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This article was first published in the second-quarter 2013 edition of Personal Finance magazine.

Medical expenses and contributions to medical schemes consume a sizeable portion of most personal budgets, so it’s important to understand how such costs are treated when it comes to taxation. In light of numerous changes to tax law in regard to medical expenses, it’s worth a recap to ensure that you are claiming correctly in your tax return.

Conversion to a tax credit system

There has been considerable media coverage of the proposal to convert medical expenses from a deduction from taxable income (section 18 of the Income Tax Act, which makes provision for a medical expense allowance) to a reduction of tax liability by way of a tax credit. The significance of this is that a tax deduction reduces the income on which your tax is based, whereas a tax credit reduces the amount of tax you have to pay. A deduction increases with your marginal rate of tax, but a credit is set at a specific rate.

In the meantime, some taxpayers will remain on the tax allowance system, whereas others will move onto a hybrid allowance/tax credit system.

Table 1 (link at the end of this article) sets out how medical expenses will be treated in the 2012/13 tax year (for which you will have to submit your return in the not-too-distant future) and compares this with the previous tax year and with the regime proposed for the 2014/15 tax year. The treatment differs according to the status of the taxpayer.

For taxpayers who will be 65 years of age or older on the last day of the 2012/13 tax year (that’s February 28, 2013 for most taxpayers), the tax allowance remains the same as it was in previous years, and there is no restriction on the amount of qualifying contributions to medical schemes and medical expenses that may be claimed. This treatment will change to a tax credit system with effect from March 1, 2014 (the 2014/15 tax year), as set out in Table 1.

Disability-related expenses

A separate category of allowances and credits applies where the taxpayer, or his or her spouse, or his or her child, suffers from a disability. It is important to note that “spouse” and “child” are defined in such a way that this category is broader than you might expect.

A “spouse” is a partner:

* Recognised in a marriage or customary union under South African law; or

* In terms of a union recognised as a marriage in accordance with any religion; or

* In a same-sex or heterosexual union that the South African Revenue Service (SARS) is satisfied is intended to be permanent.

A “child”, for the purposes of medical expenses, covers the children of both the taxpayer and the taxpayer’s spouse (so the child need not be the taxpayer’s child). To qualify, the child must:

* Have been unmarried and 18 years of age or younger on the last day of the tax year; or

* Have been unmarried and 21 years of age or younger on the last day of the tax year, if he or she was at least partially dependent on the taxpayer for maintenance and not personally liable for tax; or

* Have been unmarried and 26 years of age or younger on the last day of the tax year, if he or she was at least partially dependent on the taxpayer for maintenance, not personally liable for tax and a full-time student; or

* Be unable to maintain him- or herself because of a disability, and at least partially dependent on the taxpayer for maintenance and not personally liable for tax.

Adopted children are also covered, provided they fall within one of the above categories. A foster child or a child under your custodianship does not qualify. However, such children may still qualify as your dependants. The distinction is important, because it determines the category of allowances/credits that applies to you:

* A disabled child will qualify the taxpayer for the disability category of allowances/ credits.

* A taxpayer under 65 years of age with a dependant who has a disability (as opposed to a child with a disability) will fall into the least beneficial category for allowances/credits (the last category in the table).

For example, from the 2014/15 tax year, a taxpayer with a disabled child will receive a tax credit of 33.3 percent in respect of all the taxpayer’s qualifying expenses. Expenses in respect of a disabled dependant will create a tax credit only if the taxable income hurdle of 7.5 percent is met (that is, medical expenses exceed 7.5 percent of taxable income) and the credit will be at 25 percent, not 33.3 percent.

“Disability” means a moderate to severe limitation of the ability to perform daily activities as a result of a physical, sensory, communicational, intellectual or mental impairment. The condition must have lasted for, or have a prognosis of, greater than 12 months, and must be diagnosed by a registered medical practitioner.

SARS has prescribed diagnostic criteria for the assessment of the functional impact of disability that go beyond the mere diagnosis of a medical condition. The “Tax guide on the deduction of medical, physical impairment and disability expenses – issue 3” has useful information about the criteria that must be met and the forms that must be completed (see sections 6.2 and 6.3). The guide is available on the SARS website, www.sars.gov.za. Go to the “All publications” section, scroll down to “Income tax” and then click on “more”. Note that the information in the guide is based on legislation as at June 6, 2011, so, although certain parts of it are still useful, not all sections are relevant, because the tax treatment has changed quite significantly for some taxpayers.

For the category of taxpayer with a disability, or whose spouse or child (as defined) suffers from a disability (as defined), the treatment for the 2012/13 tax year has changed from a pure allowance system to a hybrid allowance and credit system. Contributions paid to a medical scheme create a set tax credit that reduces the final tax payable.

In addition to this credit, a deduction may be claimed to the extent that the taxpayer’s medical scheme contributions exceed four times the tax credit. All other qualifying medical expenses may also be claimed as a deduction against other taxable income. This treatment will change to a full tax credit system with effect from the 2014/15 tax year, as set out in the table.

Calculation for under-65s

For taxpayers who are younger than 65 years of age and do not fall into the disability category, the deduction/credit is more limited. The treatment for the 2012/13 tax year has also changed from a pure allowance system to a hybrid allowance and credit system.

Contributions paid to a medical scheme create a set tax credit that reduces the final tax payable. In addition to this credit, a deduction may be claimed against taxable income in certain circumstances:

Step 1. Calculate your taxable income, excluding the medical expenses deduction and also excluding any lump sum benefits from retirement funds. Multiply this by 7.5 percent, which is the tax hurdle.

Step 2. Determine whether, and by how much, your medical scheme contributions paid during the year exceeded four times the credit allowed for these contributions.

Step 3. Add any other qualifying medical expenses to the excess determined in Step 2.

Step 4. If the expenses in Step 3 exceed the 7.5 percent of taxable income calculated in Step 1, the excess will qualify as a deduction.

This treatment will change to a full tax credit system with effect from March 1, 2014.

Qualifying contributions

The medical scheme credits and allowances apply only to natural persons. In addition, only amounts actually paid during the tax year qualify. If the expenses are incurred during the tax year but are paid in the following tax year, such expenses must be taken into account only in the later year in which payment takes place.

Only contributions to medical schemes registered under the Medical Schemes Act of 1998 qualify. If contributions are made to an offshore fund, such fund must be registered in terms of similar legislation in the offshore jurisdiction. The contributions must be made by the taxpayer in respect of either the taxpayer, his or her spouse (as defined, see above) or any “dependant”.

“Dependants” for the purposes of medical scheme contributions are defined in the Medical Schemes Act as:

* The spouse or partner, dependent children or other members of the member’s immediate family in respect of whom the member is liable for family care and support; or

* Any other person who, under the rules of a medical scheme, is recognised as a dependant of a member.

The definition is fairly wide and could include, for example, payments made for your parents if they are dependent upon you for support. Such contributions could be to your own medical scheme if your parents belong to your scheme, or to a different scheme if, for example, you pay the contributions on your parent’s behalf to a scheme of which he or she is a member.

Expenses other than contributions

A number of expenses qualify provided they have been paid by the taxpayer during the tax year and are not recoverable by the taxpayer or his or her spouse. Such expenses include amounts paid to:

* Medical practitioners, dentists, optometrists, homeopaths, naturopaths, osteopaths, herbalists, physiotherapists, chiropractors and orthopaedists for services and medicines. These practitioners are required to be registered in order for the expenses to qualify.

* Nursing homes, hospitals, registered or enrolled nurses and midwives.

* Pharmacists for medicines supplied on prescription by any of the abovementioned practitioners.

The expenses must have been paid for services rendered or medicines supplied to the taxpayer, his or her spouse, his or her children, or any dependant of the taxpayer. The definition of “children” above applies here, too.

The definition of “dependant” for purposes of medical expenses (as opposed to medical contributions) is slightly different. “Dependant” here means:

* The taxpayer’s spouse;

* The taxpayer’s child;

* A child of the taxpayer’s spouse;

* Any other member of the taxpayer’s family for whom the taxpayer is liable for family care and support; and

* Any other person who is recognised as a dependant of the taxpayer in terms of the rules of a recognised medical scheme.

In most cases, the two different definitions of “dependant” should give rise to the same result. However, with modern families it is possible that anomalies may arise, so if you are a taxpayer and support an extended family, take note.

In the 2011/12 tax year, such expenditure would have created an allowance only if the dependant was admitted as a dependant of the taxpayer in terms of the taxpayer’s medical scheme. So, for example, a parent dependent on the taxpayer for maintenance and support who was a member of a medical scheme other than the taxpayer’s scheme would not have qualified, even if the taxpayer was funding all of that parent’s medical and attendant expenses. This has been relaxed from the 2012/13 tax year so that any dependant of the taxpayer now qualifies, regardless of the rules of the medical scheme. The expenses and the test of dependence on the taxpayer stand alone, so, for example, neither the taxpayer nor the parent/ dependant need even belong to a medical scheme.

Expenditure incurred outside South Africa also qualifies, provided the other requirements are met – in other words, the payments must have been made during the tax year, not be recoverable, be for ser-vices or medicines supplied to the taxpayer, spouse, child or dependant, and so on.

Physical impairment expenses

A further category of expenses qualifies for a deduction. This is expenditure necessarily incurred and paid by the taxpayer, and not recoverable by either the taxpayer or his or her spouse, as a result of any physical impairment or disability suffered by the taxpayer, his or her spouse or child or any dependant of the taxpayer.

“Physical impairment” extends beyond the conditions described and defined as a “disability”. It includes, for example, problems with eyesight or hearing, dyslexia and hyperactivity.

If the taxpayer, spouse and/or child do not meet the disability criteria, expenses relating to physical impairment may still be claimed but will be subject to deduction limits – for example, the hurdle of 7.5 percent of taxable income. (If, however, the taxpayer is 65 years of age or older, there should be no limit on the deduction for the tax years 2012/13 and 2013/14. In the 2014/15 tax year, expenses relating to physical impairment will be eligible for the tax credit of 33.3 percent.)

The “List of qualifying physical impairment or disability expenditure” effective from March 1, 2012 can be accessed on www.sars.gov.za. Go to the “All publications” section, scroll down to “Income tax (legal & policy)” and then click on “more”.

Expenditure related to disability

Certain expenditure that arises as a result of a disability may be eligible for a deduction/credit, even though it is not medical expenditure, provided it is necessary for alleviation of the disability in question. This expenditure is prescribed by SARS in the “List of qualifying physical impairment or disability expenditure” referred to above. Examples include a care-giver employed to assist a disabled person, even though the care-giver may not be a registered medical practitioner, and insurance taken out for, or maintenance or repairs to, medical equipment required by a disabled person.

If the taxpayer, the taxpayer’s spouse, the taxpayer’s child or the child of the taxpayer’s spouse has the disability, the amount of the allowance/credit is as set out for the disability category (see Table 1). Currently, such expenditure is deductible in full. From the 2014/15 tax year, it will give rise to a tax credit determined at 33.3 percent of the expenditure.

However, if it is the taxpayer’s dependant, other than a spouse or a child, who has the disability, the tax relief is less generous. In the 2011/12 tax year, such expenditure would have created an allowance only if the dependant was admitted as a dependant of the taxpayer in terms of the taxpayer’s medical scheme. So, for example, a disabled parent who was a member of a medical scheme other than the taxpayer’s scheme would not have qualified, even if the taxpayer was funding all of that parent’s medical and attendant expenses.

This has been relaxed so that any dependant of the taxpayer now qualifies, regardless of the medical scheme. However, the amount of the allowance/credit is calculated under the least beneficial category, with the hurdle of 7.5percent of taxable income to be overcome before tax relief applies. (Unless the tax-payer – note, not the disabled person – is 65 years or older, in which case the full deduction applies in the 2012/13 and 2013/4 tax years and the 33.3-percent tax credit treatment from the 2014/15 tax year.)

Admin and other matters

As with all other allowances, you must retain adequate records to support the deductions and/or credits. These include:

* Proof of contributions paid to registered medical schemes;

* For salary earners, the contributions may be reflected on the employee’s tax certificate (IRP5);

* A statement from your medical scheme setting out the total of claims submitted by you to the scheme that were not refunded to you or paid directly by the scheme to the service provider;

* A comprehensive list of expenses not submitted and not recoverable from your medical scheme, covering medical expenses, physical impairment expenses and expenses concomitant with disability, if applicable; and

* Duly completed and signed “Confirmation of disability” (ITR-DD) forms, if applicable. These forms are available on the SARS website. Go to the “All publications” section, scroll down to “Income tax (legal & policy)” and then click on “more”.

The tax treatment of medical expenses is complex and can be confusing. When completing the income tax return, SARS does most of the difficult calculations. However, when submitting the data on which SARS bases the calculations, it is important to ensure that you enter the correct data in the correct categories. These change from year to year, so it is important carefully to follow the guide that accompanies the tax return.

If you are contemplating a significant elective procedure, you may wish to maximise your tax relief by scheduling it for the tax year that will be most beneficial to you. Most medical expenses are, however, unplanned and unwelcome. My best tax planning advice is that you reduce your medical costs as much as possible by taking care of your health.

* Kari-Ann Lagler is a registered tax practitioner and independent tax consultant.