is serviced. There will be no capital redemption during the term of the loan. The company now repays the credit loan account to the shareholder without affecting its capital structure. The shareholder uses the repaid credit loan account to invest in a five-year growth plan with an insurance institution. The policy concerned is invested in the name of the shareholder and not the company. The policy is ceded by the shareholder to the financial institution as security for the repayment of the loan by the company, and the company pays only the interest on the loan for the period thereof. When the policy matures, an amount equal to the original loan amount is lent to the company by the shareholder and the company, in turn, repays the loan obligation to the financial institution. Once the shareholder s original loan account is reinstated with the company, he/she has the following options: To withdraw the balance of the maturity value of the policy (i.e. the difference between the total maturity value on the policy and the repaid loan with the financial institution). The balance can (if possible) be left with the insurance institution and capital withdrawals made there from.

236 D54 Business Assurance By implementing the plan, the funds loaned by the shareholder can thus be released in a tax-efficient manner without disturbing the company s capital financing structure. 2. Income tax implications The income tax deductibilit of interest payments is at the heart of the plan. The success of the plan depends upon the company being able to deduct the interest paid to the financial institution. The company would deduct the expense (i.e. the payment of the interest) in terms of sections 11(a) and 23(g) of the Income Tax Act. For the expense to be deductible, it must be actually incurred in the Republic in the production of income and it must not be of a capital nature. The expense must be incurred for the purposes of trade. If it can be demonstrated that the original purpose of the loan was to provide the company with working capital, any interest paid in respect of the original loan would have been deductible. If this is the case and the second loan was taken out to replace the first, interest paid on the second loan should also be deductible. 3. Estate duty implications As the policy is on the life of the relevant shareholder, the proceeds of the policy payable on his/her death will be deemed property in his/her estate for estate duty purposes. The shareholder effects the policy himself/herself and also pays the relevant premium. As such, none of the relevant exclusions contained in section s.3(3)(a)(ii) of the Estate Duty Act will apply. 4. Capital gains tax implications If the loan account redemption plan is structured correctly as set out above, consisting of bona fide loan agreements, first hand policies and security cessions, there will be no capital gains tax implications.

237 Business Assurance D55 1. Introduction Business contingency plan A member/shareholder of a close corporation/company often has to sign surety as co-principal debtor or provide personal security for a loan taken out by the business. The member/shareholder can thus incur personal liability: 1. during his/her lifetime if the business cannot repay the loan; or 2. on death or permanent disablement, if the business is then unable to repay the loan; or 3. if no one can replace him/her as guarantor or no alternative security can be given. A solution for this problem can be achieved through the business contingency plan. 2. Working of the plan The business insures the life of the member/shareholder who has signed surety or provided personal security for the loan effected by the business. The policy should preferably include disability cover and the amount of life and disability cover should be equal to the loan amount. The business pays the premiums and an agreement is entered into between the business and the member/shareholder in terms of which the business undertakes to apply the proceeds of the policy to the repayment of the loan(s) giving rise to the personal guarantees given by the member/shareholder. 3. Income tax implications See the discussions under Company-owned policies summary of tax consequences. Although there was a lot of speculation of a change of the tax treatment of premiums paid to fund these types of policies, the budget speech of 2012 proposed no amendments to the above, other than to indicate that there is an intention to make it clear that premiums for business contingency policies will not be deductible. This is as a result of SARS s view that these policies fund a capital loss rather than a business operating loss.

238 D56 Business Assurance Therefore, if employers take out a policy for this type of assurance, with the intention of making the premiums deductible in terms of the current requirements, those employers would need to take SARS intention (as stated above) into consideration, as they may find themselves in a position where they may not be allowed to deduct the premiums of such policies, once SARS confirms their intention, either by way of a further amendment to the Act or by way of a directive. 4. Estate duty implications The proceeds of the policy will form part of deemed property in the estate of the deceased unless the requirements of s.3(3)(a)(ii) of the Estate Duty Act are met, namely: (i) (ii) (iii) the policy was not effected by or at the instance of the deceased; and no premium on the policy was borne by the deceased; and no amount due under the policy has been or will be paid to the estate of the deceased; and (iv) no amount has been or will be paid to a relative of the deceased or a person wholly or partly dependent on him for maintenance, or to any family company. 5. Capital gains tax implications See the discussion under Cession of a company-owned policy (summary of tax implications).

239 Business Assurance D57 The balance sheet: Business assurance leads Introduction The balance sheet contains the details of the assets and liabilities of an undertaking (sole proprietorship, partnership, close corporation or company); these are shown under appropriate headings and at values taken from the ledger at a specific date, usually the end of the financial year. The function of the balance sheet is to show what a business owns, what it owes and to give a true and fair view of the state of affairs of the business at a particular date. For comparative purposes the balance sheet shows two sets of figures - for the present and the previous accounting periods - to show how the overall affairs of the business have changed. The balance sheet should always be read in conjunction with the notes that are attached to the annual financial statements as they set out further details and qualifications relevant to the assets and liabilities. The notes are an integral part of the accounts and are intended to give an analysis or to elaborate on certain items contained in the income statement and balance sheet. Assurance leads A thorough analysis of the financial statements may provide valuable information regarding a client s business and personal affairs which, if properly evaluated, may provide excellent assurance leads. 1. Redeemable preference shares Redeemable preference shares are used by investors to place money in a company but only for a limited time. A redeemable preference share is therefore more like a loan than a share because it has to be repaid at a certain time. Where a company has issued redeemable preference shares the Companies Act requires that this be disclosed in the financial statements on that date or earliest date on which such shares are to be redeemed. Redeemable preference shares may be redeemed out of accumulated distributable profits or out of the proceeds of a fresh issue of shares.

240 D58 Business Assurance Distributable profits have invariably been invested in assets over the years, with the result that ready cash may not be available to redeem the shares. Could the liquid resources not be provided by assurance maturing on redemption date? The company could invest annually a fixed sum outside the business by way of insurance premiums. A sinking fund policy could suit this purpose. 2. Long-term liabilities Long-term liabilities usually comprise - (a) (b) mortgage bonds debentures (debentures are loans made to the company at a fixed rate of interest and repayable at a fixed rate in the future) In terms of the Companies Act disclosure is required of the terms governing these loans and in particular the date of repayment, if paid in instalments, the periodic instalment involved must be disclosed. If repayment is fixed on a specific date, what provision is the company making to discharge these obligations in cash? A sinking fund policy could be considered in order to provide the necessary liquid funds. 3. Directors loan accounts (by the directors to the company) If the loans are long term, the terms of the loan account must be disclosed in the financial statements by way of a note. If the loan is substantial, the company would be placed in an embarrassing financial position should it be necessary to repay the loan to the estate of the deceased director. The necessary funds could be made available through assurance on the life of the director. 4. Fixed assets Retained earnings can be invested in investment policies to provide the necessary funds to replace assets or to buy additional fixed assets.

241 Business Assurance D59 5. Investments: loans (i.e. made to outsiders) Are these loans secured by life assurance? If not, the company should consider insuring such loan debtors (term assurance or whole-life policy). 6. Directors loans (loans by the company to directors) Full disclosure of such loans is usually given in the notes to the financial statements. Would the director s estate be able to liquidate the debt in the event of his/her death? To avoid liquidity problems on death, consider assurance to provide the necessary cash (term assurance). 7. Debtors Are there perhaps any large debtors who maintain a substantial monthly balance? Life assurance may provide the necessary collateral security. 8. Directors emoluments Under the Companies Act a company is required to make full disclosure of emoluments paid to directors, differentiating between: amounts paid in respect of services as directors (i.e. directors fees) amounts paid in respect of other services (i.e. salaries, commission). This gives one accurate figures of the income of directors and their approximate marginal rates of tax can be determined. Consider retirement annuity policies to neutralise the high rates of tax. 9. Employees remuneration Does the company have a pension scheme or provident fund? Consider various deferred compensation schemes for highly paid executives. A highly paid director or employee often does not get much benefit from a salary increase because of the concomitant increase in tax

242 D60 Business Assurance payable. Such employee or director may therefore prefer to enter into a deferred compensation scheme to avoid the negative effect of taxation on his/her immediate cash flow in the event of a salary increase. 10. Contingent liabilities In terms of the Companies Act, full disclosure of the nature of contingent liabilities in existence, as well as the estimate of such liabilities, is required by way of notes to the balance sheet. Guarantees given by the company and guarantees furnished on behalf of directors must be disclosed. Should the director pass away, will his/her estate be able to honour his/her obligations or will the company be called upon to honour its guarantee? To avoid possible financial embarrassment the company should consider insuring the life of the director involved. 11. Employee assurance - keyperson policies Accountants pay special attention to the adequacy of the insurance of fixed assets to ensure that the company is covered in the event of natural disasters. One of the most important business assets of any commercial organisation is its management, those people who determine policy and strategy and are responsible for the organisation s success. The loss of a key manager could cause the organisation irreparable financial harm and it is equally important to assure this valuable asset as one would insure fixed assets.

243 Business Assurance D61 1. Introduction Valuing business interests Placing the correct value on a business is a difficult and involved exercise. Various methods and assumptions can be used, as well as numerous adjustments to the underlying cash flows and balance sheet items. This might lead to different valuations given by different valuators and underwriters, potentially leading to confusion and disagreements. This section aims to reduce, and ultimately to remove, these disagreements by discussing the basic principles underlying the valuation of a business, as well as going into some detail on the different valuation methods and assumptions. Please note that these are guidelines and great care is required when valuing a business. They need to be interpreted in line with the specifics of the business being valued. In no way can these principles be applied without serious consideration of the specific situation being analysed. 2. Assumptions used in Business Valuations The assumptions used when valuing a business are of critical importance and can significantly affect the final number. Particularly important is the fair rate of return used in the business valuation. The fair rate of return is the annual return you would expect to receive if you invested in the business being valued. The more stable and more established the business, with a good solid track record, the lower return you would expect to compensate you for the risk of investing in that business. For a risky, less well established business, a higher fair rate of return would be required to compensate you for the increased risk. A reasonable range would be between 12% and 20%, but even these can vary depending on individual business circumstance. It is thus important to assess the riskiness and track record of the business being valued, and to adjust the assumptions accordingly.

244 D62 Business Assurance 3. Valuation Methods The methods used to value a business entity could vary depending on the purpose of the valuation. The following four valuation methods are explained from a Life Insurance Business Cover perspective. For example buy and sell valuations are different from contingent liability. When assessing buy and sell cover, we need to establish the respective entity s worth from either an assets and liabilities or an income generating ability point of view. This then differs with the issue of contingent liability cover, as some of the business entities under valuation will probably run with a negative asset value due to the outstanding loans and other liabilities. It is therefore essential to establish whether the business entity can still service the loans, meet its other obligations and generate profits. Some underwriting challenges include inflated values and deciding on whether the assumptions are optimistic or pessimistic? The basic assumption is that the value will change overtime and an upward trend is always welcomed as appose to a downward trend. There is always a wide gap between projections and reality. 3.1 Intrinsic Value Method This method is particularly applicable to investment and property businesses, because the values of these businesses are mainly in the net assets. It values the business as the difference between the Assets and Liabilities, also leading to it being called the Net Asset Value method. Steps: (a) (b) (c) Value all the assets at market value. Value all the liabilities. Deduct the liabilities from the market value of the assets. Step (c) gives the Intrinsic Value of the business. To calculate the value of a particular individual s share in the business, multiply the Intrinsic Value by the percentage of the individual s interest.

245 Business Assurance D63 Example: Assets R Fixed Assets R Current Assets R Liabilities R Long-term liabilities R Current liabilities R Intrinsic Value (or Net Asset Value) R If there are three partners, namely A, B and C, with ownership percentages of 35%, 40% and 25% respectively, their individual interest in the business would be: A: 35% x R = R B: 40% x R = R C: 25% x R = R Advantages of using the Intrinsic Value Method: This method can be used if the business entity s value is demonstrated mainly in its assets. The calculations are easy as the figures are taken directly from the balance sheet. Disadvantages of using the Intrinsic Value Method: This method does not take into account any future growth in the business or any other items that do not appear in the financial statements. On some occasions the book value is far below the real market value. There are no guidelines for establishing the market value for assets unless you involve a property valuation expert. It is hardly used in the first 5 years of the life of a business entity as a result of the small net asset value due to the loan accounts and other liabilities.

246 D64 Business Assurance 4. Earnings Yield Method This method is applicable where the asset base is not directly related to the earning potential of the business, for example a business that provides professional services or a trading business. The actual value is derived from the net after tax income earned from the services delivered. Steps: (a) Establish future net earnings per annum after tax. The current net earnings after tax can be taken straight from the income statement. Multiply this figure by an appropriate annual increase factor to get the next year s future net earnings per annum after tax. (b) (c) Establish a fair rate of return. Capitalise the annual future net earnings at the fair rate of return. Example: Current annual net earnings after tax: R Expected annual growth: 10% Expected future net earnings after tax: R % x R Fair rate of return: 15% (Assuming a well established business) = R Value of the business: R / 15% Notes: = R This is a forward looking method, and values the future net income streams of the business. It is a good method, because it is based on the present value of future earnings. It is important to consider the net earnings in detail. Once off amounts, such as exceptional profits, or major expense outlays, can impact the net earnings in a particular year, and should sometimes be excluded. But this is a complicated area and care

247 Business Assurance D65 must be taken to only adjust the earnings where really deemed appropriate. The earnings used should be net of all expenses and tax. Advantages of using the Earnings Yield Method: It provides one with an idea of the possible future earnings of the business entity assuming optimal or steady economic growth. This method is most applicable where the asset base is not directly related to the earning potential of the company, e.g. services companies. It is widely used in the insurance industry. Disadvantages of using the Earnings Yield Method: Care must be taken when considering the appropriate fair rate of return. This method ignores the capital employed in the business. It treats the profits as ceaseless. 5. Dividend Yield Method This method is applicable when valuing minority shares in a larger established business that provides a steady stream of dividend income. Steps: (a) (b) (c) (d) Establish the future dividend declaration. This can be calculated from the current dividend declaration. Multiply the current dividend declaration by an appropriate annual increase factor to get next year s dividend declaration. Establish a fair rate of return. Capitalise the annual future dividend declaration. Multiply this capitalised value by the number of shares held.

248 D66 Business Assurance Example: Annual dividend per share: R45 Expected annual growth: 10% Expected future dividend declaration: R % x R45 Fair rate of return: 15% (Assuming a well established business) = R49,50 Capitalised value of each dividend: R49,50 / 15% = R330 If you hold shares, your value is: R330 x = R Advantages of using the Dividend Yield Method: Most suitable when valuing shares related to a small percentage shareholding in a business entity. Disadvantages of using the Dividend Yield Method: Seldom used in the insurance industry; Ignores the assets value. 6. Super Profits Method The super profits method is essentially a combination of the intrinsic value method and the earnings yield method. It thus takes the asset value as well as the future expected earnings of the business into account in order to arrive at a value of the business. It is an appropriate method to use where the value of the business is contained in its assets as well as in its future earning potential. The super profits method takes into account the present value of the future expected earnings, constituting a fair rate of return of the business. These super earnings or profits are then capitalised over a predetermined period, during which the business is reasonably expected to maintain this high level of return on investment. A five year period is commonly used for the purpose

249 Business Assurance D67 of this time value of money calculation. Once the present value of the super profits during the e.g. five year period has been calculated, the asset value of the business is added to arrive at the total business value. Steps: (a) Establish the net assets employed in the business after deducting liabilities (i.e. the intrinsic or net asset value). (b) Determine the annual expected income after tax. These allow for the super profits expected. (c) Determine fair rate of return and the number of years over which super profits are expected (5 years). (d) Calculate what is considered as fair income (assets employed x fair rate of return). (e) Calculate the super profits = (Projected income Calculated fair income). (f) Calculate the discounted value of super profits over a number of years (from assumptions). (g) Calculate the final value for the business = value of assets (Step a) + discounted value of super profits (Step f).

250 D68 Business Assurance Example: Total capital employed R Total net assets R Expected annual income per year from this capital (Expected annual income estimated for next 5 years) R Fair rate of return (low risk investment) 15% Fair expected income from capital employed 15% x R R Super profits per year R R R Discounted value of super profits at 15% over 5 years to present value: = R x 3.35 R Total value of business R R R Advantages of using the Super Profits Method: This method is the most suited for the valuing of a majority holding in a business entity. It takes both asset value as well as expected income into account, offering a fair approach to the value of the business.

251 Business Assurance D69 Disadvantages of using the Super Profits Method: It is a complicated method and care needs to be taken when it is used. The results can be easily influenced by changing the assumption. It can be used to refine the business valuation but often either the intrinsic or earnings yield methods would be better method.

252 D70 Business Assurance Financial ratios Introduction Financial ratios are similar to a thermometer which can be used to take the temperature of a business. Like a thermometer they give only a limited but useful diagnosis. Financial ratios can be compared to that of another business in the same industry or historical ratios in order to determine a trend. 1. Liquidity ratios Liquidity deals with the ability of the business to meet its shortterm debts. Short-term debts are those debts which must be repaid within a year. Since debts can only be liquidated out of available cash resources, it follows that liquidity involves two factors, namely: the capacity of the business to generate cash, and the availability of this cash to pay short-term debts. In searching for liquidity, we look at both current assets and current liabilities, and the relationship between these categories. The logic behind this is that cash is generated from the current assets and short-term debts constitute current liabilities. Therefore, the relationship between current assets and current liabilities will reveal the ease or difficulty with which current debts can be paid. There are two methods for measuring liquidity, namely: the current ratio, and the acid test ratio. 1.1 The current ratio The formula for determining the current ratio is: Current assets Current liabilities

253 Business Assurance D71 This ratio measures how many times current liabilities are covered by current assets. Although many people in the accounting profession regard a current ratio of 2:1 as being ideal, no such absolute criteria can apply to all businesses. A business with a large turnover operating on a cash basis will require a lower current ratio than a company which grants extensive credit and sells slow-moving stock. For example: Suppose a business has R2,000,000 in current assets and R1,000,000 in current liabilities. Then the current ratio is R2,000,000/R1,000,000 = 2:1. This means for every Rand in current liabilities there is R2 in current assets. 1.2 The acid test ratio The formula to determine the acid test ratio is: Cash plus debtors and other current assets (excluding Stock) Current liabilities This ratio measures the ability of the business to meet its current liabilities in the worst possible conditions, i.e. if all current liabilities have to be paid at short notice. Note that stock is not taken into account in this calculation since it may be difficult to convert to cash. Business entities with ratios of less than 1 cannot pay their current liabilities and they should be looked at with extreme caution. Example: After perusing ABC (Pty) Ltd s financial statements for the relevant financial year, the following figures were extracted: Cash R Debtors R Current assets (excluding stock) R Stock R Current liabilities R

254 D72 Business Assurance Therefore ABC (Pty) Ltd s acid test ratio is: = 1.7: This indicates that the business would be able to meet its current liabilities with relative ease. 2. Solvency ratios 2.1 Shareholders equity to capital employed This ratio represents the proportion of assets or funds provided by the owners. Shareholders' equity Capital employed e.g = 60% 2.2 Liabilities to capital employed This ratio illustrates the proportion of funds provided by outsiders, i.e. the extent of gearing. Long term liabilities Capital employed e.g = 40% 3. Profitability ratios 3.1 Earnings per share (EPS) This ratio can only be calculated if the shares are listed on the stock exchange. It indicates the actual return on the market price. Net income after tax preference dividends Weighted average ofnumber of ordinary shares in issue = cents per share

255 Business Assurance D Price/earnings ratio (P/E) This ratio measures how many years earnings will cover the price of the share, e.g. a share with a price of R8 and EPS of R1 has a P/E ratio of R8 which means that it will take an investor 8 years of earnings to recover the purchase price of share. It indicates whether the share is relatively expensive or relatively cheap. Market price per share Earnings per share The value of the P/E is to quickly describe what happened to a business entity during the past year and how it's performing financially. A business entity with a low (P/E) could mean that the business has encountered some problems recently. One should try to determine whether those problems will likely be temporary or permanent. Some businesses on the other hand tend to have high (P/E) ratios due to the nature of the business e.g. software companies. 3.3 Dividend yield This ratio measures the dividend return based on the market price of the share. Dividend in cents per ordinary Marked price per share x 100 = % Gross/net profit margin Gross profit margin This ratio indicates the markup on goods. If the markup is quite low, it means large stock levels must be kept and it is necessary to achieve a higher level of sales. Gross profit margin = Gross profit Sales

256 D74 Business Assurance Net profit margin The profit margin ratio indicates the after-tax return (net income) on each Rand of sales. Net profit margin = Net profit Sales

257 Business Assurance D75 Notes

258 D76 Business Assurance

259 Estate Planning Estate Planning

260 Estate Planning

261 Estate Planning E1 Estate Planning Introduction Estate planning is the arrangement of an estate in terms of which the planner s objectives in dealing with the assets and liabilities are achieved. These objectives should make provision for the management of the planner s estate during his/her life and thereafter.

262 E2 Estate Planning Methods to save Estate Duty There are a number of ways in which estate duty can be saved, most of which are aimed at limiting the growth in the planner s estate. The facts of each individual case will determine whether a specific method will be suitable or not. The practical distribution of the planner s estate after his/her death must be the primary objective and the saving of estate duty should be just one of the factors to be kept in mind during the planning process. Some of the methods in which estate duty can be saved are mentioned hereunder. Ways to limit growth in the estate Sale of growth assets; Donations - by making use of the provisions of section 56(2)(b) of the Income Tax Act; Executory Donations ; By transfer of growth assets to an inter vivos trust by sale or donation; By the creation of a company and thereafter selling the growth assets to the company; By swopping growth assets for assets of equal value which increase in value at a slower rate; Making use of limited rights; The sale of bare dominium in a particular asset to a trust; Reduction of the loan account as an asset in the estate; Estate massing. Note: When advising a client on any of the above, the full implication of any recommendation has to be considered.

263 Estate Planning E3 Capital Gains Tax and Estate Planning This is a short summary of the impact of capital gains tax on estate planning and must be read with Section A on Income Tax. Disposals by the deceased A deemed disposal of assets (excluding those assets exempt from capital gains tax) takes place from the deceased to his estate at the market value as at the time of his death. The difference between the market value and the base cost of the asset during the lifetime of the deceased could result in a capital gain or loss. The base cost of the assets in the estate will be equal to the market value of the assets, for purposes of any disposal by the deceased estate. An annual exclusion of R is applicable to gains or losses by the deceased, instead of R per annum during the lifetime of the deceased. These principles are not applicable in respect of the following assets: Assets accruing to the surviving spouse will be transferred at the base cost of the deceased to the spouse. No capital gains tax (hereinafter referred to as CGT) will therefore be payable in respect of any assets accruing to a surviving spouse. (See new definition of spouse as per amendment to the Income Tax Act 58 of 1962.) No CGT is payable in respect of any assets bequeathed to a public benefit organisation. No CGT is payable in respect of the proceeds of long-term insurance policies in the hands of the policyholder. CGT could be payable in respect of second-hand policies. No CGT is payable in respect of lump-sum benefits payable from pension funds, provident funds and retirement annuities, taxed in relation to the 2nd Schedule. No CGT is payable in respect of an accrual claim transferred to a surviving spouse.

264 E4 Estate Planning Note: Spouse in relation to any person, means the partner of such person - (a) (b) in a marriage or customary or civil union recognised in terms of the laws of the Republic; in a union recognised as a marriage in accordance with the tenets of any religion; or (c) in a same-sex or heterosexual union which the Commissioner is satisfied is intended to be permanent: Provided that a marriage or union contemplated in paragraph (b) or (c) shall, in the absence of proof to the contrary, be deemed to be a marriage or union without community of property. According to Section 13(2)(b) of the Civil Union Act (No. 17 of 2006) reference to husband, wife or spouse in any other law, including the common law, includes a civil union partner (with the exception of the Marriage Act or the Customary Marriage Act). Disposals by the estate When assets are distributed by the estate to the heirs, legatees or trustees of a trust it is regarded as a disposal, the proceeds being equal to the base cost (the market value at date of death) of the estate and resulting in no CGT being payable. The base cost of the assets in the hands of the heirs, legatees and trustees are equal to the market value of the assets as at date of death. Should the deceased estate sell any assets there could be a gain or loss equal to the difference of the proceeds and the base cost. The deceased estate has an annual exclusion of R Such a disposal would apply if assets are disposed of by the executor of the deceased estate. The disposal in this instance must be treated in the same manner as the deceased would have been treated had he/she been alive. Thus the same exclusions apply.

265 Estate Planning E5 Taxation of trusts Provisions similar to those of section 7(2) to 7(8) of the Income Tax Act are contained in the Eighth Schedule. A donor may be taxed on a gain arising in a trust, should these provisions apply. There is a general rule applicable to trusts. The vesting of an asset or a gain in a beneficiary is a disposal for purposes of CGT. Any gain can be taxed in the hands of the beneficiary instead of in the trust. The gain is calculated by deducting the base cost of the asset from the market value at the time vesting takes place. This rule will only be applicable if the beneficiary is a South African resident. If the beneficiary is not a resident the gain will be taxed in the trust.

266 E6 Estate Planning Donations Tax: Exemptions In terms of the Income Tax Act, donations tax is payable in respect of the value of all property donated on or after 16 March Certain exemptions are permitted. Primarily, the first R of the value of property donated by a natural person in a year is exempt from donations tax. Other exemptions include: Section 56(1)(a) 56(1)(b) 56(1)(d) 56(1)(e) 56(1)(g) 56(1)(h) 56(1)(k) 56(1)(l) 56(1)(m) 56(1)(n) 56(2)(c) Donations in terms of ante-or postnuptial contracts Donations to a spouse. *New definition of spouse as per amendment to the Income Tax Act 58 of Donations where the donee does not benefit until the donor s death. Donations cancelled within six months. Donations of property outside the Republic. Donations by or to government or local bodies and certain institutions and funds. Voluntary awards which are subject to income tax in donee s hands. Property disposed of in terms of a trust. Property consisting of a right (other than usufructuary fiduciary) to the use or occupation of property used for farming purposes if the donee is a child of the donor. Donations made by public companies. Maintenance payments. * Spouse in relation to any person, means the partner of such person - (a) (b) (c) in a marriage or customary or civil union recognised in terms of the laws of the Republic; in a union recognised as a marriage in accordance with the tenets of any religion; or in a same-sex or heterosexual union which the Commissioner is satisfied is intended to be permanent: Provided that a marriage or union contemplated in paragraph (b) or (c) shall, in the absence of proof to the contrary, be deemed to be a marriage or union without community of property. Note: According to Section 13(2)(b) of the Civil Union Act (No. 17 of 2006) reference to husband, wife or spouse in any other law, including the common law, includes a civil union partner (with the exception of the Marriage Act or the Customary Marriage Act).

267 Estate Planning E7 Estate Pegging Worksheet Comparison of costs and benefits 1. THE COST OF A PEGGING (a) Drawing up of trust R (b) Costs of forming a company/cc R (c) Trustee s acceptance of cap R (d) Transfer costs R (A) (i) Donations Donations tax R Capital gains tax R Transfer duty R Conveyancing fees R Legal costs R Total R OR (ii) Sale Transfer duty/vat R Capital gains tax R Conveyancing fees R Legal costs R Total R (e) Submission of 2 compulsory Provisional Tax Forms R TOTAL COSTS R (B) 2. PROJECTED INCREASE IN VALUE OF ASSETS TO BE PEGGED Value at present R Expected yearly increase in value..... % p.a. for..... R Years (Future Value) Less: Value at present Total expected increase in value after..... years R (C) 3. ADDITIONAL ESTATE DUTY ATTRACTED BY INCREASE IN VALUE Increase in value R.... (C) x 20% (rate of estate duty) 4. COMPULSORY OF COSTS AND BENEFITS Additional Estate Duty Expected estate duty saving over..... years discounted at the inflation rate of..... % Less: Cost of pegging operation (B) R( ) NET SAVING R R R R

268 E8 Estate Planning 1. DONATIONS Costs involved in transferring assets Donations tax is payable at the rate of 20% on the value of property donated on or after 1 October The first R of property donated per taxpayer per annum is exempt from the payment of donations tax. The R annual exemption from donations tax is available to both spouses (s.56(2)(b)). Where the donation is made from assets forming part of the joint estate for in community of property marriages, such donation shall be deemed to have been made equally by each spouse, but where the property did not form part of the joint estate, such donation will be deemed to have been made solely by the spouse making the donation (s.57a). Depending on the type of asset that is donated, capital gains tax could be payable. METHOD OF TAX/DUTY AMOUNT TRANSFER AND TYPE OF ASSET (a) Movables Donations tax 20% (b) Immovables (c) Shares 2. SALE Donations tax plus transfer duty Marketable securities tax Donations tax (a) Movables VAT 14% (B) Immovables Transfer duty/vat (no transfer duty will be payable if VAT is payable on the purchase price). VAT is payable at a rate of 14%. 20% A donation is regarded as a disposal for purposes of capital gains tax (CGT). The proceeds will be equal to the market value of the asset and CGT as well as donations tax may be payable. No CGT will be payable in respect of a donation to a spouse. (See definition of spouse under the Donation Exemptions section.) (Refer to transfer duty below under Sale) 0.25% of taxable amount on listed and unlisted securities. 20% Rates applicable from 23 February 2011: Companies/ Close Corporation and Trusts and Natural Persons: on first R % Between R and R % on value above R Between R and R R % of the value above R Above R R % of the value above R

269 Estate Planning E9 Costs involved in the setting up and administration of trusts SERVICE COSTS 1. Drawing up of trust deed (legal fees) Average R3 500 R Trustee s acceptance of capital fees 1,5% of capital plus VAT (on 1,5%) 3. Commission on collection of income 7,5% of gross income 4. Capital administration fee 1 1,5% of the value per annum 5. General administration costs (e.g. Average R25 R50 per transaction postage and petties) 6. Costs involved in the compulsory submission of two provisional tax returns Average R600 per tax return 7. Final distribution of capital on value 2% of capital plus VAT (The charges are merely an indication of the costs)

270 E10 Estate Planning The taxation of trust income This section deals with the taxation of trust income. The following sections which affect the taxation of trust income are included in the Income Tax Act, Nr. 58 of 1962 (as amended): 1. The definition of person in section 1 includes a trust. 2. As a result of an amendment to section 6(1), trusts are no longer entitled to the primary rebate. 3. In terms of section 25B of the Act: any income received by or accrued to or in favour of any person, in his/her capacity as the trustee of a trust, shall, subject to the provisions of section 7, to the extent that it has been derived for the immediate or future benefit, of an ascertained beneficiary with a vested right, be deemed to be income accrued to the beneficiary, otherwise be deemed to be the income of the trust fund. 4. In cases where the beneficiary has acquired a vested right to the trust income as a result of the trustee exercising his/her discretion, such income is deemed to accrue to the beneficiary. Where the income accrues to the beneficiary in terms of these provisions, any deductions or allowances relating to this income are permitted to be claimed by the beneficiary. Similarly, where the income accrues to the trust, it will be entitled to such deductions and allowances. Deductions and allowances in the hands of beneficiaries are limited to the income deemed to have accrued to the beneficiary. Any deductions and allowances which are not allowed to flow through to the beneficiaries can be deducted against the taxable income of the trust in the same tax year. Such deductions and allowances are limited to the taxable income in the trust before taking into consideration the deductions and allowances. If the trust is not subject to tax in the Republic, the deductions and allowances can be deducted in the following year of assessment

271 Estate Planning E11 from income which the beneficiary of the trust receives in that year. The deductions and allowances which exceed the taxable income of the trust can be deducted in the following year of assessment from income which the beneficiary of the trust receives in that year. 5. If during a year of assessment a resident acquires a vested right to capital of an offshore trust: and the capital arose from income received by or accrued to the trust or from any receipts or accruals of such trust which would have constituted income if such trust had been a resident, in any previous year of assessment during which the resident had a contingent right to income, and the income or receipts and accruals has not been taxed in the Republic, such capital amount shall be included in the income of the resident. Tax rates Income vesting in the trust as taxpayer is taxed at a rate of 40% as from 1 March 2002 with the exception of a special trust. Definition of a special trust: A trust created solely for the benefit of a person who suffers from - any mental illness as defined in section 1 of the Mental Health Act of 1973; or - a serious physical disability, where such disability or illness incapacitates the beneficiary from earning sufficient income to maintain himself/herself; or A testamentary trust established solely for the benefit of any minor beneficiaries who are relatives of the deceased person and who are alive on the date of death of the deceased person, will be classified as a special trust until the youngest of the beneficiaries turns 21. Trusts falling into these categories will be taxed at the same rates applicable to natural persons as contained in the Income Tax section.

272 E12 Estate Planning PERSON TAXED TAXATION OF TRUST INCOME SECTION/CASE 1. SETTLOR/DONAR; Parent BENEFICIARY: Minor child (own child) (a) Parent (b) Minor child (as a trust beneficiary) Income received by or accrued to minor that is attributable to parent s gratuitous disposition. Income received by or accrued to the minor where the beneficiary has a vested right to the income retained in the trust. 2. SETTLOR: Parent BENEFICIARY: Major child 1 (a) Beneficiary (i) Income actually received (ii) Income due and payable i.e. accrued but not received. (b) Parent (c) Trustee / Donor if settler is dead) Income not received by or accrued to beneficiary as a result of settlor s stipulation or condition. Income withheld i.t.o. trustee s discretion and which does not accrue to beneficiary. s.7(3) CIR v Widan CIR v Berold Ovenstone v SIR s.1 gross income s.7(1) ITC 1328 s.25b(1) s.7(5) ITC 1328 Est. Dempers v SIR Sir V Sidley s.1 gross income s.25b(1) 3. SETTLOR: Any person BENEFICIARY: Minor child (note own child) (a) Beneficiary (b) Settlor / Donor (c) Trustee (if settler / donor dead) Note: (i) Income actually received. (ii) Income accrued but not received. Income not received by or accrued to beneficiary in terms of settlor s stipulation or condition. Income withheld in terms of trustee s discretion and which does not accrue to beneficiary. s.1 gross income s.7(1) ITC 1328 s.25b(1) & (2) S.7(5) ITC 1328 Est. Dempers SIR v Sidley s.1 gross income s.25b(1) As from 1 July 2007 the age of majority has been changed to 18 years.

273 Estate Planning E13 PERSON TAXED TAXATION OF TRUST INCOME SECTION/CASE 4. SETTLOR/ Any person BENEFICIARY: Another person s minor child with reciprocal Benefits for settler or his family Parents of beneficiary Income received by or accrued to minor child. 5. SETTLOR/ Donor spouse BENEFICIARY: Other spouse (living together) Donor Spouse Income received by or accrued to donee spouse can be taxed in the other spouse s hands if provisions of s.7(2) are met. s.7(4) s.7(2) 6. SETTLOR/ Any person who confers a right to income but retains the power to revoke or confer the right upon another BENEFICIARY: Any person Settlor Income received by or accrued in terms of conferred right so long as the power to revoke is retained. s.7(6) 7. SETTLOR/ Any person who donates/settles a right to receive income in such a manner that he remains the owner or retains an interest therein, or is entitled to regain ownership at a specified or specifiable time BENEFICIARY: Any person Settlor/Donor 8. SETTLOR/ Any resident BENEFICIARY: Non-resident Resident Any income (e.g. rent, dividends, interest) Received by the beneficiary. Income received by or accrued to a nonresident as is attributable to a donation, settlement or other disposition made by the resident. s.7(7) s.7(8)

274 E14 Estate Planning Interest-free loans 1. Income tax considerations (a) Minor children (section 7(3)) The interest-free loan is treated as a disposition within the meaning of s7(3) and any income or benefit the minor receives which is attributable to the fact that the loan is interest free, is taxable in the parent s hands (CIR v Berold and Joss v SIR). Where an interest rate is charged, but it is lower than market rates, the interest income that is attributable to the loan may be apportioned between the parent and minor child in accordance with the gratuitous and non-gratuitous elements of the disposition. If no apportionment takes place, all the interest income will be taxed in the parent s hands (Ovenstone v SIR). (b) Trust beneficiaries (section 7(5)) Where a settlor makes an interest-free loan to a trust and the trust deed contains a stipulation that the trust income is to be withheld from the trust beneficiaries until a stipulated event occurs, the income attributable to the interest-free loan will, together with the rest of the trust income, be taxed in the settlor s hands (in terms of s7(5)). When the stipulated event occurs, the income may no longer be taxed in the settlor s hands in terms of s7(5). Section 80A may, however, be applied. (c) Other cases (section 80A) Where income attributable to an interest-free loan cannot be taxed in the parent s/settlor s hands in terms of sections 7(3) or 7(5), the Commissioner may apply Section 80A. This can be done only if the requirements as set out in Section 80A are present. If the Commissioner can successfully apply s80a, the income attributable to the interest-free loan will be taxed in the hands of the person making the loan.

275 Estate Planning E15 2. Donations tax considerations In terms of common law a loan carries no interest unless there is an express agreement to that effect (Balliol Investment Co. v Jacobs). Section 55(1) defines a donation for donations tax purposes as a gratuitous disposal of property including a gratuitous waiver or renunciation of rights. It is debatable whether making an interest-free loan constitutes a gratuitous disposal of property, and therefore the failure to charge interest thereon could be said to amount to a waiver or renunciation of a right that does not exist. According to the author Silke, the present general practice of Inland Revenue is not to regard interest-free loans as donations. 3. CGT consequences In terms of paragraph 12(5) of the Eighth Schedule, SARS will regard the bequest of an outstanding loan account to an inter vivos trust or to anyone who owes the deceased money, as the writing off of a debt (ABC Trust v The CIR Case no 11410(TPD)). The debtor will be responsible for paying CGT on the difference between the outstanding debt and the base cost of the loan (base cost of a loan is zero). In TC 12399, Northern Cape Tax Court the Court found that the bequest of such a loan account as part of the residue of estate will not attract capital gains tax where it is not the intention of the testator/testatrix to specifically bequeath such loan account to the debtor. It must however be noted that SARS does not agree with this judgment and because it is a decision by the special tax court it is not binding. SARS may decide to take a similar matter to court, should this issue arise again in future.

276 E16 Estate Planning 1. Section 7 Anti-tax avoidance measures This section was designed to prevent tax avoidance, by means of trusts inter alia - see section on the taxation of trust income, and to prevent tax avoidance by means of income splitting (s.7(2)). 2. Sections (Donations tax) Donations tax is levied on certain donations. If property is disposed of for an inadequate consideration it is deemed to have been disposed of under a donation (s.58). 3. Sections 80A Section 80A to L replaced section 103(1) on 2 November 2006, and applies to any arrangements or any steps therein (or parts thereof) entered into on or after that date. At the same time, section 103(1) and (3) were deleted. Section 80A determines that an avoidance arrangement is an impermissible avoidance arrangement if its sole or main purpose was to obtain a tax benefit and (a) in the context of business (i) (ii) it was entered into or carried out by means or in a manner which would not normally be employed for bona fide business purposes, other than obtaining a tax benefit; or it lacks commercial substance, in whole or in part, taking into account the provisions of section 80C; (b) (c) in a context other than business, it was entered into or carried out by means or in a manner which would not normally be employed for a bona fide purpose, other than obtaining a tax benefit; or in any context (i) it has created rights or obligations that would not normally be created between persons dealing at arm s length; or

277 Estate Planning (ii) E17 it would result directly or indirectly in the misuse or abuse of the provisions of this Act (including the provisions of this part. Section 80B provides that the Commissioner may determine the tax consequences of any impermissible avoidance arrangement for any party by (a) (b) (c) (d) (e) (f) disregarding, combining, or re-characterising any steps in or parts of the impermissible avoidance arrangement; disregarding any accommodating or tax-indifferent party or treating any accommodating or tax-indifferent party and any other party as one and the same person; deeming persons who are connected persons in relation to each other to be one and the same person for purposes of determining the tax treatment of any amount; reallocating any gross income, receipt or accrual of a capital nature, expenditure or rebate amongst the parties; re-characterising any gross income, receipt or accrual of a capital nature or expenditure; or treating the impermissible avoidance arrangement as if it had not been entered into or carried out, or in such other manner as in the circumstances of the case the Commissioner deems appropriate for the prevention or diminution of the relevant tax benefit. The section further provides that the Commissioner must make compensating adjustments that he or she is satisfied are necessary and appropriate to ensure the consistent treatment of all parties to the impermissible avoidance arrangement. 4. Section 103(5) (Cession of interest) Where under any transaction, operation or scheme any taxpayer has ceded his right to receive any amount in exchange for any amount of dividends, and in consequence of such cession the taxpayer s liability for normal tax, as determined before applying the provisions of this subsection, has been reduced or extinguished, the Commissioner shall determine the liability for normal tax of the taxpayer and any other party to the transaction, operation or scheme as if such cession had not been effected.

278 E18 Estate Planning This section shall be deemed to have come into operation on 22 December 1988 and shall apply - (i) (ii) to any transaction, operation or scheme concluded on or after that date; and to any transaction, operation or scheme concluded before that date, if the taxpayer is at liberty to terminate the operation of such transaction, operation or scheme without incurring liability for damages, compensation or similar relief.

279 Estate Planning E19 Tax implications of retaining control in estate planning 1. Trusts (a) Income Tax Act - Section 7(6) If a settlor, in the trust deed, retains the power to revoke or transfer the right to receive income from the trust, then any income received by the person on whom the right is conferred will be taxed in the settlor s hands. Section 7(6) will be applicable for so long as the power is retained. (b) Income Tax Act - Section 7(7) While the settlor remains the owner of or retains an interest in property transferred to a trustee or beneficiary, or if the settlor is entitled to regain the interest or ownership, all the income from the property that is received by or accrues to the beneficiary will be taxable in the settlor s hands. The settlor may recover any tax payable from the person who is entitled to receive the income. (c) Estate Duty Act - Section 3(3)(d) Any property which the deceased was immediately prior to his death competent to dispose of for his own or his estate s benefit shall be deemed to be his property for estate duty purposes. A person is deemed to be competent to dispose of any property if he has the power to appropriate or freely dispose of the property, or if he is empowered to revoke or vary the trust deed provisions - section 3(5)(b)(ii). 2. Companies: Unquoted shares The valuation of shares of private companies for estate duty purposes Section 5(1)(f)(bis) of the Estate Duty Act provides the method of valuing shares in a private company. In terms of an amendment to the Estate Duty Act introduced in 1993, the term company includes close corporation and the term shares includes any member s interests or debentures. The purpose of this section is to prevent the creation of artificial values and provides as follows:

280 E20 Estate Planning (i) (ii) (iii) No regard shall be had to any provision in the memorandum and articles of association, founding statement, association agreement or rules of the company, as the case may be, restricting the transferability of the shares therein, but it shall be assumed that such shares were freely transferable; No regard shall be had to any provision in the memorandum and articles of association, founding statement, association agreement or rules of the company, as the case may be, whereby or where-under the value of the shares of the deceased or any other member is to be determined; If upon a winding-up of the company the deceased would have been entitled to share in the assets of the company to a greater extent pro rata to shareholding or membership than other shareholders or members, no lesser value shall be placed on the shares held by the deceased than the amount to which he would have been so entitled if the company had been in the course of winding-up and the said amount had been determined as at the date of his death; (iv) No regard shall be had to any provision or arrangement resulting in any variation in the rights attaching to any shares through or on account of the death of the deceased; (v) There shall be taken into account any power of control exercisable by the deceased and the company where under he was entitled or empowered to vary or cancel any rights attaching to any class of shares therein, including by way of redemption of preference shares, if, by the exercise of such power, he could have conferred upon himself any benefit or advantage in respect of the assets or profits of the company.

281 Estate Planning E21 1. Tax implications 1.1 Fideicommissum Limited interests (a) Income tax The fiduciary is taxed on any income from the fideicommissary property. When the fideicommissary becomes owner he will similarly be taxed. (b) Estate duty 1.2 Usufructs A fiduciary interest held immediately prior to death is property (s3(2)(a)). The value of the usufruct is, however determined in terms of s5(1)(b) read in conjunction with s5(2). (See section on valuing limited interests.) (a) Income tax The usufructuary is taxed on the income from the usufructuary property. When the bare dominium holder acquires full ownership he will similarly be taxed. (b) Estate duty A usufructuary interest held immediately prior to death is property (s3(2)(a)). The value is determined in terms of s5(1)(b) read in conjunction with s5(2). The value of the usufruct is, however, deductible in terms of s4(m) provided: the usufruct concerned was created by a predeceased spouse; and the property over which the usufruct was created was an asset in the estate of the predeceased spouse; and no deduction in respect of the usufruct was allowed or allowable as a deduction in terms of s4(q) in determining the net value of the estate of the predeceased spouse.

282 E22 Estate Planning 1.3 Annuities (a) Income tax Recipient: An annuity (other than a voluntary purchase annuity) is fully taxable even if paid out of capital (s.1 gross income (a)). Payer: If paid in terms of a personal obligation, the annuity is not deductible. The income is thus taxed twice, first in the hands of the annuity payer and then again in the hands of the annuitant. If the annuity is charged upon property it is payable to and taxable in the hands of the annuitant, and deductible against the income of the property, i.e. it is taxed only once. (b) Estate duty An annuity charged against property will form part of the annuitant s estate (s3(2)(a)). If the annuity is a personal obligation and it accrues to another person on the annuitant s death it will be property (s3(2)(b)). A personal obligation annuity which ceases on the annuitant s death is free of estate duty. Where an annuity is charged against property, the value of the annuity is deductible in terms of s.4(m) provided: the annuity was created by a predeceased spouse, and the property over which the annuity was created was an asset in the estate of the predeceased spouse, and no deduction in respect of the annuity was allowed or allowable as a deduction in terms of s4(q) in determining the net value of the estate of the predeceased spouse.

283 Estate Planning E23 2. Valuing limited interests for estate duty purposes: Deaths before and after 1 April 1977 Sections 5(1)(b) and (f) and 5(2) of the Estate Duty Act 45 of 1955 set out how fiduciary, usufructuary or other like interests in property (hereinafter referred to as limited interests) are to be valued for estate duty purposes. The value is determined by capitalising the annual value of the interest either over the life expectancy of the beneficiary, or, if the right of enjoyment is over a lesser period than the beneficiary s lifetime, over such lesser period. (a) Annual value The annual value of the limited interest must be determined in accordance with the provisions of section 5(2). The annual value is an amount equal to 12% (6%, if the person died before ) of the fair market value of the full ownership of the property subject to the limited interest. The Commissioner may accept a lower yield if he is satisfied that it is reasonable and it is shown that the property cannot reasonably be expected to yield an annual return of 12%. Example: Calculate the annual value of a property which has a fair market value of R Before : R x 6% = R On or after : R x 12% = R (b) Capitalising the annual value (i) Before 1 April 1977 For persons who died between 13 April 1956 and 1 April 1977, the amount to be included as property is determined by capitalising at 6% the annual value of the property over which the right is enjoyed. The tables to be used with regard to the estates of persons who died before 1 April 1977 are to be found below. Example: Calculate the present value of a limited interest of R per annum for life of X, a female, who becomes entitled to the limited interest at the age of 47 years 2 months, and Y, a male, who becomes entitled to the limited interest at the age of 69 years 6 months.

284 E24 Estate Planning X Y Age when acquired 47 years 2 months 69 years 6 months Age next birthday Present value of R1 p.a. for life 13,26 7,22 Present value of R p.a. for life R R (ii) On or after 1 April 1977 In respect of persons who died on or after 1 April 1977 the annual value of the property must be capitalised at 12%. (The tables to be used for this purpose are to be found below.) Example: On the same facts as (i) above. Assume that the annual value is R X Age next birthday Present value of R1 p.a. for life 8, ,45165 Present value of R p.a. for life R R Y 3. Valuation of limited interests: Examples 3.1 Fiduciary right Facts: P held a fiduciary right over property worth R immediately prior to death. Q (a female), the fideicommissary, is 39 years old. Calculation: Annual value of property: 12% of R = R P.V. of R1 p.a. for Q s life (a.n.b. 40) = 8, P.V. of R8 400 p.a. for life: 8, x R8 400 = R Value in P s estate = R68 744

285 Estate Planning E Value of usufruct for 4(q) deduction Facts: A leaves property worth R to C, subject to a life long usufruct in favour of his spouse, B (a female), aged 56, next birthday. Calculation: Annual value of property: 12% x R = R P.V. of R1 p.a. for B s life = 7, (q) deduction in A s estate = R Usufructuary right (ceasing) Facts: X (a female) held a usufructuary interest immediately prior to her death. The usufruct ceases and Y (a male), the bare dominium holder, acquires full ownership. The value of the property when bare dominium was acquired was R and when full ownership was acquired R X was 46 years old when acquiring the usufructuary interest. Y was 39 years old when X died. Calculation: Annual value of property: 12% x R = R8 400 P.V. of R1 p.a. for Y s life (a.n.b. 40) = 8, P.V. of R8 400 p.a. for life: 8, x R8 400 = R Remember: For estate duty purposes, the capitalised value may not exceed the difference between the present market value of the property and the value of the bare dominium when it was first acquired (assume after ). This necessitates the following calculation: Value of bare dominium when originally acquired: Annual value of property: 12% x R = R P.V. of R1 p.a. for X s life (a.n.b. 47) = 8,03119 P.V. of R4 200 p.a. for life: 8,03119 x R4 200 = R Value of bare dominium when acquired: R R = R Present market value of property = R70 000

286 E26 Estate Planning Difference between present fair market value of the property and dominium when first acquired: R R1 269 = R For Estate duty purposes the lesser of R or R may be used, therefore, the value of the usufruct ceasing is R Usufructuary right (passing to another) B held a usufructuary right over property worth R immediately prior to death. The usufruct passes to C (a female) aged 39. Annual value of property: 12% x R = R P.V. of R1 p.a. for C s life (a.n.b. 40) = 8, P.V. of R8 400 p.a. for life: 8, x R8 400 = R Value of B s estate: = R Annuity (passing to another) Facts: P (a male) received an annuity of R2 100 from the income of property held in trust. On his death, his wife, Q, aged 71, continues to receive the annuity. Calculation: Value of annuity = R P.V. of R1 p.a. for Q s life (a.n.b. 72) = 5, , x R2 100 = R P.V. of R2 100 = R Value in P s estate = R Annuity (ceasing) Facts: P received an annuity of R1 200 from the income of property held by a company. On his death, the annuity ceases. See s.5(1)(3). Calculation: Value of annuity = R1 200

287 Estate Planning E27 P.V. of R1 p.a. for 50 years = 8,3045 P.V. of R1 200 for 50 years: 8,3045 x R1 200 = R9 965 Value in P s estate: = R9 965 Note: If the property belonged to a natural person, the value of the annuity must be capitalised at 12% over the owner s life expectancy s.5(1)(c)(ii). 3.7 Bare dominium (property subject to usufruct) Facts: X inherited property subject to a usufruct. On X s death the property s market value is R30 000, and the usufructuary, Y, (a male) is 57 years old. Calculation: Annual value of property: 12% of R = R P.V. of R1 p.a. for Y s life (a.n.b. 58) = 6, P.V. of R3 600 p.a. for life: 6, x R3 600 = R Value in X s estate: R R = R Bare dominium (property charged with annuity) Facts: P owns property charged with an annuity of R On P s death the property s market value is R25 000, and the annuitant (a female) is 67 years old. She is entitled to receive the annuity for a further 12 years. Her life expectancy is 13,2 years. Calculation: Value of annuity = R P.V. of R1 p.a. for 12 years = 6,1944 P.V. of R1 500 for 12 years: 6,1944 x R1 500 = R Value in P s estate: R R9 292 = R15 708

288 E28 Estate Planning Tables for valuation of limited interests Table A: 6%: Death before 1 April 1977 Expectation of life and present value of R1 p.a. for life capitalised at 6% over expectation of life of males and females of various ages A.N.B Life expectancy P.V. of R1 p.a. for life A.N.B Males Females Males Female ,78 65,51 64,90 64,08 63,21 62,32 68,31 69,63 68,97 68,16 67,31 66,40 16,26 16,30 16,29 16,27 16,25 16,22 16,35 16,38 16,37 16,35 16,34 16, ,41 60,50 59,58 58,65 57,71 65,48 64,56 63,62 62,68 61,73 16,20 16,18 16,15 16,12 16,09 16,30 16,28 16,25 16,24 16, ,76 55,81 54,86 53,92 52,97 60,78 59,82 58,87 57,91 56,97 16,06 16,02 15,98 15,95 15,91 16,18 16,15 16,12 16,10 16, ,04 51,10 50,18 49,26 48,35 56,02 55,08 54,14 53,21 52,27 15,86 15,81 15,77 15,72 15,66 16,03 15,99 15,96 15,92 15, ,45 46,55 45,65 44,74 43,84 51,33 50,40 49,47 48,55 47,63 15,62 15,56 15,51 15,44 15,36 15,83 15,79 15,73 15,68 15, ,93 42,02 41,11 40,20 39,29 46,71 45,80 44,89 43,97 43,06 15,31 15,22 15,14 15,07 14,97 15,57 15,51 15,46 15,38 15, ,38 37,48 36,75 35,68 34,79 42,15 42,23 40,32 39,42 38,52 14,90 14,79 14,68 14,59 14,47 15,24 15,16 15,07 15,00 14, ,89 33,01 32,13 31,25 30,38 37,62 36,72 35,83 34,95 34,07 14,37 14,23 14,12 13,97 13,85 14,79 14,71 14,59 14,50 14,

289 Estate Planning E29 Table A: 6%: Death before 1 April 1977 (cont.) A.N.B Life expectancy P.V. of R1 p.a. for life A.N.B Males Females Males Female ,52 28,66 27,82 26,98 26,15 33,20 32,33 31,47 30,61 29,76 13,68 13,54 13,36 13,21 13,05 14,26 14,12 14,01 13,85 13, ,34 24,54 23,75 22,97 22,21 28,92 28,09 27,27 26,46 25,66 12,84 12,67 12,49 12,30 12,11 13,59 13,41 13,26 13,11 12, ,46 20,73 20,01 19,30 18,61 24,86 24,07 23,29 22,52 21,76 11,90 11,69 11,47 11,24 10,99 12,73 12,55 12,37 12,17 11, ,93 17,26 16,60 15,96 15,34 21,00 20,25 19,50 18,77 18,04 10,83 10,56 10,29 10,11 9,81 11,76 11,54 11,31 11,08 10, ,72 14,12 13,54 12,97 12,41 17, ,91 15,22 14,55 9,61 9,29 9,07 8,85 8,62 10,56 10,29 10,11 9,81 9, ,86 11,33 10,81 10,29 9,79 13,89 13,24 12,61 11,99 11,39 8,26 8,01 7,76 7,49 7,22 9,29 8,96 8,62 8,38 8, ,29 8,81 8,35 7,90 7,47 10,80 10,24 9,69 9,17 8,68 6,94 6,65 6,36 6,21 5,90 7,76 7,49 7,22 6,94 6, ,05 6,65 6,25 5,87 5,51 8,20 7,74 7,29 6,86 6,43 5,58 5,42 5,08 4,74 4,56 6,36 6,05 5,74 5,42 5, ,15 4,82 4,50 4,21 3,94 6,02 5,63 5,25 4,90 4,57 4,39 4,03 3,84 3,65 3,39 4,92 4,74 4,39 4,21 3,

290 E30 Estate Planning Table A: 6%: Death before 1 April 1977 (cont.) A.N.B Life expectancy P.V. of R1 p.a. for life A.N.B Males Females Males Female ,68 3,44 3,21 2,99 2,78 4,25 3,95 3,67 3,41 3,16 3,23 3,99 2,83 2,67 2,51 3,65 3,39 3,23 2,99 2, ,59 2,41 2,24 2,09 1,94 2,93 2,71 2,51 2,31 2,14 2,34 2,17 2,00 1,92 1,74 2,59 2,42 2,25 2,09 1, ,80 1,68 1,56 1,45 1,35 1,97 1,81 1,67 1,54 1,42 1,66 1,57 1,48 1,39 1,30 1,83 1,66 1,57 1,39 1, Table B: 6%: Death before 1 April 1977 Present value of R1 per annum capitalised at 6% over fixed periods Year Factor R 0,94 1,83 2,67 3,47 4,21 Year Factor R 10,11 10,48 10,83 11,16 11,47 Year Factor R 13,93 14,08 14,23 14,37 14,50 Year Factor R 15,52 15,59 15,65 15,71 15, ,92 5,58 6,21 6,80 7, ,76 12,04 12,30 12,55 12, ,62 14,74 14,85 14,95 15, ,81 15,86 15,91 15,95 15, ,89 8,38 8,85 9,29 9, ,00 13,21 13,41 13,59 13, ,14 15,22 15,31 15,38 15, , ,61 Note: Fractions of a year are to be disregarded when using this table.

291 Estate Planning E31 Table A: 12%: Death on or after 1 April 1977 Expectation of life and present value of R1 p.a. for life capitalised at 12% over expectation of life of males and females of various ages A.N.B Life expectancy P.V. of R1 p.a. for life A.N.B Males Females Males Female ,74 65,37 64,50 63,57 62,63 61,69 72,36 72,74 71,87 70,93 69,97 69,02 8, , , , , , , , , , , , ,74 59,78 58,81 57,83 56,85 68,06 67,09 66,11 65,14 64,15 8, , , , , , , , , , ,86 54,87 53,90 52,93 51,98 63,16 62,18 61,19 60,21 59,23 8, , , , , , , , , , ,04 50,12 49,21 48,31 47,42 58,26 57,29 56,33 55,37 54,41 8, , , , , , , , , , ,53 45,65 44,77 43,88 43,00 53, ,54 50,58 49,63 8, , , , , , , , , , ,10 41,20 40,30 39,39 38,48 48,67 47,71 46,76 45,81 44,86 8, , , , , , , , , , ,57 36,66 35,75 34,84 33,94 43,91 42,96 42,02 41,07 40,13 8, , , , , , , , , , ,05 32,16 31,28 30,41 29,54 39,19 38,26 37,32 36,40 35,48 8, , , , , , , , , ,

292 E32 Estate Planning Table A: 12%: Death on or after 1 April 1977 (cont.) Expectation of life and present value of R1 p.a. for life capitalised at 12% over expectation of life of males and females of various ages A.N.B Life expectancy P.V. of R1 p.a. for life A.N.B Males Females Males Female ,69 27,85 27,02 26,20 25,38 34,57 33,67 32,77 31,89 31,01 8, , , , , , , , , , ,58 23,79 23,00 22,23 21,47 30,14 29,27 28,41 27,55 26,71 7, , , , , , , , , , ,72 19,98 19,26 18,56 17,86 25,88 25,06 24,25 23,44 22,65 7, , , , , , , , , , ,18 16,52 15,86 15,23 14,61 21,86 21,08 20,31 19,54 18,78 7, , , , , , , , , , ,01 13,42 12,86 12,31 11,77 18,04 17,30 16,58 15,88 15,18 6, , , , , , , , , , ,26 10,76 10,28 9,81 9,37 14,51 13,85 13,20 12,57 11,96 6, , , , , , , , , , ,94 8,54 8,15 7,77 7,41 11,37 10,80 10,24 9,70 9,18 5, , , , , , , , , , ,07 6,73 6,41 6,10 5,82 8,68 8,21 7,75 7,31 6,89 4, , , , , , , , , ,

293 Estate Planning E33 Table A: 12%: Death on or after 1 April 1977 (cont.) Expectation of life and present value of R1 p.a. for life capitalised at 12% over expectation of life of males and females of various ages A.N.B Life expectancy P.V. of R1 p.a. for life A.N.B Males Females Males Female ,55 5,31 5,09 4,89 4,72 6,50 6,13 5,78 5,45 5,14 3, , , , , , , , , , ,57 4,45 4,36 4,32 4,30 4,85 4,58 4,33 4,11 3,92 3, , , , , , , , , , Table B: 12%: Death on or after 1 April 1977 Present value of R1 p.a. capitalised at 12% over fixed periods Year Factor R 0, , , , , Year Factor R 6, , , , , Year Factor R 8, , , , , Year Factor R 8, , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , ,333 2 Note: Fractions of a year are to be disregarded when using this table.

294 E34 Estate Planning Estate duty: Rebate of duty on successive deaths If any part of the duty is charged in respect of the value of any property on which duty had previously been payable, on the death of another person at any time within ten years of the death of the deceased, the amount of the duty attributable to the value of that property is further reduced in accordance with the following scale: 0-2 years: If the deceased dies within two years of the death of the first-dying person. 2-4 years If the deceased dies more than two years, but not more than four years, after the death of the first-dying person. 4-6 years: If the deceased dies more than four years, but not more than six years, after the death of the first-dying person. 6-8 years If the deceased dies more than six years, but not more than eight years, after the death of the first-dying person years: If the deceased dies more than eight years, but not more than ten years, after the death of the first-dying person. 100% 80% 60% 40% 20% This rebate may not, however, exceed the amount of duty attributable to that property by reason of its inclusion in the dutiable estate of the firstdying. The rebate will not be applicable if a section 4(q) deduction was allowed in the first-dying spouse s estate.

295 Estate Planning E35 How to calculate the estate duty that may be apportioned to policies owned by third parties/where there is a third-party beneficiary The proceeds of all policies on the deceased s life (except those recoverable under ante nuptial contracts, buy-and-sell and key person policies) are deemed to be property in the deceased s estate. Although the estate derives no benefit, its liability for estate duty is increased by the value of the policies. Redress is, however, to be found in the Estate Duty Act. In terms of section 11(b) the person liable for the (extra) estate duty is the person entitled to recover the amount due under the policy. The executor is also empowered by section 13(1) to recover such duty from the person liable therefore. The statutory method of calculating the apportionable duty is set out in section 13(2) of the Estate Duty Act. The following two-step method is a simplified but accurate way of establishing how much estate duty may be claimed from a third party who is entitled to recover the proceeds of a policy effected on the deceased s life. Note: The deemed value of policies owned by third parties will be the value of the proceeds of the policies less the premiums paid by such third party plus 6% compound interest. Step 1 Value of life assurance Net value of estate X duty payable Step 2 Deemed value of policies owned by third parties in Step 1 Value of life assurance X amount derived The net value of life assurance is determined by adding the proceeds of all policies on the life of the deceased deemed to be property in his/her estate (excluding policies with spouse as beneficiary).

296 E36 Estate Planning The following example illustrates how the apportionable amount is calculated. Add Assurance on own life R Policy owned by third party (less premiums paid + 6% interest) R Value of life assurance R The net value of estate R Estate duty payable (R ,5m x 20%) R Step 1 Value of life assurance Net value of estate X duty payable = R R x R = R (Step 1 amount) Step 2 Deemed value of policies owned by third parties = Value of life assurance Step 1 amount = R R x R = R9 949 The estate duty apportioned to the policy owned by the third party is, therefore, R The third party is liable for this duty and the executor may recover the apportioned amount unless directed otherwise in the will of the deceased or the contract in terms of which the policy was effected.

297 Estate Planning E37 ANC marriage Estate Duty Worksheet Note: In all the spreadsheets the estate duty abatement is R3,5m. Note that in the event of the first dying spouse not utilising any or all of the R3,5m abatement, the surviving spouse will be entitled to the unused deduction. PROPERTY AND DEEMED PROPERTY 1. R 2. R 3. R 4. R 5. R 6. R GROSS ESTATE LESS: Deductions 1. Deductible Expenses - Master s fees - Funeral expenses - Executor s fees 2. Liabilities - Income Tax (including CGT) - Bank overdraft - Mortgage Bond - Hire purchase Other Accrual claim (if married in terms of accrual system) 5. Bequests to surviving spouse (Section 4(q)) NET ESTATE R (R ) LESS: ABATEMENT (Section 4A) (R ) DUTIABLE ESTATE Estate 20% x 20% ESTATE DUTY PAYABLE R R R

298 E38 Estate Planning ANC marriage and residue is bequeathed to the surviving spouse Estate Duty Worksheet PROPERTY AND DEEMED PROPERTY 1. R 2. R 3. R 4. R 5. R 6. R 7. R GROSS ESTATE LESS: Deductions 1. Deductible Expenses - Master s fees R - Funeral expenses R - Executor s fees R 2. Liabilities - Income Tax (including CGT) R - Bank overdraft R - Mortgage Bond R - Hire purchase R - R - R 3. Other - R - R 4. Accrual claim (if married in terms of accrual system) R 5. Direct bequests to surviving spouse (Section 4(q)) R - Policies paying directly to spouse R - Other (i.e. Usufruct) R R (R )

299 Estate Planning E39 NET ESTATE OF CLIENT BEFORE DEDUCTING BEQUEST OF RESIDUE TO SURVIVING SPOUSE CALCULATION OF RESIDUE WHICH ACCRUES TO SURVIVING SPOUSE (A) CARRIED FORWARD R (A) LESS: Bequests in terms of the will and policies payable to third parties, other than the surviving spouse (excluding the bequest of the residue to the surviving spouse). 1. Bare Domimium (if usufruct bequeathed to spouse) 2. R 3. R 4. R 5. R RESIDUE BEQUEATHED TO SURVIVING SPOUSE (A-B) (R ) NET ESTATE LESS: ABATEMENT (Section 4A) (R ) DUTIABLE ESTATE Estate 20% x 20% ESTATE DUTY PAYABLE Note: In a Special Income Tax Court decision (ITC 1681) the court found that the step-by-step approach amounted to a calculation of duty on duty and that it was unjustified. This decision was upheld on appeal (CIR v The Executor of the Estate of the Late Waldo Earl Frith, 2000). R R (B) R R R R (A)

300 E40 Estate Planning Community marriage Estate Duty Worksheet PROPERTY IN THE JOINT ESTATE 1. R 2. R 3. R 4. R 5. R 6. Policies: R Spouse s policies (taken out after 1/1/99) - surrender values R Client s policies payable to the estate (no beneficiary nomination) R Investment / sinking fund policies R Surrender values of policies on life of 3rd party R GROSS ESTATE LESS: Spouse s half share (Gross estate divided by two) (R ) CLIENT S HALF SHARE OF THE JOINT ESTATE PLUS: Property + deemed property excluded from joint estate 1. Life policies: 3rd party = beneficiaries R 2. Life policies: spouse = beneficiary R 3. Ceded policies on life of client R 4. Life cover (client life assured / spouse is the owner) R 5. Life cover (client life assured / 3rd party is the owner) R 6. Assets inherited R 7. Usufruct R 8. Other R - R - R TOTAL R LESS: Deductions (R ) - Master s fees R - Administration costs R - Executor s fees R - Bank overdraft R - Mortgage Bond R - Income tax R - Liabilities (including CGT) R TOTAL R R R R TOTAL DIVIDED BY TWO CLIENT S HALF OF DEDUCTION R R

301 Estate Planning E41 Community marriage Estate Duty Worksheet (cont.) LESS: Deductions against the client s estate (R ) - Fees on excluded assets (100%) R - Funeral costs and death expenses (100%) R LESS: Bequests to spouse (see note 4q) R 1. R 2. R 3. R 4. R 5. R NET ESTATE R Less: Abatement (section 4A) (R ) DUTIABLE ESTATE R Estate 20% X 20% ESTATE DUTY PAYABLE R Note: The above method is followed by the University of the Free State for the Post Graduate Diploma in Financial Planning and the Advanced Post Graduate Diploma in Financial Planning.

302 E42 Estate Planning Community marriage and residue is bequeathed to surviving spouse Estate Duty Worksheet PROPERTY IN THE JOINT ESTATE 1. R 2. R 3. R 4. R 5. R 6. Policies: R Spouse s policies (taken out after 1/1/99) surrender R values Client s policies payable to the estate (no beneficiary nomination) R Investment / sinking fund policies R Surrender values of policies on life of 3rd party R GROSS ESTATE LESS: Spouse s half share (Gross estate divided by two) (R ) CLIENT S HALF SHARE OF THE JOINT ESTATE PLUS: Property + deemed property excluded from joint estate 1. Life policies: 3rd party = beneficiaries R 2. Life policies: spouse = beneficiary R 3. Ceded policies on life of client R 4. Life cover (client life assured / spouse is the owner) R 5. Life cover (client life assured / 3rd party is the owner) R 6. Assets inherited R 7. Usufruct R 8. Other R - R - R TOTAL LESS: Deductions (R ) - Master s fees R - Administration costs R - Executor s fees R - Bank overdraft R - Mortgage Bond R - Income tax R - Liabilities (including CGT) R TOTAL R TOTAL DIVIDED BY TWO R CLIENT S HALF OF DEDUCTION R R R R R

303 Estate Planning E43 Community marriage and residue is bequeathed to surviving spouse Estate Duty Worksheet (cont.) LESS: Deductions against the client s estate (R ) - Fees on excluded assets (100%) R - Funeral costs and death expenses (100%) R LESS: Bequests to spouse (see note 4q) 1. R 2. R 3. R 4. R 5. R R Note: In terms of section 1 of the Estate Duty Act 45 of 1955 Spouse in relation to any person, means the partner of such person - (a) (b) (c) in a marriage or customary or civil union recognised in terms of the laws of the Republic; in a union recognised as a marriage in accordance with the tenets of any religion; or in a same-sex or heterosexual union which the Commissioner is satisfied is intended to be permanent: Provided that a marriage or union contemplated in paragraph (b) or (c) shall, in the absence of proof to the contrary, be deemed to be a marriage or union without community of property. Note: According to Section 13(2)(b) of the Civil Union Act (No. 17 of 2006) reference to husband, wife or spouse in any other law, including the common law, includes a civil union partner (with the exception of the Marriage Act or the Customary Marriage Act).

304 E44 Estate Planning Calculation of residue which accrues to the surviving spouse (B) CARRIED FORWARD R (B) LESS: Bequests in terms of the will and policies payable to third (R (C ) parties, other than the surviving spouse (excluding the bequest of the residue to the surviving spouse). 1. Bare dominium (if usufruct bequeathed to R spouse) 2. R 3. R 4. R 5. R Residue bequeathed to surviving spouse (B-C) NET ESTATE Less: Abatement (section 4A) (R ) DUTIABLE ESTATE Estate 20% X 20% ESTATE DUTY PAYABLE R R R Note: The above method is followed by the University of the Free State in the Post Graduate Diploma in Financial Planning and the Advanced Post Graduate Diploma in Financial Planning.

305 Estate Planning E45 Estate planning Liquidity analysis LIQUID ASSETS 1. Cash and investments R 2. Life assurance payable to estate R 3. Bequest prices payable by heirs to the estate R 4. Proceeds from Buy-and-Sell agreement: R 5. Other R TOTAL R LESS: Cash needed to provide for: 1. Liabilities (R ) 2. Executor s fees (R ) 3. Master s fees (R ) 4. Funeral expenses (R ) 5. Income Tax (including CGT) (R ) 6. Estate duty (R ) 7. Cash bequests 7.1 (R ) 7.2 (R ) 8. Other: 8.1 (R ) 8.2 (R ) TOTAL (R ) SURPLUS/SHORTFALL

306 E46 Estate Planning Capital Needs Analysis Worksheet CAPITAL NEEDS ANALYSIS ON DEATH 1. Income objective on death (p.a.) 2. Less income already provided for (p.a.) Widow s pension Orphans pension Other Other TOTAL INCOME SURPLUS/SHORTFALL = 3. Capital required to eliminate the shortfall Interest rate % Inflation/escalation rate % Term years Capital preserved/consumed Factor* Shortfall ( ) x factor ( ) = Capital required R 4. Plus other liabilities at death Interim income required + R Other capital needs (if any) + R GROSS CAPITAL REQUIRED = R Less capital to dependants available to invest - R NET CAPITAL REQUIRED = R See Table A and B in Section C.

307 Estate Planning E47 Trust Worksheet Income Tax Saving 1. Income tax payable if there is no trust and if a trust is used Survivor s income If no Own and trust from trust Children s income from trust Gross income Less exemptions Income Less deductions Taxable income Ta per table Less rebates Tax payable R R R R R 2. Comparison: Saving in income tax Tax payable on survivor s income (if trust is not used) R Tax payable if a trust is used: by survivor R by child 1 R by child 2 R by child 3 R (R ) INCOME TAX SAVING R

308 E48 Estate Planning Calculation of accrual in terms of the accrual system Value of assets at commencement of marriage: (as shown in the ANC) Client: R... Spouse: R... Client Spouse Current value of each spouse s assets R R ( ) ( ) Less: Liabilities of each spouse s estate ( ) ( ) Less: Assets excluded from respective estates ( ) ( ) CURRENT VALUE OF RESPECTIVE ESTATES R R LESS: Original assets CPI (CPI = %) ( ) ( ) ACCRUAL R R GREATEST ACCRUAL R LESS: Smallest accrual (R ) = DIVISIBLE ACCRUAL R 2 PORTION THAT SPOUSE WITH SMALLEST ACCRUAL RECEIVES FROM OTHER SPOUSE R

309 Estate Planning E49 Important Life assurance and estate planning In these tables the client is the deceased. All the information in this table reflects the client s situation. Owner Life Assured Beneficiary Executor s Fee Estate Duty Client Client None Yes Yes - section 3(3)(a) Client Client Spouse No Yes, but section 4(q) deductible Client Client Third party No Yes - section 3(3)(a) Third party Client None/another party beneficiary for ownership No Yes - section 3(3)(a) Spouse Client None No Yes, but section 4(q) deductible Client Third party None Yes - cash value Client Third party Spouse beneficiary for ownership Client Third party Another party beneficiary for ownership No No Yes - section 3(2) - cash value Yes, but section 4(q) deductible - cash value Yes - cash value Accrual Yes - death value * No No No No (to be included for spouse) Yes - cash value No No Note: The section 4(h) deduction will only apply if a bequest is made to a charitable institution via the client s will. It will not apply if a charity is nominated as the beneficiary on a policy. * See discussion under Note 1 below.

310 E50 Estate Planning Notes 1. When parties are married out of community of property and the accrual system is applicable, the assumption is that all policies with nominated beneficiaries will be excluded for purposes of calculating the accrual. Take note that different opinions exist as to how these policies should be dealt with. The court case Daniels No v De Wet and Another 2944 / 06 delivered in June 2008 may have an influence on the calculation of accrual where life policies pay out. The court case held that death benefits from a life policy only arise after the death of the life assured. 2. When a person other than the life assured is entitled to the proceeds of the policy, the value of the policy included for estate duty purposes may be reduced by a consideration of premiums plus six per cent compound interest paid to the date of death of the life assured by such other person. 3. If the client is married in community of property and he/she is the owner of a policy and a third party is the life assured, only the client s half share of the cash value will be included in the estate for estate duty purposes.

311 Estate Planning E51 Retirement fund lump sums Retirement annuities, pension funds, provident funds Member Beneficiary Executor s fees Estate Duty Client None No No No Client Spouse No No No Client Third party No No No Accrual on Death The Estate Duty exclusion is effective in respect of the estate of a person who dies on or after 1 January When working with the table above, Retirement fund lump sums, section 37C of the Pension Funds Act must be taken into account. Sec 37C of the Pension Funds Act prescribes the manner in which a retirement fund must pay the benefits in the case of the death of a member of a fund: 1. If the member is survived by dependants: a) Within a period of 12 months of the death of the member, the benefits must be paid to some or all of such dependants in proportions as may be deemed equitable by the board of the fund. 2. If the said board does not become aware or cannot trace any such dependant within the 12 month period and the member has nominated a nominee (who is not a dependant) in writing: a) The benefit must be paid to such nominee (beneficiary), but b) If the debts of the estate of the deceased member is more than the assets I the estate, an amount equal to such shortfall must be paid into the estate, and the balance, if any, to the nominee. 3. If the member is survived by both a dependant and a nominee: a) The benefit must be paid to such dependant and nominee in such proportions as the board deems equitable (this provisions is applicable to nominations made on or after 30 June 1989).

312 E52 Estate Planning 4. If the fund does not become aware or cannot trace any dependant of the member within 12 month period and the member has not nominated any nominee: a) the benefit must be paid to the estate of the member.

313 Estate Planning E53 Intestate succession A person dies intestate when he or she dies without leaving a valid will and a person dies partially intestate in the event that a portion of the will is invalid or cannot be carried out. A brief summary of the law of intestate succession is set out hereunder. 1. The surviving spouse The new definition of spouse as per amendments to the Income Tax Act 58 of 1962 and the Estate Duty Act 45 of 1955 does not apply. Note that definition of spouse includes spouses married in or out of community of property; marriages concluded according to Muslim rites, Hindu rites, common law marriages, partners in a civil union and same-sex persons in a union which the commissioner is satisfied is intended to be permanent. Note: Legislation was not changed, but according to recent case law the following also form part of the definition of spouse: Muslim rites (Daniels v Campbell - monogamous marriages) (Hassam v Jacobs polygamous marriages) Hindu marriages (Govender v Ragavayah - monogamous marriages) Common law marriages Same-sex partners (Bhe v Magistrate, Khayelitsha) (Gory v Kolver) 1.1 No descendants If the deceased dies leaving no descendants but only a surviving spouse, the surviving spouse will inherit the entire intestate estate. 1.2 Descendants If the deceased dies leaving descendants and a surviving spouse, the surviving spouse inherits the greater of:

314 E54 Estate Planning (a) a child s share; or (A child s share is calculated by dividing the monetary value of the estate by a number equal to the number of children of the deceased who have survived him, or have died leaving descendants surviving him, plus one.) (b) such portion of the intestate estate as does not exceed in value the amount fixed from time to time by the Minister of Justice by notice in the Government Gazette. Descendants inherit the residue (if any) of the estate (see below under paragraph 2). The current amount fixed by the Minister is R Descendants Descendants mean children and further issue ad infinitum of the deceased, i.e. grandchildren, great-grandchildren, etc. Succession per stirpes and by representation means that the intestate estate is divided into so many equal portions as there are children who survive the deceased and children who have predeceased him leaving descendants surviving him. Each surviving child takes one share while the share attributed to a deceased child is divided equally among his children. If one of the latter has died leaving descendants, such descendants take the predeceased child s share per stirpes and by representation. 2.1 No spouse or descendants, but parents alive Where both parents are alive, each takes half the intestate estate. Where only one parent survives the deceased and there are descendants of the deceased parent, the surviving parent will take half of the estate and the other half devolves upon the descendants of the deceased parent. Where there is only one surviving parent and no other descendants of the predeceased parent, the surviving parent will inherit the entire estate. 2.2 Only brother/sister/descendants of brother or sister alive (no parents alive) Where there are descendants of the deceased s mother and/or father alive, half of the estate will devolve upon the

315 Estate Planning E55 descendants of the mother and half upon the descendants of the father. Where there are only descendants of one parent, such descendants inherit the entire intestate estate. 2.3 No close relatives Where the deceased is not survived by a spouse, descendant, parent, brother or sister or descendants of such brother or sister, the intestate estate devolves in equal shares upon such other blood relations of the deceased who are related to him in the closest degree. 2.4 No relations and no spouse In such a situation, after 30 years, the estate will be forfeited to the state. 2.5 Illegitimate and adopted children Illegitimate children are not prohibited from inheriting on intestacy from another blood relation. An adopted child is deemed to be a descendant of his adoptive parent or parents. He is deemed not to be a descendant of his natural parents except where the natural parent is also the adoptive parent of that child or was, at the time of the adoption, married to the adoptive parent of that child.

316 E56 Estate Planning The Wills Act, No. 7 of 1953 The signing of wills Because it is a legal document, a will must conform to certain legal requirements. These relate to the signing and witnessing of the will. The Wills Act of 1953 lays down certain requirements which must be complied with in the execution of a will. This Act has been amended with the effect that certain formalities have been relaxed. The amendment to the Act came into effect on 1 October 1992 and applies to all wills in respect of which the testator has died after that date. Where the testator has died before 1 October 1992, however, the more stringent requirements will still apply. 1. Wills in respect of which the testator has died before 1 October 1992 For a will executed after 1 January 1954, in respect of which the testator has died prior to 1 October 1992, the more stringent requirements laid down by the Wills Act will apply. 1.1 How must a will be signed? The will must: (a) be signed by the testator and two competent witnesses on every page; (b) (c) although it is not a formal requirement, be dated on the last page; and be signed on all the pages by the testator and two witnesses while they are all present at the same time. 1.2 Who may witness a will? (a) (b) For a will to be valid, the witnesses must be at least fourteen (14) years of age and able to give evidence in court. Beneficiaries under the will, or their spouses, must not sign, as witnesses to the signing of a will, will not be allowed to benefit under said will.

317 Estate Planning E57 (c) A person nominated as an executor, trustee, guardian or their spouses must not sign as a witness to the will as this will render the nomination null and void. 1.3 Codicils and amendments A codicil can be described as an appendix to a will. One is normally drawn up where minor changes are required to a will which do not warrant a complete redraft of the will. Because a codicil is also a testamentary document it must comply with the same requirements as a will for validity. Any deletion, addition, alteration or interlineation made to a will or codicil must be carefully and clearly marked or written and authenticated by the full signatures of the testator(s) and the witnesses in the margin opposite. It is not permitted simply to initial such changes or additions. If a section of the will is deleted, the testator(s) and the witnesses must sign against the deletion and, if any substituted wording has been inserted, they must also authenticate the new insertion. Only the original document needs to be signed. It is unnecessary to either sign or initial the copy of the will although it is usual to record the date on it. If both original and copy are signed, it may be difficult to ascertain which document accurately expresses the testator s last wishes. 2. Wills in respect of which the testator has died after 1 October 1992 (A will executed after 1 January 1954 and in respect of which the testator died after 1 October 1992.) The amendments to the Wills Act will be applicable and the requirements for a valid will are as follows: 2.1 How must a will be signed? (a) The will must be signed at the end thereof by the testator(s) and by two competent witnesses. If the will consists of more than one page, each page other than the page on which it ends must also be signed by the testator(s). The witnesses no longer have to sign these additional pages. In this regard it is interesting to note that signature is defined as including the making of initials.

318 E58 Estate Planning (b) (c) The signing of the will by the testator (all pages) and the witnesses (last page) must take place while they are all present at the same time. Although it is not a formal requirement, the will should be dated on the last page. Note: It should be noted that in terms of the Wills Act, the court is empowered to accept wills that do not comply with the above requirements, provided that it is satisfied that the document before the court is intended to be the testator s last will. 2.2 Who may witness a will? (a) (b) (c) For a will to be valid, the witnesses must be at least 14 years old and must be competent to give evidence in a court. Any person who signs a will as witness and the spouse of such per- son will be disqualified from receiving any benefit under that will. If, however, a court is satisfied that such person or his/her spouse did not unduly influence the testator in the execution of his/her will, or where the will concerned was witnessed and signed by at least two other competent witnesses who will not receive any benefit under the will, or where the witness or he/she spouse would be entitled to inherit from the testator in terms of intestate succession if the testator died intestate, the person or his/her spouse will be allowed to receive the benefit under the will. In the latter case, the value of the benefit the person or his/her spouse receives may not exceed the value of the portion that said person or his/her spouse would receive intestate. It must be noted that the nomination of a person as executor, trustee or guardian will be regarded as a benefit to be received by such person from that will. In other words, if a person who witnesses a will is nominated as executor, trustee or guardian under that will, such person will be disqualified from taking up such appointment except in the circumstances set out in (b) above.

319 Estate Planning E Codicils and amendments All the formalities required in the execution of a will apply for the execution of a codicil. Any amendment to a will or a codicil must be carefully and clearly marked or written and authenticated by the signature of the testator(s). The full signature of the testator must be made in the presence of two competent witnesses who must also sign next to the amendment. An amendment includes a deletion, addition, alteration or interlineation. Note that it is no longer necessary for both the deletion and substitution of a section of the will to be authenticated separately by the signatures of the testator and the witnesses - the deletion and substitution need only be authenticated once with the requisite signatures. Only the original document needs to be signed. However, if the original is in the possession of someone else, it is a good idea to date a copy so that the testator knows on what date the will was drafted.

320 E60 Estate Planning Notes

321 General General

322 General

323 General F1 Report writing The following is a suggested structure designed to give the report a logical progression. 1. Introduction/Background Start the report with a brief statement of the background facts that have a bearing on the client s specific situation or problem(s). Include a limited number of facts relevant to the report. Relevant background facts include the names, ages, and occupations of the immediate family members; what they intend or hope to do in the future, e.g. study further, travel or retire at the coast; sources of income, pensions; whether or not the client has any life assurance, a trust, a will, or dependants, etc. A good introduction shows a clear understanding of the client s environment. This is essential before any analysis of his problems can be made. The problems to be solved should flow logically from the way in which the background information is framed. 2. Areas of concern Here the critical areas that require action are described. These are the problems facing the client which must be solved. There may be one or more central problem(s), each containing subsidiary problems. Some problems may not be as obvious as others and it may be necessary to highlight the more obscure areas of concern and their consequences. For example, attempts to solve estate duty problems may lead to income tax problems, or vice versa. Lengthy calculations or tables showing that the client has a problem should not be included in the text of the report. Such calculations should rather be done in appendices attached to the report and referred to at relevant places in the text. 3. Objectives After defining the problem areas the intention behind the solutions must be outlined. After clearly identifying the objectives, they must be stated briefly. This will provide guidelines to assess what courses of action are appropriate.

324 F2 General Care should be taken to distinguish between objectives and courses of action. An objective answers the question: What do I want to accomplish? ; and a course of action answers the question: How am I going to achieve...? 4. Possible courses of action and their appraisal and evaluation Once the objectives have been established, possible ways of achieving each objective, either partially or completely, must be outlined and evaluated. Example: To provide his widow with an income from his estate, a testator can: (a) leave everything to her - this will increase her estate duty liability. (b) give her a usufruct - this is inflexible as the capital may not be used. (c) create a trust - this is flexible and involves no increase in her estate duty liability. Each course of action must be evaluated in terms of the stated objectives. There may be no best alternative, but rather a compromise of several elements. Under examination conditions, use should be made of a second answer book for Notes to the report to show the examiner how answers were arrived at without cluttering up the main body of the report. 5. Conclusion/Recommendations In the conclusion a course of action is recommended, the reasons for the course of action are given and the consequences of each action are stated. When answering an exam question the examiner will be looking for a sound reasoning ability and a decision on a course of action most likely to bring about the improved situation outlined in the objectives. A client will also require a recommended course of action matching the required needs.

325 General F3 Exchange control guidelines 1. Capital Transactions (a) The investment allowance for private individuals Currently this stands at R per annum per individual resident over the age of 18. This is subject to the applicant obtaining tax clearance from SARS. (b) Additional amounts In addition the Financial Surveillance Department will consider applications by private individuals to invest in fixed property, e.g. holiday homes and farms in SADC member countries. Furthermore, applications by private individuals for investment purposes, including offshore properties outside of SADC, will also be considered. No limit has been set. Applications will be made through authorized dealers, and must be accompanied by appropriate motivations. A certificate of good standing from SARS will be required. (c) The single discretionary allowance From 2012 the amounts intended for investment may also be exported under the single discretionary allowance, up to R per annum. No tax clearance is required. 2. Portfolio Investments by South African Institutional Investors As an interim step towards prudential regulation, retirement funds, long-term insurers, collective investment scheme management companies and investment managers are allowed to transfer funds from South Africa for investment abroad. The limit on foreign portfolio investment by institutional investors is applied to an institution s total retail assets. The foreign exposure of retail assets may not exceed 25% in the case of retirement funds and underwritten policy business of long-term insurers. Collective investment scheme management companies, investment managers registered as institutional investors for exchange control purposes and the investment-linked business of long-term insurers are restricted to 35% of total retail assets under management. Institutional investors are allowed to invest an additional five per cent of their total retail assets by acquiring foreign currency denominated portfolio assets in Africa through foreign currency

326 F4 General transfers from South Africa or by acquiring approved inward listed investments. 3. Emigration (a) Facilities for which emigrants qualify Emigrants qualify for a cash allowance (equal to a travel allowance), a foreign capital allowance and are allowed to export certain items. Cash allowance (equal to a travel allowance) Single person: Foreign exchange may be made available up to R per adult, less any amounts which may have already been used in respect of the single discretionary allowance in that yearsee below; Family unit: Foreign exchange may be made available up to R per adult, less any amounts which may have already been used in respect of the single discretionary allowance in that year, plus R per child under 18 years of age. Foreign capital allowance (Settling-in allowance) Single persons: Up to R4 million per calendar year. Family unit: Up to R8 million per calendar year. Household and personal effects, and motor vehicles, caravans, trailers, motorcycles, stamps and coins. These may be exported up to a value of R Where these amounts are not taken immediately, they can be taken later from funds or assets retained in South Africa. (b) Blocked Rands Amounts and assets exceeding these limits must be placed in the control of an authorised dealer in foreign exchange and are subject to limitations on the nature of the asset permitted. Cash and proceeds from the sale of blocked assets must be placed in a blocked account. Cash from these sources may now be utilised locally for any purposes. Emigrants may now apply to the Financial Surveillance Department (SARB) for release of blocked assets.

327 General F5 (c) Remitting income after departure Current income may be transferred through normal banking channels to the emigrant at his new place of residence. Income includes interest, dividends, director s fees, monthly pension payments and income from testamentary trusts, subject to certain formalities. Income and other amounts that may not be remitted include income from inter vivos trusts, and donations or gifts received, or capital transfers from inter vivos trusts, received within 3 years before departure. 4. The Single Discretionary Allowance A single discretionary allowance has replaced the previous allowances in respect of gifts, loans, maintenance and donations to missionaries and travel. The limit for this has been set at R per year per person over the age of 18, which may be apportioned between the following: Monetary gifts and loans Donations to missionaries Maintenance transfers Alimony and child support payments on production of a court order Wedding expenses and other special events Foreign capital allowance This discretionary allowance is in addition to the existing R4 million individual foreign capital allowance. See Capital Transactions, above Travel allowance subject to norms and factors to be considered by the authorized dealer, including duration and purpose of travel, Travel must commence within 60 days and unspent travel allowance must be repatriated and resold within 30 days Study allowance. An allowance is available in respect of full-time students attending foreign schools, universities or similar institutions. All tuition fees,

328 F6 General without limit, may be paid directly by an authorised dealer. A separate travel allowance remains in place in respect of children under the age of 18. Currently this is R per calendar year. Credit and/or debit cards may be utilised up to the limit of the amount authorised. 5. Credit and/or Debit Cards Cardholders are allowed permissible foreign currency payments for small transactions e.g. internet purchases. This is subject to a limit of R per transaction. Permissible transactions are those which may be effected by an authorised dealer. 6. Estates and transfers to beneficiaries (a) Inheritances Bequests and distributions from the estate of a deceased South African resident may be transferred to a non-resident beneficiary without limit, on production of the Liquidation and Distribution accounts. Note that conditions may apply and that where the beneficiary has been a previous resident in South Africa, they need to formally emigrate before they can be regarded as a nonresident for the purposes of this concession. South African assets in the estate of a deceased non-resident may be freely transferred. (b) Legacy transfers Cash bequests and the cash proceeds of legacies and distributions due to beneficiaries permanently resident outside the Common Monetary Area, including emigrants, may be remitted abroad, on production of the Liquidation and Distribution Account bearing a Master of the High Court Reference Number. In cases where the total assets of the resident estate is less than R , cash bequests and the cash proceeds of legacies due to nonresident legatees, including emigrants, may be remitted abroad, provided that the Last Will and Testament and Letter of Executorship/Authority have been produced. Where the beneficiary is an emigrant, it would be incumbent upon Authorised Dealers to ensure that the emigrant has formally emigrated before effecting any transfers. Where it cannot be

329 General F7 established that the beneficiary has formally emigrated, the matter must be referred to the Financial Surveillance Department. (c) Capital distributions from local testamentary trusts Capital distributions from local testamentary trusts due to nonresidents, including emigrants, may be remitted abroad, provided that the Trustees Resolution confirming the capital distribution and the Last Will and Testament confirming that the beneficiary is entitled to such capital distribution, have been viewed. (d) Death Benefits Proceeds from registered South African pension and provident schemes as well as insurance policies (annuity, endowment and life) due to non-residents, including emigrants, who are nominated beneficiaries upon the demise of the policy holder, may be transferred abroad on presentation of: Death Certificate, as well as Documentary evidence from the institution concerned reflecting the full names of the beneficiary and the amount due to the beneficiary.

330 F8 General Note: Section 54 of the Long-term Insurance Act (read with the regulations to the Act) This legislation applies to all long-term policies whether entered into before or after the commencement of this Act, excluding: (a) (b) (c) a reinsurance policy; a fund policy; or a fund member policy, for as long as no right under the policy is transferred by the fund to a life insured under the policy, or is transferred to any person except another fund for the direct or indirect benefit of a life insured under the policy. Definitions Fund policy means a contract in terms of which a person, in return for a premium, undertakes to provide policy benefits for the purpose of funding, in whole or in part, the liability of a fund to provide benefits to its members in terms of its rules, other than such a contract relating exclusively to a particular member of the fund or to the surviving spouse, children, dependants or nominees of a particular member of the fund; and includes a reinsurance policy in respect of such a contract. Fund means: (a) (b) (c) (d) a friendly society as defined in section 1 of the Friendly Societies Act; a pension fund organization as defined in section 1 of the Pension Funds Act; a medical scheme as defined in section 1 of the Medical Schemes Act; a permanent fund, established bona fide for the purpose of providing benefits to members in the event of sickness, accident or unemployment, or of providing benefits to surviving spouses, children, dependants or nominees of deceased members, or mainly for those purposes; and

331 General (e) any other person, arrangement or business prescribed by the Registrar. F9 Fund member policy as defined in the regulations means a long-term policy other than a fund policy: (a) (b) (c) (d) of which a fund is the sole policyholder; under which a specified member of the fund (or the surviving spouse, child, dependant or nominee of the member) is the life insured; which is entered into by the fund for the exclusive purpose of funding the fund s liability to that member (or the surviving spouse, children, dependants or nominees of the member) in terms of the rules of the fund; and if the fund holding the policy is a fund contemplated in paragraph (c) of the definition of benefit fund in section 1 of the Income Tax Act, only insofar as provision is made therein for unemployment benefits. Free surrender value means the value of the consideration which the insurer would provide if the policy is surrendered on the day preceding the date of commencement of an extended restriction period. Restriction period means a period of five years which begins on the date, if it is 1 January 1994 or later - (i) (ii) when the first premium period begins; or during a premium period after the first, on the first day of the month in which an excess premium is received by the insurer. Extended restriction period means a restriction period - (a) (b) (c) which has not expired; and which includes every earlier restriction period any part of which runs concurrently with it; and the commencement date of which, from time to time, is the commencement date of the earliest restriction period which runs concurrently with it.

332 F10 General Policy benefit means one or more sums of money, services or other benefits, including an annuity, but excluding a loan in respect of a policy or consideration upon the surrender of a policy. Premium period means one of a succession of periods, each of twelve months duration, the first of which commences on, and ends twelve months after the first day of the month which the first premium, or any part thereof, is received by the insurer, or, if it is a later date, the first day of the month in which the undertaking of the insurer to provide policy benefits under the policy becomes operative. Restricted amount means an amount equal to the aggregate of the free surrender value plus the total value of premiums in an extended restriction period plus 5% compound interest per annum less the aggregate of all payments already made by the insurer in respect of the policy whether as a policy benefit or on the surrender of any part of the policy in the extended restriction period plus 5% compound interest per annum. Provisions relating to policies (excluding annuities) Policy term Minimum five-year term (including deferred compensation and keyperson assurance, but excluding pension, provident, retirement annuity and benefit funds (to the extent that the latter provides unemployment benefits)). Premiums Single or recurring. Recurring-premium policies may have any premium payment term but payment intervals may not be greater than twelve months. Premium increases Maximum of 20% of the higher of the total value of the premiums paid in any one of the immediately preceding two premium periods. (Provided that, if a premium is increased during the second premium period, the percentage increase shall be determined in relation to the first premium period only.) Premium decreases No limit Surrenders and Only one surrender and one loan are allowed loans during an extended restriction period.

333 General F11 The restricted period will not apply in the following instances: (a) (b) (c) the death, curatorship or sequestration of the estate of the policyholder who is a natural person; or the winding up, liquidation, curatorship or judicial management, upon an order of court, of a policyholder who is a juristic person; or the actual surrender value does not exceed the restricted amount by more than R (In this case, the whole surrender value can be taken. It only applies to full and not to partial surrenders.) Surrender and loan values The value on surrender or loan against the policy may not be more than the restricted amount as defined. Provisions relating specifically to annuities Policy term Policy benefits Minimum five-year term. The payments by the insurer to the insured must be made at intervals not exceeding twelve months. At least one of the payments that is to be made by the insurer to the insured must be made after the commencement of the period of 31 days preceding the expiry of the extended restriction period concerned, unless the insured has died prior to the expiry of the extended restriction period. The payments by the insurer to the insured in any twelve-month period may not differ by more than 20% from the total amount of payments in

334 F12 General the immediately preceding period of twelve months, except in the case of an annuity (a) which constitutes a linked benefit, where the difference in the period concerned results solely from the determination of the value of the relevant assets; or (A linked benefit means a policy benefit, the value of which is not guaranteed by the long-term insurer and is determined solely by reference to the value of particular assets specified in the policy and which are held by or on behalf of the long-term insurer specifically for the purpose of the policy.) (b) (c) payable in terms of a policy under which there are two or more policyholders or life assured and the difference results solely from a reduction in the annuity payable as a result of the death of one of the owners of the policy or life assured (a joint and survivorship annuity); or where the difference results solely from a reduction in the annuity payable during the period concerned consequent upon the surrender of a part of the policy. Loans Surrenders Restricted commuted values No loans may be effected against annuities. Only one surrender or part surrender is allowed against an annuity during an extended restriction period. Within any extended restriction period the restricted commuted value will be limited in the case of either a full or partial commutation to a return of the annuity consideration plus 5% compound interest less the accumulated value of the payments already made under the annuity contract plus 5% compound interest.

335 General F13 Exception to If the actual commuted value exceeds the restricted commuted restricted commuted value by not more than value R2 500, the actual commuted value may be paid. If the actual commuted value exceeds the restricted commuted value by more than R2 500, only the restricted commuted value may be paid. Alternatively, the annuity may be partsurrendered for an amount equal to the restricted commuted value only. (See section A for income tax consequences of commutation.)

336 F14 General Basic interest calculations on a financial calculator Before starting any calculation the following important points should be borne in mind: 1. If you are dealing with periodic payments, determine whether the payment will be made at the beginning or the end of each period and set the calculator accordingly. 2 Ensure that the interest rate you will use corresponds with the compounding period. Example: the investment is made for a period of three years at a 12% rate of interest, compounded quarterly. As it is compounded quarterly, there are 12 (3 x 4) compounding periods and the interest rate to be used in your calculation will be 3% (12 4). 3. Determine whether different cash flow signs must be used. Should, for example, the investor invest R100 per month and after a period of five years, the accrued amount is R8 857, the monthly payment (PMT) must be entered as a negative amount (-100) as it represents the cash outflow, while the accrued amount (FV) must be entered as a positive amount as it represents a cash inflow. Note: Premiums on policies are calculated in begin (BGN) mode and mortgage bond calculations are calculated in end (END) mode. Examples: 1. The client invests R250 per month for ten years at the beginning of each month at 15% per annum (nominal). What will he receive? HP 12C HP 10BII SHARP f Clear Fin Clear All 2ndF CA g BEG BEG 2ndF BGN 250 CHS PMT 12 P/YR 250 +/- PMT 10 g n 250 +/- PMT 10 2ndF nn 15 g i 15 I/YR 15 2ndF ii FV = 69664,32 10 x P/YR COMP FV = 69664,32 FV = 69664,32

337 General F15 2. A lump sum of R is invested for a term of 12 18%, compounded annually. How much will he receive? HP 12C HP 10BII SHARP f Clear Fin Clear All 2ndF CA PV 1 P/YR /- PV 12 n /- PV 18 i 18 i 12 N 12 n FV = ,53 18 I/YR COMP fv = FV = ,53 3. As in 2 above, except that the interest rate of 18% is compounded quarterly. HP 12C HP 10BII SHARP f Clear Fin Clear All 2ndF CA CHS PV 4 P/YR /- PV 12 Enter 4 x n /- PV 18 4 = 4,5 i 18 Enter 4 i 12 x P/YR 2 x 4 = 48 n FV = ,12 18 I/YR COMP FV = ,12 FV = ,12 4. The client wants to save R150 per month (at the end of each month) so that he has R after 14 years. What is the annual rate of return he should receive in order to achieve his objective? HP 12C HP 10BII SHARP f Clear Fin Clear All 2ndF CA 150 CHS PMT End 150 +/- PMT 14 g n 12 P/YR FV FV 150 +/- PMT 14 2ndF nn i = 0, FV COMP i = 0,93 x 12 = 11,11 14 x P/YR x 12 = 11,11 I/YR = 11,11 NB: With the HP 12C and the Sharp the answer of 0,93 should be multiplied by 12 as it is the interest rate per month. With the HP 10BII the calculator is already set on 12 periods per annum: consequently it is not necessary to multiply by 12.

338 F16 General 5. How long will it take an investor to accumulate R if he has R5 000 to invest at the end of each six months and can earn an interest rate of 18% per annum? HP 12C HP 10BII SHARP f Clear Fin Clear All 2ndF CA g END 2 P/YR FV FV FV /- PMT 5000 CHS PMT /- PMT 18 2 = 9 i 18 Enter 2 i 18 I/YR COMP n = 11,18 n = 12 N = 11,18 2 = 5,59 years 2 = 6 years 2 = 5,59 years NB: Note that the answer obtained here must be divided by two as there are 12 half-yearly compounding periods. The HP 12C rounds off the answer automatically to the next highest number, hence the answer of 12 and not 11, Your client will receive R when he retires in 25 years time. How much is that amount worth today if one assumes an inflation rate of 15% over the next 25 years? HP 12C HP 10BII SHARP f Clear Fin Clear All 2ndF CA P/YR FV 25 n FV 25 n 15 i 15 I/YR 15 i PV = ,91 25 N COMP PV = ,91 PV = ,91 7. You win a competition which offers the following alternatives as prizes: either a lump sum of R immediately or R2 350 per month payable at the beginning of each month for 10 years. Which alternative is more profitable if an inflation rate of 15% is taken into account?

339 General F17 The present value of the periodic payments should, therefore, be determined before exercising a choice. HP 12C HP 10BII SHARP f Clear Fin Clear All 2ndF CA g BEG BEG 2ndF BGN 2350 CHS PMT 12 P/YR /- PMT 15 g i /- PMT 10 2ndF nn 15 I/YR 10 g n 10 x P/YR 15 2ndF ii PV = ,44 PV = ,44 COMP PV = ,44 Although the second alternative will generate a total of R , this will not be the better choice as the present value of the periodic payments is less than R The first one will thus be more profitable. Valuation of market value of long-term gilts (e.g. Eskom stock) E.g. Coupon rate of a long-term stock = 12% p.a. payable annually in arrears Nominal value of stock = R Term to maturity = 6 years Market-related interest rates = 18% HP 12C HP 10BII SHARP f CLX Clear All 2ndF CA g END End 2ndF END ENTER 12% 1 P/YR x 12% = PMT x 12% = PMT FV +/- PMT FV 6 N /- FV 6 N 18 i 6 N 18 i PV = ,38 18 I/YR COMP PV = ,38 PV = ,38 NB: Under normal circumstances income on long-term stock is paid six-monthly and the calculation should, therefore, be adapted to reflect this should this be the case.

340 F18 General Nominal and effective rate of interest Bank pays a nominal rate of interest of 12% p.a. which is compounded quarterly. What is the effective rate of interest? HP 12C HP 10BII SHARP f CLX Clear All 2ndF CA g END 4 P/YR 4 2ndF EFF 12 ENTER 12 NOM% 12 = 4 n i EFF % = 12,55 12,55 CHS PMT FV = 12,55 Simple vs compound interest R p.a. invested for four years at the beginning of each year. Compare the difference in interest earned between 15% p.a. simple interest and 15% interest compounded annually in arrears. Simple Interest Compound Interest HP 12C HP 10BII SHARP x 15% x f CLX Clear All 2ndF CA ( ) = g BEG BEG 2ndF BGN interest CHS PMT 1 P/YR /- PMT 15 i /- PMT 15 i 4 n 15 I/YR 4 n FV = ,81 4 N COMP FV FV = ,81 = ,81 = , interest = ,81 = ,81 interest interest Difference = , = 2 423,81

341 General F19 Simple vs compound interest R invested for four years. Calculate the difference in interest earned between 15% p.a. simple interest and 15% interest compounded annually in arrears. Simple Interest Compound Interest HP 12C HP 10BII SHARP x 15% x 4 f CLX Clear All 2ndF CA = interest CHS PV 1 P/YR /- PV 4 n /- PV 4 n 15 i 15 I/YR 15 i FV = ,63 4 N COMP FV FV = ,63 = ,63 = , interest = ,63 = ,63 interest interest Difference = , = ,63 Debt repayments Your client has a mortgage bond of R repayable over 25 years at a fixed interest rate of 17% p.a. What is his repayment at the end of each month? HP 12C HP 10BII SHARP f CLX Clear All 2ndF CA g END END 2ndF END PV 12 P/YR PV 25 g N PV 25 2ndF n n 17 g i 25 x P/YR 17 2ndF ii PMT = ,80 17 I/YR COMP PMT PMT = ,80 = ,80

342 F20 General Resultant Rate Your client wants to invest R5000 per annum for the next 5 years at 9%; she wants to increase her premium at 6% every year. How much will she receive at the end of the 5-year term, if she invests the R5000 at the beginning of every year? It is not possible to input both the growth rate of 9% and the escalation rate of 6% using a financial calculator. To calculate the future value it is, therefore, necessary to use the resultant rate. The formula is as follows: [{ 1 + i 1 + e } - 1] x 100 In the formula i = the growth rate e = the escalation rate [{ 1.09 } - 1 ] x 100 = 2, This rate must now be used to calculate the Present Value of the escalating investment. Once the Present Value has been calculated, the Future Value of the investment can now be established by using the actual growth/interest rate of 9% HP 10Bll Step 1 Step 2 Shift Clear All 1 P/YR /- PMT I/YR 5 N PV = ,21 Shift Clear All 1 Shift P/YR ,21 PV 9 I/YR 5 N FV = ,70

343 General F21 Table A - Life Expectancy Tables used to calculate VPA s Age Now Male annuitants Female annuitants ,254 52,317 51,380 50,443 49,506 48,568 47,631 46,692 45,753 44,814 43,875 42,936 41,998 41,060 40,123 39,187 38,253 37,321 36,391 35,464 34,640 33,620 32,704 31,792 30,885 29,984 29,089 28,200 27,318 25,443 25,576 24,716 23,866 23,024 22,192 21,369 20,557 19,755 18,965 18,186 17,421 16,668 15,930 15,206 14,498 13,806 13,131 12,473 11,832 11,211 57,467 56,535 55,602 54,668 53,733 52,799 51,864 50,928 49,992 49,056 48,120 47,184 46,248 45,311 44,376 43,441 42,508 41,565 40,644 39,714 38,787 37,861 36,938 36,018 35,100 34,187 33,276 32,370 31,468 30,570 29,677 28,789 27,906 27,028 26,156 25,290 24,431 23,579 22,734 21,897 21,069 20,250 19,442 18,645 17,860 17,086 16,326 15,580 14,849 14,133

344 F22 General Table A - Life Expectancy Tables (continued) Age Now Male annuitants Female annuitants ,608 10,024 9,460 8,916 8,393 7,890 7,409 6,948 6,508 6,090 5,692 13,433 12,750 12,085 11,438 10,810 10,202 9,614 9,047 8,501 7,976 7,473 This table was checked by Old Mutual Product Solutions. The editors acknowledge Soshan Soobramoney from Old Mutual for his contribution.

345 General F23 Table B - Compound Interest Table One rand per month paid in advance The sum to which one rand per month, paid at the beginning of each month, will increase, at compound interest at undermentioned rates per annum. Year 3% 4% 5% 6% 7% Year , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , ,

346 F24 General Table B - Compound Interest Table One rand per month paid in advance The sum to which one rand per month, paid at the beginning of each month, will increase, at compound interest at undermentioned rates per annum. Year 8% 9% 10% 11% Year , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , ,

347 General F25 Table B - Compound Interest Table One rand per month paid in advance The sum to which one rand per month, paid at the beginning of each month, will increase, at compound interest at undermentioned rates per annum. Year 12% 13% 14% 15% Year , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , ,

348 F26 General Table B - Compound Interest Table One rand per month paid in advance The sum to which one rand per month, paid at the beginning of each month, will increase, at compound interest at undermentioned rates per annum. Year 16% 17% 18% Year , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , ,

349 General F27 Table B - Compound Interest Table One rand per month paid in advance The sum to which one rand per month, paid at the beginning of each month, will increase, at compound interest at undermentioned rates per annum. Year 19% 20% 21% 22% Year , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , ,

350 F28 General Table C - Compound Interest Table One rand per annum paid in advance The sum to which one rand per annum, paid at the beginning of each year, will increase, at compound interest at undermentioned rates per annum. Year 3% 4% 5% 6% 7% 8% Year ,030 2,091 3,184 4,309 5,468 1,040 2,122 3,246 4,416 5,633 1,050 2,153 3,310 4,526 5,802 1,060 2,184 3,375 4,637 5,975 1,070 2,215 3,440 4,751 6,153 1,080 2,246 3,506 4,867 6, ,662 7,892 9,159 10,464 11,808 6,898 8,214 9,583 11,006 12,486 7,142 8,549 10,027 11,578 13,207 7,394 8,897 10,491 12,181 13,972 7,654 9,260 10,978 12,816 14,784 7,923 9,637 11,488 13,487 15, ,192 14,618 16,086 17,599 19,157 14,026 15,627 17,292 19,024 20,825 14,917 16,713 18,599 20,579 22,657 15,870 17,882 20,015 22,276 24,673 16,888 19,141 21,550 24,129 26,888 17,977 20,495 23,215 26,152 29, ,414 24,117 25,870 27,676 22,698 24,645 26,671 28,778 30,969 24,840 27,132 29,539 32,066 34,719 27,213 29,906 32,760 35,786 38,993 29,840 32,999 36,379 39,995 43,865 32,750 36,450 40,446 44,762 49, ,537 31,453 33,426 35,459 37,553 33,248 35,618 38,083 40,646 43,312 37,505 40,430 43,502 46,727 50,113 42,392 45,996 49,816 53,865 58,156 48,006 52,436 57,177 62,249 67,676 54,457 59,893 65,765 72,106 78, ,710 41,931 44,219 46,575 49,003 46,084 48,968 51,966 55,085 58,328 53,669 57,403 61,323 65,439 69,761 62,706 67,528 72,640 78,058 83,802 73,484 79,698 86,347 93, ,073 86,351 94, , , , ,503 54,078 56,730 59,462 62,276 61,701 65,210 68,858 72,652 76,598 74,299 79,064 84,067 89,320 94,836 89,890 96, , , , , , , , , , , , , , ,174 68,159 71,234 74,401 77,663 80,702 84,970 89,409 94,026 98, , , , , , , , , , , , , , , , , , , , , ,023 84,484 88,048 91,720 95, , , , , , , , , , , , , , , , , , , , , , , , , ,

351 General F29 Table C - Compound Interest Table One rand per annum paid in advance The sum to which one rand per annum, paid at the beginning of each year, will increase, at compound interest at undermentioned rates per annum. Year 9% 10% 11% 12% 13% 14% Year ,090 2,278 3,573 4,985 6,523 1,100 2,310 3,641 5,105 6,716 1,110 2,343 3,710 5,228 6,913 1,120 2,374 3,779 5,353 7,115 1,130 2,407 3,850 5,480 7,323 1,140 2,440 3,921 5,610 7, ,200 10,028 12,021 14,193 16,560 8,487 10,436 12,579 14,937 17,531 8,783 10,859 13,164 15,722 18,561 9,089 11,300 13,776 16,549 19,655 9,405 11,757 14,416 17,420 20,814 9,730 12,233 15,085 18,337 22, ,141 21,953 25,019 28,361 32,003 20,384 23,523 26,975 30,772 34,950 21,713 25,212 29,095 33,405 38,190 23,133 27,029 31,393 36,280 41,753 24,650 28,985 33,883 39,417 45,672 26,271 31,089 36,581 42,842 49, ,974 40, ,160 55,765 39,545 44,599 50,159 56,275 63,002 43,501 49,396 55,939 63,203 71,265 47,884 54,750 62,440 71,052 80,699 52,739 60,725 69,749 79,947 91,470 58,118 67,394 77,969 90, , ,873 68,532 75,790 83,701 92,324 70,403 78,543 87,497 97, ,182 80,214 90, , , ,999 91, , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , ,

352 F30 General Table C - Compound Interest Table One rand per annum paid in advance The sum to which one rand per annum, paid at the beginning of each year, will increase, at compound interest at undermentioned rates per annum. Year 15% 16% 17% 18% 19% 20% Year ,150 2,473 3,993 5,742 7,754 1,160 2,506 4,067 5,877 7,977 1,170 2,539 4,141 6,014 8,207 1,180 2,572 4,215 6,154 8,442 1,190 2,606 4,291 6,297 8,683 1,200 2,640 4,368 6,442 8, ,067 12,727 15,786 19,304 23,349 10,414 13,240 16,519 20,321 24,733 10,772 13,773 17,285 21,393 26,200 11,142 14,327 18,086 22,521 27,755 11,523 14,902 18,923 23,709 29,404 11,916 15,499 19,799 24,959 31, ,002 33,352 39,505 46,580 54,717 29,850 35,786 42,672 50,660 59,925 31,824 38,404 46,103 55,110 65,649 33,931 41,219 49,818 59,965 71,939 36,180 44,244 53,841 65,261 78,850 38,581 47,497 58,196 71,035 86, ,075 74,836 87, , ,810 70,673 83,141 97, , ,841 77,979 92, , , ,139 86, , , , ,021 95, , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , ,

353 General F31 Table D - Compound Interest Table - One rand principal The sum to which one rand principal will increase, at compound interest at undermentioned rates per annum. Year 3% 4% 5% 6% Year ,030 1,061 1,093 1,126 1,159 1,040 1,082 1, ,217 1,050 1,102 1,158 1,215 1,276 1,060 1,124 1,191 1,262 1, ,194 1,230 1,267 1,305 1,344 1,265 1,316 1,368 1,423 1,480 1,340 1,407 1,477 1,551 1,629 1,418 1,504 1,594 1,689 1, ,384 1,426 1,469 1,513 1,558 1,539 1,601 1,665 1,732 1,801 1,710 1,796 1,886 1,980 2,079 1,898 2,012 2,133 2,261 2, ,605 1,653 1,702 1,754 1,806 1,873 1,948 2,026 2,107 2,191 2,183 2,292 2,407 2,527 2,653 2,540 2,693 2,854 3,026 3, ,860 1,916 1,974 2,033 2,094 2,279 2,370 2,465 2,563 2,666 2,786 2,925 3,071 3,225 3,386 3,399 3,603 3,820 4,049 4, ,157 2,221 2,288 2,357 2,427 2,772 2,883 2,999 3,119 3,243 3,556 3,733 3,920 4,116 4,322 4,549 4,822 5,112 5,418 5, ,500 2,575 2,652 2,732 2,814 3,373 3,508 3,648 3,794 3,946 4,538 4,765 5,003 5,253 5,516 6,088 6,453 6,840 7,251 7, ,898 2,985 3,075 3,167 3,262 4,104 4,268 4,439 4,616 4,801 5,792 6,081 6,385 6,705 7,040 8,147 8,636 9,154 9,703 10, ,360 3,461 3,565 3,671 3,782 4,993 5,193 5,400 5,616 5,841 7,392 7,761 8,150 8,557 8,985 10,903 11,557 12,250 12,985 13,

354 F32 General Table D - Compound Interest Table - One rand principal The sum to which one rand principal will increase, at compound interest at undermentioned rates per annum. Year 7% 8% 9% 10% Year ,070 1,145 1,225 1,311 1,402 1,080 1,166 1,260 1,360 1,469 1,090 1,188 1,295 1,412 1,539 1,100 1,210 1,331 1,464 1, ,501 1,606 1,718 1,838 1,967 1,587 1,714 1,851 1,999 2,159 1,677 1,828 1,992 2,172 2,367 1,772 1,949 2,143 2,358 2, ,105 2,252 2,410 2,578 2,759 2,332 2,518 2,720 2,937 3,172 2,580 2,813 3,066 3,342 3,642 2,853 3,138 3,452 3,797 4, ,952 3,159 3,380 3,616 3,870 3,426 3,700 3,996 4,316 4,661 3,970 4,328 4,717 5,142 5,604 4,595 5,054 5,560 6,116 6, ,140 4,430 4,740 5,072 5,427 5,034 5,436 5,871 6,341 6,848 6,109 6,659 7,258 7,911 8,623 7,400 8,140 8,954 9,850 10, ,807 6,214 6,649 7,114 7,612 7,396 7,988 8,627 9,317 10,063 9,399 10,245 11,167 12,172 13,268 11,918 13,110 14,421 15,863 17, ,145 8,715 9,325 9,978 10,676 10,868 11,737 12,676 13,690 14,785 14,462 15,763 17,182 18,728 20,414 19,194 21,114 23,225 25,548 28, ,424 12,224 13,079 13,995 14,974 15,968 17,246 18,625 20,115 21,724 22,251 24,254 26,437 28,816 31,409 30,913 34,004 37,404 41,145 45, ,023 17,144 18,344 19,628 21,002 23,462 25,339 27,367 29,556 31,920 34,236 37,317 40,676 44,337 48,327 49,785 54,764 60,240 66,264 72,

355 General F33 Table D - Compound Interest Table - One rand principal The sum to which one rand principal will increase, at compound interest at undermentioned rates per annum. Year 11% 12% 13% 14% 15% Year ,110 1,232 1,368 1,518 1,685 1,120 1,254 1,405 1,573 1,762 1,130 1,277 1,443 1,630 1,842 1,140 1,300 1,481 1,689 1,925 1,150 1,322 1,521 1,749 2, ,870 2,076 2,304 2,558 2,839 1,974 2,211 2,476 2,773 3,106 2,082 2,353 2,658 3,004 3,394 2,195 2,502 2,852 3,252 3,707 2,313 2,660 3,059 3,518 4, ,152 3,498 3,883 4,310 4,784 3,478 3,896 4,363 4,887 5,473 3,836 4,334 4,898 5,535 6,254 4,226 4,818 5,492 6,261 7,138 4,652 5,350 6,153 7,076 8, ,311 5,895 6,543 7,263 8,062 6,130 6,866 7,690 8,613 9,646 7,067 7,986 9,024 10,197 11,523 8,137 9,276 10,575 12,056 13,743 9,358 10,761 12,375 14,232 16, ,949 9,933 11,026 12,239 13,585 10,804 12,100 13,552 15,179 17,000 13,021 14,714 16,627 18,788 21,230 15,667 17,861 20,362 23,212 26,462 18,822 21,645 24,891 28,625 32, ,080 16,739 18,580 20,624 22,892 19,040 21,325 23,884 26,750 29,960 23,990 27,109 30,633 34,616 39,116 30,166 34,390 39,204 44,693 50,950 37,857 43,535 50,066 57,575 66, ,410 28,205 31,308 34,752 38,575 33,555 37,582 42,091 47,142 52,800 44,201 49,947 56,440 63,777 72,068 58,083 66,215 75,485 86,053 98,100 76,143 87, , , , ,818 47,528 52,756 58,559 65,001 59,135 66,232 74,180 83,081 93,051 81,437 92, , , , , , , , , , , , , , ,151 80,087 88,897 98, , , , , , , , , , , , , , , , , , , , , ,

356 F34 General Table D - Compound Interest Table - One rand principal The sum to which one rand principal will increase, at compound interest at undermentioned rates per annum. Year 16% 17% 18% 19% 20% Year ,160 1,346 1,561 1,811 2,100 1,170 1,369 1,602 1,874 2,192 1,180 1,392 1,643 1,939 2,288 1,190 1,416 1,685 2,005 2,386 1,200 1,440 1,728 2,074 2, ,436 2,826 3,278 3,803 4,411 2,565 3,001 3,511 4,108 4,807 2,699 3,185 3,759 4,435 5,234 2,840 3,379 4,021 4,785 5,695 2,986 3,583 4,300 5,160 6, ,117 5,936 6,886 7,987 9,265 5,624 6,580 7,699 9,007 10,539 6,176 7,287 8,599 10,147 11,974 6,777 8,064 9,596 11,420 13,589 7,430 8,916 10,699 12,839 15, ,748 12,468 14,462 16,776 19,461 12,330 14,426 16,879 19,748 23,105 14,129 16,672 19,673 23,214 27,393 16,171 19,244 22,900 27,252 32,429 18,488 22,186 26,623 31,948 38, ,574 26,186 30,376 35,236 40,874 27,033 31,629 37,006 43,297 50,658 32,324 38,142 45,008 53,109 62,669 38,591 45,923 54,649 65,032 77,388 46,005 55,206 66,247 79,497 95, ,414 55,000 63,800 74,008 85,850 59,270 69,345 81,134 94, ,065 73,949 87, , , ,371 92, , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , ,

357 General F35 Table E - Present value of R1 per period What R1 payable annually in arrears is worth today Year 3% 4% 5% 6% 7% 8% Year , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , ,

358 F36 General Table E - Present value of R1 per period What R1 payable annually in arrears is worth today Year 9% 10% 11% 12% 13% 14% Year , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , ,

359 General F37 Table E - Present value of R1 per period What R1 payable annually in arrears is worth today Year 15% 16% 17% 18% 19% 20% Year , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , ,

360 F38 General Table F - Present value of R1 What R1 due in the future is worth today Year 3% 4% 5% 6% Year , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , ,

361 General F39 Table F - Present value of R1 What R1 due in the future is worth today Year 7% 8% 9% 10% Year , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , ,

362 F40 General Table F - Present value of R1 What R1 due in the future is worth today Year 11% 12% 13% 14% 15% Year , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , ,

363 General F41 Table F - Present value of R1 What R1 due in the future is worth today Year 16% 17% 18% 19% 20% Year , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , ,

364 F42 General Medical Schemes 1. Introduction The Medical Schemes Act, No. 131 of 1998 as amended (called the Act) and the subordinate legislation thereto, in the main, regulate medical schemes. Extracts of certain of these provisions are dealt with below. 2. Purpose of the Act The purpose of the Act is to consolidate the laws relating to registering medical schemes and to provide for the establishment of the Council for Medical Schemes as a juristic person. Furthermore, its purpose is to provide for the appointment of the Registrar of Medical Schemes, to make provision for the registration and control of certain activities of medical schemes, to protect the interest of members of the Medical Schemes; to provide for measures for the co-ordination of medical schemes; and to provide for incidental matters. 3. Role-players 3.1 Council for Medical Schemes and Registrar of Medical Schemes The Council for Medical Schemes has been established in terms of s.3 of the Act. The Council is a juristic entity entitled to sue and to be sued. The Council consists of up to 15 members appointed by the Minster of Health, with its head office in Pretoria. The Minister of Health appoints a Registrar of Medical Schemes and any Deputy Registrars, after consultation with the Council (s.18). The Registrar is appointed as the executive officer of the Council managing the affairs of the Council. Functions of the Council (s.7) Functions of the Council include the following: Protecting the interest of the beneficiaries of medical schemes at all times

365 General F43 Controlling and co-ordinating the functioning of medical schemes in a manner that is complementary with the National Health policy Making recommendations to the Minister on criteria for measurements of quality and outcomes of the relevant health services provided for by medical schemes, and such other services as the Council may from time to time determine Collecting and disseminating information about private health care Investigating complaints and settling of disputes relating to the affairs of medical schemes Making rules not inconsistent with the provisions of the Act, for the purpose of performing its functions and exercising its powers Advising the Minister on any matter concerning medical schemes Performing any other function conferred on the Council by the Act or by the Minister of Health Powers of the Council (s.8) The powers of the Council include the following: Approving the registration, suspension and cancellation of registration, of medical schemes or benefit options Exempting, in exceptional cases, medical schemes from certain provisions of the Act In general, taking any appropriate steps to perform its functions in accordance with the provisions of the Act This is a summary; for more details see Section 8 of the Act. Functions and Powers of the Registrar (s.42 - s.46) The function of the Registrar, generally, is to manage the affairs of the Council. Certain powers of the Registrar are set out in s.42 to s.46 of the Act and include the following:

366 F44 General Request of the principal officer of a medical scheme, further particulars where an application is made to be registered as a medical scheme or where the rules of the medical scheme are to be amended. Dealing with enquiries regarding a medical scheme. Note that schemes are obliged to reply to such enquiries within 30 days or such other period as stipulated. Inspecting or requiring the production of any report or other relevant documents of the medical scheme, to enable it to obtain any information pertaining to the medical scheme. On the authority and in accordance with the instructions and directions of the Council, place any restriction on the administration costs of a medical scheme and may further prescribe the basis on which such costs shall be calculated in certain circumstances. If the Registrar is of the opinion that a medical scheme is not financially sound, directing the scheme to take steps to rectify the situation. In this regard, the Registrar is also empowered to give written notice to the medical scheme to amend its rules. In addition to those provisions under chapter 9 of the Act, the Registrar has a variety of other duties and powers. 3.2 Administrator The administrator is defined as any person who has been accredited by the Council in terms of s.58, and shall, where any obligation has been placed on a medical scheme in terms of the Act, also mean a medical scheme. In terms of s.58 no person is allowed to administer a medical scheme unless the Council has granted accreditation to such person. The Regulations provide that accreditation as an administrator is only valid for a period of 24 months. The administrator must enter into an agreement with a medical scheme wherein the terms and conditions of the administration of the scheme are recorded. Provisions

367 General F45 relating to the administrator may be found in Chapter 6 of the regulations. 3.3 Board of Trustees The board of trustees is defined to mean the board of trustees charged with managing the affairs of a medical scheme, and which has been elected or appointed under its rules. Structure The Act, in terms of s.57(1 to 3), provides the following: Every medical scheme must have a board of trustees consisting of persons who are fit and proper to manage the business of the medical scheme. At least 50% of the members of the board of trustees must be elected from amongst members. An employee, director, officer, consultant or contractor of the holding company, subsidiary, joint venture or associate of the administrator of the medical scheme or a broker is not allowed to be a member of the board of trustees. Duties In terms of s.57(4) and s.57(6) of the Act, duties of the board of trustees include the following: Appointing a principal officer of the medical scheme who is a fit and proper to hold such office Ensuring proper records are kept of all operations and resolutions pertaining to the medical scheme Ensuring proper control systems are employed Ensuring adequate and appropriate information is communicated to the members of the medical scheme relating to their rights, benefits, contributions and duties in terms of the rules of the medical scheme. Ensuring that the rules, operation and administration of the medical scheme comply with the Act and other applicable laws Ensuring confidentiality of medical records relating to the member s state of health

368 F46 General Taking steps to ensure that the interests of beneficiaries are protected at all times Acting with due care, diligence, skill and good faith Taking reasonable steps to avoid conflicts of interest Acting with impartiality in respect of all beneficiaries 3.4 Officer and Principal Officer A principal officer is appointed by the board of trustees in terms of s.57(4) of the Act. A principal officer must be a person who is fit and proper to hold such office. Any notice required or permitted to be given to a medical scheme in terms of the Act, if given to the principal officer, will be deemed to have been given to the medical scheme. 3.5 Member and Prospective Member A member is defined in s.1 of the Act as a person who has been enrolled or admitted as a member of a medical scheme or who, in terms of the rules of a medical scheme, is a member of such medical scheme. 3.6 Dependant The Act defines a dependant to mean: (a) (b) the spouse or partner, dependant children or other members of the member s immediate family in respect of whom the member is liable for family care and support; any other person who, under the rules of a medical scheme, is recognised as a dependant of a member. In terms of the current prescribed model rules issued by the Council, Dependant is defined as: a member s spouse or partner who is not a member or a registered dependant of a member of a medical scheme; a dependent child; the immediate family of a member in respect of whom the member is liable for family care and support;

369 General F47 any other person who is recognised by the Board as a dependant for purposes of these Rules. The model rules define the word spouse as the person to whom a member is married in terms of any law or custom. The model rules also define a member family to mean the member and all the registered dependants. Furthermore, the model rules define the word partner as a person with whom the member has a committed relationship based on objective criteria of mutual dependency, irrespective of the gender of either party. The model rules further define the word dependent - in relation to a dependant other than the member s spouse or partner, a dependant who is not in receipt of a regular remuneration of more than the maximum social pension per month or a child who, due to a mental or physical disability, is dependent upon the member. (Note that the scheme may specify an amount greater than the maximum social pension.) 3.7 Child Dependant A child dependant is not defined in the Act, but in the Regulations published in terms of s.67 of the Act. In terms of the Regulations, a child dependant is defined as a dependant who is under the age of 21 or older if the rules of the scheme permit it. The current model rules define a child as a member s natural child, or a stepchild or a legally adopted child or a child in the process of being legally adopted or a child in the process of being placed in foster care, or a child for whom the member has a duty of support or a child who has been placed in the custody of the member or his/her spouse or partner and who is not a beneficiary of any other medical scheme. 3.8 Beneficiary In terms of the Act, beneficiary means a member or a person admitted as a dependant of a member.

370 F48 General 3.9 Broker In terms of the Act, a broker is defined as a person whose business, or part thereof, entails providing broker services, but does not include - (i) (iii) (iii) an employer or employer representative who provides service or advice exclusively to the employees of that employer; a trade union or trade union representative who provides service or advice exclusively to members of that trade union; or a person who provides service or advice exclusively for the purposes of performing his or her normal functions as a trustee, principal officer, employee or administrator of a medical scheme, unless a person referred to in (i), (ii) or (iii) elects to be accredited as a broker, or actively markets or canvasses for membership of a medical scheme. The Act also defines broker services namely, the provision of service or advice in respect of the introduction or admission of members to a medical scheme; or the ongoing provision of service or advice in respect of access to, or benefits or services offered by, a medical scheme Late joiner In terms of the regulations a late joiner means an applicant or the adult dependant of an applicant who, at the date of application for membership or admission as a dependant, as the case may be, is 35 years of age or older, but excludes any beneficiary who enjoyed coverage with one or more medical schemes as from a date preceding 1 April 2001, without a break in coverage exceeding three consecutive months since 1 April The regulations prescribe a formula to calculate the penalties payable by such late joiners.

371 General F49 Calculating the late joiner penalty The premium penalties are as follows: Penalty bands Maximum penalty 1 4 years... 0,05 contribution 5 14 years... 0,25 contribution years... 0,5 contribution 25+ years... 0,75 contribution To determine the applicable penalty band to be applied to a late joiner in terms of the first column of the table the following formula is applied: A = B minus (35 + C) Where: A means the number of years referred to in the first column of the table; B means the age of the late joiner at the time of his or her application for membership or admission as a dependant; and C means the number of years of creditable coverage which can be demonstrated by the late joiner. In terms of regulation 13 the late joiner penalty can only be applied to the portion of the contribution related to the member or any adult dependant who qualifies for late joiner penalties. 4. Medical Schemes 4.1 Types of Medical Schemes There are two types of medical schemes: commercial and restricted membership schemes (or so-called in-house schemes). A commercial medical scheme is also referred to as an open scheme and is open for membership to the general public.

372 F50 General In-house schemes (defined in the Act as restricted membership schemes ) are formed by large companies who wish to establish a private (closed) medical scheme for their employees. To be eligible for membership of this type of scheme, the member must be an employee or pensioner of the employer and membership is, therefore, closed to the general public. The Act defines a restricted membership scheme as a medical scheme, the rules of which restrict the eligibility for membership by reference to: (a) (b) (c) employment or former employment or both in a profession, trade, industry or calling; employment or former employment or both by a particular employer, or by an employer included in a particular class of employers; membership or former membership or both of a particular profession, professional association or union; or any other prescribed matter. 4.2 Membership Admission In terms of s.24(2)(e), a medical scheme is not allowed to unfairly discriminate against any person on one or more arbitrary grounds, including race, age, gender, marital status, ethnic or social origin, sexual orientation, pregnancy, disability and state of health. The Rules of a medical scheme pertaining to the terms and conditions applicable to the admission of a person to a medical scheme, must provide for the determination of contributions on the basis of income or the number of dependants, or both the income and the number of dependants, may not provide for any other grounds, including age, sex, past or present state of health, of the applicant or one or more of the applicant s dependants, the frequency of rendering relevant health services to an applicant, or one or more of the applicant s dependants other than the provisions as prescribed (s.29(1)(n)). In terms of s.29(3)(a to c), a medical scheme may not provide in its rules:

373 General F51 (a) (b) (c) for the exclusion of any applicant or a dependant, subject to the Act, from membership except for a restricted membership scheme; for the exclusion of any applicant or dependant who would otherwise be eligible for membership to a restricted membership scheme; and for the imposition of waiting periods other than as provided for in s. 29(A). (Refer to waiting periods below.) Continued Membership The Registrar will not register a medical scheme under s.24 unless provision is made in the scheme s rules for the following: The continuation, subject to conditions as may be prescribed, of the membership of a member, who retires from the service of his employer or whose employment is terminated by his employer on account of age, ill-health or other disability and his dependants (s.29(1)(s)). Continued membership of a member s dependants, subject to conditions as may be prescribed, after the death of that member, until such dependant becomes a member of, or is admitted as a dependant of a member of another medical scheme (s. 29(1)(t)). Benefit Options In terms of s.33, a medical scheme must apply to the Registrar for the approval of any benefit option if the medical scheme provides members with more than one benefit option. In order to remain financially sound, medical schemes impose certain limits on the amount and type of relevant health services that members may claim annually. However, the Act provides that every medical scheme is to offer prescribed minimum benefits (PMB) to its members. Annexure A of the Regulations list the PMB package and every medical scheme must provide cover for these PMB conditions and the treatment prescribed. The medical scheme may provide in their rules that the cost of a PMB condition will only be paid in full, if those services are

374 F52 General obtained from a designated service provider. The medical scheme may specify a co-payment in their rules which may be imposed if the member voluntarily receives treatment for a PMB condition at a provider other than the designated service provider. (See regulation 8) Limits on benefits (Reg. 9, 9A, 9B and 10) Except for PMB, a medical scheme may pro rata reduce annual benefits in respect of persons joining the scheme within a particular financial year. In terms of the regulations, a medical scheme may not provide in its rules for the accumulation of unexpended benefits from one year to the next other than funds in personal medical savings accounts (PSA) of the member. Medical schemes are prohibited from allocating more than 25% of the total gross contributions toward the PSA during the financial year. PSA funds must be used for the exclusive benefit of the member and his or her dependants but may not be used to offset contributions, provided that the medical scheme may use funds in a member s personal medical savings account to offset debt owed by the member to the medical scheme following that member s termination of membership of the medical scheme. A PSA credit balance must be transferred to another medical scheme or benefit option with a PSA, as the case may be, when the member changes medical schemes or benefit options. A PSA credit balance must be taken as a cash benefit, subject to applicable taxation laws, when the member terminates his or her membership of a medical scheme or benefit option and then enrols in another benefit option or medical scheme without a PSA; or does not enrol in another medical scheme. It is important to note that funds in the member s PSA cannot be used to pay for the costs of PMB.

375 General F53 Waiting Periods The Act defines a general waiting period to mean a period in which a beneficiary is not entitled to claim any benefits. Condition-specific waiting period is defined in the Act as a period during which a beneficiary is not entitled to claim benefits in respect of a condition for which medical advice, diagnosis, care or treatment was recommended or received within the twelve-month period ending on the date on which an application for membership was made. The provisions of s.29a state the following: (1) A medical scheme may impose upon a person in respect of whom an application is made for membership or admission as a dependant, and who was not a beneficiary of a medical scheme for a period of at least 90 days preceding the date of application - (a) a general waiting period of up to three months; and (b) a condition-specific waiting period of up to twelve months. Note that the member will not be covered for any treatment or diagnostic procedures for PMB conditions for the duration of the waiting periods. (2) A medical scheme may impose upon any person in respect of whom an application is made for membership or admission as a dependant, and who was previously a beneficiary of a medical scheme for a continuous period of up to 24 months, terminating less than 90 days immediately prior to the date of application - (a) a condition-specific waiting period of up to twelve months, except in respect of any treatment or diagnostic procedures covered within the PMB; (b) in respect of any person contemplated in this subsection, where the previous medical scheme had imposed a general or condition-specific waiting period, and such waiting period had not

376 F54 General expired at the time of termination, a general or condition-specific waiting period for the unexpired duration of such waiting period imposed by the former medical scheme. (3) A medical scheme may impose upon any person in respect of whom an application is made for membership or admission as a dependant, and who was previously a beneficiary of a medical scheme for a continuous period of more than 24 months, terminating less than 90 days immediately prior to the date of application, a general waiting period of up to three months, except in respect of any treatment or diagnostic procedures covered within the prescribed minimum benefits. (4) A medical scheme may not impose a general or a condition-specific waiting period on a beneficiary who changes from one benefit option to another within the same medical scheme, unless that beneficiary is subject to a waiting period on the current benefit option, in which case any remaining period may be applied. (5) A medical scheme may not impose a general or a condition-specific waiting period on a child dependant born during the period of membership. (6) A medical scheme may not impose a general or condition-specific waiting period on a person in respect of whom application is made for membership or admission as a dependant, and who was previously a beneficiary of a medical scheme, terminating less than 90 days immediately prior to the date of application, where the transfer of membership is required as a result of - (a) change of employment; or (b) an employer changing or terminating the medical scheme of its employees, in which case such transfer shall occur at the beginning of the financial year, or reasonable notice must have been furnished to the medical scheme to which

377 General F55 an application is made for such transfer to occur at the beginning of the financial year. (7) A medical scheme may require an applicant to provide the medical scheme with a medical report in respect of any proposed beneficiary only in respect of a condition for which medical advice, diagnosis, care or treatment was recommended or received within the twelvemonth period ending on the date on which an application for membership was made. (8) In respect of members who change medical schemes in terms of subsection (6), where the former medical scheme had imposed a general or condition-specific waiting period and such waiting period had not expired at the time of termination, the medical scheme to which the person has applied may impose a general or condition-specific waiting period for the unexpired duration of such waiting period imposed by the former medical scheme. 4.3 Provisions relating to Complaints and Appeals Chapter 10 of the Act deals with Complaints. In terms of s.47(1) and (2) the Registrar must, where he has received a complaint, furnish the party concerned with full details of the complaint and request that such party furnish the Registrar with written comments thereon within 30 days or such further period as the Registrar may allow. Once the Registrar is in receipt of the comments he may either resolve the matter or submit the matter to the Council, whereupon they will take such steps, as deemed necessary to resolve the complaint. In essence a complaint is defined as a complaint against any person who is regulated by the Act and who contravened the Act or acted improperly in respect of a matter that falls within the jurisdiction of the Council. Parties may appeal against the decision of the Registrar and the provisions relating thereto are found in s.48 to s.50 of the Act.

378 F56 General 4.4 Provisions relating to Financial Soundness of the Scheme Stringent requirements are provided for in s.35 of the Act and under Reg Duties and Obligations of the Broker Certain provisions relating to brokers are set out hereunder. Compensation of brokers (S.65 and Reg. 28) Section 65 of the Act provides that no person may act or be compensated as a broker unless the Council has accredited such person. This section provides further that a broker may not be directly or indirectly compensated for providing broker services by any person other than - a medical scheme; a member or prospective member, or the employer of such member or prospective member, in respect of whom such broker services are provided; or a broker employing such broker. Reg. 28(1) provides that a medical scheme is not allowed to compensate any person in terms of section 65 for acting as a broker unless such person enters into a prior written agreement with the medical scheme concerned. Reg. 28(2) provides that, subject to sub-regulation (3), the maximum amount payable to a broker by a medical scheme in respect of the introduction of a member to a medical scheme by that broker and the provision of ongoing service or advice to that member, shall not exceed - R65,65 plus value-added tax (VAT), per month, or such other monthly amount as the Minister shall determine annually in the Government Gazette, taking into consideration the rate of normal inflation; or 3% plus value added tax (VAT) of the contributions payable in respect of that member, whichever is the lesser.

379 General F57 Reg. 28(3) states that a medical scheme may not differentiate the amount of compensation offered to brokers for the introduction of members to the scheme based upon the anticipated claims experience, age, health status or employment status of the members being introduced. Reg. 28(4) goes on to state that sub-regulation (2) must not be construed to restrict a medical scheme from applying a sliding scale based on the size of the group being introduced provided that prescribed maximum amount is not exceeded and that it may not pay a lesser amount for the introduction of individual members than the per capita amount payable in respect of introduction of members who form part of a group. Reg. 28(6) provides that the ongoing payment by a medical scheme to a broker in terms of this regulation is conditional upon the broker - continuing to meet service levels agreed to between the broker and the medical scheme in terms of the written agreement between them;and receiving no other direct or indirect compensation in respect of broker services from any source, other than a possible direct payment to the broker of a negotiated professional fee from the member himself or herself (or the relevant employer, in the case of an employer group). In terms of Reg. 28(7), a medical scheme shall immediately discontinue payment to a broker in respect of services rendered to a particular member if the medical scheme receives notice from that member (or the relevant employer, in the case of an employer group), that the member or employer no longer requires the services of that broker. Reg. 28(8) provides that a medical scheme may not compensate more than one broker at any time for broker services provided to a particular member. Reg. 28(9) provides that any person who has paid a broker compensation where there has been a material misrepresentation, or where the payment is made consequent to unlawful conduct by the broker, is entitled to

380 F58 General the full return of all the money paid in consequence of such material misrepresentation or unlawful conduct. Admission of members to a medical scheme (Reg. 28A) A medical scheme must not prevent a person from applying for membership of a medical scheme for the reason that such person is not using a broker to apply for such membership. Accreditation of brokers (Reg. 28B) Any person desiring to be accredited as a broker must apply in writing, and the application must be accompanied by documentary proof of a recognised educational qualification and appropriate experience; documentary evidence of having passed or current enrolment in a relevant course of study recognised by the Council; in the case of a juristic person, documentary proof and a sworn affidavit that any person employed by the person, or acting under the auspices of the person, who provides or will provide advice on medical schemes to clients, is accredited with Council as a broker or an apprentice broker; and such additional information as the Council may deem necessary. A recognised educational qualification and appropriate experience means Grade 12 education or equivalent educational qualification; and a minimum of two years demonstrated experience as broker or apprentice broker in health care business. Those not meeting the qualifications for a broker may apply to the Council for accreditation as apprentice brokers and such applications must be accompanied by prescribed documentary proof. In the case of a natural person, an application for accreditation as a broker or an apprentice broker must also be accompanied by information to satisfy the Council that the applicant complies with

381 General F59 any requirements for fit and proper brokers which may be determined by the Council, by notice in the Gazette; and any relevant requirements for fit and proper financial services providers or categories of providers which may be determined by the Registrar of Financial Service Providers in terms of the Financial Advisory and Intermediary Services Act. The Council must, after consideration of an application, either grant the application (which could be subject to certain conditions), or refuse the application providing reasons for such refusal. Accreditation is only granted for a period of twenty-four months. The Council will also provide the successful applicant with a certificate from the Registrar, clearly specifying the expiry date of the accreditation and any conditions that may be imposed by the Council in terms of the regulations. The Council may add, withdraw or amend any condition or restriction in respect of the accreditation (after affording the broker an opportunity to be heard), if the Council is satisfied that any such addition, withdrawal or amendment is justified and will not unfairly prejudice the interests of clients. An application for a renewal of accreditation must be made to the Council at least three months prior to the date of expiry of the accreditation and upon such other conditions as prescribed. A person will be disqualified from accreditation as a broker or an apprentice broker if he or she - is an unrehabilitated insolvent; is disqualified under any law from carrying on his or her profession; or has at any time been convicted of any offence involving dishonesty (e.g. fraud, theft, corruption or forgery), and has been sentenced therefore to imprisonment without the option of a fine.

382 F60 General Suspension or withdrawal of accreditation (Reg. 28C) The Council may at any time suspend or withdraw any accreditation granted in terms of these regulations if the Council is satisfied that the relevant broker or apprentice broker - no longer meets the requirements contemplated in the regulations; failed to make a full disclosure of all relevant information to the Council, or furnished false or misleading information; has contravened or failed to comply with any provision of the Act; has failed to comply in a material manner with any relevant code of conduct for financial service providers published in terms of the Financial Advisory and Intermediary Services Act; has conducted business in a manner that is seriously prejudicial to clients or the public interest; or is disqualified from performing broker services in terms of the regulations. Before suspending or withdrawing any accreditation, the Council is to afford the broker or apprentice broker concerned, a reasonable opportunity to make a submission in response to any allegation made against such broker or apprentice broker. Where the accreditation is suspended or withdrawn, the Council must make known the terms of the suspension or withdrawal or subsequent lifting thereof, by means of any appropriate public media announcement. On withdrawal of the accreditation of a person as a broker or apprentice broker, the Council may determine a reasonable period within which such person may not reapply for accreditation as a broker or apprentice broker, taking into account the nature of the circumstances giving rise to such withdrawal.

383 General F61 6. Penalties In terms of s.66 of the Act, any person who contravenes the legislation may be fined or imprisoned for a period not exceeding five years, or both a fine and imprisonment. S.66(3) read with the regulations also provide that a penalty of R1 000 per day for non-compliance will be payable where any person fails to furnish the Council or the Registrar with a return, information, financial statement, document or a reply to an enquiry (contemplated in the legislation), within the prescribed or specified period.

384 F62 General 1. Introduction Money Laundering This section gives a broad overview of the concept of money laundering and South African legislation relating thereto. Money laundering may generally be described as any process that obscures the illegal nature or existence, location or application of the proceeds of a crime. Put differently, money laundering is a process of using the proceeds of an unlawful activity and converting it so that the proceeds appear to be derived from a legitimate source. 2. Prevention of Organised Crime Act 121 of 1998 (POCA) This Act repealed the entire Proceeds of Crime Act 76 of 1996 and repealed the money laundering provisions contained in the Drugs and Drug Trafficking Act 140 of Chapter 3 of POCA deals specifically with money laundering provisions, namely: 2.1 Offences Section 4 makes it an offence for any person who knowingly launders the proceeds of unlawful activities. For example, an intermediary will contravene this section if he or she sells a client an insurance policy with the knowledge that the money for such policy has been derived from the proceeds of an unlawful activity. Section 5 makes it an offence for any person to knowingly assist another person to benefit from the proceeds of unlawful activities. Section 6 makes it an offence to acquire, use or possess property that one knows is the proceeds of unlawful activities. Note that the knowledge requirement referred to in s.4, s.5 and s.6 will also be satisfied if a person ought reasonably to have known that the property concerned is or forms part of the proceeds of unlawful activities.

385 General F Unlawful activities Proceeds of unlawful activities are defined as: any property or service, advantage, benefit or reward; which was derived, received or retained, directly or indirectly, in SA or elsewhere, at any time before or after the commencement of the Act, in connection with or as a result of any unlawful activity carried on by any person. Unlawful activity is defined as any conduct which constitutes a crime or which contravenes any law, whether the conduct occurred before or after the commencement of the Act or whether it occurred in SA or elsewhere. 2.3 Reporting S.7 of POCA dealt with the reporting obligations in respect of suspicious transactions. S.7 has since been repealed and replaced by S.29 of the Financial Intelligence Centre Act (FICA) to extend the obligation to any person who carries on business or who is in charge of a business or who is employed by a business. Refer to the FICA section for further detail. 2.4 Penalties Section 8 provides for substantial penalties for the contravention of the sections mentioned above. Upon conviction of contravening s.4, s.5 or s.6 one could face a fine not exceeding R100 million or imprisonment not exceeding 30 years. Furthermore, the proceeds of the crime may also be forfeited to the state in terms of the confiscation and forfeiture powers under Chapter 5 of POCA.

386 F64 General 3. Financial Intelligence Centre Act 38 of 2001 (FICA) Certain definitions in POCA have been incorporated by the Financial Intelligence Centre Act 38 of 2001 (FICA). These include the meaning of money laundering, assisting persons to benefit from the proceeds of unlawful activities, and the acquisition, possession or use of proceeds of unlawful activities. FICA also repealed the reporting duty under POCA, which has the effect that suspicious transactions must now be reported under FICA. FICA has further been amended by the provisions of the Protection of Constitutional Democracy Against Terrorist and Related Activities Act 33/2004, POCDATARA (refer to the note at the end of this section). A broad overview of the salient provisions of FICA is set out hereunder. 3.1 Purpose of FICA The purpose of FICA is to establish a Financial Intelligence Centre and a Money Laundering Advisory Council in order to combat money laundering activities; to impose certain duties on institutions and other persons who might be used for money laundering purposes and to amend POCA. 3.2 Definitions Accountable Institution means a person referred to in Schedule 1 of the Act. In this regard, item 8 of the Schedule includes a person who carries on a long-term insurance business, as defined in the Long-term Insurance Act 52 of 1998, including an insurance broker and an agent of an insurer. Business relationship means an arrangement between a client and an accountable institution for the purpose of concluding transactions on a regular basis. Centre means the Financial Intelligence Centre (FIC) established by the Act. Council means the Money Laundering Advisory Council established in terms of the Act, and Director means the director of the aforesaid Council.

387 General F65 Money laundering or money laundering activity means an activity which has or is likely to have the effect of concealing or disguising the nature, source, location, disposition or movement of the proceeds of unlawful activities or any interest which anyone has in such proceeds. The definition extends the aforesaid meaning to include any activity contemplated in POCA. Note: The knowledge requirement will be satisfied if a person ought reasonably to have known that the property concerned is or forms part of the proceeds of unlawful activities. Proceeds of unlawful activity has the meaning attributed to it in terms of POCA. Single transaction means a transaction other than a transaction concluded in the course of a business relationship. Unlawful activity has the meaning attributed to it in terms of POCA. 3.3 Role-players Accountable Institutions The provisions of FICA are applicable to those persons or entities listed in Schedule 1 to the Act. It includes, amongst others, assurers, independent brokers, attorneys, banks and estate agents. Financial Intelligence Centre (FIC) The FIC has been established in terms of the Act. Accountable institutions are required to provide FIC with certain information as required by the Act. The principal objective of FIC is to assist in the identification of the proceeds of unlawful activities and the combating of money laundering activities. Other objectives of FIC include, amongst others, to make available information collected to investigating authorities, the South African Revenue Services and to exchange information with similar bodies in other countries regarding money laundering activities.

388 F66 General A Director of the FIC must be a fit and proper person, appointed by the Minister of Finance. Money Laundering Advisory Council (Council) The Council is to advise the Minister of Finance on policies and best practices in identifying and combating money laundering. It must also act as a forum in which the FIC, associations representing categories of accountable institutions, organs of state and supervisory bodies can consult one another. Supervisory Bodies In Schedule 2 to FICA, the Supervisory Bodies are listed, namely: the Financial Services Board, the South African Reserve Bank, the Registrar of Companies, the Estate Agents Board, the Public Accountants and Auditors Board, the National Gambling Board, the JSE Securities Exchange and the Law Society. In terms of the provisions of FICA these bodies are obliged to report to the FIC all suspicions of money laundering activities relating to accountable institutions and the FIC may also require related information from such bodies. 3.4 Identification and verification of clients and other persons FICA provides that an accountable institution may not establish a business relationship or conclude a single transaction with a client unless it has taken the prescribed steps to establish and verify the identity of a client and, if such client is represented by another person, to also establish the authority of such person in the business relationship and to verify the identity particulars relating to such person. Implementation of this provision took effect on 30 June 2003 and is therefore applicable to clients who transacted with the accountable institution on or after 30 June Where an accountable institution had established a business relationship with a client prior to FICA, such accountable institution may not conclude a transaction in the course of that business relationship unless the prescribed steps have

389 General F67 been taken. Implementation of this provision (i.e. relating to existing clients) took effect on 30 June Reference is made above to the prescribed steps in the identification and verification process. In this regard regulations have been promulgated which set out the duties of the accountable institution. Depending on the entity that an accountable institution is dealing with, certain information is to be obtained in the identification of such an entity and which information must then be verified by comparing the particulars with other information. A further distinction is also made between South African citizens, residents, legal entities and foreign nationals and legal entities. So, for example, where a natural person (RSA citizen) wants to purchase a life assurance policy, the accountable institution would need to identify the client by obtaining the full names, date of birth, identity number and residential address of such client. These details must then be verified by comparing it, for example, with the identity document of the client. As far as the particulars relating to the residential address are concerned, the regulations require the accountable institution to verify such details by comparing these particulars with information which can reasonably be expected to achieve such verification and is obtained by reasonably practical means, taking into account any guidance notes concerning the verification of identities which may apply to that accountable institution. Guidance Notes The regulations allow accountable institutions to have regard to guidance notes in certain instances of identification and verification of clients. In the case of verifying the client s residential address, the guidance notes could, for example, provide that a utility bill reflecting the name and residential address of the client may be used. Specific Exemptions The legislation also provides for exemptions in terms of which accountable institutions do not have to identify and verify clients under certain circumstances. There are general exemptions and exemptions that apply to certain accountable institutions in particular. Some of the specific

390 F68 General exemptions applicable to life assurers and independent brokers include, amongst others, the following: Any long-term insurance policy, which provides benefits only upon the death, disability, sickness or injury of the life insured under the policy. Any long-term insurance policy in respect of which recurring premiums are paid, which will amount to an annual total not exceeding R25 000, subject to the condition that identification and verification obligations would have to be complied with in respect of every client who increases the recurring premiums so that the amount of R is exceeded; who surrenders such a policy within three years after its commencement; or to whom that accountable institution grants a loan or extends credit against the security of such policy within three years after its commencement. Any long-term insurance policy in respect of which a single premium not exceeding R is payable, subject to the condition that identification and verification obligations would have to be complied with in respect of every client who surrenders such a policy within three years after its commencement; to whom that accountable institution grants a loan or extends credit against the security of such a policy within three years after its commencement. Any contractual agreement to invest in unit trust or linked product investments in respect of which recurring payments are payable amounting to an annual total not exceeding R25 000, subject to the condition that identification and verification obligations would have to be complied with in respect of every client who liquidates the whole or part of such an

391 General F69 investment within one year after the making of the first payment. Any unit trust or linked product investment in respect of which a once-off consideration not exceeding R is payable, subject to the condition that identification and verification obligations would have to be complied with in respect of every client who liquidates the whole or part of such an investment within one year after making the first payment. Any other long-term insurance policy on condition that within the first three years after the commencement of the policy the surrender value of the policy does not exceed 20% of the value of the premiums paid in respect of that policy. General Exemptions A significant general exemption applicable to all accountable institutions provides that: Every accountable institution is exempted from compliance with the identification and verification obligations in respect of a business relationship or single transaction which is established or concluded with that institution (the second accountable institution) by another accountable institution (the primary accountable institution) acting on behalf of a client of that primary accountable institution, subject to the condition that the primary accountable institution confirms in writing to the satisfaction of the second accountable institution that - It has established and verified the identity of the client in accordance with the Act, or In terms of its internal rules and the procedures ordinarily applied in the course of establishing business relationships or concluding single transactions the primary accountable institution will have established and verified the identity of every client on whose behalf it will be establishing business relationships or concluding single transactions with the second accountable institution.

392 F70 General 3.5 Record keeping FICA requires that, whenever an accountable institution establishes a business relationship or concludes a transaction with a client, it must keep record of, inter alia, the following: The identity of the client The identity and authority of a person acting on behalf of the client The identity and authority of a client acting on behalf of another person The manner in which the identity was established The nature of the business relationship or transaction The parties and amounts involved in the case of a transaction The name of the person who obtained the information on behalf of the accountable institution Documents used to identify and verify the client or other person Records may be kept in electronic form and accountable institutions must keep records, which relate to: the establishment of a business relationship, for at least five years from the date on which the business relationship is terminated, and in respect of a transaction which is concluded, for at least five years from the date on which that transaction is concluded. FICA also provides that third parties may keep records on behalf of the accountable institution as long as the accountable institution has free and easy access to the records. Where third parties are used to keep records, the accountable institution must provide FIC with the particulars of such third parties.

393 General F Reporting duties and access to information Note: The provisions outlined below came into operation on 3 February Accountable institutions to advise FIC may require an accountable institution to advise whether a specified person is or has been a client or whether any specified person has acted on behalf of such a client. Cash transactions above prescribed limit The FIC requires that an accountable institution report particulars of transactions concluded with a client in excess of the prescribed amount within a prescribed period. Suspicious and unusual transactions A person who carries on a business or is in charge of or manages a business or who is employed by a business and who knows or suspects that - the business has received or is about to receive the proceeds of unlawful activities; a transaction or series of transactions to which the business is a party is unlawful; the business is facilitated or is likely to facilitate the transfer of the proceeds of unlawful activities; has no apparent business or lawful purpose; a transaction is conducted for the purpose of avoiding to give rise to a reporting duty under the Act; or business conducted may be relevant to the investigation of an evasion or attempted evasion of a duty to pay any tax, duty or levy imposed by legislation administered by the Commissioner for the South African Revenue Service; or the business has been used or is about to be used in any way for money laundering purposes,

394 F72 General must, within the prescribed period (i.e. 15 days) after the knowledge was acquired or the suspicion arose, report to FIC the grounds for the knowledge or suspicion and the prescribed particulars concerning the transaction or series of transactions. A person who knows or suspects that a transaction or a series of transactions about which enquiries are made, may, if that transaction or those transactions had been concluded, have caused any of the consequences referred to in the paragraph above, must report to the FIC the grounds for the knowledge or suspicion and the prescribed particulars concerning the transaction or series of transactions. No person who made or must make a report as required by FICA may disclose that fact or any information regarding the contents of any such report to any other person, including the person in respect of whom the report is or must be made, unless such disclosure is made - within the scope of the powers and duties of that person in terms of any legislation; for the purpose of carrying out the provisions of FICA; for the purpose of legal proceedings, including any proceedings before a judge in chambers; or in terms of an order of court. Similarly, no person who knows or suspects that a report has been or is to be made in terms of FICA may disclose that knowledge or suspicion or any information regarding the contents or suspected contents of any such report to any other person, including the person in respect of whom the report is or is to be made. Reporting procedures and furnishing of additional information The FIC may request an accountable institution to furnish it with further information after having received a report from such an institution and which information is to be provided without delay.

395 General F73 Continuation of transactions An accountable institution may continue with and carry out the transaction in respect of which the report is required to be made unless FIC directs otherwise. Intervention and monitoring orders by FIC Under certain circumstances the FIC may direct an accountable institution not to proceed with the carrying out of a particular transaction or proposed transaction for a specified period, to enable the FIC to make the necessary inquiries concerning such a transaction and, if necessary, to inform an investigating authority thereof. The FIC may also, under certain circumstances, obtain a court order in terms of which an accountable institution is to report to the FIC on such terms and in such confidential manner as may be specified in the court order. Information held by supervisory bodies and the South African Revenue Services The FIC requires of these supervisory bodies to report any suspicions they may have relating to an accountable institution that, wittingly or unwittingly, has or is about to receive proceeds of unlawful activities. The FIC may also require such bodies or SARS to provide it with relevant information pertaining to suspected money laundering activities. Confidentiality Except under certain circumstances relating to attorney client privilege, there is no duty of secrecy or confidentiality or any other restriction on the disclosure of information required to be provided in terms of FICA. Protection of persons making reports Unlike POCA, FICA protects those persons and/or accountable institutions against criminal or civil action who in good faith performed obligations set out in the Act. Any person or accountable institution who had made a report or supplied information in terms of the Act cannot be

396 F74 General compelled to give evidence in criminal proceedings arising from such a report. Access to information held by the FIC and protection of confidential information Only certain specific investigating authorities or supervisory bodies may, subject to certain conditions, have access to the information held by FIC. No person may disclose confidential information held by or obtained from FIC except - within the scope of the powers and duties of that person in terms of any legislation; for the purpose of carrying out the provisions of FICA; for the purpose of legal proceedings, including any proceedings before a judge in chambers; or in terms of an order of court. Referral of suspected offences FIC may, upon reasonable grounds of suspecting an accountable institution of failing to comply with FICA, refer the matter to the relevant investigating authority or supervisory body. 3.7 Measures to promote compliance by accountable institutions Note: The provisions set out hereunder came into operation on 30 June Formulation and implementation of internal rules Every accountable institution is obliged to formulate and implement internal rules concerning, amongst others, the identification and verification requirements and the record keeping requirements. Accountable institutions are also required to make its internal rules available to each of its employees involved in transactions to which FICA applies and must supply FIC or an applicable supervisory body with a copy of such rules upon request.

397 General F75 Training and monitoring of compliance Accountable institutions must provide training to its employees to enable them to comply with FICA and the internal rules of the particular accountable institution. Accountable institutions must also appoint a person with the responsibility to ensure compliance by the employees of the accountable institution with the provisions of FICA and the internal rules applicable to them; and the accountable institution with its obligations under FICA. 3.8 Offences and Penalties The following offences and penalties are applicable : Failure to identify persons - imprisonment not exceeding 15 years or a fine not exceeding R Failure to keep records - imprisonment not exceeding 15 years or a fine not exceeding R Failure to formulate and implement internal rules - imprisonment not exceeding 5 years or a fine not exceeding R Failure to provide training or appoint compliance officer- imprisonment not exceeding 5 years or a fine not exceeding R Provisions relating to the offences listed below have come into operation on 3 February If convicted of any of the offences listed below, a penalty of imprisonment not exceeding 15 years or a fine not exceeding R , may be imposed: Failure to comply with a request of FIC Failure to comply with direction of FIC Failure to comply with monitoring order Disclosure of information obtained from FIC

398 F76 General Obstructing FIC representative in performing his/her duty Conducting transactions to avoid reporting duties Note: The Protection of Constitutional Democracy Against Terrorist and Related Activities Act 33 of 2004 (POCDATARA) amended certain provisions of FICA (sec 29) to extend the reporting of suspicious and unusual transactions to also cover reporting of property which is connected to terrorist activities. It also amended sec 28A of FICA which requires the reporting of any property that is associated with terrorist activities. These provisions came into operation on 20 May 2005.

399 General F77 Compliance in terms of the Policyholder Protection Rules (Long-term Insurance Act 52/1998) On 1 July 2001 the Policyholder Protection Rules (PPR) were promulgated in terms of the Long-term Insurance Act. As of 30 September 2004 these rules have subsequently been repealed, and replaced by a new set of rules. The new PPR has as its objective to ensure that long-term policies are entered into, executed and enforced in accordance with sound insurance principles and practice in the interest of the parties and the public interest. The rules furthermore specifically state that it does not impact on the duty of any person to comply with the provisions of FAIS. The Financial Advisory and Intermediary Services Act of 37/2002, has effectively included the provisions of the previous PPR as part of the Act. The new PPR deals with amongst other issues regarding direct marketers, agreements with intermediaries, and rules on cancellation of polices and rules of fund policies.

400 F78 General 1. Introduction The Financial Advisory and Intermediary Services Act The Financial Advisory and Intermediary Services Act 37 of 2002 (FAIS) was promulgated on 15 November Anyone rendering financial services, as defined, must be licenced in order to operate. The purpose of FAIS is to regulate the rendering of financial advisory and intermediary services, and thereby make the financial services industry more professional. FAIS will be regulated by the Financial Services Board. A broad overview of certain provisions of the legislation and subordinate legislation is set out hereunder. 2. Pertinent definitions Financial services providers (FSP or simply a provider) are defined as persons who furnish advice and/or render intermediary service as part of a regular feature of their business. Advice means any recommendation, guidance or proposal of a financial nature furnished, by any means or medium to any client or group of clients in respect of dealings with financial products, and whether or not: the advice is given while doing financial planning for the client, or a financial product is sold as a result of such advice. However, advice does not include giving factual advice: On the procedure for entering into a transaction in respect of a financial product; In relation to the description of a financial product; In answer to routine administrative queries regarding a financial product; In the form of objective information about a financial product, or By displaying or distributing promotional material.

401 General F79 Financial Product is defined very widely and includes, amongst others, long and short-term insurance policies, benefits provided by pension fund organisations, shares, money-market instruments, participatory interests in collective investment schemes (e.g. unit trusts), foreign currency denominated investment instruments, bank deposits, and health service benefits provided by medical schemes. However, it does not include fixed property. Product Supplier means any person who issues a financial product by virtue of any law. Intermediary Services is defined as any act, other than the furnishing of advice as defined, performed by a person for, or on behalf of a client or product supplier which: Results in a client entering into a transaction with a product supplier in respect of a financial product; or Is done with a view to a dealing in, managing, keeping in safe custody, maintaining or servicing a financial product in which a client has invested, or collecting or accounting for premiums, or processing a client s claim against a product supplier. Client means a specific person or group of persons, excluding the public, who is or may become the subject to whom a financial service is rendered intentionally, or is the successor in title of such person or the beneficiary of such service. Key Individuals are defined as natural persons responsible for the managing or overseeing, either alone or together with other people, the activities of an FSP, or of a representative. Representative means any person who renders a financial service for or on behalf of an FSP, in terms of conditions of employment or any other mandatory agreement, but excludes a person rendering clerical, technical, administrative, legal, accounting service, which service: does not require judgement on the part of that person; or does not lead a client to any specific transaction in respect of a financial product in response to general enquiries. Administrative & Discretionary FSP s. The former renders intermediary services in respect of certain financial products on the instruction of clients or other FSP s through the method of bulking

402 F80 General (e.g. a LISP). The latter provides a discretionary intermediary service as regards the choice of financial product, but does not bulk client s funds or financial products belonging to clients (e.g. an asset manager). There is a specific code relating to these FPS s which will not be covered hereunder. 3. Licensing As from 30 September 2004, any person rendering financial services, as defined, must be licensed. In applying for a licence, the FSP must include details of its key individuals and, if applicable, details of its representatives. The Act makes provision for FSP s to apply for any exemption from any provision of the legislation. Once the Registrar is satisfied with the application, it will issue the FSP with a licence authorising the FSP to act as such. The Registrar has certain powers such as the imposition of certain conditions to the licence. The Registrar may also, for example, suspend or withdraw a licence where the FSP no longer meets the requirements of the legislation. Once licensed, the FSP must display a certified copy of the licence in each of the FSP s business premises; ensure that all the FSP s business documentation, advertisements and other promotional material indicate that the FSP is licensed to act as such; and ensure that the licence is available to persons requesting proof of such licence. 4. Key Individuals Both FSP s and their representatives may need to have key individuals. The FSP must include details of its key individuals in its licence application to act as an FSP. Key individuals are required to possess personal character qualities of honesty and integrity; meet the competency and operational requirements; and also the financial standing requirements as provided for in the Fit and Proper Requirements contained in the subordinate legislation.

403 General F81 The Registrar may require to seek prior approval for a key individual to act as such, if one key individual takes over from another key individual; a new key individual is appointed; or a key individual s personal circumstances have changed so that the individual is no longer a fit and proper person, as defined. 5. Representatives A Representative is a person who renders a financial service to a client for or on behalf of an FSP. (Refer to the definition above.) A person may not carry on business by rendering financial services to clients for or on behalf of a person who is not registered to act as an FSP. A person may not act as a representative of an FSP, unless that person is able to provide clients with confirmation certified by the FSP, that: the representative has a service contract or other mandatory agreement to represent the FSP, and the FSP accepts responsibility for the activities that the representative performs within the scope of, or in the course of implementing, such contract or agreement. Representatives must meet similar requirements, as those required for key individuals, namely that they have to possess personal character qualities of honesty and integrity and meet the competency requirements, as set out in the Fit & Proper Requirements. FSP s must maintain registers of representatives (and key individuals of such representatives, where applicable), which must be regularly updated and be available to the Registrar for reference or inspection purposes. The register must: contain the name and business address of every representative (and key individual of a representative, where applicable); state whether representatives act for the FSP as employees or as mandatories, and specify in which categories representatives are competent to render financial services.

404 F82 General A FSP must ensure that representatives who are no longer competent to act when rendering a financial service on behalf of the FSP, are prohibited from rendering any further financial service. Put differently, such a representative is to be debarred from rendering financial services on behalf of the FSP. The FSP must remove such representatives names (and the names of the key individuals of such representatives, where applicable) from its register, and inform the Registrar in writing within a period of 30 days of having done so. The provider is under a further obligation to take immediate steps to ensure that debarment does not prejudice the interests of such representatives clients, and to properly conclude any unconcluded business of such representatives. 6. Fit and Proper Requirements FAIS has introduced a number of fit and proper requirements applicable to financial services providers. In order to be deemed fit and proper an FSP, and where applicable any key individual and/or representative of such FSP, must meet the experience and qualification requirements as well as complete the necessary regulatory examinations and continuous professional development requirements as set out in the FSB s Board Notice 106 of 2008 (hereinafter referred to as Board Notice 106 ) (as amended). The date by which a particular requirement will need to be obtained/completed, will depend on when the individual was first authorised to render financial services in the financial services industry. (i) Experience FSP s, key individuals and representatives need to meet the experience requirements as stipulated in Part IV of Board Notice 106. (ii) Qualifications FSP s, key individuals and representatives need to meet the qualification requirements as stipulated in Part V of Board Notice 106.

405 General F83 (iii) Regulatory Examinations Details regarding the regulatory examinations are contained in Part VI of Board Notice 106. There are two levels of regulatory examinations: Regulatory Examinations Level 1 All persons in the financial services industry will need to complete these examinations, which will test knowledge relating to the regulatory framework that governs the financial services industry. Regulatory Examinations Level 2 Only representatives will need to complete these examinations, which will be product specific examinations. Where a key individual also renderers financial services, these examinations would also have to be completed by such individual. (iv) Continuous Professional Development (CPD) The CPD requirement has been introduced to ensure that financial services providers maintain professional competence, knowledge and skill at a level required to ensure that the client receives competent professional service based on up-to-date developments in legislation and the financial services industry. Details regarding the CPD requirements are contained in Part VII of Board Notice 106.

406 F84 General The table that follows is a summary of the qualifications, regulatory examinations and CPD requirements of Board Notice 106. Representat ives and KI s authorised prior to 31/12/2007 Representatives and KI s authorised in 2008 and 2009 KI s authorised in 2010 Representatives authorised in 2010 Date by which qualifications must be obtained 31/12/2009 Choice: Present Qualification: 31/12/2011 Must already be in possession of required qualification 31/12/2015 Date by which RE1 must be obtained New Qualification: 31/12/ /06/ /06/ /12/ /12/2012 Date by which RE2 must be obtained 31/12/ /12/ /12/ /12/2016 Date by which 1st round of CPD s must be completed 31/12/ /12/ /12/ /12/2017 KI s authorised as from 1 Jan 2011 and onwards Representatives authorised as from 1 Jan 2011 and onwards Date by which qualifications must be obtained Must already be in possession of required qualification Complete a FSB approved qualification within 5 years of authorisation Date by which RE1 must be obtained Must already be in possession of RE1 Complete within 2 years of authorisation Date by which RE2 must be obtained Complete within 6 years of authorising as a representative Complete within 6 years of authorisation Date by which 1st round of CPD s must be completed Start the year after completing RE 2 Start the year after completing RE 2

407 General F85 Where a representative or a key individual has not held a regulated role in terms of FAIS for a period of 5 years or longer, he or she will be deemed a new applicant and will need to obtain the qualification and regulation examinations requirements relevant to his or her new application date. Note: For ease of reference, all of the Board Notices and all the abovementioned information can be accessed via the FSB website at 7. Compliance Officer A FSP must ensure that an independent compliance function exists or is established, as part of its obligation to manage the risks of its business. A FSP with more than one key individual, or one or more representatives, must appoint at least one compliance officer to monitor compliance with the Act by the FSP and its representatives. It follows that it is not necessary for a natural person, conducting business as an FSP alone and for his/her own account, to appoint a Compliance Officer. If it is unnecessary to appoint a compliance officer; however, the FSP or key individual is personally responsible for the compliance obligations laid down in the Act and, in this regard, certain persons could fulfil this function including, inter alia, a sole proprietor, a member of a close corporation or a director of a company, trustee or an auditor of a firm. The FSP may appoint a person who does not fall into one of these categories, provided the person possesses the prescribed minimum qualifications and experience. Where compliance monitoring is by an FSP to a corporate body, partnership or trust, the individual ( natural person ) responsible for the compliance function must have the required qualification and experience. The Registrar may not approve any person as a compliance officer unless that person is suitably qualified, fit and proper, has appropriate knowledge of FAIS and will be able to keep written records and submit written reports.

408 F86 General Compliance Officers are obliged to fulfil their function with the diligence, care and degree of competency which may be expected from a person responsible for such function. Compliance Officers must submit reports in the manner and regarding the matters prescribed by the Registrar. 8. General Code of Conduct for FSP s and Representatives General Provisions Providers must at all times render financial services honestly, fairly, with due skill, care and diligence, and in the interests of clients and the integrity of the financial services industry. All representations made and information provided to a client must be as follows: Factually correct; Easily comprehensible with no misleading statements; Adequate and appropriate in the light of the financial service offered and the client s financial knowledge, allowing the client sufficient time to make an informed decision; Reflected in specific monetary terms if they pertain to amounts, sums, values, charges, fees, remuneration or monetary obligations. Where the latter is not reasonably pre-determinable, the basis of calculation must be adequately described. A client may request written confirmation of representations made and information provided orally. Such a request must be fulfilled within a reasonable time period. Representations made and information provided in writing must be in a clear and readable print size, spacing and format. The provider must disclose to the client the existence of any personal interest in the relevant service, or an actual or potential conflict of interest in relation to such service, and take all reasonable steps to ensure fair treatment of the client. Services must be rendered in accordance with the contractual relationship between the parties and the reasonable requests of the client.

409 General F87 Client instructions must be executed as soon as reasonably possible, with client interests accorded appropriate priority over the interests of the provider. Client transactions must be accurately accounted for by the provider. Providers must not deal in any financial products for their own benefit, where the dealing is based on advance knowledge of pending transactions for or with clients, or on any non-public information, the disclosure of which would be expected to affect the prices of such product. A provider may not disclose confidential information about a client or product supplier without their prior written consent, unless such disclosure is required in the public interest or under any law. Representations made and information provided to a client by the FSP need not be duplicated or repeated to the same client unless material or significant changes affecting that client occur, or the relevant financial service renders it necessary, in which case a disclosure of the changes to the client must be made without delay. In all client interactions, an FSP must act honourably, professionally and with due regard to the convenience of the client. At the commencement of any contact initiated by the provider, the FSP must explain the purpose of the contact. Where a provider s licence, terms of employment or mandate enable such provider to render financial services in respect of a choice of product suppliers, the provider must exercise judgement objectively in the interest of the client concerned. When comparing different financial products, product suppliers, providers or representatives, a provider must make clear the differing characteristics of each. An FSP may not make inaccurate, unfair or unsubstantiated criticisms of any financial product, product supplier, provider or representative. When rendering a financial service, a provider may not request a client to sign any written or printed form or document unless all the details which must be inserted by the client, or on behalf of the client, have already been inserted.

410 F88 General A provider must, at the request of a client, provide the client with a written statement of an account in connection with any financial service rendered to the client. An FSP must fully inform a client in regard to the completion or submission of any transaction requirement: That all material facts must be accurately and properly disclosed, and that the accuracy and completeness of all answers, statements or other information provided by or on behalf of the client, are the client s own responsibility That, if the provider completes or submits any transaction requirement on behalf of the client, the client should be satisfied as to the accuracy and completeness of the details Of the possible consequences of the misrepresentation or non-disclosure of a material fact or the inclusion of incorrect information That the client must on request be supplied with a copy or written or printed record of any transaction requirement within a reasonable time. Information on FSP (Provider) A provider must, at the earliest reasonable opportunity, furnish the client with the following: Full business and trade names, and registration number (if any) Postal and physical addresses Telephone number and cell phone numbers (if any) Internet and addresses Contact details of appropriate contact persons or offices Confirmation of the legal relationship between the FSP, product supplier(s) and representative (if any), to make clear which entity accepts responsibility for the provider s actions Representatives need to confirm their contractual relationship with the licence holder

411 General F89 Names and contact details of the relevant compliance department or, in the case of a representative, such detail concerning the FSP to which the representative is contracted Details of the financial services which the provider is authorised to provide in terms of the relevant licence and of any conditions or restrictions applicable thereto Whether the FSP holds suitable guarantees or professional indemnity or fidelity insurance cover or not Where information is provided orally, the FSP must confirm such information in writing within 30 days. Information on Product Supplier A provider must, at the earliest reasonable opportunity and only when appropriate, furnish the client with the following: Name, postal and physical address and telephone numbers of the relevant product supplier Contractual relationship between the provider and product supplier (if any), and whether the provider has contractual relationships with other product suppliers Names and contact details of the relevant compliance department of the product supplier Client complaints procedures maintained by the relevant product supplier Existence of any conditions or restrictions imposed by the product supplier with regard to the types of financial products or services that may be provided or rendered by the provider. Where applicable, the fact that the provider directly or indirectly holds more than 10% of the relevant product supplier s shares, or has any equivalent substantial financial interest in the product supplier Where applicable, the fact that the provider, during the preceding 12-month period, received more than 30% of total remuneration, including commission, from the product supplier Where information is provided orally, the provider must confirm such information in writing within 30 days.

412 F90 General Within a reasonable time of being requested to do so, an FSP who is also a product supplier must provide other FSP s with sufficient particulars to enable such other FSP s to make the necessary disclosures about the product supplier and its product. Information about Financial Service A provider must give the client a reasonable and appropriate general explanation of the nature and material terms of the relevant contract or transaction, and generally make full and frank disclosure of any information that would reasonably be expected to enable the client to make an informed decision. Any material illustrations, projections or forecasts in the possession of the provider must be given to the client, whenever reasonable and appropriate. A provider must, at the earliest reasonable opportunity, furnish the client with the following: Name/class/type of financial product Nature and extent of benefits to be provided, including details of the manner in which such benefits are calculated and the manner in which they will accrue For investment products or products with an investment component: concise details of the manner in which the value of the investment is determined, including concise details of any underlying assets or other financial instruments; separate disclosure of any charges and fees to be levied against the product; and information concerning the past investment performance of the product Nature and extent of monetary obligations assumed by client, and the manner of payment or discharge thereof, the consequences of non-compliance and any anticipated or contractual escalations, increases or additions. Monetary obligations include commission, consideration, fees, charges or brokerages payable to the provider by the client, or payable by the product supplier or any other person other than the client concerned Concise details of any special terms or conditions, exclusions of liability, waiting periods, loadings, penalties, excesses, restrictions or circumstances in which benefits will not be provided

413 General F91 Any guaranteed minimum benefits or other guarantees To what extent the product is readily realisable or the funds concerned are accessible Any restrictions on or penalties for early termination of or withdrawal from the product, or other effects, if any of such termination or withdrawal Material tax considerations Whether cooling-off rights are offered and, if so, procedures for the exercise of such rights Any material investment or other risks associated with the product In the case of an insurance product in respect of which provision is made for increase of premiums, the amount of the increased premium for the first 5 years, and thereafter on a 5-year basis, but not exceeding 20 years Furnishing of advice The FSP or representative of the FSP must, prior to providing a client with advice take reasonable steps to seek from the client appropriate and available information regarding the client s financial situation, financial product experience and objectives to enable the provider to provide the client with appropriate and suitable advice; conduct an analysis based on the information obtained; identify the financial products that will be appropriate to the client s risk profile and financial needs, subject to the limitations imposed on the provider in terms of FAIS or any contractual arrangement. The provider must disclose to the client the financial implications, costs and consequences, including: fees and charges in respect of the replacement product; special terms and conditions, exclusions of liability, waiting periods, loadings, penalties, excesses, restrictions or circumstances in which benefits will not be provided, which may be applicable to the replacement product;

414 F92 General in the case of an insurance product, the impact of age and health changes on the premium payable; differences between the tax implications of the replacement product and the terminated product; material differences between the investment risk of the replacement product and the terminated product penalties or unrecouped expenses deductible or payable due to termination of the terminated product; to what extent the replacement product is readily realisable compared to the terminated product vested rights, minimum guaranteed benefits or other guarantees or benefits which will be lost as a result of the replacement; Note: A replacement contemplated in FAIS is a replacement of one financial product with another. Accordingly, the meaning of replacement is not confined to the replacement of a long-term policy with another long-term policy. A provider providing advice to a client to replace an existing longterm insurance policy with any other financial product must, within 5 working days from the date of providing the advice, notify the issuer of the long-term insurance policy of such advice. In the process of giving advice, the provider must provide written motivation as to why a specific financial product is recommended to the client; ensure that the client understands the advice, and ensure that the client is in a position to make an informed decision. Where a full analysis could not be undertaken, because of the following: The client has not provided all the information requested by the provider to conduct the analysis. In the light of the surrounding circumstances there was not reasonably sufficient time to conduct the analysis. The provider must ensure that the client clearly understands the following: A full analysis could not be undertaken.

415 General F93 There may be limitations to the appropriateness of the advice given. The client should take particular care to consider on his or her own whether the advice is appropriate considering the client s objectives, financial situation and particular needs. Where a client elects not to follow the provider s advice, or elects to receive more limited information or advice than the provider is able to provide: the provider must alert the client as soon as reasonably possible of the clear existence of any risks. the provider must advise the client to take particular care to consider whether any product selected is appropriate to the client s needs, objectives and circumstances. A provider must keep a record of the advice furnished to a client. Such record must reflect the basis on which the advice was given and, in particular, must include the following: A brief summary of the information and material on which the advice was based. The financial products which were considered. The financial product(s) recommended, with an explanation of why the product(s) selected are likely to satisfy the client s identified needs and objectives. Risk management A provider must employ resources, procedures and appropriate technology that can reasonably be expected to eliminate, as far as reasonably possible, the risk that clients, product suppliers and other providers or representatives will suffer financial loss through theft, fraud, other dishonest acts, poor administration, negligence, professional misconduct, and culpable omissions. A provider must, to the extent required by the registrar, maintain in force suitable guarantees or professional indemnity or fidelity insurance cover. Advertising An advertisement is defined to mean any written, printed, electronic or oral communication (including public radio service communications), directed at the general public, or to a client on

416 F94 General request, by a provider to call attention to the marketing or promotion of financial services offered by the provider, and which does not purport to provide detailed information regarding such financial services. Advertisements must not contain fraudulent, untrue or misleading information. When advertising financial products, there are prescribed details, which must be disclosed by such providers relating to, for example, illustrations, warning statements and past performance. Where a provider advertises a financial service by telephone, the provider: must keep an electronic, voice-logged record of all communications, until such time as it becomes clear that no rendering of a financial service will follow. must be able to provide a copy of such record on request by a client or the Registrar within seven days of being requested to do so. Need not provide the full complement of compulsory disclosures over the telephone. If the promotion results in the rendering of a financial service, however, the compulsory disclosures pertaining to the provider and the product supplier must be provided to the client in writing within 30 days of the relevant interaction with the client. Similar provisions apply to advertisements by public radio service. Complaints A FSP must maintain an internal complaints resolution system and procedures aimed at: ensuring that complaints can be resolved in a manner which is fair to both clients and the FSP and its staff. ensuring that clients have full knowledge of the procedures established for internal resolution of their complaints, details of which must be reduced to writing. The details to be reduced to writing include the client s rights to refer his complaint to the Ombud, should his complaint be dismissed or remain unresolved after four weeks from receipt thereof, as well as the name, address and other particulars of the Ombud.

417 General F95 ensuring that clients have easy access to such procedures at any office/branch or through ancillary postal, telephonic or electronic help desk support and that such access is appropriately made known by public press or electronic announcement or separate business communications to existing clients. A FSP must ensure that adequate human resources, properly trained in the provisions of, and other resources, are employed within such system and that provision is made for both complaints of a routine nature, as well as the escalation of serious non-routine complaints. On receipt of a complaint at any office/branch of a FSP or ancillary postal, telephonic or electronic help desk support, the FSP is to notify the client that the complaint must, if possible, be submitted in writing, contain all relevant information and copies of all relevant documentation. The FSP must promptly acknowledge in writing receipt of complaints and communicate details of contact staff to be involved in the resolution of the complaint. The FSP must ensure that the complaint is forwarded to the relevant staff member and that it receives proper consideration, by ensuring that management controls are available to exercise effective control and supervision of the process. If the complaint cannot be resolved within four weeks from receipt thereof, or in the event of the FSP having decided not to accommodate the client, the FSP must advise the client of his/her right to pursue the matter with the Ombud within six months, and provide the client with the necessary contact details pertaining to the Ombud and a clear summary of the relevant provisions of the Act regarding the adjudication of complaints by the Ombud. The provider s internal complaints resolution system and procedures must be contained in a written policy document. Termination of Agreement or Business Subject to any contractual obligations, a provider must give immediate effect to a client s request to terminate any agreement with the provider or relating to a financial product or advice.

418 F96 General Where a client makes such request on the advice of the provider, the provider must take reasonable steps to ensure that the client fully understands all the implications of the termination. A provider who totally ceases to operate as such must notify all affected clients and take the necessary steps to ensure that any outstanding business is completed promptly or transferred to another provider. Where a representative ceases to act for a provider, such provider must immediately take the necessary steps to notify all affected clients and ensure that outstanding business is completed or transferred to such provider or another representative of such provider. Waiver of Rights No provider may request or induce a client to waive any right or benefit conferred on the client by or in terms of the General Code of Conduct, and no provider may recognise, accept or act on any such waiver by the client, and any such waiver is null and void. 9. Record Keeping A FSP must maintain a register of representatives (and key individuals of such representatives where applicable), which must contain the name and business address of each representative (and key individual) and the categories in which such representative is competent to render financial services. A FSP must ensure that representatives who no longer comply with the Fit & Proper Requirements are removed from the register and that the Registrar is informed accordingly. In terms of the Act, an FSP must maintain records for a minimum period of five years, regarding the following: Known premature cancellations of transactions/financial products. Complaints received and whether or not resolved. Continued compliance with its licence conditions and restrictions, if any. Cases of non-compliance with the Act and the reasons therefore.

419 General F97 A FSP is not required to keep such records itself, but must ensure that they are available for inspection within seven days from receipt of a request by the Registrar. A provider must be able to store and retrieve transaction documentation, and record all written communications relating to a financial service rendered to a client. Records of all clients instructions must be reduced to writing and kept. All records must be kept for a period of five years after termination, to the knowledge of the provider, of the product concerned or, in any other case, after the rendering of the financial service concerned. Records may be kept in an electronic format that is readily reducible to printed form. 10. Offences and Penalties A person will be guilty of an offence and liable on conviction to a fine not exceeding R , or to imprisonment for a period not exceeding ten years, or to both a fine and imprisonment, if that person: acts, or offers to act, as a FSP, without possessing a valid licence issued by the Registrar. fails to comply with the duties relating to the availability and display of the licence at the premises and on the documentation of the FSP. renders financial services as a representative for or on behalf of a person who is not an authorised FSP. acts as a representative for an FSP without being able to provide confirmation, certified by the FSP, that he or she may render financial services for or on behalf of the FSP, and that the FSP accepts responsibility for such services. acting as an FSP, fails to debar a representative who is no longer competent to act as such. fails to maintain records as prescribed. (unless exempted) fails to have its financial statements audited and reported on by an external auditor.

420 F98 General carries on any activity which has been declared to be an undesirable business practice, or fails to comply with a direction issued by the Registrar in this regard, within 60 days. deliberately makes misleading, false or deceptive statements, or conceals any material fact in any application in terms of FAIS.

421 General F99 Notes