The South African Revenue Service recently published a draft Interpretation Note relating to the taxation of medical lump sums. Employers often provide various incentives to attract and retain employees with scarce skills. One form of benefit is to cover the medical aid contributions of former employees in retirement. This could be an expensive and risky exercise for a taxpayer as medical inflation may exceed general inflation, or a former employee’s chronic illness can be protracted.
In order to counter such a risk, taxpayers may seek to settle this liability upfront. Two common approaches to settling liabilities upfront are:
- to make a lumpsum payment to an insurer for a policy of insurance; or
- to make a direct lump-sum payment to the former employee or dependant.
Depending on the facts, the taxpayer may shift their contractual responsibility to provide post-retirement medical benefits to the insurer, former employee, or dependant. Previously, the tax treatment of a lump sum paid by a taxpayer to cancel the obligation to provide for the post-retirement medical benefits of a former employee was uncertain and arguably not deductible. Since the introduction of section 12M, a taxpayer can claim an immediate deduction of a lump sum payment made for purposes of covering the post-retirement medical aid contributions of a specified former employee or dependent.
A deduction under section 12M will be available if the lump sum is paid by the taxpayer during the taxpayer’s year of assessment in the course of the taxpayer’s trade to:
- any former employee who retired from the taxpayer’s employment on the grounds of old age, ill-health or infirmity or any dependant of such former employee, or
- to an insurer under a policy of insurance taken out solely in respect of one or more of the above-mentioned former employees or their dependants.
Importantly, the purpose of making the lump sum payment is to enable the former employee or their dependants to make a contribution to a specified medical scheme or a specified medical scheme fund.
The deduction is limited to the extent that the lump sum payment is for the purpose of making a contribution to a specified medical scheme or medical scheme fund in respect of the above-mentioned former employee or dependant.
This article is a general information sheet and should not be used or relied upon as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice. Errors and omissions excepted (E&OE)
