South Africans are generally not known for their ability to save. Over the years a number of measures relating to tax have been implemented to encourage savings. The recently released Taxation Laws Amendment Bill, contains the new incentive to encourage savings.
Current savings incentive
The current savings incentive applies to natural persons and provides taxpayers with a exemption for a some South African sourced interest. For someone who is at least 65 years young, the exempt amount is equal to R34 500, while for those younger, the amount is R23 800.
The weaknesses and abuses of this exemption are widely known. The simplest form being a structure where a taxpayer operates a business in the form of a company. A number of taxpayers (often related) would advance loans to the business. The purpose being to strip profits out of the company in the form of interest payments to the ‘funders’. The business gets a deduction for the interest paid, while the interest income qualifies for the exemption in the hands of the recipients. The result of this transaction is that a portion of the profits of the company could end up in the hands of shareholders and connected persons without being taxed.
New savings incentive system
With effect from 1 March 2015 a new savings incentive system, to be known as tax free investments will be introduced. Like the existing regime, it applies to natural persons only. In terms of this incentive, any amount that accrues to or that is received by a person in respect of a tax free investment is exempt from normal tax. A corresponding exemption from dividends tax also exists.
A tax free investment is any financial instrument or long-term insurance policy which is administered by a person designated by the Minister, owned by a natural person or a deceased/insolvent estate of a natural person and that complies with regulations to be made by the Minister. The intention appears to be that these financial instruments will be instruments issued by regulated entities such as banks, collective investment scheme companies, the government and linked investment services providers. Unlike before, tax free investments cannot be made between connected persons where the payer would be able to deduct the returns paid to the investor and the investor escape tax as a result of the exemption. The exact nature and details of these tax free investments are still to be announced and interested investors should keep a keen eye out for developments.
The savings incentive in the system is found in the provisions governing the saving of the funds into the investment. An investor may save R30 000 per annum in cash into a tax free investment, up to a maximum contribution of R500 000 over the taxpayer’s lifetime. This overall limit means that a person who makes use of his annual limit every year, can only save into the tax free investment system for 17 years while still making contributions that qualify for the incentive.
Any returns (mostly interest or dividends) as well as capital appreciation realised on the tax free investment will be exempt from tax. A person is allowed to transfer amounts between one tax free investment to another tax free investment without exceeding this threshold. In addition, any re-investment of amounts from a tax free investment (returns or gains) into a tax free investment will not trigger a person to exceed the thresholds. The last aspect mentioned is of extreme importance as this is where the benefit of the tax free investment regime lies.
If a person starts making investments of R30 000 per annum into a tax free investment, his returns that will be exempt will only be R3 000 if a 10% rate of return is assumed. This is significantly less than the current exemption.
A person is allowed to contribute more than the annual limit into a tax free investment but at the cost of 40% of the investment. This is effectively the price to be paid for the future tax free benefits on the investment and the benefit of tax free compounded returns on investment.
Please contact a member of our Tax Team if you would like to discuss any of the issues raised.