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Circular reference problem rears its head in new Taxation Laws Amendment Bill

Circular reference problem rears its head in new Taxation Laws Amendment Bill
Photo by Bloomberg

2nd September 2014


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The draft 2014 Taxation Laws Amendment Bill (TLAB) brings with it some important proposed changes to the formula that employers use to calculate the fringe benefit value of their contributions to employees’ defined benefit funds. The TLAB raises the possibility of making incorrect payroll calculations in certain circumstances, unless legislators make changes to some of their formulas and definitions.

The current law

Under retirement reforms legislated in 2013, employer-paid contributions to a pension, provident or retirement annuity fund must be valued as a fringe benefit for employees with effect from 1 March 2015.

The retirement benefit value of a defined contribution fund is directly linked to the value of the employer-paid contribution (plus growth and minus expenses). As such, the fringe benefit value is specified to be equal to value of the contribution.

However, the value of the employer’s contribution to a defined benefit fund is not an accurate reflection of the employee’s retirement benefit value. The reason for this is that a defined benefit fund determines an employee’s retirement benefits according to a formula specified in the rules of the fund.

The employee’s benefit is usually based on the pooled contributions from all members of the fund, and also takes into account factors such as the employee’s last (or average) pensionable salary and years of service. To cater for this, the 2013 legislation stated that the value of the fringe benefit (‘X’) should calculated according to the following formula:

X = Y × ((A × AF) + (L × LF))

‘Y’ is the employee’s Retirement Funding Income (RFI) and the other variables are factors that reflect the annuity and lump sum accrual rate of the fund and the employee. 

However, as the Payroll Authors Group of South Africa pointed out, this formula requires that the rates and factors be transferred from the fund to the employer per member of the defined benefit fund every tax year. The volumes involved doing this for every member of the fund mean that this approach is impractical.

Proposed Law

Government has taken these concerns into account. In the new TLAB, the formula was changed to:

X = (A x B) - C


  • ‘A’ is the fund member category factor
  • ‘B’ is the employee’s RFI and
  • ‘C’ is the employee’s contribution to the fund.

This means that the 2014 formula consolidates the four accrual rates and factors of the 2013 formula into a single ‘fund member category’ factor applied per group of members (rather than for each individual member). This new formula is a vast improvement on the older one because it vastly simplifies an unwieldy formula. But there is a caveat.

Circular reference

Before I delve deeper into the catch in the 2014 formula, it is worth pointing out that the 2013 amendments introduced a new definition of RFI that differs from the current definition of Retirement–Funding Employment (RFE).

The current RFE definition includes the full value of the travel allowance and excludes the retirement fund lump sum benefit and retirement fund lump sum withdrawal benefits. The new definition of RFI is based on the full definition of remuneration in the Fourth Schedule without any special inclusions or exclusions.

In practical terms, this means that the fringe benefit raised on the contribution to the defined benefit fund is included in Fourth Schedule remuneration and can potentially be included in the value of RFI depending on the rules of the fund.  And if it is included in RFI, there will be a circular reference: B is used to calculate X, and X then changes the value of B, which in turn recalculates the value of ‘X’,  ad infinitum.

As such, the value of the fringe benefit X can never be consistent with the value of RFI B. This will have a knock-on effect on the employee’s total remuneration value and the various taxes that are calculated from remuneration.

Closing words

Of course, the fringe benefit value might be excluded from RFI by the fund’s rules. The issue for payroll suppliers is that there is no guarantee this will be the case. 

Since having a potential ‘circular reference’ in a payroll calculation on which PAYE and other taxes will be calculated is out of the question, the Payroll Authors Group of South Africa will report the problem to legislators in our comments on the TLAB.


Written by Rob Cooper, tax expert and Director of Legislation Updates and Proposed Legislation at Sage VIP Payroll & HR

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