In the recently reported case of Anglo Platinum Management Services v SARS [2015] ZASCA 180 (the Anglo case), the judgment of which was delivered on 30November 2015, the Supreme Court of Appeal (SCA) ruled in favour of the taxpayer in respect of a motor vehicle salary sacrifice scheme. The judgment stresses the importance of employers and employees properly agreeing to, understanding and correctly implementing remuneration structures that contain a salary sacrifice component.
Before dealing with the SCA judgment, it is useful to touch on the basic principles of a salary sacrifice arrangement, or more eloquently put, a salary substitution arrangement. I use the word substitution, as that is what it boils down to: it is the substitution of a cash component of an employees overall cost to company remuneration package, for a non-cash benefit, that generally results in a lower amount subject to the deduction of employees tax.
Historical case law on the issue of salary sacrifice or salary substitution schemes (see ITC 1663 [1999] 61 SATC 363 and ITC 1682 [2000] 62 SATC 380) does not provide clear guidance, but the courts have acknowledged the fact that it is lawful for an employee to sacrifice their salary in return for some quid pro quo from the employer, which has the effect of reducing the employees ultimate tax liability. The above was confirmed in the Anglo case. The important aspect of such a scheme seems to be that it must be implemented properly, there must be attention to detail, and that the provisions of the Income Tax Act, 1962 (the Act) and, in particular, the Seventh Schedule to the Act, dealing with fringe benefits, are carefully considered.
Furthermore, it is important that there is a valid agreement (or agreements) between the employer and employee, both parties understand the implications of the agreement (or agreements), the salary sacrifice must be made prior to the accrual of any amount, and relevant internal policies and procedures are adhered to. The aforementioned was seemingly adhered to in the Anglo case, which involved a salary sacrifice scheme whereby employees substituted a portion of their cash remuneration in exchange for a non-cash use of a motor vehicle. The case did not focus on the determination as to whether a fringe benefit for the use of a motor vehicle actually existed the question was whether the mechanics of the scheme resulted in an antecedent divestment of a right to remuneration. In other words, did the scheme result in the employees divesting themselves of an amount after accrual? If so, the salary sacrifice scheme would not be properly implemented.
The salient features of the scheme, as set out by the SCA, were as follows:
- The employees had to complete certain documentation which set out how they wished their cost to the company remuneration packages to be structured, as between cash and other benefits, which included the use of a motor vehicle.
- Once an employee had chosen to participate in the scheme and had selected a vehicle of his choice, Anglo Platinum Management Services (Anglo) purchased it and paid the dealer in cash. The vehicle was then entered into Anglos asset register and depreciation was claimed on it.
- The vehicle was registered in the employees name, but Anglo owned the vehicle until the employee had settled the finance obligation and paid the related fringe benefit tax on it.
- The cost of the vehicle purchase was recovered from the employee through a monthly deduction predetermined at the time they elected to participate in the scheme from the portion of their salary they had to forgo in return for the use of the vehicle.
The cost recovered from the employee also included a notional interest portion and insurance premiums.
The abovementioned process was, however, not at the heart of the dispute. The scheme had two more complex elements being:
- the entitlement of the employees to claim an amount of credit in the notional account; and
- their contractual obligation to pay insurance premiums on the motor vehicles. The South African Revenue Service (SARS) argued that the entitlement to the aforementioned credit and the obligation to pay the premiums, are inconsistent with a genuine salary sacrifice scheme as, in substance, the employees retain their power over their salary packages.
The witness for Anglo testified that notional accounts were prepared and sent to its employees who chose the taxable benefit of the use of their motor vehicles. The notional accounts, set out the optimal value of the motor vehicle, defined as the theoretical representation of the capital amount outstanding at the end of each month determined according to the reducing cap method. This was part of the methodology used to determine the actual value of the motor vehicle, taking into account the deemed finance costs. In addition to being represented as part of the capital cost of the motor vehicle, notional interest was recorded separately in the notional accounts.
The notional accounts also detailed actual payments Anglo made for maintenance and running expenses, insurance premiums and licensing fees. The aforementioned payments were debited to the notional account, as was the notional interest. The predetermined monthly deduction from the employees salary appeared from month to month as a credit in the notional account.
It appears that, from time to time, there would be a shortfall in the notional account where the actual expenditure plus notional interest exceeded the amounts credited to an employee through the monthly deduction, resulting in a recovery from the employee. Where the amount credited to the employee exceeded the expenditure, the employee could withdraw the money available, once every quarter, subject to the deduction of employees tax. If the credit amount was not withdrawn, it would be rolled over into the following month or quarter. At the end of the financial year the credit (if any) would be paid to the employee, subject to the deduction of employees tax.
Counsel for SARS pushed Anglos witness to concede that the credit in the notional account was in fact a contractual right to claim the credit and not merely an election. The SCA accepted that the employees had a right to claim any credit in the notional accounts, but that they could elect not to claim it quarterly, in which case they could still claim whatever credit remained at the end of the financial year. The SCA stated that the amounts that became available to be claimed quarterly were both unanticipated and insignificant simply because it was not possible to predetermine future running expenses and notional interest for the motor vehicles. The SCA went on to state that the fact that these insignificant and unanticipated amounts could (not would) become available to the employee in the future because of inevitable future adjustments to the predetermined cost of the benefit could not and did not detract from the efficacy of the scheme.
Properly understood, the SCA stated that the credit to which an employee became entitled when he elected to participate in the scheme, was not unconditional, but in fact a contingent right, exercisable at a later date and on the occurrence of an uncertain future event. If the event did not materialise, there was no right to be exercised and until it was exercised, there could not have been an accrual of income.
The SCA concluded that, in substance and in form, Anglo and its employees participating in the scheme achieved what they set out to do: fund a taxable benefit from a salary sacrifice. The SCA stated that this was achieved by properly designing and implementing the scheme and that the recovery of the vehicle total cost, including the running expenses was obtained from the salary sacrifice, not from the employees.
On the basis that the credit claimable arose from a small unpredicted and unanticipated future contingency, the SCA ruled that SARS argument that the use of the vehicles was in reality a consideration received by each employee as part of their employment and thus taxable under paragraph (c) of the definition of gross income, as opposed to paragraph (i) as a taxable benefit by virtue of a valid salary sacrifice, had to fail.
The important aspect that employers should take from the Anglo case is that salary sacrifice arrangements remain perfectly legal. The difficulty that often arises is that the actual implementation and maintenance of a scheme, doesnt necessarily reflect what has been agreed to with the employee and vice versa. Anglo effectively countered SARS arguments that there wasnt an antecedent divestment of a right to income, on the basis that it paid attention to detail and the scheme reflected, in substance and in form, what the parties agreed to and intended with its implementation and what it set out to achieve in the first place.
Cliffe Dekker Hofmeyr
ITA: section 1(1), definition of gross income paragraphs (c) and (i) and the Seventh Schedule
MARCH 2016 ISSUE 198
(Refer to article 2435, July 2015, Issue 191)
In the recently reported case of Anglo Platinum Management Services v SARS [2015] ZASCA 180 (the Anglo case), the judgment of which was delivered on 30November 2015, the Supreme Court of Appeal (SCA) ruled in favour of the taxpayer in respect of a motor vehicle salary sacrifice scheme. The judgment stresses the importance of employers and employees properly agreeing to, understanding and correctly implementing remuneration structures that contain a salary sacrifice component.
Before dealing with the SCA judgment, it is useful to touch on the basic principles of a salary sacrifice arrangement, or more eloquently put, a salary substitution arrangement. I use the word substitution, as that is what it boils down to: it is the substitution of a cash component of an employees overall cost to company remuneration package, for a non-cash benefit, that generally results in a lower amount subject to the deduction of employees tax.
Historical case law on the issue of salary sacrifice or salary substitution schemes (see ITC 1663 [1999] 61 SATC 363 and ITC 1682 [2000] 62 SATC 380) does not provide clear guidance, but the courts have acknowledged the fact that it is lawful for an employee to sacrifice their salary in return for some quid pro quo from the employer, which has the effect of reducing the employees ultimate tax liability. The above was confirmed in the Anglo case. The important aspect of such a scheme seems to be that it must be implemented properly, there must be attention to detail, and that the provisions of the Income Tax Act, 1962 (the Act) and, in particular, the Seventh Schedule to the Act, dealing with fringe benefits, are carefully considered.
Furthermore, it is important that there is a valid agreement (or agreements) between the employer and employee, both parties understand the implications of the agreement (or agreements), the salary sacrifice must be made prior to the accrual of any amount, and relevant internal policies and procedures are adhered to. The aforementioned was seemingly adhered to in the Anglo case, which involved a salary sacrifice scheme whereby employees substituted a portion of their cash remuneration in exchange for a non-cash use of a motor vehicle. The case did not focus on the determination as to whether a fringe benefit for the use of a motor vehicle actually existed the question was whether the mechanics of the scheme resulted in an antecedent divestment of a right to remuneration. In other words, did the scheme result in the employees divesting themselves of an amount after accrual? If so, the salary sacrifice scheme would not be properly implemented.
The salient features of the scheme, as set out by the SCA, were as follows:
- The employees had to complete certain documentation which set out how they wished their cost to the company remuneration packages to be structured, as between cash and other benefits, which included the use of a motor vehicle.
- Once an employee had chosen to participate in the scheme and had selected a vehicle of his choice, Anglo Platinum Management Services (Anglo) purchased it and paid the dealer in cash. The vehicle was then entered into Anglos asset register and depreciation was claimed on it.
- The vehicle was registered in the employees name, but Anglo owned the vehicle until the employee had settled the finance obligation and paid the related fringe benefit tax on it.
- The cost of the vehicle purchase was recovered from the employee through a monthly deduction predetermined at the time they elected to participate in the scheme from the portion of their salary they had to forgo in return for the use of the vehicle.
The cost recovered from the employee also included a notional interest portion and insurance premiums.
The abovementioned process was, however, not at the heart of the dispute. The scheme had two more complex elements being:
- the entitlement of the employees to claim an amount of credit in the notional account; and
- their contractual obligation to pay insurance premiums on the motor vehicles. The South African Revenue Service (SARS) argued that the entitlement to the aforementioned credit and the obligation to pay the premiums, are inconsistent with a genuine salary sacrifice scheme as, in substance, the employees retain their power over their salary packages.
The witness for Anglo testified that notional accounts were prepared and sent to its employees who chose the taxable benefit of the use of their motor vehicles. The notional accounts, set out the optimal value of the motor vehicle, defined as the theoretical representation of the capital amount outstanding at the end of each month determined according to the reducing cap method. This was part of the methodology used to determine the actual value of the motor vehicle, taking into account the deemed finance costs. In addition to being represented as part of the capital cost of the motor vehicle, notional interest was recorded separately in the notional accounts.
The notional accounts also detailed actual payments Anglo made for maintenance and running expenses, insurance premiums and licensing fees. The aforementioned payments were debited to the notional account, as was the notional interest. The predetermined monthly deduction from the employees salary appeared from month to month as a credit in the notional account.
It appears that, from time to time, there would be a shortfall in the notional account where the actual expenditure plus notional interest exceeded the amounts credited to an employee through the monthly deduction, resulting in a recovery from the employee. Where the amount credited to the employee exceeded the expenditure, the employee could withdraw the money available, once every quarter, subject to the deduction of employees tax. If the credit amount was not withdrawn, it would be rolled over into the following month or quarter. At the end of the financial year the credit (if any) would be paid to the employee, subject to the deduction of employees tax.
Counsel for SARS pushed Anglos witness to concede that the credit in the notional account was in fact a contractual right to claim the credit and not merely an election. The SCA accepted that the employees had a right to claim any credit in the notional accounts, but that they could elect not to claim it quarterly, in which case they could still claim whatever credit remained at the end of the financial year. The SCA stated that the amounts that became available to be claimed quarterly were both unanticipated and insignificant simply because it was not possible to predetermine future running expenses and notional interest for the motor vehicles. The SCA went on to state that the fact that these insignificant and unanticipated amounts could (not would) become available to the employee in the future because of inevitable future adjustments to the predetermined cost of the benefit could not and did not detract from the efficacy of the scheme.
Properly understood, the SCA stated that the credit to which an employee became entitled when he elected to participate in the scheme, was not unconditional, but in fact a contingent right, exercisable at a later date and on the occurrence of an uncertain future event. If the event did not materialise, there was no right to be exercised and until it was exercised, there could not have been an accrual of income.
The SCA concluded that, in substance and in form, Anglo and its employees participating in the scheme achieved what they set out to do: fund a taxable benefit from a salary sacrifice. The SCA stated that this was achieved by properly designing and implementing the scheme and that the recovery of the vehicle total cost, including the running expenses was obtained from the salary sacrifice, not from the employees.
On the basis that the credit claimable arose from a small unpredicted and unanticipated future contingency, the SCA ruled that SARS argument that the use of the vehicles was in reality a consideration received by each employee as part of their employment and thus taxable under paragraph (c) of the definition of gross income, as opposed to paragraph (i) as a taxable benefit by virtue of a valid salary sacrifice, had to fail.
The important aspect that employers should take from the Anglo case is that salary sacrifice arrangements remain perfectly legal. The difficulty that often arises is that the actual implementation and maintenance of a scheme, doesnt necessarily reflect what has been agreed to with the employee and vice versa. Anglo effectively countered SARS arguments that there wasnt an antecedent divestment of a right to income, on the basis that it paid attention to detail and the scheme reflected, in substance and in form, what the parties agreed to and intended with its implementation and what it set out to achieve in the first place.
Cliffe Dekker Hofmeyr
ITA: section 1(1), definition of gross income paragraphs (c) and (i) and the Seventh Schedule