WHEN IS AN ANNUITY NOT AN ANNUITY? Cape Tax Court (ITC 1797 (2005) 67 SATC 377)

Abstract

The decision of the Cape Tax Court in ITC 1797 (2005) 67 SATC 377, upheld on appeal by a full bench of the Cape High Court sub nom CSARS v Higgo (2006) 68 SATC 278, throws new light on the nature, for tax purposes, of an “annuity” and the taxability of the returns on an amount invested by a person in a typical so-called “living annuity”. The usual terms of a “living annuity” – as exemplified by the facts of this case – are that the investor pays a financial institution a lump-sum and, in return, is entitled to withdraw, in each year, not less than 5% and not more than 20% of the amount invested, until such time as the capital amount and interest is exhausted. If any capital remains when the investor dies, then his rights to the residue pass to his heirs, who can withdraw in the same way until the capital and interest have been exhausted.
In this case, SARS argued that the monthly amounts paid to the taxpayer
in terms of the “living annuity” in question were indeed an “annuity” for
income tax purposes, and were therefore taxable as such in his hands.
At first instance, the Cape Tax Court had held in ITC 1797 (2005) 67
SATC 377 that the amounts, paid under the living annuity in issue, were not
an “annuity” for income tax purposes, and that what was repaid to the
taxpayer, month by month, were part-repayments of the initial capital
investment plus interest. This finding was upheld on appeal by the Cape
High Court.
It follows that only the interest component of the monthly return on the
investment, derived by an investor in this particular arrangement, is subject
to income tax, bearing in mind that receipts and accruals of interest up to a
specified annual amount are exempt from tax; see section 10(1)(xv)(bb) of
the Income Tax Act 58 of 1962 (hereinafter “the Act”).