An overhaul of the current retirement dispensation and the promotion of savings has been on the cards since at least the 2012 Budget when the Minister of Finance announced that a series of discussion papers would be released on these matters.
It was revealed by National Treasury (Treasury) in a paper entitled Strengthening retirement savings (14 May 2012) that the reforms would include measures to encourage non-retirement household savings. The reason given was that, if long-term savings are locked up in retirement funds (as a result of proposed preservation requirements), individuals may be faced with difficulties in meeting financial obligations that may arise in the short to medium term. As a means of encouraging individuals to not rely on retirement savings for their short to medium needs, but to save additional amounts for such purposes, it was proposed that tax free savings accounts be introduced. Traditionally, the only incentive available for non-retirement household savings was the annual interest exemption for individuals.
A discussion paper was released by Treasury on 4 October 2012. Subsequent to that things went quiet and no details were mentioned in the 2013 Budget. However, in the 2014 Budget it was announced that tax free savings accounts would be introduced during 2014, which announcement was followed by a paper entitled Non-retirement savings: Tax free savings accounts (14 March 2014) which provided further details.
On 17 July 2014 Treasury released the draft Taxation Laws Amendment Bill 2014, which introduces the first draft of the long-awaited provisions relating to tax free savings accounts.
The provisions are structured around the concept of a 'tax free investment', which is defined as any financial instrument that meets certain requirements. Some of these requirements are that the financial instrument must:
- have been issued by a bank, long-term insurer, portfolio of a collective investment scheme in property or securities, or the government;
- be administered by an authorised user of a licenced exchange or certain financial service providers;
- be held by a natural person; and
- meet the requirements of relevant regulations.
The idea is that persons may invest in a variety of instruments, including unit trusts, exchange traded funds, fixed deposits, retail bonds, real estate investment trusts and certain insurance investment products, without paying tax on the returns or growth. These instruments will however be subject to strict regulation. It also appears that direct share purchases will be excluded.
From a technical perspective, any amounts received by or accrued to a person in respect of a tax free investment will be exempt from normal tax. Also, capital gains and losses will be disregarded in respect of the disposal of any tax free investments. An exemption in respect of dividends tax will apply to the extent that any income generated by a tax free investment constitutes a dividend.
Tax free investments will however be subject to certain limitations. Specifically, a person will only be allowed to contribute R30 000 per year of assessment towards tax free investments, and a lifetime limit of R500 000 will apply.
Income and proceeds derived from tax free investments that are reinvested in tax free investments will not be subject to these limitations. In other words, the returns and growth on tax free investments may be capitalised free of any limitation.
Persons will also be allowed to transfer amounts from one fund to another without falling foul of the limitations, apparently to encourage competition between service providers.
However, a person will be penalised if the limits in respect of contributions are otherwise exceeded. Where the annual limit of R30 000 is exceeded, the amount of the excess will be taxed at 40%. A similar penalty will apply in respect of the lifetime limit of R500 000, however, amounts previously invested but withdrawn may again be reinvested up to the R500 00 limit (subject to the annual limit).
The amount must also be contributed in cash, as opposed to in the form of any other assets.
Tax free investments appear to be aimed at middle-income households. This is so because those falling below the tax threshold will not benefit from the incentive in the first instance, and the strict limits on contributions implies that high-income earners will have to put the bulk of their money elsewhere.
It is however an interesting question whether, despite the 40% penalty that applies in respect of exceeding the relevant limits, it might still be beneficial to an investor to put excess amounts in tax free investments. For example, an investor might be willing to pay the 40% penalty on the capital invested where it is guaranteed that all future income generated by the investment, as well as capital growth, would be tax free. Depending on the expected return, this could potentially make sense from a long-term investment perspective.
It is further interesting to note that Treasury has indicated that the annual interest exemption for individuals will remain for the time being, but will become less relevant to the extent that it is diminished as a result of inflation.