In Anglo Platinum Management Services v SARS,(1) the Supreme Court of Appeal (SCA) recently ruled in favour of the taxpayer in respect of a motor vehicle salary sacrifice scheme. The judgment underlines the importance of employers and employees properly agreeing, understanding and implementing any remuneration structures that contain a salary sacrifice component.
A 'salary sacrifice' or 'salary substitution' arrangement is essentially the substitution of a cash component of an employee's overall cost-to-company remuneration package for a non-cash benefit, generally resulting in a lower amount subject to the deduction of employees' tax.
Historical case law provides no clear guidance,(2) but the courts have acknowledged that it is lawful for an employee to sacrifice his or her salary in return for some quid pro quo from the employer, with the effect of reducing the employee's ultimate tax liability. This was confirmed in Anglo. The important aspects for the success of such a scheme seem to be the following:
- It must be implemented properly, with attention paid to detail;
- The provisions of the Income Tax Act (58/1962) must be carefully considered – particularly the Seventh Schedule to the act, dealing with fringe benefits;
- There must be a valid agreement between the employer and employee and both parties must understand its implications;
- The salary sacrifice must be made before the accrual of any amount; and
- Relevant internal policies and procedures must be observed.
The above best practices were seemingly implemented in Anglo, which involved a salary sacrifice scheme whereby employees substituted a portion of their cash remuneration in exchange for non-cash use of a motor vehicle benefit. The case did not focus on whether a fringe benefit for the use of a motor vehicle actually existed; instead, 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 have been improperly implemented.
The salient features of the scheme, as set out by the SCA, were as follows:
- Employees completed certain documentation which set out how they wished their cost-to-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 selected a vehicle, Anglo purchased it and paid the dealer in cash. The vehicle was then entered into Anglo's asset register and depreciation was claimed on it.
- The vehicle was registered in the employee's name, but Anglo owned it 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 salary deduction – predetermined at the point of election to participate in the scheme – in return for use of the vehicle.
The cost recovered from the employee also included a notional interest portion and insurance premiums.
The scheme included two more complex elements. Employees were:
- entitled to claim an amount of credit in a notional account; and
- contractually obliged to pay insurance premiums on the motor vehicles.
The South African Revenue Service (SARS) argued that the entitlement to credit and obligation to pay the premiums were inconsistent with a genuine salary sacrifice scheme as, in substance, the employees retained power over their salary packages.
The witness for Anglo testified that notional accounts were prepared and sent to those employees who chose the taxable benefit of use of its 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 payments made by Anglo for maintenance and running expenses, insurance premiums and licensing fees. These payments were debited to the notional account, as was the notional interest. The predetermined monthly deduction from the employee's salary appeared from month to month as credit in the notional account.
It appears that there would occasionally 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. Conversely, where the amount credited to the employee exceeded the expenditure, the employee could withdraw the money available, once every quarter, subject to employees' tax. If the credit 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 employees' tax.
Counsel for SARS pushed Anglo's 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 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, because it was impossible to predetermine future running expenses and notional interest for the motor vehicles. The SCA further stated 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.
The SCA stated that the credit to which an employee became entitled when he or she 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; until it was exercised, there could be no 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 recovery of the vehicle's total cost – including 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 dismissed SARS's argument that use of the vehicles was in reality a consideration received by each employee as part of his or her 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).
Anglo demonstrates to employers that salary sacrifice arrangements remain perfectly legal. The difficulty that often arises in practice is that the actual implementation and maintenance of a scheme does not necessarily reflect what has been agreed with the employee and vice versa. Anglo effectively countered SARS's arguments that there was an antecedent divestment of a right to income, on the basis that it had paid attention to detail and that – in substance and in form – the scheme reflected what the parties had agreed and intended, in terms of both its implementation and objective.
For further information on this topic please contact Ruaan van Eeden at Cliffe Dekker Hofmeyr Inc by telephone (+27 11 562 1000) or email (firstname.lastname@example.org). The Cliffe Dekker Hofmeyr website can be accessed at www.cliffedekkerhofmeyr.com.
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