Making sense of your IRP Part 3: How to make sure you get lump sum tax deductions

Steven Jones - Moneyweb Tax

Did you receive a lump sum payment during this tax year? The classification code is critical.
Many an objection has been submitted to the South African Revenue Service (Sars) regarding the incorrect taxation of lump sums, and often this is due to the payment being disclosed against the incorrect code. Because the tax treatment of lump sums is so varied, having them coded correctly is critical.

3901 - Gratuities. These payments normally arise when an employee retires or is retrenched, and the amounts that can be classified as a "gratuity" are many and varied. In the case of a retrenchment, such a gratuity would normally include any severance pay forming part of the retrenchment package, while on retirement, the amount can be an actual gratuity paid (the cash equivalent of the traditional gold watch, perhaps?).

In both cases, accumulated leave pay is often included as part of the gratuity in order to take advantage of the preferential tax rates, whereas in the case of a resignation this is normally included with normal income.

The main tax benefit of a gratuity is that there is a "once-in-a-lifetime" tax-free amount of R30 000, with any balance being taxed at average rates.

3902 - Pension / RAF lump sums (resignation / transfer / surplus apportionment). Amounts included under this code comprise cash withdrawals from approved pension or retirement annuity funds (RAFs) upon resignation. Also included are transfers to non-approved funds or provident funds, as well as lump sums arising from pension fund surplus apportionments taken in cash. However, any such payments that are transferred to another approved fund should not be included under this code, since these transfers do not attract tax.

For the 2008 tax year, the first R1 800 of lump sums arising from withdrawal is tax-free, with the balance taxed at average rates. Currently under discussion is a proposal to allow a "once-in-a-lifetime" tax-free amount of R23 000 (based on 50% of the tax-free threshold in 2008/09), and the balance ring-fenced and taxed according to the tables.

3903 - Pension / RAF lump sums (retirement / death). In this case, the tax treatment is vastly different, which means that it is critical that codes 3902 and 3903 are not used incorrectly. There is a "once-in-a-lifetime" tax-free amount of R300 000, with the balance taxed on a sliding scale. For most people, these rates are far more preferential than for lump sums accruing on resignation.

3904 - Provident fund lump sum (resignation / transfer / surplus apportionment). The tax treatment for provident lump sums on retirement is similar to that of pension funds. However, since employee contributions are normally not tax-deductible, the repayment of such contributions is tax-free. Such employee contributions refunded should therefore not be included as part of the lump sum.

3905 - Provident fund lump sums (retirement / death). The tax treatment of provident lump sums on retirement or death has been harmonised with that of pension funds, except for the fact that as is the case with provident lump sums on resignation, any employee contributions previously disallowed are refunded tax-free, and are therefore not included as part of the lump sum.