We all know tax is a minefield and that the ever-vigilant South African Revenue Service doesn't miss a trick. So we asked top accounting firms KPMG and Deloitte & Touche to highlight hazards they have spotted lying in wait for the unwary taxpayer facing yet another tax deadline.
TAX RETURN TERRORS
Tanya Linington, Deloitte & Touche
Never has the individual income tax return appeared so simple and yet contained so many pitfalls for the unwary taxpayer.
The 2001/02 form was very different from the old one, and more difficult to complete correctly, because it was the first return to deal with the taxation of worldwide income and capital gains. Unfortunately, the accompanying information brochure provided you with very little guidance.
The 2002/03 form will be different again, but it won't be much simpler considering the complexity of the information required.
Incorrect or incomplete disclosure by the taxpayer can result in the following penalties:
- Triple taxation on amounts not disclosed;
- Review and revision of your tax assessments going back more than three years if you have not disclosed taxable income;
- Taxation of tax-free amounts; and/or
- Duplication of amounts - double taxation.
You would also waste a lot of time trying to correct problems, or convincing the tax authorities that you are not a criminal. It is all too easy to make genuine mistakes that result in the submission of incorrect information or unintentional non-disclosure, especially when the format of the tax return form changes. For example, the 2001/02 return had an all-inclusive section for allowances and fringe benefits, instead of a separate section, as in previous years.
There were also numerous instances where the return contained more than one place in which the taxpayer could disclose a certain kind of income. For example, there were four possible places for disclosing foreign income. This could result in amounts being taxed more than once - or not at all.
Returns are designed so that certain questions and answers flag the taxpayer's disclosure in other parts of the return. For instance, a taxpayer might disclose that funds have been taken offshore, but might neglect to disclose income on those foreign funds or to include those foreign funds in the totals of assets and liabilities. This could result in the South African Revenue Service (SARS) charging you a deemed interest rate on the offshore funds, with disastrous tax consequences for you (see "Offshore Offsides" below).
Tax experts are still trying to get to grips with the subtleties of the worldwide basis for taxation (instead of the source basis that prevailed before) and of capital gains tax (CGT). So the likelihood of the ordinary taxpayer grasping what is required and correctly disclosing items of this nature, is slim. You would need a thorough knowledge of the residency rules and CGT legislation to be sure that you are doing things correctly. The level of risk is very high and the tax authorities have little sympathy when things go wrong.
So the message is clear: taxpayer beware. It is important that you keep detailed supporting schedules of amounts disclosed in your tax return.
You should err on the side of caution if you are uncertain about any aspect of your return and how or whether items need to be disclosed. The best advice is to seek the help of a well-qualified professional. That could save you tax - and from getting into deep water with the tax authorities.
OFFSHORE OFFSIDES
Delia Ndlovu, Deloitte & Touche
That deceptively simple-looking tax return is particularly tricky when it comes to disclosing your offshore assets. This is an area where you cannot afford to make a mistake, because, in terms of the latest amendments to the Income Tax Act, SARS has the authority to estimate the amount, in foreign currency, of any offshore assets it believes a taxpayer owns outside South Africa.
With effect from March 1, 2002, a taxpayer who fails to disclose offshore investment income is liable to pay the Receiver of Revenue's estimate, which is reached by applying the official interest rate of 13.5 percent.
SARS also has the power to estimate taxable income in respect of taxpayers who have earned offshore income, not directly, but through offshore trusts and companies to which the taxpayer has made a donation or interest-free loan.
It is unclear whether SARS will attempt to estimate an income on offshore funds that do not earn any income. Even if you have not earned any income because your offshore funds are invested in endowment policies and roll-up unit trusts (in which the interest is re-invested), it is clear that you should disclose these assets.
The following example illustrates the severity of the problem: An investor on a marginal tax rate of 40 percent who used his/her offshore allowance to invest R750 000 offshore on August 1, 2002, does not properly disclose this investment in his/her return for the tax year ended February 28, 2003.
SARS is tipped off about this investment, and estimates the income derived from the offshore investment for the 2003 tax year as follows: R750 000 x 13.5 percent = R101 250.
The amount of R101 250 will be included in the investor's taxable income for the 2003 tax year. The additional tax payable will be R40 500 (marginal rate of 40 percent).
Obviously, this method of estimation by SARS is very onerous for taxpayers. The problem with applying the official rate of interest is that this rate does not bear any relation to the rate of return earned by the taxpayer on his/her offshore investment.
Tax compliance issues relating to offshore investments are complex and, in certain instances, unclear. For this reason you may need to consult a professional adviser if you have any offshore investments.
COMPANY CAR TROUBLE
Deborah Tickle, KPMG
It is common practice for companies to buy cars they have been leasing, at the end of the lease period, so they can sell the vehicles to employees who have been using them. In doing so, however, the com-anies may be exposing themselves to unnecessary tax.
It all depends on whether the lease ends with a final payment outstanding - known as the residual value of the car.
- In the event that the residual value is equal to the fair market value of the car.
The company will not be liable for any income tax, whether it buys the car to sell to an employee or directs the leasing company to sell the car to the employee or a third party.
- In the event that the residual value is less than the fair market value of the car.
The company will be liable for income tax on the difference between the car's residual value and the fair market value. This is because SARS regards lease payments - which companies deduct for tax purposes - as "down-payments" on the purchase price. If the residual value is less than the market value, the company is regarded as having recouped the rental payments to that extent, so the difference between the two amounts is taxable.
When the employee buys the car for the same residual value, the employee benefits from the fact that he or she is able to buy the car at less than its fair market value. In that case, the employer has to add the amount of that benefit to the employee's remuneration and deduct employees' tax from it.
But here is the tax trap: If the company buys the car, it will be taxed on the difference between the residual amount and the fair market value. Then, if it sells the car to the employee for the same residual value, the employee will also be taxed on the fringe benefit. Thus the difference between the residual amount and the fair market value will have been taxed twice. And there is nothing that anyone can do about it at that stage.
To avoid the tax trap, the company should, before the lease expires, advise the leasing company to sell the car directly to the employee. The employee will inevitably pay tax on the benefit, but because it has been taxed in the employee's hands, the company will not have to include the same amount in its taxable income. So it will have avoided the double bind.
INTEREST DEDUCTION DYNAMICS
Deborah Tickle, KPMG
Interest is only deductible for tax purposes when the loan on which the interest is charged has been used in the production of income. Consequently, when you raise a loan in the form of a mortgage bond on your home, you are not allowed to deduct the interest on the bond, because you use your home to live in and not to generate income.
However, if you use a loan from the bank to fund your business operations, the interest on that loan is tax-deductible. Similarly, if your company or close corporation (CC) borrows money to buy, for example, stock or plant and machinery, for use by the company or CC to earn income, the interest on the loan is also tax-deductible.
So what happens if you use your mortgage bond to raise money to lend to your company to fund its business operations? If you charge your company interest, your company will be able to deduct that interest against the income it earns for tax purposes. You will receive interest from your company, and you will have to include that interest in your income for tax purposes. However, the interest you pay to the bank on that portion of the bond that you used to lend to your company will be allowable as a deduction against the interest paid to you by your company.
That seems straightforward enough... but is it?
What happens if you lent some spare cash to your company when it started trading? Your company will pay you interest and you have to include that interest as income in your tax return - and be taxed on it.
Say you now want to buy a home. You go to your bank to ask for a mortgage bond to use to purchase the house. You must pay interest on the bond. The interest is not tax-deductible, because the bond has been used for a purpose other than producing an income.
Thus, on the one hand, you are receiving interest from your company that is taxable in your hands, but on the other, you cannot deduct the interest that you are paying on the bond. Quite an ironic situation.
What could you have done differently? Instead of taking the full amount of the bond to buy your house, you could have asked the company to repay your loan. The company would not have had the money, so it would have had to go to the bank to obtain a loan to use to repay the loan it took from you.
Your company would still be able to deduct the interest on the new loan, because the loan from the bank would be used by your company to replace an existing loan that was used to produce income.
You would then have been able to use the money from your company, together with your bond, to buy your home. Consequently, your interest bill would have been much reduced, because your bond would have been less, and you wouldn't be taxed on interest received as there wouldn't be any.
At a later stage, your company might need further money, or might wish to repay the loan from the bank (perhaps because the interest rate is quite high). You might borrow an additional amount from your bond and lend that to the company to pay for new stock or machinery, or to repay the existing loan from the bank. Your company would pay you interest, which is taxable. But, the interest on the portion of your bond that was used to lend to your company would be tax- deductible against the interest received, and if these were equal, there will be no tax!
Here is the moral of the story: In order for interest to be tax-deductible, you must be able to show that the money borrowed was used for the purpose of generating income.
This article was first published in Personal Finance magazine, 1st Quarter 2003. See what's in our latest issue