A few readers have correctly rapped me over the knuckles for taking a too simplistic approach to what is known as income-splitting.
In last week's column on how you should take full advantage of the various exemptions and tax deductions to which you are entitled, I wrote the following about the interest exemptions:
"Remember that both spouses can claim the exemption. If one spouse has no investments, the other should donate money to his or her partner (you are allowed to do this without tax consequences) to derive the full tax advantage."
I should have pointed out that you cannot simply transfer the money from one spouse's interest-earning investment to another, because this could fall foul of section 7(2) of the Income Tax Act, which reads:
"Any income received by or accrued to any person married with or without community of property (hereinafter referred to as the recipient) shall be deemed for the purposes of this Act to be income accrued to such person's spouse (hereinafter referred to as the donor) if (a) such income was derived by the recipient in consequence of a donation, settlement or other disposition made by the donor on or after March 20, 1991, or of a transaction, operation or scheme entered into or carried out by the donor on or after that date, and the sole or main purpose of such donation, settlement or other disposition or of such transaction, operation or scheme was the reduction, postponement or avoidance of the donor's liability for any tax, levy or duty which, but for such donation, settlement, other disposition, transaction, operation or scheme, would have become payable by the donor under this Act or any other Act administered by the Commissioner; or "
So if one spouse gave, say, R100 000 to the other spouse for the purposes of reducing his or her income tax and the recipient earned interest of R10 000 a year on the money, the R10 000 would be included in the donor spouse's taxable income and would be taxed at the donor's marginal rate of tax, with the donor spouse being able to claim only one interest exemption.
The only exception is with a couple who are married in community of property. Any passive income, such as interest earnings on an investment held by either spouse, is automatically split for tax purposes between the two spouses. And each spouse can claim the maximum tax exemption on his or her portion of the interest earned.
The new tax-free interest and otherwise taxable dividend exemption thresholds are up to R19 000 for anyone under the age of 65 and R27 500 for anyone 65 and older.
Section 7(2) is not aimed so much at the interest exemptions but more at significant income-splitting.
If section 7(2) did not exist, it would make sense to transfer assets (such as rented property, interest-earning investments and non-exempt foreign equities) that earn taxable returns to a spouse who earns no taxable income or who is on a lower marginal rate. The reason is the tax paid would be far less than it would be for someone who is on the top rate of 40 percent.
The taxman's intention is not to prevent transfers of wealth between spouses. However, the reasons for the transfers should not be solely for tax manipulation purposes.
If the taxman's intention was to prevent any potential for income- splitting, there would be a total ban on tax-free transfers (donations) between spouses. Donations tax would apply in all cases.
Intention for transfers
So when is a transfer of wealth between spouses a tax dodge and when is it not?
Deborah Tickle, a director of international corporate tax at KPMG who occasionally writes for Personal Finance, says there are no specific guidelines.
Tickle says: "Suffice it to say that, in order for section 7(2) to apply, the spouse who has provided the funds which gave rise to the income in the other spouse's hands must have had the sole or main purpose of reducing, postponing or avoiding tax in their own hands.
"Thus, where, for example, one spouse gives housekeeping money to the other spouse, who takes it and spends sparingly such that they have some money left over and puts it in a bank account, there would not be a section 7(2) deeming event.
"Clearly, if the amount given is excessive in relation to the housekeeping needed, the South African Revenue Service could question whether there was a motive of tax avoidance. The onus would then be on the taxpayer to prove otherwise."
Other examples could be:
- Payment of contributions to a non-working spouse's retirement savings. The aim would be to cater for the spouse's retirement needs and not to avoid tax.
- One spouse gives an amount to the other for him or her to open a bank account in his or her name so that when the donor spouse dies and his or her accounts are frozen, the surviving spouse has money available until the estate is wound up.
You should be able to produce documents to support your claim that the arrangement is legitimate.
The way the bank account is used should also reflect that its purpose is legitimate.
- One spouse purchases and pays the mortgage bond on a property that is registered in the name of the non-working or low-income spouse. Normally, the reason for buying a property in the name of a non-working spouse is to protect the family home from repossession should the income-earning spouse go bankrupt (for example, because he or she is engaged a high-risk business).
Tickle says your intention for the transfer is the key to determining how income from the asset is taxed.
Consider marginal rates
One of the easiest ways to legally overcome the restraints of section 7(2) is when both spouses are earning a living but one spouse is earning far less than the other.
The living expenses should be paid by the spouse who earns the higher income, while investments should be made in the name of the lower-earning, lower-tax-paying spouse in order to take maximum advantage of his or her lower marginal tax rate and any exemptions that may apply.
To me, it does not seem as if the taxman is on a mission to get at any spouse who transfers assets. The intention is to stamp out gross manipulation. For example, if on retirement, you commute R300 000 of your retirement benefits tax-free to a cash lump sum and then donate the cash to your spouse, I think the taxman would take action.
However, if you have been contributing over a number of years to a retirement savings scheme on behalf of your spouse, it is highly unlikely the taxman will come knocking on your door, even if the amount is substantial.
Before I am accused of being too simplistic again: if your spouse earns no income, you should not be contributing to a retirement annuity on his or her behalf, because your spouse cannot deduct the contributions if he or she does not earn any income.
When contributions are not tax-deductible, it may be better to save through a non-tax-incentivised vehicle, such as a unit trust or an exchange-traded fund.