Think about the tax before you act

Two case studies highlight how you can end up paying dearly if you don’t understand the tax implications of a transaction. reports

ONE OF your financial resolutions for the new year should be this: don’t rush into any decision involving a large amount of money. Not only may the outcome be very different from what you expected, but the transaction may be irreversible.

Before you sign on the dotted line, take a step back and carefully consider all the implications of your decision – particularly those related to tax – preferably with the guidance of a trusted financial adviser.

Personal Finance recently came across two cases in which people not well versed in tax matters made what turned out to be extremely costly financial decisions.

HEAVY TAX ON SIMPLE INTEREST

Pierre Puren, a financial adviser at PSG Wealth in Jeffrey’s Bay, relates the story of Mrs X, a pensioner, who invested R2 million in a bank investment deposit.

Mrs X, Puren says, is 62 years of age, married, and receives a pension of R15 000 a month. She invested R2m for a term of five years, with the investment offering an 11% return on her capital.

The interest rate advertised, Puren says, was a simple, non-compounding rate. “That meant that Mrs X earned 11% interest on her original amount invested, each year until maturity, at which point she would get her capital back with all the interest. There was no compounding, which meant that the interest would not be capitalised annually.”

Puren says Mrs X’s first shock came when she received almost R270 000 less than she would have done if the 11% had been a compound interest rate. She decided to have her funds paid out, but little did she know what was in store.

Puren says her contract stated that the total interest would be paid at maturity, when the five years were up. The interest would not be declared annually and could not be included in her taxable income for each of the five years she was invested.

Mrs X received her original capital of R2m, plus interest of R1.1m (11% of R2m multiplied by five). On gathering relevant documentation for her tax return, she noticed that a tax certificate (IT3B) issued by the bank showed interest of R1.1m to be included in her taxable income.

Her income of R15 000 a month amounted to R180 000 for the year. According to the 2016/17 tax tables, she would be liable for R18 900 in income tax on this amount. However, the R1.1m interest she received increased her marginal tax rate from 18% to 41%, and she was now liable for R406 931 in income tax (taking into account her annual interest exemption of R23 800) – an additional, unexpected cost of R388 031.

Therefore, from the R1.1m she received from her investment, R388 031 had to be paid to the Receiver of Revenue, leaving her with net interest of R711 969.

RA CASH PAYOUT

In a recent edition of GrayIssue, Allan Gray’s monthly newsletter, Carrie Furman, a tax specialist at Allan Gray, relates the story of Mr W, who, on reaching 60, decided to retire from his retirement annuity fund.

Furman says Mr W submitted his retirement notification to Allan Gray, informing the company that he wanted to withdraw R400 000 and transfer the remainder of his investment to a living annuity.

“He chose R400 000 as his lump sum, assuming that, because it was below the R500 000 retirement lumpsum amount that is tax-free, he would not have to pay tax on it.”

Mr W was hit with an unexpected tax bill of R121 500.

What Mr W did not realise, Furman says, is that, when calculating the tax on your retirement cash lump sum, the South African Revenue Service (Sars) takes all previous taxable cash lump sums you