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Employers, employees and their taxes

Taxes of Employees and Employers

The right to strike has not always been a collective bargaining method South Africans could employ to get their employers’ attention. These days however, it seems like the majority of labour negotiations are concluded either by employers giving into the demands of employees who are threatening to strike, or by parties reaching agreement after a period of strike action.

Paying reasonable wages and treating workers fairly in exchange for honest and productive work seems like a simple equation but in practice, it remains a challenge that is further complicated by the state of our economy and the often cited, yet misunderstood earnings disparity between executives and ordinary workers.

The right to strike is essential to our democracy and the effects are, at the very least, bothersome. Yet when strikes rage on for a protracted period, or parties renege on previous agreements and turn to acts of violence and intimidation, the effects are debilitating to our economy – this was evident in the recent labour action in the platinum mining, metal and agricultural sectors. Occasionally however, they capture our attention for different reasons, such as the recent strike by the cast of a local soap opera.

So, while the cast of Generations’ antics are entertaining us off-screen, some employers are making concerted efforts to bridge the gap between employer and employee. One such way is to offer staff financial relief by providing them with free or subsidised accommodation. However, David Honeyball, Tax Partner at Grant Thornton Cape cautions that such gestures may result in an unexpected tax liability.

One group of employees that has successfully used strike action in 2013 to increase their minimum earnings from R69 to R150 per day, is farm workers. However, their employers are not enjoying the same good fortune and their cash flows may be severely affected by new VAT rules, explains Cliff Watson, Tax Director at Grant Thornton Johannesburg.

Then, in our transfer pricing feature, we move away from labour relations as Christel du Preez explains the impact the proposed changes to Section 31 secondary adjustments will have on multinational companies. Christel is a Senior Tax Manager at Grant Thornton Johannesburg.

Accommodation provided to employees

By David Honeyball, Tax Partner Grant Thornton Cape

Some employers provide residential accommodation for their employees, especially when the employees work far from their homes. While this provides some practical benefit to the employees who save money and time by not commuting between home and work, they should be taxed on the value of the accommodation, whether it is furnished, unfurnished, supplied with or without meals, power, water or other utilities.

In some cases, this arrangement gives rise to a taxable fringe benefit, but employers can help employees to reduce the tax burden.

The provisions of paragraph 9, read with paragraph 2(d) of the Seventh Schedule of the Income Tax Act, hold that employees must be taxed on the cash equivalent of the benefit. These sections provide a number of calculation methods to determine the rental value of this accommodation, but in essence, the value is determined by the property’s rental value, less any amount that the employee pays toward the accommodation provided.

Sometimes an employer may source and provide rental accommodation from a third party to the employee. In these instances, the determined rental value can be higher than the actual value, giving rise to a fringe benefit, which is higher than the actual cost, or economic benefit to the employee. As a result, employers have to apply to SARS for a tax directive to ensure that the employee’s calculated fringe benefit is in line with the actual market / economic value of the use of the accommodation.

In terms of the Taxation Laws Amendment Bill of 2014 (TLAB), SARS proposed an amendment to the definition of rental value to cater for these situations. The proposed amendment provides that, if the employer provides rental accommodation that it rents from a third party, the rental value will be considered equal to the actual cost to the employer.

It is anticipated that this amendment will apply in respect of years of assessment commencing on or after 1 March 2015. Until then, employers will still need to apply for the directives to reduce the fringe benefit.

Employers are reminded that an exemption applies to expatriate employees, living in South Africa temporarily, away from their usual place of residence. The employee is not taxed on the accommodation for two years from the date of arrival in South Africa and commencing employment. It also applies if the accommodation was provided and the employee was physically present in the Republic for a period of 90 days in that year of assessment.

New VAT rules may negatively affect farmers’ cash flows

By Cliff Watson, Tax Director Grant Thornton Johannesburg

Usually, farmers are registered to pay VAT on a six-monthly cycle. This means that these farmers have to finance the VAT that they incur on their operating and capital costs for long periods before they get a refund from SARS. The VAT Act currently provides that some farmers may acquire certain goods that are used or consumed for agricultural, pastoral or other farming purposes at the zero-rate. This rule was implemented mainly to assist these farmers with their cash flow before they earn income from their produce.

New proposed rules 
SARS and the Treasury have however proposed in the latest Draft Taxation Laws Amendment Bill 2014 (TLAB), that the zero-rating provision be repealed from 1 April 2015. This effectively means that the products currently qualifying for the zero-rate, will be subject to VAT at the standard rate of 14% in future.

The reason provided, is that certain farmers have entered into transactions to obtain fraudulent input tax deductions.

It is unclear why SARS is not clamping down on a minority of delinquents, but is instead choosing to tar all farmers with the same brush and repeal the concession, which will be to the detriment of the majority of law abiding farmers.

The opposition
Obviously, all affected farmers and their unions and cooperatives strongly contested the proposed repeal. SARS and Treasury have subsequently initiated discussions with the relevant stakeholders, which we believe should have been their first port of call.

Alternatives
In order to qualify for the concession, the relevant farmer has to apply to SARS to obtain a specific notice of registration (VAT 103). Before SARS will issue such a certificate, it must satisfy itself that farmer carries on agricultural, pastoral or other farming operations. All suppliers of these qualifying products must satisfy themselves that the farmer is in possession of such a notice and also retain a copy thereof for SARS’ audit purposes. Additionally, where such a certificate has been issued in error, the farmer is in default in respect of his VAT obligations. If the farmer ceases to carry on agricultural, pastoral or other farming operations or has used the notice of registration for purposes other than the carrying on of these operations, SARS may cancel the authorisation immediately and require the farmer to surrender the notice of registration. The farmer will therefore not be able to make use of this concession anymore.

SARS may issue a new form of notice from a future date, which will replace all current notices and will allow qualifying farmers to apply for the new notice in time. This will allow SARS to fully satisfy themselves that the applicants qualify and eradicate all fraudulent or invalid notices. This will create a once-off administrative burden for SARS and farmers, but will have a continuous benefit.

Last resort
However, should SARS and Treasury go ahead with the proposed repeal, farmers may request SARS to register on a bi-monthly, or even monthly VAT cycle to assist in their cash flow. This will enable the farmers to obtain a refund from SARS of the additional 14% that they have to finance significantly sooner. It will however, also result in a continuous administrative burden and increased compliance cost for SARS and the farmers as the VAT returns and possible audit in respect of refunds submitted could increase six-fold.

Hopefully, we are not going to experience similar draconian proposals to other zero-rating provisions or other tax implications to replace SARS’ risk management and assurance obligations.

Transfer pricing – changes to secondary adjustments

By Christel du Preez, Senior Tax Manager Grant Thornton Johannesburg

The proposed amendment
The Draft Taxation Laws Amendment Bill 2014 proposes a revision of transfer pricing compliance in in the form of a deemed dividend, from 1 January 2015. It proposes that in future, the Section 31 secondary adjustment be deemed a dividend in specie, to be paid by the South African taxpayer to its foreign connected person.

In other words, if a South African company fails to charge its foreign holding company an arm’s length price, the difference of such an affected transaction will be deemed a dividend paid to the foreign holding company, subject to dividend withholding tax (DWT). For example, a foreign holding company pays its South African subsidiary R65m for goods while the arm’s length price is R100m. Section 31 will apply, increasing the income of the South African subsidiary by R35m and creating a deemed dividend in specie which, in terms of the proposed revision, will be subject to DWT.

Secondary adjustments explained
The Organisation for Economic Co-operation and Development’s Transfer Pricing Guidelines explains the term secondary adjustment as follows:

“To make the actual allocation of profits consistent with the primary transfer pricing adjustment, some countries having proposed a transfer pricing adjustment will assert under their domestic legislation a constructive transaction (a secondary transaction), whereby the excess profits resulting from a primary adjustment are treated as having been transferred in some other form and taxed accordingly. Ordinarily, the secondary transactions will take the form of constructive dividends, constructive equity contributions, or constructive loans.”

In short, transactions that do not take place at arm’s length will be subject to an additional, or secondary, adjustment that taxes the excess profit generated from the transaction.

Cause for change
Since the introduction of transfer pricing legislation in South Africa in 1995, secondary adjustments were made in the form of deemed dividends. However, when DWT replaced Secondary Tax on Companies (STC), secondary adjustments were made in the form of “deemed loans”. In other words, an affected transaction resulted in a deemed loan for the South African resident, in respect of which the taxpayer is deemed to have accrued arm’s length interest, subject to South African tax.

However, the Draft Explanatory Memorandum explained the reasons for reviewing the legislation, including that these loans are never repaid in practice and no contractual obligation exists to repay such loans. Furthermore, the legislation caused uncertainty about the currency of the loans as well as exchange control and accounting problems.

Conclusion
SARS is still relentlessly conducting transfer pricing audits. The challenge for taxpayers is that they still await updated transfer pricing guidelines and the uncertainty is compounded by the lack of legal precedence as no transfer pricing cases have reached our courts yet.

Therefore, although not specifically required by SARS, drafting a transfer pricing policy document is essential to any taxpayer that may need to defend foreign transactions with connected parties to SARS. These documents must set out the economic justification and the considerations before entering into a transaction, as well as the method used to establish an arm’s length price and the systematic process followed to set arm’s length international transfer prices. Additionally, companies’ international transactions with foreign connected persons should be reviewed annually, noting any changes in the functions or structure of the company that may affect transfer pricing policies.

Contact our South African Transfer Pricing leader, AJ Jansen van Nieuwenhuizen if you need assistance regarding any transfer pricing related matters, or if you wish to discuss the effect of Section 31 on your business.