Draft Taxation Laws Amendment Bill [B-2011]: Bendels Consulting, Palabora Mining Company, Webber Wentzel, PriceWaterhouseCoopers, Deloitte & Touche, and Ditikeni Investment Company submissions: public hearings

Meeting report

Introduction
Ms N Sibhidla (ANC) acted as Chairperson, on account of the absence of Mr T Mufamadi (ANC) who was involved in another meeting.  She welcomed delegates, Members and guests.

Bendels Consulting. Submission
Mr Eugene Bendel, Chief Executive Officer (CEO), Bendels Consulting, said that his firm was a niche tax law practice that specialised in the provision of tax law advice relating to healthcare. Accordingly, all comments made in this submission related to medical matters. Bendels Consulting was a wholly independent tax law practice and was not affiliated, formally or informally, to any special interest group(s) in the stated industry. His focus would therefore be on the implications for health care of the Draft Tax Laws Amendments Bill. 

Unless otherwise stated, all statutory references made below were to the Income Tax Act 1962 (Act No. 58 of 1962) as amended.

Definition of special trusts in Section 1 paragraph (a)
Mr Bendel examined the definition of special trusts in Section 1 paragraph (a). Such special trusts were created solely for a person with mental illness or a serious physical disability. With effect from 01 March 2009, there was a substantial change to Section 18 (3) of the Income Tax Act. This change replaced the old definition of handicapped persons. At the same time, however, the definition of a Special Trust in section 1, as contemplated in paragraph (a) of the said definition remained unchanged. It was submitted that the definition of a paragraph (a) Special Trust should be amended so as to align it with the definition of “disability” as contained in section 18(3).

Medical expense deductions (Section 18(1))
Notwithstanding section 23, section 18(1) allowed for the deduction of certain expenses (for the sake of convenience, here referred to as “qualifying medical expenses”) by any taxpayer who was a natural person.

It was common cause that road accident fund settlements (among other claims such as medical malpractice, negligence, workmen’s compensation claims etc.) were placed in trust in order to protect the natural person.  It followed from this that there were two parts to this issue:
1) maintaining, growing and/or sustaining the value of the assets for as long as is practically possible while at the same generating sufficient income, and
2) minimising the expenses of the trust.

It was clear that both (1) and (2) above should be consistent so as to allow the natural person to achieve an acceptable net after tax result.

The proposed change to the exemption of annual receipts from the Road Accident Fund (RAF) (2.8 of the Bill's explanatory memorandum) should provide some assistance in addressing after tax income receipts.

Mr Bendel submitted that substantial concerns arose regarding the tax deductibility of qualifying medical expenses.  As a natural concomitant, trusts created for “disabled” persons by their very nature incurred and paid substantial amounts of qualifying medical expenses. Yet such qualifying medical expenses, as a matter of current tax law, were not tax deductible in accordance with the provisions as set out in Section 18.  It was clear from the wording of Section 18(1) that only natural persons were entitled to tax deductions by virtue of Section 18.

In the circumstances described above, it was submitted that the tax treatment was anomalous.  An amendment to the Section 18 was respectfully requested in order to redress the clear and unfettered imbalance which existed at present. The alternative of having a curator bonis was in most cases not a viable and/or constructive long-term option. There were a number of permissible tax planning ways in which to ensure tax equality. However, the costs involved in implementing such plans would be done to the financial detriment of the natural person.

An amendment should therefore be made to the pre-amble of Section 18(1). In full recognition of tax abuse, due care and consideration would need to be given prior to introducing any such amendment and Bendels Consulting would be glad to add further input on this for consideration by Parliament.

Section 18(1) (d)
Section 18(1) (d) had become a big issue over the past few years. The South African Revenue Service (SARS) issued for public comment, a List of Qualifying Physical Impairment or Disability Expenditure (the “First Prescribed List”). Even though the First Prescribed List became effective from 1 March 2009, the First Prescribed List was only made available to the public for comment several months after 1 March 2009. The due date for submission of public comments was in October 2009 yet the First Prescribed List became effective as of 1 March 2009.

SARS issued a new Prescribed List (the “Second Prescribed List”). The Second Prescribed List was due to become effective from 1 March 2011 but it was not yet in the public domain.

The Second Prescribed List was only issued to stakeholders (it was noted here that Bendels Consulting was not a stakeholder) on 13 May 2011. Stakeholders were given less than one month to submit comments on the Second Prescribed List despite the fact that it was due to become effective from 1 March 2011.

There were changes and major issues concerning the Second Prescribed List. It was unanimous from the various stakeholders and affected taxpayers spoken to and corresponded with (and in his own opinion) that any Prescribed List could not and must not be all inclusive and/or exhaustive. The pace at which modern medical science was developing meant that a historic, or retrospective, list of expenditure could and should only be used as a broad guide. The implementation of any new Prescribed List should be deferred until all stakeholders and the public had had sufficient time to reflect on all relevant matters. The matters were complex in tax law as well as medical science. It was noted that stakeholders and affected taxpayers (and in many cases even their tax law advisors) were not always well placed to comment on tax law matters relating to medical issues and the implications thereof.

Section 18(2) (b)
As noted above, the “old” (more limiting) definition of “handicapped person” was repealed and replaced by the new definition of “disability” in Section 18(3).

The consequence for tax purposes of a taxpayer, his or her spouse or child having a “disability” as defined in Section 18(3) was that all qualifying medical expenses were tax deductible by virtue of section 18(2)(b).

An issue that arose for many taxpayers was where guardians and/or siblings were supporting the person with the Section 18(3) “disability”. For example, the person with the “disability” might be 50 years old and both his/her parents deceased or unable to provide any financial support. In these cases, Section 18(2)(b) did not provide the same relief to the guardians or siblings as Section 18(2)(b) was clear in its ambit that it only applied to the taxpayer, his or her spouse or child with a disability.

Mr Bendel submitted that this might have been an unintended oversight on the part of Parliament and/or not considered when the law was implemented. In any event, he asked Parliament to make a change to the Bill, which he believed was anomalous.

Seventh Schedule
Paragraph 12A
Broadly, paragraph 12A(1) provided for all medical aid contributions paid by an employer on behalf of an employee to be taxable as a fringe benefit in accordance with the Seventh Schedule.

But, sub-paragraph 5(d) of paragraph 12A provided that no value should be placed on the on the benefit where the person was entitled to a rebate under Section 6(2)(b). A person was entitled to rebate under Section 6(2)(b) if he or she was over the age of 65.

Paragraph 12B
Similar to paragraph 12A(1), paragraph 12B(1) provided for a fringe benefit to accrue where medical costs were paid by an employer, directly or indirectly, in respect of an employee, his or her spouse or child or other relatives or dependants.

As in paragraph 12A above, no value should be placed on the benefit where the person was entitled to a rebate under section 6(2)(b)–sub-paragraph 12B(3)(b)(iv).

Rationale for paragraph 12A and 12B exclusions
The rationale for the exclusion from fringe benefits tax for persons over the age of 65 was considered sound. The reason for this submission was that the inclusion of the amounts as fringe benefits under the Seventh Schedule would have no net tax effect (apart from timing). This was because all qualifying medical expenses for taxpayers over the age of 65 were tax deductible by virtue of Section 18(2)(a).

The point at issue was that all qualifying medical expenses were also fully tax deductible by virtue of Section 18(2)(b) i.e. where a Section 18(3) “disability” existed.

The above situation was anomalous as a matter of law and Parliament was respectfully requested to review and amend this. With due respect and concern to taxpayers over the age of 65, Mr Bendel submitted that the changes which should be made were the deletion of paragraphs 12A(5)(d) and 12B(3)(b)(iv) to the Seventh Schedule.

The above submission was respectfully made due to the complexities of the Prescribed List and the potential for abuse. Employers, in his experience, were reticent to get involved in personal medical tax matters for their staff. Additionally, the Prescribed List was not something employers were familiar with. The tax benefit (albeit timing in nature) may additionally result in discriminatory issues where employees had “disabilities” or a “disability” within the family.

Mr Bendel trusted and hoped that the engagement process and invitation extended to all members of the public would result in a fairer tax system for all South Africans and South Africa.

(Please see attached document for the full and definitive content of Bendels Consulting's submission.)

Palabora Mining Company Ltd (PMC). The effect of suspending section 45 on PMC's BEE transaction Mr Keith Mathole, General Manager: Corporate Affairs, Palabora Mining Company Ltd (PMC, the Company) gave a presentation that was brief and on the effect of suspending Section 45 of the Income Tax Act on PMC's Black Economic Empowerment (BEE) transaction. He gave a background to the PMC and the BEE transaction itself, the consultation process which PMC had followed, and concluded with the submission.  The key points were that the BEE transaction enabled a meaningful economic benefit to the historically disadvantaged South African including the communities of the Phalaborwa area and the employees of the Company, which had tried to make the transaction as broad-based as possible. The transaction structure had sound commercial reasons. It was not a tax avoidance scheme, and, moreover, was fully taxable, so there would be no tax loss to South Africa. The suspension of Section 45 would result in a tax charge to the Company which would not be financially feasible for the transaction. The Company was first formed in 1956 in Phalaborwa area in Limpopo and had been listed on the Johannesburg Stock Exchange (JSE) for many years. The company extracted copper and was the major producer of refined copper as well as vermiculite and magnetite. It employed 2 500 permanent staff, plus 1 500 contractors. Of the 2 500 permanent staff 79% were historically disadvantaged South Africans (HDSAs). The market capitalisation of the Company was R6.1 billion (not dollars). Its generated revenue of R7 billion in the 2010 financial year realised a profit of R595 million. The historically disadvantaged South African equity participation was a requirement of the Broad-Based Socio-Economic Empowerment Charter for the South African Mining and Minerals Industry (Mining Charter). It was therefore a business imperative for PMC to secure a conversion of its old mining rights to new order mining rights under the Minerals and Petroleum Resources Development Act, 2002. One of the requirements for the Company to receive the conversion was to place a transaction introducing HDSAs into the Company. The Company had followed a very extensive consultation process beginning in 2008 with consultation of all the communities in the locality, the employees through the unions and the other BEE partners.

Mr Mathole showed Members a diagram illustrating the structure of the transaction (slide 5). Currently, the PMC operated and was listed on the JSE; it had incorporated a new company called Palabora Copper and it was through this that the HDSAs would be introduced into the Company. So both PMC and the partners would subscribe to shares in Palabora Copper at a nominal amount. The PMC would retain 74% of Palabora Copper, while the three BEE partners would own 26%: 10% to the communities; 10% to all employees; and 6% to the BEE consortium.

Essentially PMC would transfer all its assets and liabilities down to Palabora Copper, and there would be an inter-company loan that Palabora Copper would have to repay to PMC over a period which was interest-bearing and the loan would be repaid through the cash flows generated by the business and based on the current consensus pricing the loan would be repaid over approximately the next two years, which was very good for the BEE partners.

Mr Mathole emphasised that there would be no tax loss to South Africa (slide 7). As Palabora Copper would be fully geared it was able to issue shares to BEE partners at a nominal amount or negligible cost. This enabled the empowerment partners to become shareholders without raising funds. It created a stable structure and value for the BEE partners from the beginning. The empowerment partners would have full voting rights from the beginning and the same class of shares as PMC in the newly created company Palabora Copper. Therefore the structure was not dependent on strong growth in the listed share price or the interest rate. It was, the PMC believed, a sound commercial transaction.

If PMC were to go outside and the structure was funded by a third party, the third party would have required the Empowerment Partners to raise R6.1 billion of debt. A structure at the level of PMC was considered inappropriate as it would have required a finite term and it was also dependent on the future price of PMC shares on the stock exchange. The commercial attributes of the structure and of the empowerment partners enabled the economic benefits to flow through to the partners. The price would be transparent. It would be based on the PMC's current share price. There would be full voting rights from day one for the BEE partners and a minimum dividend of R28 million annually increasing by inflation from the first day; the BEE partners would also be represented on the board of directors.

Members were given a picture of community participation in Palabora (slide 11). There were five communities in the area that represented approximately 80% of the population of Palabora. The population of Palabora was between 120 000 and 150 000 people. Communities would own the 10% through a community trust and they would receive dividends from the Company. The community portion of the dividends had been guaranteed. Again the employees would also own 10% through an employee trust, in which all the employees would participate in the transaction except present and future expatriates and the CEO. Dividends would be received from Palabora Copper and would be distributed equally to employees, without regard to position, seniority or union affiliation. All employees would benefit directly as beneficiaries.

The PMC had engaged in robust consultation with the communities and the consortium. In February 2009 it engaged the trade unions–the National Union of Mineworkers (NUM) and Solidarity. The communities as well as the BEE consortium had engaged their own lawyers to represent them in the transaction agreements representing all three parties. The communities also appointed their own financial advisor in 2008 to represent their interests in the transaction. The transaction agreements were prepared and negotiated and signed on 10 June 2010.

The outstanding conditions of the transaction would be fulfilled shortly and the transaction was about to be implemented. As a result, the suspension of Section 45 would impact negatively and PMC would incur costs. The transaction was fully taxable. If Section 45 was suspended PMC would therefore pay tax on the R6 billion price in terms of the transaction that would have no loss to the South Africa’s tax revenues and was aimed at broad-based empowerment and bringing broad-based empowerment partners into the Company. The PMC did not believe that this legislation was designed to halt such transactions. The tax charge was not financially feasible for PMC or its empowerment partners. Since the release of the draft Bill, PMC's shareholders had been gravely concerned and PMC's shares had lost value heavily in the previous week, given the uncertainties that the Bill was creating on the PMC transaction itself. The PMC had engaged in a vigorous process and had incurred significant costs and expended much time in putting the structure in place which it believed was sound, viable, and sustainable. The proposed suspension would therefore set PMC back significantly and could put the mining rights of the Company in jeopardy and therefore the operation of the Company.

(Please see attached document for additional detail).

Webber Wentzel. Draft Taxation Laws Amendment Bill 2011: comments
Ms Anne Bennett, Webber Wentzel, submitted that the Draft Taxation Laws Amendment Bill that was released earlier this month was quite a mammoth piece of draft legislation–183 pages. Webber Wentzel had decided to focus on three burning issues as described in the slides, namely:
•the suspension of Section 45 of the Income Tax Act
•some proposed changes to Section 8E and Section 8EA
•certain aspects of the headquarter company regime

The above three shared a common theme. Webber Wentzel believed that the proposals were in breach of core principles of certainty, fairness, and reasonableness, all of which should be fundamental in any tax system.

Section 45
With regard to the suspension of the inter-group relief in Section 45, two conflicting comments were both made in the media statement released by National Treasury announcing the suspension of Section 45.  National Treasury had wished to note that inter-group relief was a common feature of most advanced tax systems.

However, later in the same document, National Treasury stated that Section 45 roll-over relief, which was South Africa's form of inter-group relief, would be wholly suspended for approximately 18 months. During this period, the continued need for this relief would be re-evaluated.

Webber Wentzel found it hard to rationalise having both these statements in the same document. It inter-group relief was a long standing feature of most advanced tax systems, it had to be asked why South Africa would want to suspend it for 18 months and re-evaluate whether it was needed at all.

Section 45 was a long-standing feature of the Income Tax Act. In its current form, with some changes, it had been around since 2001. Prior to that there was another provision in the Act which achieved very similar results. Overall this type of provision had been with us for almost two decades.

Section 45 provided that when assets were moved around within a group of companies, this move could be done on a tax-neutral basis. The reason for this was that, in substance, there was no economic gain or loss. In the end, the assets were still owned economically in South Africa, by the same party who owned them at the beginning of the day.

This relief was needed for internal reorganisation, for BEE transactions, and for all mergers and acquisitions aimed at increasing efficiency, profits, growth, and jobs. Suspending a measure that by National Treasury's own admission was found in all advanced tax systems sent a big message of uncertainty and a lack of sophistication to foreign investors. Unfortunately those who would be harmed by the suspension would not be the foreign investors, who could go and find other markets, but South African businesses and their employees and the South African economy. 

The suspension of Section 45 was made with immediate effect from 03 June 2011. That signalled that it was a dire measure. No mention was made of this in the budget in February. It was extremely unusual for tax proposals to be implemented during the year if they had not been raised and discussed in the February budget. The suspension came without any advance consultation with commerce, industry and tax ad visors. Moreover, the suspension was implemented immediately regardless of its cost to the economy and disruption to many tax payers. Mustek was the first publicly disclosed casualty. Following the suspension it was reported that the consortium that had been bidding to buy the shares in Mustek had pulled out because they believed that there would be similar consequences to those that Members had heard about with Palabora. The tax charge that would have to be raised would make the deal uneconomic and Mustek's share price fell 12%. It obviously sent a very negative message to foreign investors looking to put money into the country.

Webber Wentzel asked what the emergency was that National Treasury decided that it was necessary suddenly to introduce such a measure with such severe economic impact without any form of consultation. Webber Wentzel was not aware of any economic study that National Treasury or SARS had conducted to weigh up both the cost of the suspension of Section 45 and its potential benefits to SARS. In terms of cost, what would have to be taken into account would be downward values moving on the JSE, impacts on the rand, certainly impacts on deal flows into South Africa, impacts on a number of businesses on a day to day basis and on companies seeking to reorganise internally and move assets from their left side to their right side simply for the sake of economic efficiency.  Now they would not be able to do that and would therefore have higher costs.

Webber Wentzel asked if the Standing Committee on Finance had been provided with scientific analysis of the revenue impact of the abuses that National Treasury sought to curtail.

Webber Wentzel asked if National Treasury had conducted a scientific study of alternative measures which could address the abuses and its concerns without having such a drastic impact on the South African economy. 

National Treasury had given a justification and explained that it was immediate; however, National Treasury needed more time to gather all the facts.

Funnel schemes and push-down structures
National Treasury had mentioned two particular problems:
•the so-called funnel schemes (which were tax abusive)
•excess debt schemes: the push-down structures (in which companies took on more debt)

However, National Treasury and SARS had known about the funnel schemes for about five years. A discussion document had been issued in 2006. In 2008 a media statement on funnel schemes was released. At the same time SARS was given additional powers to require parties making use of Section 45 to submit additional information and returns if the tax authorities called upon them to do so that any abuse could be identified very early. Those powers were never exercised. SARS never asked for that additional information but it had the ability to obtain it for the past three years.

SARS and National Treasury knew who was using these funnel schemes. They knew largely to whom these funnel schemes were sold. The failure of SARS and National Treasury to take action against funnel schemes needed to be explained.

SARS and National Treasury could have applied the general anti avoidance rule in the Income Tax Act, but did not do so. There had recently been a Supreme Court decision around simulated schemes which decision would be strongly supportive of SARS if an action was to be taken on the basis of simulation against funnel schemes. Targeted legislation against funnel schemes could have been introduced, but this had not happened. Suspending Section 45 to prevent abuse of funnel schemes was therefore not justified, and was like banning motor vehicles because of the use of some of them in crime.

Debt push-down structures were fundamentally different from funnel schemes, but there seemed to be some confusion between the two in the various documents. In debt push-down structures genuine debt as opposed to manufactured debt was pushed down so that it became adjustable against the operating assets of a business being acquired. Again, SARS and National Treasury had been aware in detail of these structures since at least 2004. Detailed discussions had been held and some changes made to Section 45.

Webber Wentzel had given a detailed document to National Treasury in 2007 explaining how these structures worked. SARS and National Treasury chose not to collect information.

SARS and National Treasury should be concerned about excessive debt but would do better to impose debt limitation rules. Section 45 was not the problem. If companies were claiming too much tax deductible debt then one should talk about what was a reasonable amount of tax deductible debt and how to put in place limitations. Certain limitations existed already.

Section 8E and 8AE
Webber Wentzel said that the changes to Section 8E and 8EA were effectively retrospective. There had been no mention of these amendments in the budget. There was no advance consultation with industry and advisers. Abuse had not been identified. Many innocent transactions would be caught in the net with adverse consequences. Tax payers could apply for exemptions but highly subjective criteria would be applied and application needed to be made to the Minister of Finance and such application would take several years to be processed.

Headquarter companies
Webber Wentzel submitted that the changes to the provisions on headquarter companies would cause companies to move from South Africa. We were battling with severe competition. Companies would rather be based here than in Mauritius, but this proposal would have the opposite effect. (slides 18-19).

(Please see the presentation document.)

Discussion
Mr D van Rooyen (ANC) spoke from the viewpoint of togetherness in building the country on the basis of a sound economy. In reality the revenue base of South Africa in the past financial year had decreased. This was acknowledged by all. The mechanism for enhancing revenue collection was SARS. It was essential to enhance the broader objective of revenue collection to meet the country's needs. So we were all together in this particular process. We must make sure that the revenue collection was not compromised. With the exception of Webber Wentzel, those who had submitted had not offered a clear alternative to the suspension of Section 45. Only Webber Wentzel had indicated what should be done. South Africa's economic system was quite a composite system. Webber Wentzel had noted that Mustek's share price had fallen on the announcement of the suspension of Section 45. PMC had said also that their shareholder price decreased as a result of that pronouncement. From a layman's perspective, there were many variables that could cause share prices to drop, and as everyone was aware, the global economic situation was volatile. He asked why those who had submitted had identified the pronouncement as the specific cause of the falls in share prices mentioned.

Dr M Oriani-Ambrosini (IFP) sought clarity on the first submission. He noted that legal entities were not capable of receiving medical expenses. Medical expenses were always directed towards a specific individual. If we were deducting medical expenses, why limit them at all? Any person should be able to deduct those expenses.  He did not understand the rationale. A general trust provided for the welfare of an individual to the extent that it incurred medical expenses was providing the same service to an individual whether the individual was involved or the medical trust. All that should be of concern was whether the medical expenses were necessary. There should not be a listing of what was necessary, because what was necessary could change.

Dr Oriani-Ambrosini asked Webber Wentzel for their views; he said that if the Committee passed the Bill it would do so in September or October; by passing the Section 45 suspension as submitted to the Standing Committee, it would make taxable in October what took place on 03 June 2011, which was then not taxable. The Standing Committee had the right to do so. There was no notion of restitution.  He did not buy the notion that people knew because there was a draft Bill, because this was very demeaning to the role of Members of Parliament. People were entitled to believe that Members did apply their minds to legislation; the Standing Committee could change the Bill. The National Treasury could not do tax planning on the basis of what the National Treasury merely planned, until Members of Parliament, who stood for the principle of no taxation without representation, applied their minds to how the law might be changed.  So it had to be asked how one could retroactively make something taxable in October that was not taxable on 03 June 2011.  He wondered how National Treasury had produced this plan and why.

In respect of Section 8A and Section 8AE, relating to the amendments that the Standing Committee had made the previous year, Members had been warned that the amendment would have negative effects on the choice of foreign companies in locating their headquarters here in South Africa. He asked if National Treasury was pursuing a policy of collecting as much money as possible irrespective of the consequences of shrinking the tax base and undermining the economy, and effectively being short-sighted. Was the National Treasury pursuing a policy of getting as much money as possible at the risk of shrinking the economy?

Dr George asked Mr Bendel about trusts created for people with disabilities. He was not sure where the individual who was disabled fitted in.

Dr George, in part response to Mr Van Rooyen, said that there was a great deal of noise of late about nationalisation of mines, and this might be impacting very negatively on share prices. 

Dr George said that his whole understanding of the suspension of Section 45 of the Income Tax Act was that, according to National Treasury's briefing to the Standing Committee the previous week, the door was not closed and that the law was in place and that it would remain in place until Parliament amended it or chose not to amend it. However, National Treasury was saying that it was aware of abuses and that it wanted to prevent such abuses. So, according to his understanding, if there was a transaction that was currently in progress, and there was any confusion or uncertainty about it, then the door remained open for discussion. He asked Palabora if there had been any robust discussion with SARS or the National Treasury regarding this transaction. If not, why not? If so, what was the outcome? 

Dr Z Luyenge (ANC) appreciated the elaborate manner in which those who had submitted had presented their cases. They had clearly indicated that they really believed in what they were saying. He noted that they were crying foul on the part of National Treasury for not being scientific in most cases. They did not believe that National Treasury had tested its assumption beyond reasonable doubt. Those who had submitted were the stakeholders and that was why they were part of this process. They were by no means spectators and they had a responsibility to ensure that the economic climate in South Africa remained cordial to life in the entire country, of which they were the main sponsors in terms of taxes. As Mr Van Rooyen had indicated, they needed to come up with recommendations to National Treasury, and the Standing Committee would be responsible enough to say how best it considered the submitted recommendations from these important stakeholders. It was important that such stakeholders did not only rise up and cry foul but be prompt and proactive in saying what they wanted to see happening. These stakeholders should not wait for an amendment or even wait for National Treasury to create a space for them. There should instead be a regular process of engagement.

Mr Mark Linington, Director, PMC, replied that PMC had not had a discussion with SARS. The law was quite clear; the Section 45 provision applied, so there was no need to discuss the transaction with SARS. PMC's proposal was that it did not want the suspension to be enacted. It proposed that if there were specific concerns that they should be addressed.

Mr Linington further replied that the funnel schemes should be addressed with tools at SARS's disposal. PMC did not believe that there was abuse. There may have been excessive clearing in the boom years of 2006-2008 when the world was awash with cash; but today it was a very difficult world, and PMC did not understand what National Treasury's concerns were.

Mr Mathole added PMC would have a formal engagement with National Treasury and thereafter it would submit a formal submission to National Treasury on impact of suspension of 45 on the BEE transaction of PMC.

Mr Mathole informed Members that two weeks previously, when the bill was released, 26% of the values of the Company's shares on the JSE was lost. Both the fund manager and the adviser called PMC in panic and wanted to know what PMC's take on the Bill was. PMC informed them that it was still studying the Bill and that due process needed to be followed like public hearings and submissions to National Treasury. That sort of panic made PMC think that there was a clear link between the uncertainty over the Bill and the confidence of shareholders. 

Mr George Negota, Director, PMC, said that there was a need to reconcile the objectives of National Treasury and other pockets of policy in Government; such reconciliation was never done. The response of National Treasury was a knee jerk response.  National Treasury was ignoring others. An example was the BEE applications which were in progress and which could be dumped in the dustbin. BEE was a Government policy but one could see the way in which it would be affected negatively by the response. SARS did have a discretion and could have held back. It had the means to discuss each case based on its merits. If the debt was being pushed down, and National Treasury's concern was that it was being abused, and the state was therefore going to loose the basis of this income, National Treasury had every right to bring that to the attention of the role players and to the attention of affected parties. But this was never done; it was a bad example because that kind of behaviour created uncertainty through just one decision. He did not think that it was the policy of this Government to create BEE and then wipe it away just because of one comment.

Mr Bendel thanked Dr Oriani-Ambrosini for his confirmation that the SARS list should not be an all inclusive list. As modern medical science advanced, one could not anticipate what expenses might or might not be incurred.He explained his reason for submission.The main question that had arisen was the deduction of medical expenses in relation to special trusts. According to Section 1 paragraph (a) a special trust could be created only for a person who suffered from a mental illness or serious physical disability and was unable to manage his or her own medical affairs or maintain himself. The trust could be created only for that individual. The reason for his proposal that Section 18(1) include those kinds of trust was that he as a tax advisor would not want to become involved in arrangements for his clients which would be for their detriment where medical expenses were paid by the beneficiaries themselves. It made it simpler for a tax law perspective that a special trust should be created that would be able to obtain the tax deduction as opposed to the income flowing through to the beneficiary that would then be paid out by the beneficiary as a natural person who would then fall within section 18(1).

Ms Bennett replied that there was no scientific way of showing that the fall in the Mustek share price was linked to the news of the Section 45 suspension. However, the knowledge that PMC would have to pay tax of an amount up to R6 billion and perhaps not be able to enter into a BEE transaction, which might in turn jeopardise its ability to obtain its mining rights, made it hard to believe that this would not have an impact on the value of the Palabora shares. When such transactions were likely to be stopped by the suspension of Section 45, there was likely to be some impact on the value of that company. Webber Wentzel was in full agreement that SARS and National Treasury had an important and difficult job to do; this country needed the money that was collected from tax payers. One had to stop tax abuse but without disturbing normal commercial activity. This was not as easy an activity as tax advisers sometimes made it sound. Webber Wentzel accepted that it had a responsibility to assist SARS and the National Treasury. Webber Wentzel had regularly interacted with National Treasury and offered to provide international tax precedence research. Members would appreciate that it was hardly possible for a financial firm to go to an institution and ask it to stop selling funnel schemes. However, it could advise its clients not to enter into a funnel scheme. On the other hand, if National Treasury and SARS did not act against funnel schemes, it put the firm which was advising its clients to avoid them at risk. It sought the support of SARS and the National Treasury. Webber Wentzel had provided National Treasury with a huge amount of information in regard to the steps involved in debt push down structures and the steps involved in funnel schemes to the extent that it had been aware of them. Ms Bennett believed that Webber Wentzel had fulfilled its responsibility in this regard. She agreed that a robust fiscus was important, and for that reason she would have liked a consultation with SARS and National Treasury before a decision to suspend Section 45 which, as had been correctly pointed out, would not actually be suspended until Parliament decided to pass the Bill later in the year. In some respects National Treasury was being short sighted in regard to headquarters companies. This concept was a very good one.  National Treasury had expended much time and energy in developing and pushing for this concept.  It had not been an easy task for National Treasury and it was something that could be very good for South Africa. But it could be so easily derailed; a headquarters company regime needed to be certain; the investors needed to be sure that the legislation was not going to be changed suddenly; moreover, flexibility was needed although South Africa should not behave as a tax haven. Making companies go for Ministerial approval to establish a headquarters company, as distinct from moving to Mauritius where the law was absolutely certain, was a deterrent to investment in South Africa.

Dr Oriani-Ambrosini felt that his question concerning the medical trusts had not been fully understood. He asked why the Bill should not allow tax deductions from the income of any trust when made in respect of medical expenses. Why only specialised trusts?

Mr Bendel replied that the particular issue was that, where a special trust was created, it was not possible for the individual (a natural person) to incur the medical costs themselves. For that reason, he had submitted that special trusts should fall within the provisions for natural persons. Special trusts were taxed in most respects as natural persons apart from the interest exemptions and primary rebates although they were not natural persons. These were issues with which he was faced on a daily basis in dealing with people with disabilities. It made more sense for him to create and advise on paying the medical expenses so as to create Section 20 assessed losses to cover future income and no taxes would be paid as a consequence until those assessed losses had been utilised.

PriceWaterhouseCoopers. Presentation
Prof Osman Mollagee, Associate Professor, University of the Western Cape (UWC), Partner and Director: Tax Technical, PriceWaterhouseCoopers (PWC), listed topics for discussion:

•Legislative Process
•Perceived change of policy
•Ambit of anti-avoidance rules
•Proposals welcomed
•Section 45
•Hybrid Instruments
•Controlled Foreign Corporation reorganisations
•Foreign dividend exemption
•Removal of Value Extraction Tax (VET)
•Debt without maturity dates
•Headquarter companies

Mr David Lermer, Global Tax Leader: Africa, PWC, the firm's regional head in Africa and responsible for intentional tax and transfer pricing, began by saying that PWC was extremely proud of this process. It had its pluses and minuses, and the big plus was that where something looked as if it had gone too far and in this case he thought that the pendulum had swung in the wrong direction, as regards the manner in which legislation was being proposed, it could be corrected. The legislation as it currently stood was very clear. He was referring to Section 45. The suspension was effective from 03 June 2011. Because of that statement, and because one was talking about a Section that simply dealt with business– not tax–moving between two group companies, it had a major impact and a major creation of uncertainty. All that PWC was saying was that this process allowed tax payers and the Standing Committee to examine all the evidence and correct the position if they thought fit. Because of that PWC was always concerned that there was a pressure on time. There were now two Bills introduced only once during the year. This was a major improvement. One now had until the middle of August to sort things out. This again was a major improvement. However, what one did not have, and which, PWC believed undermined this process, was the ability for the public to engage with the Standing Committee after it had received the responses back from National Treasury. Mr Lermer would refer later to a specific example where a provision was put in after the public hearings and there was no mechanism by which anyone could have said to the Standing Committee that the provision concerned was problematic. This related to a specific test in relation to dividend income.  It was not a new issue this year: the first formal submission on this was in 2008, however, while there had been sympathy for it, it had never been put in place. PWC was not asking for a full set of public hearings. PWC appreciated that scheduling in Parliament was difficult. However, there was surely enough time for a morning or afternoon session after National Treasury had brought back its responses for interested parties to simply indicate five or fewer major items. That would go a long way to ensuring that Members were in an appropriate position to make an informed decision on what was being said at that stage.

There was no doubt that there had been a change in policy on how to treat debt. There appeared to be a slant that all debt was bad. This was crazy. In today's world in which we had just come through the worst recession in decades, in which there had indeed been over-leverage, people were looking for instruments to provide funding – funding that created economic growth. The problem with that the proposed legislation was simply blunt. PWC appreciated that information had come late; National Treasury did not have this knowledge at the time of the budget speech – it came later: National Treasury had to act; however, PWC was concerned that what National Treasury finally did was related to a specific commercial provision and hence the collateral damage witnessed.

As Members had heard from Webber Wentzel, it was clear that there had been binding rulings from SARS on what was acceptable from the perspective of debt interest. Therefore to be faced now with no notification and wide-ranging proposals resulted in the present added confusion and casualties in the market. The biggest tax collector was economic growth. PWC was concerned that the balance as it stood now until the situation as to Section 45 was resolved–Mr Lermer appealed that it was not necessary to wait 18 months – the problem was that there was no certainty, and the biggest tax collector was economic growth, while it was necessary to create a firm tax environment.

The positive side was that PWC knew that this would be discussed. National Treasury had immediately gone out and sought consultation. So while PWC did not agree with, nor condoned, an amendment of this nature, without notification, PWC certainly applauded the past, present, and hopefully the future, actions that National Treasury had taken and would take, and in the manner in which National Treasury interacted with the public.

Anti-avoidance rules, when they were not specifically designed to deal with the matter at hand, increased uncertainty. They affected legitimate commercial transactions, and honest tax payers could be labelled as tax abusers. PWC had compiled some statistics, and Prof Mollagee would deal with them.  PWC thought that the solution should have been more targeted action at the source of the problem. The problem was very simple: we were paying too much interest and obtaining tax relief on it. The problem that we faced here and now – and it was a global problem - was what was acceptable debt compared to acceptable equity. It had to be asked what debt was, what it should look like, and what the amount of interest relief that we in terms of policy should accept as being appropriate tax deductions. PWC was concerned that National Treasury did not yet know the answer. Many countries were examining the same problem. However, as far as PWC knew, no country had introduced a provision to prevent the transfer of assets within groups. They had all focused on rules such as South Africa already had, withholding tax, which South Africa was going to introduce, and possibly a further interest cap using specific provisions on profit cover and cash flows. There was enough international precedent. PWC was not sure why National Treasury was taking the present route. On the positive side, there was a lot of good in this legislation and there was a list of items-such as giving foreign tax credits for South African companies that were providing services to Africa which had been talked about extensively and were now provided for, with which PWC was comfortable. (Please see attached document.)

Prof Mollagee listed the three bases for PWC's objections to suspension of Section 45:
•Extent of the “abusive” transactions
•How the suspension had been imposed
•The deeper policy issue around interest deductibility

From a PWC internal review, PWC estimated that only about 10% of the Section 45 transactions on which PWC was advising, until 02 June 2011, were debt push-downs. Most (90%) transactions were routine intra-group transfers. (Slide 8)

Mr Lermer added that the only problem that National Treasury was worried about was where the transaction between companies created external debt so that money was leaving the group or the companies and arriving somewhere where it was not taxed. So if the money was going to a South African bank and being taxed in the bank, that was acceptable; however, if somehow the interest flowed out and there was a mechanism or black-box, then that was not acceptable. PWC was talking about the volume of normal transactions being 90%; the problem facing National Treasury was that there were a few transactions which were large in value.

Prof Mollagee criticised the way in which the suspension had happened. He sought to dispel the myth that Parliament still had to pass the Bill for the suspension to become reality. In reality, Section 45 had been suspended from 03 June 2011. The last time there was a debate on Section 45, PWC had produced a number of proposals. Eventually they were promulgated in late July. The changes had taken place on 21 February 2008 which was the date of the budget speech. Tax payers knew there was a history of retrospective implementations. So no one would touch these Section 45 transactions, even though Section 45 was alive on the Statute Book. He emphasised the need to be clear on that point.

PWC had received questions in its tax practice from foreign investors who were worried about such sudden changes in South Africa's tax laws. The uncertainty was unfriendly to foreign investment.

Prof Mollagee said that Section 41(5) had been there for three years but had never been used.  Instead of just 'killing' Section 45, it had to be asked why SARS had not used the existing legislative provision to obtain information about such transactions and require approval of them.

Prof Mollagee referred to the deeper policy issue. As he had said earlier, there was a tiny minority of Section 45 transactions that were debt push-downs. It had to be asked what the problem was. There was confusion currently on this subject. PWC had thought that push-downs were acceptable. This was the message it had been receiving for the past decade. He explained in greater detail about debt push-downs and more specifically, tax relief for the interest on acquisition debt (incurred in buying assets or shares).

South African law treated interest on buying assets differently from interest on buying shares. Internationally, there was no difference on interest irrespective of buying assets or shares. Until 03 June 2011 these debt push-downs had been condoned, with effective parity with the rest of the world in treatment of such transactions. Now there was confusion since National Treasury had gone on record as saying that one of the reasons for suspending Section 45 was that it facilitated push-downs.

Prof Mollagee discussed issues (hybrid instruments) around Sections 8E and 8A. In this he 'stole some of Treasury's concepts', when it used the pluses and the minuses. The choice of funding instrument determined whether one received interest or dividends. National Treasury was concerned about abuse. Prof Mollagee explained in greater detail. These proposals embodied much broader instruments, and he was concerned that these transactions would be made unaffordable.

BEE transactions were the ones that needed the finance. For the BEE shareholders there would be no tax deductions. There was a mismatch. One could either invest in normal interest-bearing debt, which resulted in the mismatch, or choose (a perfectly acceptable choice until 02 June 2011) rather to use dividends or preference shares to fund the same deal. Under the new provisions the latter would be regarded as undesirable and the income would be treated as taxable income. This would be the effect on the majority of such transactions. This produced a double-tax effect. There was an undoubted retrospective effect.  (Slides 12-14)

Mr Lermer referred to the slide on CFC restructuring:  the proposal was commended since it promoted South African competitiveness abroad.
Concerns:
•“Consideration” requirement (S44(4) prevented application to many foreign mergers
•Loss of para64B relief would trigger a tax charge
•No transfer of value out of South African tax net
•95% minimum group - appeared inequitable and unnecessary
•Termination of amalgamated company – might not be required in terms of foreign law .
(Slide 15)

With regard to foreign dividend exemption and restrictions on the participation exemption, Mr Lermer was concerned about:
•The foreign financial instrument holding company (FFIHC) test (with effect from 01 October 2011) – too onerous
•10% tax on foreign dividends would represent additional cost
•Combination of these factors would discourage dividend repatriation
•Consider disallowing deduction to address avoidance concerns
(Slide 16). 

Mr Mollagee discussed the removal of value extraction tax (VET) and the broadening of 'dividend' definition. This effectively removed the specification of 'deemed dividends', and gave rise to concerns around increased (rather than reduced) uncertainty, scope for disputes, etc. (Slide 17).

Mr Mollagee discussed debt without maturity dates and the re-characterisation of interest as dividends. The proposed Section 8G was too wide and there would be a negative effect on the real estate investment industry. The retrospective application would create uncertainty. Tax payers had the right to plan affairs without being subjected to detrimental amendments. (Slide 18).

Mr Lermer referred to Webber Wentzel's submission with regard to headquarter companies and advise the Committee not be so sidetracked by tax issues that it missed the bigger picture. There could have been a way to say that South Africa was the regional hub and was open for business. Unfortunately the pendulum of this Bill was too weighted on administrative burdens, onerous reporting requirements, and subjective concerns as to whether or not we had an erosion of the tax basis and other problems. (Slide 19).

There was a balance between protecting the tax base and international competitiveness. This year there were too many provisions that were weighed on one side. Because of those few items that had really hit the press and occupied people's minds, one felt sure that there were a number of items that one would find out about in the months to come.

(Please refer to the presentation document and to PWC's Representations letter).

Deloitte & Touche. Commentary
Mr Roelofse Le Roux, Director: Tax, Deloitte & Touche (Deloitte), referred Members to his written submission on a number of technical matters. He focused on four particular areas on which he wished Members to give further thought-certainty, consistency, message, and the use of available tools.

Mr Roelofse submitted that absolute certainty in a tax environment was an unattainable ideal. However, a tax system should at least provide a minimum level of certainty to tax payers to plan their affairs. Without that underlying level of certainty the system's credibility was undermined and it became arbitrary. The present proposals risked undermining that reasonable certainty, especially suspending Section 45 relief and treating certain share instruments as debt under certain circumstances. Changing the rules in this manner could be extremely costly, as others had submitted.

As to the submissions on treatment on some share provisions as debt, there seemed to be a view that debt was bad and should be taxed accordingly. Shares (equity shares or preference shares) were, however, fundamentally different from debt and played a different role in the economy from debt, quite apart from tax.
In respect of the perpetual debt instruments being introduced, it would seem that National Treasury was proposing to treat debt as equity and equity as debt, for no apparent good reason, particularly the use of preference shares which, in particular, were being targeted. It was somewhat mystifying. There were in the Act certain provisions that dealt with preference shares and preference share funding where these functioned more as debt than as equity that would frustrate the intended tax benefits for tax payers. The proposals received went beyond that by fundamentally seeking to re-characterise different legal instruments differently. These particular proposals undermined certainty and also created inconsistent treatment between tax payers and the revenue authorities. Essentially what a lot of these rules did was to treat the payment of a dividend on a share as a dividend from the point of view of the payer, which denied the payer tax deduction. 
These rules sought to tax the dividend in the hand of the recipient as  income. This was not fair. It was the view of SARS that a preference share was nothing other than an instrument of debt, and should be taxed as such. It seemed that, under these proposals, National Treasury wanted 'to have its cake and eat it'.  Mr Roelofse submitted that with these proposals we were falling short of consistency of treatment in tax matters. He referred to an opinion of the late Chief Justice Corbett that there was nevertheless a measure of satisfaction to be gained from a result that was both fair to the tax payer and to the fiscus.   

 Deloitte failed to understand why SARS did not use the existing tools that were available, specifically the general anti-avoidance rule, and tax these unwanted, impermissible tax schemes. If these were used the strengths in the law would become apparent. Mr Roelofse referred to a recent court case.

As Mr Lermer had mentioned, on international headquarters companies specifically, one had an excellent initiative introduced into the Income Tax Act. This initiative should really be used to market South Africa as a place for investment. Yet one year after its implementation, a requirement was proposed that companies would have to apply to the Minister who would have to satisfy himself that there was no erosion of the tax base. On the other hand, the requirements for headquarters companies ensured that there would be such erosion. Companies would not be interested in establishing themselves as intentional headquarters companies if they felt that the rules could change from year to year. Deloitte's message was that sometimes it was necessary to be courageous, as National Treasury had been, in getting legislation into our books, but the latest change to the rules on headquarters companies sent the wrong message to the international investment community.

(Please refer to Deloitte's commentary letter for full details.)

Ditikeni Investment Company. Comments
Mr Kurt Miller, spoke on behalf of Ditikeni Investment Company, which was a broad-based investment company set up by non-governmental organisations (NGOs) more than 10 years previously. It impacted more than two million people in each province of the country. The entity was set up to find a way to create an endowment to help support the various NGOs in their operations and act as a broad-based empowerment partner in which the NGOs were the shareholders.

Ditikeni Investment Company utilised preference shares. Hence the proposed changes to Section 8E were of concern to the Company. Hence the written submission sent the previous afternoon.

Ditikeni Investment Company was a traditional investment business which was simply raising redeemable preference shares. There was no elaborate structure surrounding those shares, no derivative structure, and no complex security structures. Its shares were simply redeemable, participating, cumulative preference shares which now, in a sense, would be taxed.

There would be a number of consequences for Ditikeni Investment Company.

Ditikeni Investment Company was a simple investment company which this proposed legislation would severely impact.

Secondly, the company was using straightforward capital structuring techniques. There was a debt and equity element to make sure that the structure was efficient. The efficiency of the structure including the commercial consequences would be impacted by the proposed legislation. This applied not only to Ditikeni but to a large number of the empowerment transactions, which would impact a large number of people who had subscribed to transactions like those of MTN and Vodacom.

Any profit received from Ditikeni from those transactions flowed back to the NGOs which it assisted. 

Ditikeni Investment Company was concerned at the retrospective nature of the legislation. It had structured many of its transactions on a preference share basis.

Ditikeni Investment Company, while acknowledging abuse, was also concerned at the blanket changes to address avoidance concerns through preferential share arrangements.

Ditikeni Investment Company felt that the effective double-tax that would occur under this new legislation   would impact its shareholders, and make much of its capital-raising non-viable.

Ditikeni Investment Company proposed that specific legislation be introduced to address the anti-avoidance measures and combat the schemes that were avoiding tax through their preference share arrangements.

(For full details of Ditikeni Investment Company's submission, please refer to Ditikeni's comments letter.)

Discussion
Mr N Koornhof (COPE) asked if the suspension of Section 45 was legal or if it could be contested in court.

Dr George was not a lawyer but could not imagine that a Government department could suspend a provision of a law. This would result in mayhem. He understood that National Treasury had identified a problem with Section 25. However, in his understanding, National Treasury could not suspend this provision. Nevertheless, he understood Prof Mollagee's point about de facto suspension, in so far as now there was uncertainty, no one would touch this provision, and as Deloitte had said, the uncertainty was bad for business. There was a problem, and Members could not just sit and do nothing for 18 months, because there was too much uncertainty. 

Dr George was also confused because National Treasury had told Members the previous week that the door was not entirely shut.  National Treasury was standing in the doorway with the aim to prevent further abuses.
So, Dr George said, this provision was still on the Statute Books. The Standing Committee had not recommended its removal. The discussion that SARS was supposed to be having with stakeholders did not seem to be happening, although Dr George observed that Prof Keith Engel, Chief Director: Legal Tax Design, National Treasury, who was present as an observer, was nodding his head, so maybe it was happening.  The point was that it was exceptionally confusing to a Member of Parliament, because Dr George could not understand where we were. As far as Dr George was concerned, the law stood and if people wanted to use it, they must use it. If they did not get their relief, they would have to go to court and test it. This was what the law said. SARS, however, was saying that one could not use this provision. But Parliament had not yet removed it.

Mr Lermer said there was a possibility that this suspension could be taken up in the Constitutional Court. PWC had considered it, but did not want to take that route. If one examined the specific legislation, it could be seen that National Treasury had added another section to say that, if the transaction took place between 03 June 2011 and 31 December 2012, Section 45 would not apply.  National Treasury had not, technically, suspended Section 45.

Mr Lermer agreed with Dr George. National Treasury should not have suspended a business provision on the first day without notice.  National Treasury had done it before, on Secondary Tax on Companies (STC) and the dividends exemption. It was on the day of the budget. However, that measure was appropriate and 'right on the button' as there was a tax avoidance. It was not a commercial transaction that had been going on for 10 years. The message that PWC wanted the Standing Committee to consider was that we had to be more aware of the collateral damage from using a blunt instrument.

Also there was a perception that when the draft legislation was published, there would be one or two items that were incredibly harsh put in to test the response of members of the public and the business community. The beauty of it was that there were workshops that SARS was organising and that generally one obtained the right solution in the end. Meanwhile, the present situation was incredibly confusing for the tax payers.

Mr Le Roux added that maybe somebody with strong nerves could undertake a Section 45 transaction today, because the law was still in place, but one was looking at the Constitutional Court as a place to contest the matter. He would be interested in reading how lawyers took up the matter. This, however, was not practicable, and, in effect, Section 45 had been suspended.

The unhappiness was not so much that National Treasury did not want to allow inter-group transfers, because ultimately it was for National Treasury to define the tax laws, but with the way the Suspension had been carried out and certainty undermined.

The Chairperson pointed out that this was the beginning of the Parliamentary process. On the completion of the public hearings, the Standing Committee would engage with the submissions and with the Draft Bill itself, deliberate, and advise the Executive accordingly. If the Standing Committee needed more information, she hoped that those who had submitted would assist the process. She noted that National Treasury planned workshops, and the Standing Committee would receive National Treasury’s recommendations and responses to these submissions in August 2011.

Committee business
The Chairperson proposed establishing a team within the Standing Committee to examine this legislation and direct Members as to the direction to be taken and to ensure a coordinated approach. Fortunately there was enough time to do this work before August.

Dr George supported the idea, but would be away for part of the period.

Mr Van Rooyen agreed, and said that the research component should be engaged. Dr George could participate, during his absence, by email correspondence.

The Chairperson thought that the legislation should be finalised around September 2011. She noted Dr George, Mr Van Rooyen, Mr Koornhof, Ms P Adams (ANC), and Dr Luyenge as volunteers to participate in the team. The Chairperson could also participate if he had time. However, anyone else who could make a contribution could be invited to participate, so long as Members thought that person could assist the process. 

The meeting was adjourned.