On occasions when company executives have to pay back a portion of their remuneration, the fiscus may unjustifiably benefit at the expense of employers from the tax previously paid on these amounts. This situation could be made fairer by adding a simple provision to the Income Tax Act.
Company executives may sometimes have to pay back some of their remuneration to their former employers. This could arise either from current economic volatility impacting incentive arrangements, or the various corporate financial scandals which have engulfed SA over the last few years.
What is often forgotten in these often highly-emotive events is that, in most instances, income tax would have been paid by the executive on a portion of the remuneration now being returned to his or her former employer.
The former executive may have only received up to 55c in the rand of this perceived excessive or ill-gotten compensation, and the fiscus would have been the beneficial recipient of the balance. So the executive may be unable to repay the full amount. The mechanism currently included in the Income Tax Act to mitigate this situation is not only anomalous, but practically unworkable and inefficient from the perspective of the employer, when large sums of money are involved.
In this regard, section 11(nA) of the Income Tax Act currently permits an individual to claim a deduction against his/her income of any amount which the individual actually repays to his/her employer.
Issues which relate to this provision and its inadequacies are probably best explained by way of a simple example. Assume that in Year 1, Mr X was paid a ZAR10 million bonus by Company A, in relation to which ZAR4.5 million was paid in tax to SARS and ZAR5.5 million was actually received by Mr X. Further assume that Mr X is, for whatever reason, required to repay the full amount of his bonus (ZAR10 million) to the company in Year 2 and that Mr X did not earn any significant amount of income in Year 2.
To the extent that Mr X repays what he can, being ZAR5.5 million, to the company in Year 2, he would be entitled to a tax deduction of this amount. However, where he paid no tax to SARS during Year 2, he would not be entitled to apply his erstwhile tax deduction of ZAR5.5 million in claiming a cash refund from SARS and Mr X would simply instead derive a tax loss of ZAR5.5 million that may be carried over to subsequent tax years. While the tax loss may be carried forward to be set off against income earned by Mr X in subsequent tax years, Mr. X will have to earn sufficient future income to be able to benefit from the deduction of the ZAR4.5 million tax previously paid by him.
From Company A's perspective, to the extent that Mr X does not earn any significant income again in his lifetime, no probable basis exists for the ZAR4.5 million ever to be recovered from Mr X, other than seeking to sequestrate him. (Depending on the facts, he may never have been recalcitrant in any way and may have previously been a loyal servant of the company).
An anomalous issue exists in that had Mr X earned sufficient income in Year 1 to repay the ZAR10 million to Company A, he would have managed to recover the full amount of tax previously paid to SARS in Year 1 (as PAYE) and all the parties (including SARS) would have been satisfied with the outcome. This is because he would be entitled to claim the ZAR10 million paid back to Company A as a deduction against his taxable income of ZAR10 million, in respect of which ZAR4.5 million tax was paid to SARS. In practice, these issues unfortunately seldom manifest themselves in the same year in which the bonus was required to be repaid by the executive.
We argue that this is an untenable scenario which is easily remedied in a way that is unlikely to burden the fiscus materially.
We propose that a provision be introduced to allow an executive's employer (Company A in the above example) to lodge an application with SARS that would enable the employer to claim a refund directly from SARS of the tax that was previously paid by the executive in a tax year prior to the tax year in which the executive repays the money to his/her employer.
To avoid manipulation (which in any event is highly unlikely), it is submitted that an amount of the tax that was previously paid should be repaid by SARS to the employer pro rata to the amount of after-tax earnings that the individual actually pays back to his/her employer. The fact that the executive paid tax on the amount that now has to be repaid to the employer should be easily proved.
So, for example, if Mr X repays ZAR5.5 million to Company A (i.e. 100% of the after-tax amount paid to him), SARS should be required to repay 100% of the tax withheld directly to Company A. i.e. ZAR4.5 million. However, if Mr X only repays, say, ZAR2.75 million (50% of the after-tax amount he received) to the employer, then SARS should only be obliged to repay ZAR2.25 million to Company A.
We believe this would be a workable remedy which would enable the executive to meet his/her obligation to repay to his/her employer the full remuneration previously earned, while ensuring that the fiscus is not unwittingly enriched at the expense of the executive or his/her former employer.