One of the risks faced by those of us in advisory professions is that, in our work, we frequently find ourselves encroaching on the terrain of other professionals. And, in doing so, we can easily find ourselve out of our depth, whether it is the accountant drawing up what he thinks is a simple contract or a ?standard? trust deed for his client or a litigation attorney advising on estate planning or doling out investment advice. For us, as financial advisors, the risk is probably twice as large because, from time to time, we find ourselves moving perilously close to the terrain of both the accountant and the attorney. And yet, it is a risk that all of us in advisory professions have to take from time to time. The alternative is to have our businesses grind to a halt for fear of treading over the line.
One aspect that is unusually prevalent in our profession, and which requires extra awareness and caution from us, is that of tax. These days, in our much more professional industry, most advisors are, to some extent, aware of the factors that give rise to a liability to pay tax and have a basic awareness of tax strategy.
In this article, I hope to outline briefly these factors and how they operate to determine the taxpayer?s liability to tax and will endeavour to illustrate how each may be used to obtain a positive result for the client. This, I hope, will:
1. create greater awareness among financial advisors of the possibilities for tax planning in their client?s affairs; and
2. The need to refer clients, timeously, to a specialist to obtain this advice ? both in estate planning matters and when structuring a new transaction and drawing up contracts.
My experience is that few people are sufficiently mindful of the fact that matters of financial planning have legal consequences, and, while a situation may be improved prior to entering into an agreement or finalising an investment, it is often impossible and at best usually very difficult and expensive to rectify a lack of planning at a later stage.
A closer inspection of our tax acts reveals four recurring factors to be, seemingly, present in respect of all the taxes and duties commonly encountered by the financial advisor. Think of them as the ?who, when, where and what of tax?. For the purposes of this article, I will try to stick to Income Tax and Capital Gains Tax (CGT). (Interestingly, these four factors seem to determine not only the taxpayer?s liability to tax, but also determine the deductibility, or not, of expenditure for Income Tax purposes.)
1. Incidence ? the who of tax
The first factor is that of incidence, or the need of determining the person or entity that will be responsible for paying the tax.
Of the four factors, this one is usually the easiest to manipulate and is of special importance. Most of us are aware of the fact that the tax rates of individuals, companies and trusts all differ. In its simplest form, this is the factor which is manipulated when advising a client to choose a specific entity, rather than another, as party to a transaction to avail them of the preferential tax rate or treatment that may be applicable to that person or entity.
Recently, financial planners have become much more aware of this factor as a result of the advent of CGT in 2001. The difference in the inclusion rate for CGT of natural persons (25% of the capital gain), on the one hand, and companies and ordinary trusts (50% of the capital gain) on the other, combined with the differing tax rates applicable to these three entities, result in a significant difference to the rates at which CGT is payable by these three tax entities. A natural person will only be liable for CGT at a maximum of 10%, while a company will be liable for CGT at 14% (50% of the gain taxed at 28%) and ordinary trusts will be liable for CGT at 20% (50% of the gain taxed at a rate of 40%).
Remember, only individuals and special trusts qualify for an annual exclusion to be deducted from their aggregate capital gain/loss in order to calculate their net capital gain, which will then be multiplied by the inclusion rate and taxed at the rate relevant to that individual or entity.
The importance of the choice of party to a contract is well illustrated in the case of African Life Investment Corporation (Pty) Ltd v SIR??. From the judgement, it appears that, at the time, there was a particularly advantageous system of taxation applicable to long-term insurers. One of the results of this system was to allow all profits from long-term insurers resulting from share dealings to remain free of Income Tax. As a long-term insurer, the African Life Insurance Company used to always operate under this system.
In 1963, the directors of the African Life Group decided to consolidate the share portfolios of the various subsidiary long-term insurance companies in its stable into a single new company which it formed specifically for this purpose. Ironically, the intention of this exercise was administrative convenience and not tax savings. In the process, it was lost on everyone involved that, as the new company was not itself involved in the business of long-term insurer, the benefits available to long-term insurers were unavailable to it. The result of this consolidation was that profits of share dealings of nearly half a million rand that used to be impervious to tax suddenly became taxable.
A matter of time ? the when of tax
Whether it is Income Tax, CGT, VAT or Estate Duty, there comes a time when the tax is due, of which such a time corresponds with one of the various events that give rise to the liability to tax. From an Income Tax perspective, this liability arises when an amount has been ?received by or accrued to? the individual or entity. ? From an Estate Duty perspective, the liability arises at the time of death of the individual.?CGT and VAT also have their own timing rules as to when the tax liability occurs. In the instance of CGT, the liability is determined in relation to the time that an asset is disposed of or deemed to be disposed of ? and in the instance of VAT the liability is usually based on the accrual of the amount to the vendor ? although a payments (cash) basis is allowed in some cases. ?
It is obvious then, that, if you could manipulate the time at which the liability to pay tax occurs, you may be able to secure an advantage for your client, due to a change in tax rates, a change in the client?s status or, most obvious of all, by reason of the client?s wish to defer the liability.
Accordingly, when drafting an agreement for a client, it is necessary for the draughtsman to take into account the aspect of time when determining, among others, how and when invoicing and payment in respect of the contract is to be calculated and made. From an estate planning perspective, it becomes especially important to take into account the ability to defer Estate Duty or CGT by virtue of the exclusions and roll-overs offered in terms of those statutes in respect of bequests to spouses.
2. Source ? the where of tax
South Africa imposes Income Tax (and CGT) on its residents on a worldwide basis. However, non- residents are taxed based on whether or not the relevant income was derived from a ?source?? in South Africa. In order to determine the source, first you need to determine what the origin, cause or reason for the income is, and secondly, whether that origin, cause or reason is located in South Africa.? If so, then the income is from a South African source and the non-resident will be liable to tax thereon.
From the perspective of a financial advisor, operating in South Africa, this may be a factor that infrequently offers itself for use and may seem unimportant. Situations, however, may occur where it could be useful to a client and advisors should be aware of its impact on the liability to tax and be mindful of the possibility that occasionally a beneficial tax result may be obtained as a result of its use.
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? African Life Investment Corporation (Pty) Ltd v SIR (1969 (4) SA 259 A)
? Definition of Gross Income ? sec 1. ? Income Tax Act 58 of 1962
?Sec 9 Estate Duty Act 45 of 1955
?Sec 26A of the Income Tax Act 58 of 1962 and par 11 of the Eighth Schedule to the Income Tax Act
? Sec 23 Value-Added Tax Act 89 of 1991
? Definition of Gross Income ? sec 1. ? Income Tax Act 58 of 1962; Par 2 of the Eighth Schedule to the Income Tax Act 58 of 1962
?CIR v Lever Brothers and Unilever Ltd 1946 AD 441.
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