Tax Advice

tax-advice

Stocks and shares are not your only investment option

Many people simply don’t know what to do about increasing their capital for a rainy day.

One piece of advice, however, cannot change: buy low, sell high. This is the key to all investment success.

The thing is, many people don’t know what ‘low’ or ‘high’ are in relation to orthodox investments. Also, orthodox investments are not as solid as they used to be. So why buy stocks and shares when you are not a stock market expert?

Alternative investments can be very rewarding and tax-efficient. They include fine wine, antiques, watches, stamps, classic cars and art. Many people have a reasonable knowledge of these items, but fail to use it to their advantage.

Yet investors need to adopt unorthodox thinking in these volatile times to ensure good, tax-effective returns.

So long as you do, in fact, buy low and sell high, does it matter with which commodity you deal? And there are no fund managers or brokerage fees involved in selling, say, antiques, depending on the platform you use to sell them.

Already there
Many farmers already have items on their farms that, restored to a good condition, would sell for a handsome sum. Talk about buying low and selling high! If the item is already there, the only cost involved is the preparation for sale.

As for capital gains tax (CGT), Paragraph 53 of the Eighth Schedule excludes ‘personal use assets’. Even boats less than 10m long and aircraft that weigh less than 450kg are excluded. Coins not made of gold or platinum are also excluded.

This creates a very wide range of potential alternative investment avenues, where the sale of the items are, in fact, tax-free.

How many farmers have sheds full of all manner of interesting goods, from old coal-burning stoves to antique tools?

Yet they persist in investing in assets that are not only taxable, but require great expertise to ascertain their worth.

It’s easy to sell high or buy low when you know the value of the assets being dealt with. In contrast, stock market and other investments are governed by so many variables that only a highly paid expert can get to grips with them.

But that old Land Cruiser or Land Rover under the tarp is easy to value. Just pick up a classic car or 4×4 magazine.

No expert required, no tax on the sale, no brokerage fees, and no fund managers. The seller is in charge of the process, from picking it up out of the dirt to final polishing.

You might be the richer for it, and there’s an element of fun in it too.

Advocate Peter O’Halloran is a tax specialist.

When losses are not deductible

In Solaglass Finance Company v The Commissioner for Inland Revenue, heard in the Supreme Court of Appeal in 1989, Solaglass had made loans available to a number of subsidiary companies. The loans became bad and could not be recovered.

The majority of the judges held that the losses were not deductible; one ruled that they were.

The difference of opinion originated in sections 11 and 23 of the Income Tax Act. Section 11(a) allows deductions where losses are incurred in the production of income, provided that such losses are not of a capital nature.

Section 23(g) provides instances where amounts meeting the Section 11(a) criteria are not allowable. The two sections must be read together.

The majority of judges held that, although allowable under Section 11(a), the company’s losses were disqualified as tax deductions by Section 23(g).

No trade
According to the section, only amounts wholly and exclusively laid out for the purposes of trade are deductible.

The judges believed that Solaglass’s losses did fall into this category, not least because they held that the word ‘trade’ had to refer to the trade actually carried out by the company.

The main ‘trade’ of Solaglass was the financial support of its subsidiaries. This support was given by consolidating the debt of all the subsidiaries and ensuring that each had the necessary funds to operate daily.

The subsidiaries then placed excess funds with the company. An important piece of evidence was that the interest rate charged between the company and the subsidiaries varied according to the financial position of each.

Put another way, Solaglass was not an independent lender, but an interested and connected party, and the losses it incurred could not be deemed part of ‘trade’.

A different take
The dissenting judge took a different view of the matter. He agreed that the company existed to support the subsidiaries, but held that the main business of the company (its ‘trade’) was to lend money within the group.

Therefore, the money that was lost had been utilised for the exclusive purpose of trade. The judge felt that the fact the company dealt only with loans made to subsidiaries did not detract from the exclusive trade requirement.

Nonetheless, the majority carried the day and the money lost was held by the court to be non-deductible.

What exactly is a carbon tax?

A carbon tax is levied on the emission of hydrocarbon fuels. Typically, the fuel is burnt to produce energy. When burnt, the end-product is carbon dioxide (CO2).

Types of hydrocarbon fuel include coal, petrol, diesel and natural gas.

Revenue officials are of the view that a heavy tax will discourage the use of such fuel. But cars, aeroplanes, ships, trains, trucks, tractors and many other implements burn hydrocarbon fuel. Electricity also comes to us via this kind of fuel since the turbines that produce electric power are most often coal- or diesel-powered.

At this stage, attempts to reduce the use of hydrocarbon fuel have proved futile. Everyone relies on it, from the farmer to the office clerk.

I believe the only thing that will reduce the use of hydrocarbon fuel is a lack of it. If there is no more of it, industry must make another plan.

Moreover, the argument can be made that there are no truly energy-creating
devices that are totally environmentally neutral. Even wind turbines are harmful to nature, as they kill birds.

Local carbon tax bill
In South Africa, the Carbon Tax Bill will be implemented in 2019. Other countries already have a carbon tax in place.

But will the taxes really be used to mitigate climate change?

Or is the tax simply another way to increase the tax base?

From government communications, the idea seems to be to tax every ton of CO2 released at R120. However, a number of thresholds have been proposed to reduce this high number.

For certain industries, a 60% threshold will apply; they will be taxed on only 40% of their emissions.

Then there is a mix of performance exemptions for certain sensitive sectors of the economy and an offset allowance. Presumably, the allowance will follow the Kyoto Protocol. In this model, traders sell carbon credits to carbon emitters; this credit reduces the emissions on paper.

The tax-free thresholds allowed will be a maximum 95% of the emissions.

How farmers can benefit from carbon credits
Two aspects of the new tax should be of interest to South African farmers. Credits can be obtained by growing carbon ‘sinks’, plants that use considerable CO2. Using other forms of energy can also lower the operational costs of the farm.

Keep your assets safe and save on tax

Placing your assets in a trust offers a unique double benefit: you get to enjoy the assets, yet they no longer belong to you.

And because they are not yours anymore, they cannot be taken from you. So, if you run into financial difficulties, the assets are safe. In addition, if you die and your assets are in trust, there are no tax or estate consequences.

READ Why should your business pay more tax than necessary?

A word of caution, however: before using a trust asset, you need to ensure that all the trustees have given their consent to this.

In fact, running a trust is all about communication. It’s impotant to have regular trust meetings, and to minute the decisions of the trustees. Also, arrange for a professional to review the decisions regularly, for tax and other purposes.

Loans and interest
If you sell assets to the trust, the trust will either pay you cash, if it has money, or it will owe you the money.

In a previous column, we saw that interest has to be charged on the loan owing to you.

This can be used to your benefit.

READ Bank loans: advice for smaller producers

In terms of the Income Tax Act, a certain amount of interest is exempt from tax in your hands. For this year, that amount is R23 800. That’s per person, per year!

For a husband and wife, that’s nearly R50 000/year. At the official rate of interest, about R500 000 can be utilised as a loan account between spouses before the interest attracts tax.

One way of making such an investment into a trust grow is to fund an asset with a potentially high value.

A good example is a classic car, bought at a reasonable price, restored to concourse condition, and placed in trust. If the loan attracts interest, the income earned when the asset is utilised can be distributed among beneficiaries without further tax consequences.

A company can be set up in the trust with the loan amount. In a farming situation, for example, that company might take over certain income-producing activities. If the company generates money, the funds can be used to settle the loan.

Although this is expensive, it is worthwhile, as the assets are particularly secure if there are no loan accounts owing. Loan accounts can nonetheless be attached; they can be thought of as loose ends.

Once the trust is a standalone financial entity, the negative aspects of the various tax laws directed at trusts do not apply anymore.

Then the true benefit of the trust, namely its protection, is absolute.

Why should your business pay more tax than necessary?

Taxes are paid by taxpayers with the means to do so. That is obvious.

Yet some tax administrators assume that higher tax rates will mean more money for government. Not so.

As I’ve noted before, there comes a stage at which the taxpayer says, “No more!” Think of a steeplechase.

When the jumps are at the correct height, the race continues at pace. Raise the jumps too high, and the horse balks and perhaps quits the race.

It’s the same with taxes. To change analogies, taxpayers tire of being milked like dairy cows of everything that they produce.

So they modify their behaviour. Dividends too costly at 20% withholding tax? No one takes dividends anymore.

Salaries, loans and vat

Fortunately, dividends are not the only way to get money out of a company. Salaries, taxed on a sliding scale, could work well, especially if your partner and children work in the same company.

Then there are loans. This is more of a short-term option, but with some imagination, loans to and from the company could work for a business owner.

The deeming of interest on loans is not that much of a problem. Such interest is seen as a ‘donation’ and donation tax is set at 20%.

Raised taxes and raised VAT create further opportunities.

The VAT threshold is R1 million, which is a great incentive for a small business to provide excellent value by keeping the turnover below R1 million.

This is especially so if sales are direct to the public. And as far as possible, do business with other non-VAT-registered entities; the savings can be quite considerable.

It might be too late for Income Earning Eddie to deregister as a VAT vendor, but Wendy Wife could run a micro business on the side.

You can enjoy turnover tax at extremely low rates, and zero administration. The top tax rate at a turnover of close to R1 million is 3%!

These are some of the approaches that taxpayers can take. The point is, choose different paths. Those where the hurdles have been raised too high are unaffordable.

Why be poor because of government? Why pay for other people’s mistakes? It’s within your power to choose less expensive tax options.

If ever there was a time to begin to actively manage the tax cost of your business, this is it.

Challenge conventional thinking; it might be costing you unnecessary money!

Advocate Peter O’Halloran is a tax specialist.

Estate planning: are trusts still worthwhile?

Many families in South Africa have established trusts for asset protection and as a shield against high estate duty and other charges on death.

A trust, however, is a strange phenomenon. It is often thought to be akin to a private company, but of course it’s very different.

To begin with, a trust is not owned by anyone. Once a farm and financial assets have been placed into the trust, they cease to belong to the person who ceded the assets to the trust.

Moreover, the method used to place assets in the trust, rather than the trust itself, is targeted by the legislature to limit the tax/estate duty advantages of a trust.

Often the assets are donated to the trust. In this case, donation taxes might apply. If the assets are sold to the trust and the latter does not have the capital to pay, the resulting loan account will have repercussions from the point of view of tax and asset protection.

For example, the new Section 7C of the SA Income Tax Act seeks to tax loan accounts by deeming interest upon loans.

The safest method of placing an asset in a trust is for the trust to buy the asset with its own funds. The sale must take place at a reasonable value, however, or donations tax might be triggered.

But how do you create wealth in the trust in the first place? There are four ways in which to do this:

  • You can start a fresh company to operate a new endeavour. You would typically take a salary from the company, but, before it has any value, you place the shares of the company in the trust. When dividends are declared, they are received in the trust, invested and used to purchase assets or finance loans from commercial banks with which to buy assets.
  • If a trust has already bought a company and this has given rise to a loan account, the trust may obtain finance from a commercial bank to repay the loan account from the connected person, and so avoid tax.
  • You can bequeath assets to a trust in your will.
  • Life insurance held by a trust can be used to buy assets upon the demise of an estate planner.

The second or third generations of trust beneficiaries are not hard hit by anti-avoidance provisions. Also, as we’ll see in a later article, the taxes generated by the new rules (such as Section 7C) need not be especially punitive.

Advocate Peter O’Halloran is a tax specialist.

The bare dominium transfer explained

A generation ago, it was fairly common amongst farming families that on the death of a father, the outright ownership of the farm was bequeathed to a child and the use or usufruct was bequeathed to the mother for her lifetime.

The estate duty advantages of such planning have since been curtailed by legislation, but there are still advantages to be had in a bare dominium transfer.

The mechanics are that the estate planner, call her X, would transfer the bare dominium in a property to her son, call him Y, or perhaps to a trust.

A full transfer might be preferable, but this is an expensive exercise. In a bare dominium transfer, the value of the bare dominium is much less than the value of the right of enjoyment or usufruct.

Typically, the planner retains the use of the property. Where the property is not subject to a mortgage bond, transfer of bare dominium provides protection from other creditors.

How it works
Let’s say that the fixed property is worth R2 million and X is 64 years old. According to government tables provided for the calculation of such rights, the factor to be utilised in this case is 6,262822.

The annual right-of-enjoyment value is either true market value (basically what X might get as rental on the open market) or 12%, whichever is the lower.

A rental of R20 000/month is reasonable. Thus the R240 000 annual value of the right of enjoyment is acceptable. This gives a usufruct value, retained in the hands of X, of about R1 500 000. The remaining value of R500 000 is the bare dominium value, and this is transferred to Y.

Because the bare dominium as property is R500 000, which is lower than the R750 000 threshold, no transfer duty is payable.

X pays her conveyancer to do the transfer, free of transfer duty. The provisos in the Transfer Duty Act, which affect the foregoing calculation, apply only when fixed property is transferred to more than one person.

The transaction has no immediate capital gains tax consequences, as X remains the occupier of the fixed property. Donations taxes might be payable on the transfer to Y, depending on whether the property is sold to the son or whether it is an out-and-out donation.

Whichever method of transfer is chosen, the amount of donations tax is far less than would have been the case with an out-and-out transfer of the entire fixed property.

The importance of estate planning

Proper estate planning ensures that the succession of heirs to the family business and assets causes minimal friction and cost.

The surviving spouse and dependants will be left with sufficient funds to carry them through to death or self-sufficiency, while the fallout that would otherwise accompany a major business reversal (the death of the owner) is contained as far as possible.

Proper estate planning also benefits you in your own lifetime, enabling you to retire with health problems, and their accompanying costs, and other aspects planned for.

To avoid triggering adverse tax consequences, an estate planner should have a sound understanding of the tax and value added tax implications, as well as the capital gains tax effect of any suggested changes of ownership.

The movement of assets out of the planner’s hands is often a key consideration in any estate plan. In 2017, for example, the rules regarding sales of assets to trusts and companies changed, and loan accounts might now attract income tax.

This has to be taken into account so that cash flow is not affected and taxation costs do not increase disproportionately.

This said, the use of trusts for asset protection and for the benefit of youthful or inexperienced family members is still a good solution. But proper trust administration and tax reporting are crucial.

The tools of estate planning remain the will, testamentary and inter-vivos trusts,
companies, antenuptial contracts, loan accounts and shareholders’ agreements, life
assurance, and retirement and health plans.

With many South Africans operating in more than one jurisdiction, new
opportunities and risks present themselves.

For example, SARS plans to tax the offshore earnings of South Africans who leave their families behind for extended periods to seek gainful employment elsewhere, and this will have to be reckoned with.

But different jurisdictions might have better planning opportunities than are available in South Africa, and South Africans who venture offshore can add offshore trusts, companies and partnerships and other forms of corporate structures to the list of planning tools.

They might also be able to use double tax agreements between South Africa and
the country of operations to their advantage.

At the same time, however, they should plan for problems in the offshore jurisdiction.

In a follow-up series of articles, the tax consequences of trusts and offshore companies
will be discussed in more detail.

Advocate Peter O’Halloran is a tax specialist. 

How increasing taxes brings in less money

When tax rates rise above a certain point, they detrimentally affect rates of production.

This is according to a theory proposed by US economist, Prof Arthur Laffer.

Put another way, if a government increases taxes in an attempt to increase its revenue, it will achieve the opposite effect after a certain point, receiving less revenue in the form of taxes.

Laffer advocates lowering tax rates, as tax cuts actually increase revenue for the state by leading to increased production and hence more taxable income (not to mention more jobs).

It could also be argued that lower tax rates allow people to save, or have more disposable income with which to stimulate business.

Moreover, when tax rates are so high that they threaten the existence of tax activities (businesses), these taxpayers are likely to seek other jurisdictions from which to operate.

At lower rates, small tax increases serve to increase productivity. But the level of productivity flattens out and then begins to drop as the tax rates increase.

The Laffer curve illustrates this theory, showing that there comes a point at which government revenue drops to zero. This happens when government so overburdens taxpayers that virtually all income and business profits are taken by the revenue authorities.

At this stage, there is no more incentive to produce goods or work.

Critics of the theory claim that tax cuts do not always stimulate growth. If conditions in a country are unhealthy for taxpayers who would otherwise benefit (as when the right to their personal property is not guaranteed), they are likely to take their extra cash to jurisdictions where their rights and freedoms are guaranteed.

Whatever the case, for tax reductions to assist with economic growth, the rights and freedoms of the taxpayers that drive the economy must be guaranteed as well.

In short, government activity should be positive for business. Instead of focusing on taxes, government should seek to provide the law and order, political stability and some of the infrastructure that business requires to produce good results.

Advocate Peter O’Halloran is a tax specialist.

The libertarian’s views on taxes

Libertarians believe in minimal government interference, low taxation, slashing bureaucratic regulation of business, and the promotion of charitable, rather than government, welfare.

They also believe in the non-aggression principle, which holds that force should be used only in self-defence.

This principle spills over into libertarian tax theory. Libertarians argue that taxation should be kept to the minimum.

In their view, most government programmes are wasteful. They see the role of the state as principally to provide law and order in the form of policing, armed forces and courts of law.

Taxes may be gathered to fund these services. (Libertarians do, however, oppose taxation to fund a war of aggression; armed forces should protect the country and not be belligerent.)

Any tax demand over and above what is necessary for the provision of essential security is deemed a contravention of the non-aggression principle.

Property rights
Property rights are inviolate for libertarians. If you seek to protect your property by avoiding high taxation or refusing to pay tax clearly meant to line the pockets of those not entitled to the tax, government steps taken against you are a violation of your rights and the non-aggression principle.

On the other hand, you have a duty to pay taxes for the provision of law and order. If you refuse to do so, government has a right to collect what is due to it, and this will not be considered a violation of the non-aggression principle.

Indeed, this is seen as a form of self-defence undertaken by government on behalf of those who have paid legitimate taxes, because non-payers are indirectly subsidised by them, thus unlawfully intruding upon the property rights of those who have paid the legitimate taxes.

Clearly, libertarians favour ‘small government’ and regard big government as wasteful and expensive.

High taxes are required to keep it operational, and this leads to the diminution of property rights over time. In addition, politicians tend to pander to the demands of the masses to stay in power and this leads to less secure property rights.

By contrast, small government means lower taxes, higher productivity and improved freedom through less business and social regulation.

There are also more business opportunities, as most services have to be provided by private industry, not government.

It’s certainly something to think about.

Life insurance products and tax benefits

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At the death of the insured person, a life policy pays a tax-free lump sum to the beneficiaries of the policy. The premiums, however, are paid with after-tax money, and so are not tax-deductible.

If you are in business, you can ensure that your company does not lose value at your death by entering into a ‘buy and sell’ agreement with senior staff, who would use policy proceeds to buy the business for value on your death. The money would go to your heirs.

Capital gains tax might be payable on the sale of the business, but the policy proceeds would be tax-free.

An endowment policy is an excellent instrument for forced saving. It can be used as security for debt and, although the premiums are paid after tax, the proceeds are tax-free.

As a business tool, this is a handy life raft, although its use is restricted to the business.

Protection from creditors
A policy upon your life is protected from the creditors of your estate, both during your lifetime and after your death, up to its full value, provided that the provisions of Section 63 of the Long-Term Insurance Act are complied with.

That is, the policy must be at least three years old; it must not have been taken out to cover debts or ceded for debt; and it must be payable to your spouse, child or parent.

In a family business, the benefits of such a policy are enhanced in that the policy can provide much-needed capital to buy a business from a parent, while at the same time providing liquidity for a surviving parent.

Another useful business tool is a retirement annuity policy, as it is protected against creditors. It cannot be used as security for debt, however, and must remain in force until you are at least 55.

A small lump sum is paid out and a portion thereof is tax-free.

The rest of the policy proceeds must be used to fund an annuity for you for the remainder of your life.

A retirement annuity policy is tax- deductible. It therefore has a double advantage: it is proof against creditors and may be used to save a bit of tax.

Because it pays out a small lump sum and the majority of the proceeds have to fund an annuity for income, it is not really suitable if the plan is to save for a lump-sum to buy a boat or a house at retirement, for example.

But it is useful for providing some income that is not susceptible to attachment by creditors.

Advocate Peter O’Halloran is a tax specialist.

The erosion of tax rights

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A number of important issues relating to retrospective and retroactive tax statutes recently came before Judge Hans Farbicius in Pienaar Bros (Pty) Ltd v CSARS (case number 87760/ 2014).

The main thrust of the dispute related to whether a taxation statute can be made retrospectively applicable to a transaction already completed.

In broad terms, the transaction involved transferring assets to a new BEE company, in terms of Section 44 of the Income Tax Act. This offers certain tax concessions when such deals are put together.

As the law stood at the time of the completion of the deal, the profits of the ‘old’ company could be transferred to the ‘new’ company’s share premium account, from which a tax-free disbursements could be made. No secondary tax on companies would have been payable.

Unfortunately, some months later, the law was changed. In terms of the amended Section, secondary tax on companies was payable on deals concluded after a certain date, which was prior to the amendment.

In South African law, there is a strong presumption against statutes that come into effect retrospectively. This was one of the pillars of the argument raised by the applicant. The taxpayer asked for the assessment that SARS made as a result of the application of the amended section to be declared invalid and set aside.

However, in his ruling released in May this year, the judge found that such a statute can be made retroactively applicable. Therefore, the tax raised by SARS was lawful, even though the amount was tax-free in terms of the statutory provisions that existed at the time of the transaction.

The ruling will no doubt be the subject of much discussion in academic and tax circles, and I will be discussing it in more detail in future columns.

For now, suffice it to say that the ramifications are ominous, for SARS will surely seek to exploit the judgement to the maximum. And tax advantages won in the past might now be open to retrospective attack.

Worse, thanks to the ruling, taxpayers will find it next to impossible to defend themselves.

Currently, about the only recourse they have is to move the business to a jurisdiction where they are not open to such attacks.

Will the ruling be challenged? Time will tell.

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