Remuneration structuring or salary sacrifice – SCA endorses taxpayer scheme

transfer pricing 102Ever since the Margo Commission recommended that there should be a uniform system for the determination of the value of benefits of employment, and the enactment of the Seventh Schedule to the Income Tax Act, there has been a tension between SARS and employers over the legitimacy of structured remuneration packages. There are few reported cases of instances in which employers have resisted a challenge by SARS. In the recent judgment of Cachalia JA, in the matter of Anglo Platinum Management Services (Pty) Ltd v C:SARS [2015] ZASCA 180 (30 November 2015), the employer’s remuneration practices were found to be legitimate.

The matter at issue was succinctly summarised in the opening paragraph of the judgment:

‘This appeal involves a salary sacrifice scheme whereby the appellant, Anglo Platinum Management Services (Pty) Ltd (the taxpayer), gave its employees an opportunity to participate in what it believed, and still believes, was a legitimate arrangement. The scheme involved its employees sacrificing or foregoing a portion of their cash remuneration “packages” in return for their use of company-owned motor vehicles.’

Legal principles

The determination of ‘gross income’, in so far as it relates to remuneration, is found in two paragraphs of the definition of that term in section 1 of the Income Tax Act. These are paragraphs (c) and (i). The inter-relationship of these provisions is explained in paragraph [4] of the judgment:

‘For present purposes the effect of these provisions is that where any amount is received or accrued for services rendered by virtue of any employment, it is included in the employee’s gross income under para (c) and is thus fully taxable. However, the proviso in para (c) precludes any benefit, in respect of which the provisions of para (i) apply, from being dealt with as having been received or accrued for services in respect of any employment under para (c). Paragraph (i) of the definition of ‘gross income’ includes the ‘cash equivalent’ as determined under the Seventh Schedule, of the value of any benefit or advantage – henceforth referred to simply as a benefit – granted to the employee as part of his employment.’

The facts

Annually, employees of the taxpayer concluded an agreement with the taxpayer on the manner in which their remuneration for the forthcoming year would be structured. They were offered elections in terms of which they could forego the receipt of an amount of cash and, in lieu of such cash, receive a benefit in kind. The elections were recorded in a document signed by the employees. One of the benefits that could be elected was the right of use of a company-owned motor vehicle, in terms of the company car scheme.

The taxpayer had established the scheme on the basis that the employee elected to receive the benefit of the use of a motor vehicle in exchange for foregoing the right to be paid a certain amount in cash which was not to exceed the determined cost of acquiring and operating the vehicle. A motor vehicle was purchased by the employer and capitalised in its financial records. For purposes of administering traffic fines and licensing, the vehicle was registered in the name of the employee.

In order to determine the amount that the employee would forego, a notional calculation was made on the assumption that the vehicle had been purchased and financed by a loan at the market rate of interest. The notional financing transaction was recorded in a memorandum account, which was debited with the cost of the vehicle and notional interest, and credited with the salary foregone. In the event that the balance in the memorandum account should reduce to zero, the employee would have the right to acquire the vehicle for no consideration.

In addition, a further notional amount was determined in respect of the operating costs of the vehicle, which was also foregone by the employee. This amount was credited in the memorandum account, while the actual cost incurred by the employer in respect of fuel, maintenance, insurance and licensing were debited.

Quarterly, a financial adjustment was made to the extent that the operating costs debited to the memorandum account were greater or less than the notional credits for operating costs. If the notional credit was less than the actual cost, the amount was recovered from the employee. Where the notional credit exceeded the actual cost, the amount was repayable to the employee and subjected to PAYE. The employee had the right to elect to defer the payment until the end of the financial year, at which time any remaining credit balance had to be paid and taxed.

By this means, the salary foregone in respect of the operating cost of the vehicle was “trued up” to an amount equal to the actual cost incurred by the employer.

The Tax Court decision

The Tax Court decision is reported on the SARS website (Case No. 12984, 5 September 2014). Evidence for the taxpayer had been given by the person who had devised and administered the motor vehicle scheme. It is evident that the witness had been exposed to lengthy and rigorous cross-examination by counsel for SARS. Mavundla J found as follows in paragraph [18] of his judgment:

‘I must hasten to point out that X left a poor impression in my mind. I find that he does not measure to acquit the onus resting on the appellant on the balance of probabilities, that the respondent was wrong in its assessment and that the appeal must succeed.’

In essence, Mavundla J found that the evidence for the taxpayer could not be relied upon. He referred to the notional (memorandum) account as ‘fictitious’ and ruled that:

‘The amounts restructured or allocated as company car accrued to the employees and [are] taxable in terms of the provisions of paragraph (c) of “gross income” as defined in section 1 read with paragraph 1 of the Fourth Schedule to the Act—definition of ‘remuneration’, subparagraph (a).”

The taxpayer’s arguments for remission of interest and penalties imposed by SARS were rejected, and the taxpayer was ordered to pay the Commissioner’s costs of opposing the appeal.

The SCA’s approach

Cachalia JA described the approach taken by the Tax Court in paragraph [7] of the judgment:

‘The Tax Court, in which Mavundla J presided,seems to have misunderstood the taxpayer’s case to be that because it had devised a legitimate salary sacrifice scheme, which did not attract liability for income tax under para (c) of the definition of ‘gross income’, no tax liability on its part arose at all. It thus proceeded to adjudicate the dispute without considering whether the relevant paragraphs of the Seventh Schedule, para (i) of the definition of ‘gross income’, proviso (i) to para (c) and para (b) of the definition of ‘remuneration’ in the Fourth Schedule, applied. And, having overlooked these provisions, it seems to have approached the taxpayer’s evidence on the unarticulated premise that the scheme was a sham, disguised to conceal its true nature. It consequently dismissed the taxpayer’s appeal against the assessment and ordered the taxpayer to pay the costs of the appeal, implicitly finding that its grounds of appeal had been unreasonable.’

In considering who had the obligation to pay the insurance premiums, Cachalia JA found that the taxpayer’s witness had stood firm on his assertion that the taxpayer was obliged to pay the insurance premiums and found that this was supported in the documentary evidence and in the conduct of the parties to the agreements.

The judgment of Cachalia JA, in paragraph [10], set out the approach that should be adopted when testing the evidence of witnesses:

‘It is a question of fact in each case whether a salary sacrifice agreement was achieved. In this regard a court is not concerned with the subjective belief of the parties to the agreement – no matter how genuine this belief may be – but with whether the facts, objectively viewed, establish that this result was attained. It must thus consider the oral and documentary evidence to assess the probabilities. The taxpayer bears the burden of proving that the Commissioner’s decision to disallow its objection to the assessments was wrong. And where, as in this case, the taxpayer’s is the only oral evidence, it must be considered carefully in the light of the available documentary evidence before a court is able to conclude whether or not the taxpayer has discharged the onus.’ (Footnotes omitted)

One of SARS’ arguments in the Tax Court had been that the employer was extending a credit facility to the employees. SARS did not persist with this argument before the SCA. Its argument was succinctly summarised in paragraph [16] of the judgment:

‘It is the manner in which the scheme was implemented: in particular 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 that lie at the heart of this dispute. The Commissioner contends that the entitlement to this 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.’

SARS’ counsel contended that the notional account was not fictitious but that it was in fact a memorandum of the amount owing by employees to the taxpayer for the purchase and operation of the employee’s vehicles. He urged further that the facts that the cost of insurance was debited in the memorandum account and that the employee had the right to recover amounts quarterly, where the actual operating costs were less than the sacrificed credit, were inconsistent with a ‘genuine’ salary sacrifice.

After a thorough examination of the evidence, Cachalia JA found the amounts paid in or paid out quarterly represented ‘insignificant and unanticipated amounts’ which did not detract from the efficacy of the scheme. This was tested in paragraph [30] of the judgment:

‘One may test this by asking what the Commissioner’s response would have been if the scheme was able to achieve a perfect symmetry between the cost of the benefit and the amount the employee gave up, which is what the scheme in substance sought to achieve? The answer is evident; he would have accepted that this was a genuine salary sacrifice. I see no reason why on the facts of this case we should come to a different conclusion.’

The premise on which SARS had based its case – that the employee, through the right to recover any excess credit in the memorandum account, had a vested right to receive the so-called ‘sacrifice amount’ – was found to be false. As was explained in paragraph [31]:

‘So, properly understood, the credit to which an employee became entitled when he elected to participate in the scheme was not unconditional. It was a contingent right, exercisable at a later date and on the occurrence of an uncertain future event: a quarterly credit balance in the notional account. 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 this income as contemplated in para (c) of the definition of “gross income”.’

Similarly, in considering who had the obligation to pay the insurance premiums, Cachalia JA found that the taxpayer’s witness had stood firm on his assertion that the taxpayer was obliged to pay the insurance premiums and found that this was supported in the documentary evidence and in the conduct of the parties to the agreements. This evidence could not be refuted by SARS, which was ‘a stranger to these agreements’.

The conclusion at which the SCA arrived was that the scheme was, in fact, genuine, as Cachalia JA stated at paragraph [35]:

‘To conclude: the parties sought to fund a taxable benefit from a salary sacrifice. They were entitled to do so in accordance with the relevant provisions of the Act. And they achieved this through the scheme they agreed on and implemented. The following features of the scheme indicate that it was properly designed and implemented: The taxpayer purchased the motor vehicles, owned and claimed depreciation on them. The recovery of their total cost, including their running expenses was obtained from the salary sacrifice, not from the employees. In return for the amount they had foregone the employees received a taxable benefit; i.e., the use of the vehicles.’

The appeal was therefore allowed, with costs, and the decision in the Tax Court was set aside.

PwC Comment

Salary sacrifice is permissible

This decision puts beyond doubt that our law recognises that it is possible by contract to structure employee remuneration packages on a ‘salary sacrifice’ basis. Such arrangements should be reflected in relevant documentary evidence and given effect in the conduct of the parties. It clearly distinguishes the circumstances in which the application of paragraphs (c) and (i) of the definition of ‘gross income’ are applicable.

It is interesting to note also that, when forced to defend its stance in the SCA, SARS did not persist in some of its well-worn arguments for asserting that a salary sacrifice is not genuine. Some of these had been urged, and apparently found favour, in the Tax Court. They included the following assertions:

  • That a ‘sacrifice’ is not a genuine diminution in the remuneration package; and
  • The fact that pension contributions were not adjusted by reference to the cash element of the remuneration indicated that there was no sacrifice of salary.

The issues before the Tax Court were wider than the issue dealt with in the SCA judgment

An examination of the judgment in the Tax Court reveals that original assessment related to the taxpayer’s motor vehicle scheme, which gave employees the option of a company car benefit or a travel allowance. It is clear from the Tax Court judgment that the assessment raised by SARS related to PAYE allegedly not paid in respect of both the car benefit and travel allowances.

Although the travel allowance element of the assessment was not referred to expressly in the judgment of the SCA, the fact that the SCA allowed the appeal and set aside the PAYE assessment in its entirety leads one to conclude that the travel allowance issue must have been conceded by SARS.

This article first appeared on pwc.co.za.

Author: PwC South Africa

 

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