Employer-owned disability benefit policies: Impact of amendment to section 11(w) of the Income Tax Act
What is section 11(w)?
Section 11(w) of the Income Tax Act specifies the criteria that an employer-owned policy has to adhere to in order for the premiums to be tax deductible in the hands of the employer. This includes premiums paid by the employer under employer-owned disability benefit policies.
Why was 11(w) amended and when is the amendment effective?
Section 11 (w) was amended in November 2010, with the main aim being the removal of the favourable tax dispensation with regards to deferred compensation arrangements through employer owned policies. The effective date of this change is the first day of the employers first tax year commencing on or after 1 January 2011.
What is the impact of the change?
One of the subsequently identified knock-on effects of the change is that premiums paid by the employer on employer-owned disability policies are no longer deductible by the employer. It now has to be taxed in the employees hands as a fringe benefit.
However, the portion of premiums pertaining to the employer waiver of retirement fund contributions will still be deductible by the employer under 11(w) and not taxed in employees hands. ASISA, the Association of Savings and Investments in South Africa, engaged with Treasury on 25 November 2010, where it was agreed in principle to change the Act, as the impact on disability policies was an anomaly that had to be addressed. No written correspondence has, however, been issued in this regard.
What are the potential solutions?
For employers there are two options available:
Option 1: Tax the premiums as a fringe benefit in the hands of the employee
Include the employer premiums (excl. waiver) in the employees income as a fringe benefit. The waiver component still remains deductible in the hands of the employer and is therefore not taxed in employees hands. For example, if the premium is R10 and the waiver portion is R1, then R9 will be taxed as a fringe benefit in the employees hands and the R1 is tax deductible by the employer.
The employers benefit consultant will have to advise the employer as to the portion of the premium that is in lieu of the waiver. If there is no waiver in place, then the full premium will be taxed as a fringe benefit in the hands of the employee.
Please liaise with your payroll administrator or auditor to assist you with the actual implementation.
Option 2: Amend employment contract
Restructure employees service conditions, making it the employees responsibility to pay the premiums (excl. waiver). Also, policy wording and retirement fund rules will need to be amended where necessary.
From a “time” effect point of view, option 1 may be the easier solution to ensure compliance over the short term. Should the Act be amended in the near future, further action may be required. We undertake to keep you informed as to developments in this regard.