Salary-sacrifice schemes must be well controlled
Employers that have salary-sacrifice arrangements with employees must have documentation and audit systems in place to show that a cash benefit has been exchanged for a non-cash benefit.
This is the view of Ruaan van Eeden, a director in the tax practice of law firm Cliffe Dekker Hofmeyr, who was commenting on a judgment by the Supreme Court of Appeal.
A salary-sacrifice arrangement is where employees agree to forego a portion of their cash salaries for a benefit provided by their employer. The arrangement reduces the employees’ tax liability.
The case involved Anglo American Platinum Management Services, which gave its employees the option of sacrificing a portion of their salary in return for the use of a company-owned car.
The South African Revenue Service (SARS) said the scheme did not qualify as a valid salary-sacrifice agreement in terms of the Income Tax Act and assessed the tax on the scheme to be R11 543 041 for the period 2004 to 2008. Anglo appealed the assessment in the Tax Court, which ruled in favour of SARS. Anglo then took the case on appeal to the Supreme Court of Appeal.
In a judgment handed down in November 2015, Judge Azhar Cachalia upheld Anglo’s appeal and set aside the order of the Tax Court.
The judgment outlined the main features of the scheme as follows:
* Employees had to complete certain documents that set out how they wanted their cost-to-company package to be structured 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, Anglo bought it and paid the dealer in cash. The vehicle was entered into Anglo’s asset register and depreciation was claimed on it.
* The vehicle was registered in the employee’s name, but Anglo owned the vehicle until the employee had settled the finance obligation and paid fringe benefit tax on it.
* The cost of buying the vehicles was recovered from the employees by a predetermined monthly deduction – from the portion of their salary they had to forego in return for using the vehicles.
SARS’s case that the scheme was not a valid salary-sacrifice arrangement was based on the fact that the employees were entitled to claim a credit in a notional, or simulated, account.
Anglo and the employees entered into a “notional instalment sale agreement” whereby notional interest on the amount paid for the car was calculated over the period of the operation of the scheme. This was not actual interest, because Anglo had paid for the vehicles in cash. It was a calculation of what the vehicles would have cost had Anglo bought them on credit.
The notional interest was debited to the accounts. The employer’s costs for car maintenance, insurance premiums and licensing were also debited.
If the set deduction exceeded the expenditure, the employee was allowed to withdraw the credit once a quarter, or it would be rolled over to the following quarter. At the end of the financial year, the credit amount would be paid to the employee, taxed as gross income.
SARS argued that the employees’ right to claim the credit was in conflict with their (apparent) agreement to divest themselves of the cash remuneration that made up the sacrificed portion.
But Judge Cachalia said SARS’s contention that the employees retained their right to claim such money “on demand”, and therefore did not divest themselves of this right, rested on the incorrect premise that the right had vested when the remuneration agreement was concluded, whereas it was a contingent right – a right conditional on an uncertain future event.
The employees could exercise their right to the credit only if there was 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, no gross income could be accrued.
Judge Cachalia said the amounts that became available to be claimed quarterly were both unanticipated and insignificant, because it was not possible to predetermine the future running expenses and the notional interest. The running costs varied from month to month and from employee to employee. The fact that these amounts could become available to the employees in the future, because of inevitable adjustments to the predetermined cost of the benefit, did not detract from the efficacy of the scheme.
Van Eeden says Anglo’s appeal succeeded because it was able to show that the arrangement was a genuine salary-sacrifice scheme. He says employers that set up such schemes must have proper documentation in place that shows that employees were fully informed of how the scheme works, what was agreed to, and how the scheme affected the employees’ remuneration packages.
Administrative and audit systems must be in place so that employers can show that the scheme is being implemented as intended, Van Eeden says.