Tax and income protection policies

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In South Africa, employees (as defined in the Fourth Schedule to the Income Tax Act), are generally very limited in the extent to which they can claim tax deductions against their employment income.  The reason for this is that section 23(m), which applies where a person derives income mainly from remuneration (i.e. by virtue of employment with an employer), allows very few tax deductions against this type of income (remuneration).

The Taxation Laws Amendment Act No. 43 of 2014 which was promulgated on
20 January 2015 has now further limited the tax deductions available to employees with effect from 1 March 2015, by deleting the deduction that was available for premiums paid in respect of income protection policies.

Prior to 1 March 2015, an employee could deduct the premiums that he or she contributed to an income protection policy if the policy insured that person against the loss of income as a result of illness, injury, disability or unemployment and, upon subsequent pay-out of the policy, the proceeds which constitute income as defined (i.e. not capital in nature and not exempt).

In the Explanatory Memorandum to the Taxation Laws Amendment Act No. 43 of 2014, the drafters of the legislation make it clear that according to Treasury there is essentially no difference between capital protection plans (where a person is insured against the loss of his or her income earning capacity) or income protection plans (where a person is insured against the loss of future income) and that both these type of plans are of a personal nature.  In the case of a capital protection plan no deduction of the premiums will be allowed in terms of the general deduction formula (section 11(a) read together with s 23(g) of the Income Tax Act) as it is capital in nature.  However, when the capital protection policy pays out, it will be tax-free as it won’t fall within the gross income definition contained in section 1 of the Income Tax Act due to the fact that it is capital in nature.

Therefore, with effect from 1 March 2015, subparagraph (iii) of section 23(m), which allowed individuals to deduct contributions they made to income protection policies, has been deleted.  In addition, section 23(r) has been introduced (also with effect from 1 March 2015) which explicitly denies a deduction in respect of any premium paid by a person in respect of an insurance policy (including income protection policies) that covers against illness, injury, disability, unemployment or the death of that person.

However, it is not all bad news. When an individual receives a pay-out in terms of an income protection policy, the proceeds will be included in the gross income of the individual (by virtue of the gross income definition contained in the Income Tax Act) but that person will then qualify for an exemption of the full amount in terms of section 10(1)(gI) of the Act.  All future policy pay-outs (in respect of income protection policies) will therefore also be tax-free.