RETIREMENT FUNDS: TAX ON UNCLAIMED BENEFITS
The Income Tax Act, when read with the Fourth Schedule, provides that a pension fund that pays or becomes liable to pay any amount by way of a pension is required to deduct employees’ tax from such pension before paying the balance to the pensioner. The amount deducted is to be paid to SARS within seven days after the end of the month during which the amount was deducted.
It is the experience of many funds that some members exit the fund and become entitled to a pension, but do not claim their benefit, presumably because they are unaware of their entitlements. The approach that has been adopted by SARS is that those unclaimed benefits have accrued to members and are amounts that the fund becomes liable to pay as at the time of such accrual. Accordingly, SARS has been issuing assessments requiring funds to deduct and remit employees’ tax in respect of the total value of unclaimed benefits.
The first issue that a number of funds face is that SARS has generally applied a rate of 30% in determining the amount to be deducted. In many funds’ experience, that rate represents a higher average tax rate than that applicable to those members who have failed to claim their benefits. In some instances SARS has agreed to reduce the assessment rate to 18%, being the minimum rate stipulated in the Income Tax Act in such circumstances.
However, many members who have not claimed their benefits may not have earned sufficient income to reach even the lowest threshold of income tax. If such a member were to claim a benefit eventually, he or she would be required to render an income tax return in order to procure the refund of the tax over-deducted by the fund. Trustees of funds should be sensitive to this issue and advise late claimers of their rights in that regard, in accordance with the trustees’ duties under the Pension Funds Act.
The second issue that trustees and administrators need to be sensitive to is the proper treatment of unclaimed benefits and fund interest. Once an amount that is taxable, such as a benefit, accrues, employees’ tax must be deducted and remitted. Thereafter, interest that accrues on the post-tax amount is not regarded as remuneration, so there should be no obligation on the fund to deduct employees’ tax from such interest once the benefit and interest are eventually paid over to the beneficiary. However, the practice of some defined contribution funds is to credit the accounts of members on a regular (monthly, quarterly or annual) basis with the appropriate fund interest, being, in simplistic terms, the rate of growth experienced by the fund as a whole over a determined period.
Some defined benefit funds also apply fund interest, or a pre-determined rate of interest, to the value of unclaimed benefits, even though the unclaimed benefits are held in the common asset pool, and not held separately. These approaches amount to a decision by the trustees on behalf of the member to reinvest the accrued benefit in the fund. If the member were to claim the benefit upon its accrual, he or she would have to invest the amount elsewhere (unless the option to elect a deferred pension were available), in which case employees’ tax would be deducted on the amount of the benefit, and subsequent investment returns would fall to be dealt with outside of the scope of employees’ tax. Instead, the member is placed in a position of receiving an enhanced benefit (or what appears to be an enhanced benefit) at a point in the future, the whole value of which is subject to an employees’ tax withholding because of the definition of remuneration in the Income Tax Act. If the fund were to invest unclaimed benefits in independent interest-generating vehicles it should be able to avoid the withholding of employees’ tax in relation to the interest portion, and should also be in a position to prove a lower liability for employees’ tax in relation to its unclaimed benefits liability.
A third issue that SARS’s approach has highlighted is the question of accrual in relation to death benefits. Death benefits do not form part of the estate of the deceased member, so they do not accrue to that estate upon the member’s death, according to the provisions of the Pension Funds Act. Trustees of funds are not bound to accept the proposed allocation of death benefits as stipulated by a former member in a beneficiary nomination form. Effectively, the trustees have up to twelve months to determine how the death benefit is to be apportioned among potential beneficiaries, being nominees and dependants of the deceased member, and if that cannot be achieved within that period, then the benefit is to be paid into the Guardian’s Fund. Therefore if a portion of the value of the unclaimed benefits of a fund relates to death benefits that have not yet been allocated, that portion will, due to a deeming provision in the Income Tax Act, be subject to employees’ tax notwithstanding that it is likely to be paid to a person who has no former or current relationship with the fund. Presumably the recipients of such benefits would therefore be entitled, in their next income tax return, to seek a refund of any amount over-deducted by the fund. In that event, trustees should also inform beneficiaries of death benefits of their rights in that respect. It would therefore seem sensible that funds should have a basis to apply for an appropriate directive to avoid paying employees’ tax in respect of unclaimed death benefits that “accrued” less than twelve months previously, especially if there is a realistic prospect of identifying and paying beneficiaries within that period.
Funds should also take care that any surplus in the fund as at the date of assessment should not be included in the amount assessed for determining employees’ tax on unclaimed benefits. It is axiomatic that assets that are surplus to the actual and projected liabilities of the fund cannot become payable to satisfy future claims for unclaimed benefits, because the value of unclaimed benefits should correspond to a projected liability for payment of such benefits in due course.
Finally, the basis for SARS’s assessment in respect of unclaimed benefits is that a member acquires a right to claim a benefit at the time that the benefit accrues. Even though the member does not claim or receive the benefit at that time, the member does acquire, by operation of law, the right to claim the benefit from that time and into the future. It has been said that it is the value of that right that accrues in the tax year that the benefit becomes claimable. SARS has assessed unclaimed benefits on the basis of the value of the benefits themselves. Funds should consider whether the value of the benefit is indeed the appropriate value to be taken into account for the purposes of such an assessment or whether a case can be made that a lesser value should be taken into account, since the member has not actually received the value of the benefit in the tax year under consideration. This is particularly pertinent in light of the fact that some funds have rules that provide that unclaimed benefits lapse and cease to be claimable after a stipulated period, usually of two or three years.
Trustees of retirement funds are enjoined to take all reasonable steps to ensure that the interests of members are protected at all times and to act with due care, diligence and good faith. They are also required to ensure that adequate and appropriate information is communicated to members informing them of their rights, benefits and duties in terms of the rules of the fund. These duties should inform trustees’ conduct in their interactions with SARS as much as in any other context.