Legislation

Taxation of lump sum benefit

Before October 2007, the calculation of the tax free portion of a lump sum payment was quite complex. The amount was calculated in terms of two formulas.

(Formula A & B under the Second Schedule of the Income Tax Act)

Tax free

According to these formulas, the tax free amount was determined by the number of years a person was a member of the fund or his average salary of a pre-determined period.

Taxable portion

The tax on the taxable portion, i.e. what was left of the lump sum after the tax free portion was deducted, was then determined using the "average rate of tax".

Amendments

Even though the calculation of the tax free amount was simplified, it will only effect lump sums accruing to tax payers from 1 October 2007. All other lump sums should still be dealt with using the "old" formulas as discussed.

Both the old and new formulas distinguish between:

• Benefits payable on death
• Benefits payable on retirement
• Benefits payable on withdrawal or resignation.

It is therefore still crucial to distinguish between the above to ensure that the correct formula is used.

Lump sums - Benefits payable at death and retirement

Tax free portion

With effect from 1 October 2007, Formula A has been repealed and Formula B was simplified. As a result, the tax free portion of the lump sum paid by a pension fund, provident fund or retirement annuity fund is now calculated in terms of only one formula:

Z = C + E - D 

C = R 300 000

E = Own contributions which were not allowed as a deduction plus any tax-free public
     sector portion previously transferred to the fund.

D = Previous deductions against lump sum benefits

Taxable portion

The taxable portion of the lump sum i.e.

Total Lump sum less Z

Is included in the deceased tax payer's gross income and then transferred directly to the taxable income where it is ring fenced against other deductions, exemptions and losses.

The tax payable on the lump sum is calculated in terms of a separate scale of rates without taking rebates into account.