On 6 November 2018, the South African Revenue Service (“SARS”) issued a binding private ruling (“BPR 312”) in accordance with sections 78(1) and 87(2) of the Tax Administration Act.[1] This ruling set out the tax implications of varying employment contracts.
Here the applicant (a resident company) previously entered a profit share arrangement with Mr X, who was entitled to nominate certain employees (of two 100% held subsidiaries of the applicant) to also benefit from this arrangement. The parties subsequently entered into a cancellation agreement to terminate the profit share arrangement and to allow for certain payments to be made by the subsidiaries to the nominee employees.
Although the payments (and the subsequent tax implications thereof in terms of the Income Tax Act[2]) seems standard for this type of agreement, the ruling neatly confirms these implications of each of these payments for both the subsidiaries and the employees.
Firstly, the subsidiaries would pay a pre-determined cancellation fee to the affected employees as compensation for cancelling the profit share arrangement, including payments to other employees pursuant to the cancellation agreement even though they were not applicants to the ruling or parties to the cancellation agreement. The ruling confirmed that both these payments were deductible for income tax purposes under the general deduction formula.[3]
Secondly, a cash portion was retained by the applicant to be released to Mr X in August 2021. This amount was treated as security for Mr X to comply with certain obligations he had in terms of these agreements. The cash portion will be forfeited if Mr X is dismissed prior to the date of release.
SARS confirmed that the cash portion was a pre-payment subject to section 23H in the hands of the applicant. Also, that both the cancellation fee and the retained cash portion should be included in the employees’ gross income.[4] Mr X will, however, qualify for a tax deduction should the amount be forfeited in terms of section 11(nA), which allows for a deduction of any voluntary award received by virtue of employment that was included in taxable income but is subsequently refunded.
Lastly, the cancellation agreement made provision for agreements that allowed for restraint of trade payments to be made to certain employees. The subsidiaries could deduct these amounts in terms of section 11(cA) while these payments were to be included in their gross income in terms of paragraph (cB) of the definition of “gross income” in section 1.
[1] No. 28 of 2011.
[2] No. 58 of 1962. Any subsequent references to “sections” are to the sections of this Act.
[3] Section 11(a) read with section 23(g).
[4] Paragraph (d) of the definition of “gross income” in section 1 which specifically allow for a payment as a result of a variation of employment.
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