It's not always easy to see the tax implications of financial decisions you make. And more so now, that South Africa's tax legislation has changed significantly in the last two years. Personal Finance has enlisted the help of Deborah Tickle, a tax partner at KPMG, to explain common tax problems. This week, she deals with the new exemptions on interest income.
In his Budget speech this year, Finance Minister Trevor Manuel said that, for the 2003 tax year the exemption for domestic interest and dividends would be increased from R4 000 to R6 000 for persons under 65 and from R5 000 to R10 000 for persons over 65.
He said, however, that "with a view to encouraging taxpayers to make their savings available for domestic capital formation, foreign interest and dividends will in future only be exempt up to R1 000 out of the total exemption limit".
The draft legislation that will put effect to this statement has been put before Parliament. It states that an amount of R1 000 of any foreign dividend received will be tax free. To the extent that this tax-free amount is not used up, it may be set off against foreign interest. If this tax-free amount is not used up, it may be set off against local interest. But the amount of local interest that may be received tax-free may total a further R9 000 for people 65 and over, and a further R5 000 for people under 65.
So what does this mean? Let's say you are under 65 and have obtained a tax clearance certificate from the South African Revenue Service that allows you to invest up to R750 000 outside South Africa. You have invested some of your money in a bank account in the Isle of Man, and a further amount in some foreign shares. You also have a local investment account and some local shares.
In the 2003 tax year you earn R600 in taxable foreign dividends and R1 500 in foreign interest. You also earn R3 000 in local interest and R2 000 in local dividends. The R600 foreign dividend will be tax free, and R400 of the foreign interest will be tax-free. The R1 000 tax-free amount for foreign dividend and interest will then have been used up. The local interest will also be tax-free since it is less than R5 000, the balance of the tax-free amount. In fact, there will still be a balance of R2 000 available to set off against taxable local interest.
Local dividends are not taxable in any event. You will, however, still be taxed on R1 100 of foreign interest. This is where the exemption differs to the past since, in the past, the whole tax-free amount could have been set off against taxable interest and dividends, regardless of where they were from.
What if you had earned R6 000 in local interest only? This full amount would be tax-free.
The tax-free amounts apply to each taxpayer, and an innovative reader asked whether he couldn't just donate some of his investments to his wife, so that they could take advantage of the tax-free amounts twice!
This seemed like a particularly good idea since there is no donations tax when you donate to your spouse.
Our reader is quite entitled to make such a donation and his wife may receive the income. But it is important to be aware of the fact that there is a provision in the tax law that specifically treats the income as if it belongs to the spouse that donated the investment, if the sole or main purpose of the donation was to avoid tax. Thus, the expected benefit of the donation will be lost.
Where a couple are married in community of property, though, the investment income will be taxed in both spouses hands equally, and both will then be able to set off the tax-free amounts against the income. However, there should be other considerations, apart from tax, to take into account before a couple decide to marry in community of property!