Taxation Laws Amendment Bill: National Treasury report-back
Mr Ismail Momoniat, Deputy Director-General: Tax and Financial Sector Policy, National Treasury, was accompanied by Mr Cecil Morden, Chief Director: Economic Tax Analysis, National Treasury, Professor Keith Engel, Chief Director: Legal Tax Design, National Treasury, and Mr Franz Tomasek, Group Executive: Legislative Research and Development, South African Revenue Service (SARS).
Mr Momoniat said that National Treasury was reporting back to the Standing Committee on the process of the Taxation Laws Amendment Bill, from the release of the draft Bill on 02 June 2011 to the receipt of comments on revised legislation due by 17 August 2011 which had been followed by a workshop on 31 August 2011 (slide 1).
Mr Momoniat noted that National Treasury had received over 500 pages worth of comments from about 60 organisations: a list had been circulated, and the comments were on the website as well.
With regard to Section 45, National Treasury had received many comments and issued a press release on 03 August just to explain the process and have further consultations. Those who felt that they were affected by specific provisions were invited to come forward. Thereafter some further proposals were released, together with some draft legislation.
National Treasury had felt that it was a once-in-ten-years provision where it had to take some draconian steps, because it felt that the scale of tax avoidance was very significant. The figure was R325 billion per annum. National Treasury invited organisations to come and provide details. Certainly, while this was normally done by SARS, since these were policy issues, National Treasury and SARS had done this jointly.
In response, National Treasury and SARS produced a revised draft of the June version for further comment by the end of August. Again there were further meetings. There were real structural issues involved, in particular, the tax treatment of debt versus equity. This was the underlying big structural issue that had to be dealt with. Talk about the suspension had been a temporary, interim option, until the structural problem had been resolved.
Dealing with the structural problem was a complex issue, and would take time. National Treasury would deal with it later in the presentation.
National Treasury felt that it did need an interim arrangement, so it had moved away from a suspension clause; it had what the Minister had called a 'three lights approach' to the transactions – green, amber and red. Some people, according to the rules, would be able to go ahead. Others would need some kind of pre-approval process. National Treasury had now refined the approach. The response document gave detail on the specific approach.
National Treasury sought to point out that indeed there was a problem; certainly that needed to be acknowledged on every side, not just by National Treasury. There was some undue tax avoidance behaviour, which undermined the tax system. This needed to be addressed, even in the interim, since it was rather expensive. The new proposals did offer a way forward.
Mr Momoniat pointed out that today's briefing was on the comments received and National Treasury and SARS' response, not a presentation of the amendments to the actual Bill. After today's meeting, the actual revised Taxation Laws Amendment Bill would be finalised and would be introduced to the House in October.
Medical scheme credit
The other big issue was related to medical credits. National Treasury had tried to go out and meet affected organisations. It had held workshops with the elderly and disabled and released, in June, a discussion paper on the medical credits.
Mr Morden explained medical scheme contributions and other medical expenses – past reforms (slide 4); conversion of medical deductions to medical tax credit – comparison: deductions vs credit (slide 5); deductions vs credit – illustration of the higher 'subsidy' for individuals with higher marginal rate under the deduction regime (table, slide 6); the original proposed medical tax credits (2012/13) (slide 7); the revised proposal for 2012/13 (slide 8); a more equitable system (table, slide 9); and proposals under consideration for 2013/14 (slide 10).
Mr Morden commented that the medical credits proposal was accompanied by a detailed discussion document. Monetary caps had been introduced to cap the deduction. In subsequent years those thresholds had been adjusted at a rate comparable to the rate of general inflation. For administrative reasons, National Treasury regarded all payments by employers as taxable fringe benefits to obtain a full picture of what actually was to the benefit of the individual. This was a neutral arrangement, since the individual could still deduct those expenses from income tax up to the cap. In subsequent years these thresholds were adjusted. The next phase of the reform was to convert the deductions into a credit. The difference between a deduction and a credit was summarised, and an explanation given of the rationale for the credit. The deduction provided a larger subsidy to the people in the higher income brackets, whereas if converted to a credit there was a little bit more equity in the system.
It was shown how, under the present system, the higher the income, the higher the tax relief granted. This was an inequity that National Treasury sought to address.
The proposal as per the legislation released in June to convert the medical deduction into a credit was illustrated. The proposal was for R216 per month for the first two beneficiaries – the taxpayer and the first dependent and then R144 for each of the subsequent beneficiaries. This was a ratio of 70%. Also in the proposal at that stage was the idea of a supplementary credit for people with disabilities and those over the age of 65.
In the discussion document, there was another component – the out of pocket expenses.
For people under 65 National Treasury would stick to the medical credit full contributions. However, the supplementary credit for disabled people was dropped. For out of pocket expenses the current system would largely be retained. Medical expenses in excess of four times the credit would be lumped with out of pocket expenses.
Next year, out of pocket expenses would be reviewed with the intention of converting to credits.
For the over 65s, National Treasury had decided not to do anything this year. The current system would remain unchanged. There would be full deductibility of contributions and expenses, but the supplementary credit that was part of the proposal had been dropped. So the current regime for the over 65s remained unchanged.
For next year, for people below the age of 65, National Treasury would convert the out of pocket expenses to a credit of 25% with a 7.5% threshold. This meant the expenses in excess of 7.5% of one's taxable income.
For the disabled people, there was also the proposal to convert the out of pocket expenses to a credit, but National Treasury had not yet finalised the rate.
Section 45 and related matters
Prof Engel explained the initial proposal (02 June 2011) (slide 12); the process – round 1 (June/July) (slide 13); the process – round 2 (August/September) (slide 14); and basic tax law mathematics (table, slide 15).
Prof Engel commented that it was important to understand the distinction between debt and shares, since the two had different effects in taxation. The real question was 'Does the label follow the substance?' The two proposals were going after the same issue from different angles.
The first issue was on Section 45. Originally there had been a decision to suspend, temporarily, Section 45, to protect the fiscus. At the same time, National Treasury was pursuing hybrid share issues.
One of the initial proposals was that you could not have a share if it was redeemable in three years. Shares were meant to be held in perpetuity. With a share, there should not be a right of redemption. So the three-year minimum was changed to a 10-year minimum.
There were certain rules to stop third party back guarantees. The purpose of these new rules was basically to prevent the shifting of taxable income and losses among taxpayers and the closure of funnel schemes and Collective Investment Schemes (CIS) schemes. (Slide 12).
After having gone through the initial rounds there was quite a lot of heat on the issue. National Treasury had never intended to close transactions that were not a risk to the fiscus. It was always difficult in tax policy to balance tax avoidance with commercial needs. There was a balance, and always a need for a fine scalpel. The difficulty with Section 45 was that the instrument was too blunt. There were arguments that, if one closed Section 45, there were many pure intra-group deals (slide 13). Such deals were not a risk to the fiscus, and people needed to make such deals in order to restructure.
The second class was Section 45 transactions involving Black Economic Empowerment (BEE), where a company set up a subsidiary with vendor financing, where basically the group was financing the BEE party. There was only a small class of those, but it was an important class.
Then there was another group - general merger and acquisition activity, private equity and special project financing.
The intra-group transfers and the BEE were generally not a risk to the fiscus.
National Treasury was concerned about general merger and acquisition activity, private equity and special project financing. This was the biggest risk, as, while important to the economy, it was posing a risk to the tax base.
On the hybrid shares side (slide 12), the argument was that the anti-preference share rules were seriously going to impact on BEE deals. The bulk of the BEE issues arose around preference share funding, since BEE deals generally relied on such funding. Also in making a share acquisition, one often used preference shares because, when borrowing money to acquire shares, one was not able to deduct the interest. This was a unique feature of the South African system. In order to overcome that, one needed preference shares.
So having heard all these arguments, and National Treasury had virtually said it towards the end of the last session with the Standing Committee, National Treasury had wanted those concerned to show it the facts – to enable it to take out the scalpel and cut away the good from the bad. So National Treasury had had six days of one-on-one meetings (slide 13). However, those who were worried were reluctant to come forward. To give the taxpaying community its credit, many useful things were said.
Then National Treasury' went into the second round, and issued revised legislation on 03 August and allowed for two weeks of comment.
The suspension of Section 45 was lifted (slide 14).
If anyone wanted an interest deduction, a pre-approval process was required, by way of a gatekeeper function (slide 14).
At the same time there were other issues (slide 14). Moving the minimum redemption date from three years to 10 years affected BEE adversely to a quite significant extent, and this was National Treasury's biggest problem. From the tax policy perspective, those redeemable shares were really debt. However, National Treasury was ignoring them because of their role in the economy. Nevertheless, this was a deviation from principle. A unique feature of the South African system was that when you borrowed money to buy shares you did not get the interest deduction. These were the main changes made. Given those changes, the volume of concern dropped dramatically. In the response document, Members would note further adjustments based on the comments received.
The essential point to note was that what National Treasury was asking the community to do was to provide more facts, since the more facts that it could provide, and the more it could show the transactions and the details, the more National Treasury could have a finer scalpel.
Prof Engel showed a chart that indicated the essential concerns. Tax came down to basic mathematics. If you had interest that was deductible on the one side, it was included on the other. There was a minus and a plus. If you had dividends, it was not deductible and not to be included. So the two were equal, but the game that a tax planner would try to play was to get to the target where the player got the deduction and the payee did not have income. This was the area of concern (slide 15). Sometimes there were good policy reasons for that tax leakage that was cause for concern. Taxpayers were worried when they made a payment and it was not tax deductible but it was to be included on the other side. Some of the changes to the preference share funding were designed to prevent exactly that problem. This was the essential issue.
Section 45 issues – excessive debt
Prof Engel explained reorganisations and leveraged buyouts (slide 17); intra-group leveraged buyout (LBO) transactions (i.e. Section 45) (flow-chart, slide 18); liquidation LBO transactions (i.e. Section 47) (chart, slide 19); amalgamation transactions (i.e. Section 44) (chart, slide 20); new proposals (slide 21); narrowed discretion (slide 22); and creditor offloading (slide 23).
Companies could always borrow money. The only rules against excessive borrowing where there was leakage were the thin capitalisation rules for cross-border debt. Those three-to-one rules were being examined currently. A practice note should be issued in the next few months. Basically there were no limits on the amount of debt that one could have.
National Treasury was in a situation of constantly acquiring new information and having to make adjustments, and trying to be as fair as possible while protecting the tax base.
National Treasury was especially concerned about excessive debt.
Secondly, it was concerned if the debt had share-like terms. If you borrowed money to buy a house – even to the extent of an 80% mortgage bond – that was genuine debt and deductible and nobody was going to dispute the fact. It was a lot of leverage, but it was truly debt. However, when a debt became excessive in the corporate world, it began to look more and more like shares. Often in the corporate world one had mezzanine debt, where one could convert it to shares or delay the payments. This could lead to a situation where the creditor bore the risk of the debtor's operations. National Treasury did not have a problem with foreigners. It wanted genuine debt investment, which, if genuine, it would treat like debt. If it was equity investment, it would treat it like equity. The new dividends tax was designed to encourage equity investment. So it was not an anti-foreigner issue. However, there were some other players on the domestic scene – the exempt four funds. Pension funds were going to be a growing problem.
Prof Engel explained in very great detail intra-group leveraged buyout (LBO) transactions (i.e. Section 45) (flow-chart, slide 18).
Prof Engel commented that National Treasury wanted assurance that the bank debt was real debt and was not excessive.
Prof Engel explained in very great detail liquidation LBO transactions (i.e. Section 47) (chart, slide 19); amalgamation transactions (i.e. Section 44) (chart, slide 20); new proposals (slide 21); narrowed discretion (slide 22); and creditor offloading (slide 23).
Prof Engel commented that Section 47 was not as flexible as Section 45. There was some case law, and also some rulings, which suggested again a linking of debt to assets. However, people misunderstood this; it was not possible to do this with any acquisition. The acquiring company and the target company had to have mutually shared activities.
The purpose of the governmental approval process (slide 21) was to ensure that facts were brought to the table. This was a temporary process, envisaged to continue for only two years.
The debt equity issues were structural issues that had involvements across the board, all of which would have to be addressed by 2012.
There were some issues around the approval process. Originally approval required the agreement of SARS and the Minister. Under the new proposals, it was an administrative process, and the Minister would not be involved (slide 21). It would run similarly to the rulings process. However, there would be some consultations with National Treasury, since these were policy issues. There would be continued consultations with industry; however, it was impossible to give clarity without the facts. The approval process would be subject to objection and appeal. If taxpayers were in the middle of a transaction, SARS was willing that taxpayers could contact SARS in advance to discuss whether SARS was likely or not to proceed.
The biggest issue was the main leakage issue – where the debt was to an exempt person (a foreigner or a pension fund).
If a taxpayer did not obtain approval, the taxpayer lost the deduction, but, in general, the deduction was retained as a debt note. He explained with reference to slide 15. All that National Treasury sought to do was to restore the balance and achieve a neutral position for the fiscus.
There had been concern that too much power was vested in the Executive by way of regulation. People were looking for safe harbours. Therefore, National Treasury had decided to include a narrowed discretion (slide 22).
Prof Engel and Mr Momoniat commented on creditor offloading (slide 23).
In this regard, Mr Momoniat preferred moral suasion, to get those debtors to also pay their tax due. However, to the extent that tax morality was weak, it might be necessary to pursue the money. The Standing Committee's guidance would be welcome, as there was abuse.
Section 8EA and 8E – hybrid shares
Prof Engel explained the overall theory (slide 25); the South African paradigm (slide 26); the revised proposal (slide 2Prof Engel 7); the acquisition and pledge of ordinary shares (flow-chart, slide ); the acquisition and pledge of ordinary shares (flow-chart, slide ); proposed revisions to third party backed financing (slide 30); the Section 8E funnel problem (chart, slide 31); and basic preference share revisions (slide 32).
Prof Engel commented that these shares were mainly debt. BEE companies needed preference share funding, because they had no income. Taxpayers wanted National Treasury to consider their taxation from an aggregate viewpoint, but there was a small group who played a dangerous and expensive game of splitting the deal amongst multiple taxpayers and made it as hard as possible for SARS to audit them. It was National Treasury's aim to manage and trace preference share funding in a way that was easy to audit.
In the revised proposal, National Treasury had created a safe harbour for borrowing money to acquire ordinary shares (slide 27). That allowed all the BEE structures through. There could also be a third party guarantee if part of the same group.
Prof Engel explained in detail the funnel schemes (slide 31). These schemes were trying to arbitrage both exchange control and tax.
Prof Engel said that the tracing rule would be eliminated (slide 32).
National Treasury and South African Revenue Service Draft response document
Mr Momoniat said that some of this information lent itself to presentation in the form of a lecture, but National Treasury wanted to alert Members by way of this supplementary document.
Prof Engel said that National Treasury had appreciated the comments of PricewaterhouseCoopers (PWC).
National Treasury wanted to make living annuities more competitive. However, it was not just a tax issue; it was also a regulatory issue. The situation was more complicated because there were no regulations governing post retirement income funding. National Treasury would issue a small bill later this year, in draft form. The aim was to open up competition between the banks and the collective investment schemes.
Mr Momoniat said that it was necessary to look at living annuities from the perspective of financial stability and regulation. The tax and regulatory issues were often aligned. A separate series of bills was thought desirable and these would, hopefully, be published later this year, in draft form, for the Committee's consideration.
Prof Engel said that there was a rule to limit the use of preference share funding held in trust. Many executives were trying to hide their salaries by setting up a trust and claiming that their money was being received not as salary but as preference share funding; and there were people who desperately tried to lower their tax rate. There were some anti-avoidance rules to address that. These anti-avoidance rules actually picked up legitimate employee trusts where people were obtaining an equity stake. National Treasury had changed the legislation to say that to hold ordinary shares through a trust was acceptable, but not to hold any other assets thereby. The problem was that someone might hold incidental assets that maintained the trusts. National Treasury would allow those incidental assets. However, the shares themselves must have an ordinary flavour. They could not be preference shares, as were necessary to hide the bonuses.
Definitions: an ordinary share and a preferential share
An ordinary share was where the holder just got a share of the company's profit.
A preferential share was when the holder received the profits in a more 'carved-up' way, like calculated with reference to interest, or with a higher level of connectivity. With a preference share the shareholder did not receive a fixed percentage of the company. A number of companies were concerned at National Treasury's attempts to clean up the legislation.
Dividends tax (bottom of page 7) was planned for 01 April as announced in the budget.
Foreign dividend issues (page 10)
Many of the foreign companies were dual-listed, with shares on the Johannesburg Stock Exchange (JSE) and shares in on the London stock exchange. From the legislation it might appear that they were being taxed doubly. However, this was not intended in the Explanatory Memorandum (EM) nor in the legislation. National Treasury had therefore 'cleaned up the legislation' to say that on all dividends, domestic and foreign, the maximum rate of tax was 10%. In some cases, domestic and foreign dividends were exempt. So it was now all even across the board.
The other issue of concern was that foreign dividends were going to be taxable if they arose from a foreign financial instrument holding company.
Perpetual debt (page 15)
Prof Engel explained the difference between a share and a debt. When you held a share, you held it for ever. When you had a debt, you had to pay it off. There were instruments in the market on which debt never had to be repaid. Such instruments were really shares. Unfortunately, the property loan stock company world operated on the assumption that perpetual debt was really debt not shares. National Treasury had had discussions with this industry for quite some time. The proposal was to create a special regulatory paradigm for it, either under the existing framework, or under the new framework. When that came into place, National Treasury could restore this proposal.
Research and development incentive (page 21)
There had been much discussion. The biggest issue around research and development was that National Treasury now required a pre-approval process. So if you did research and development and you wanted the normal deduction, you just received the normal deduction, and National Treasury was satisfied. However, if you wanted the incentive, you now required a pre-approval from the Department of Science and Technology (DST). People asked if they had to obtain pre-approval before the project began. Research and development was a continuous process. Application for approval could be submitted after the research and development project had started, even some years after, and the special deduction and incentive would take effect, after approval had been given, from the date of submission of the application. That way, the approval process was retained. The reason for the approval process was that this was really a grant. Also the DST knew best what it was looking for. This was not something that was easy for SARS auditors. So it was a more flexible and continuous approval.
Film incentive (page 25)
The current law said that if you wanted to produce a film, all of your expenses were deductible upfront, whether they were capital expenses or not. This had given rise to many avoidance schemes. This had been going on for 20 years. Over time, National Treasury had 'carved back' the avoidance schemes, and frankly most people regarded this as a no-go area, as they feared an audit. The film deduction was not working, because it was encouraging advisors in the tax field to obtain additional fees. At the same time it was not helping the film industry, because, if you wanted to make money from the film expense deductions, you really wanted to loose money. Thus the advisor would help the film producer loose money in such a way as not really to loose money but to receive the tax deduction. So National Treasury proposed for the film incentive that all film income be tax exempt. Thus if a film producer made profits these were fully tax free. The industry was happy with that, but did not like the lack of a loss. National Treasury, however, had argued that the film industry was getting the best of both worlds, but the industry responded that most films made no money anyway, so the exemption did not mean that much. So the result was a compromise. If one invested in a film from one's own funds, and this meant real funds not borrowed funds, and if you lost money from the film, National Treasury would give a deduction after two years. It would be a net loss after two years. Now the film industry was very happy.
The international issues
Most people would welcome the changes.
The Value Added Tax
There were two amendments. National Treasury had put in some relief for developers. If you were a residential property developer, when you bought your construction materials, you obtained VAT input credits. When you sold property there was a VAT out-charge. However, if you left the VAT system, there was a deemed VAT out-charge, because you had left the system. A property developer was deemed to have left the system if he rented, rather than sold, the property that he had developed. So many property developers had built houses to sell them, but then found, because of the economic crisis, that they could not sell them. If they decided therefore to offer the houses for rent, they had then to repay the VAT, and this forced them into bankruptcy. National Treasury proposed that, if developers were in that situation, National Treasury would give them a deferral of three years.
However, property developers wanted the amendment backdated. However, in law, one did not backdate amendments. However, it was agreed that SARS would deal with this situation administratively to provide some flexibility and not force developers into bankruptcy.
The other issue around the developers was that the speculators wanted the incentive as well. The problem there was that speculators caused a lot of avoidance. Many speculators played games and used the VAT system as 'a piggy bank'. Also speculators were not in the same situation as developers. They might have one or two houses that they could not 'flip', whereas the developers might have a hundred houses that they could not 'flip', and this entailed substantial VAT.
VAT and the electronic printed material
Mr Morden said that the last issue was a combination of administrative simplicity and developments in technology that had taken place over the years. In the Value Added Tax (VAT) legislation there had been, since the introduction of VAT, a 100% exemption on imports of printed material with the intention primarily of simplifying administration. There had since been a suggestion that National Treasury introduce a similar provision for services, which were really electronic printed material. The proposal was to raise the exemption to R500. The industry, however, had complained that this would put it at a disadvantage, since imported books would enter without the imposition of VAT, while locally produced books would still be subject to VAT. National Treasury had acknowledged this issue and decided that for electronic goods there would also be an exemption of R100, but the bigger issue was how to integrate the VAT system into the electronic world. More and more people were downloading documents and by-passing VAT. It was not an easy issue, but one that we would have to confront in the next couple of years in order to establish a system to collect VAT and level the playing field between physical shops and electronic shops.
Mr Momoniat commented that in United States, even without VAT, the big book stores were closing down because they were losing out to Amazon. The way in which books were sold had obviously changed. For those of us with 'these toys' there were now other ways of obtaining books. It would be interesting to determine how one was going to deal with the situation.
Mr Morden said that it would not be easy, but we would have to confront it otherwise it would undermine the VAT system in future.
The Chairperson observed that it was not just the music industry that was suffering.
Mr Momoniat commented that book publishing companies often did not have anyone to represent them, and even sent their submissions late. However, National Treasury had still looked at them even though the submissions were received late, since it did affect their livelihood. In the medium to long term it would be necessary to consider how the book publishers competed with the electronic age.
The Chairperson observed that Members had received an intense briefing, which reflected the amount of work that National Treasury had done since the Committee's last interaction with it on this subject.
(See documents for further details.)
The Chairperson said that Members needed a workshop, not to delay matters, but to acquaint Members sufficiently with the issues for policy-making purposes.
Mr D van Rooyen (ANC) welcomed the presentation and asked about the cost of the changes envisaged in terms of administration. He asked about the 10% dividend allocation. How would it assist in promoting entrepreneurship? Would it be fair to new entrants?
Ms Z Dlamini-Dubazana (ANC) thanked Mr Momoniat and his team and asked for clarity on the conversion of medical schemes to credits. The proposal itself indicated that the individuals themselves within the marginal brackets would benefit from the conversion. However, she was not too sure how, because the majority of those individuals were the public servants, such as teachers and nurses. How would they benefit from this initiative?
The conversion talked about 'out of the pocket' expenses. A self-employed individual who contributed to a medical scheme would not benefit from a deduction to a credit. Was this really intended? If yes, why? If no, how were we going to do it?
She was worried. What was National Treasury proposing, in two years time, to do with people over the age of 65? This group of the population currently was sitting on unlimited deductions in respect of medical expenses. However, the National Treasury was implying that after two years the situation would change. As legislators, Members needed to know clearly what would happen after two years.
If an individual or a company went to court, it had to be asked if the court would make a fair judgement on a tax neutral position. What was a tax neutral position? How would a court come to a final decision?
Quite a number of issues were ambiguous. On slide 13 of the presentation, if one looked at that diagram, it appeared that there was the bank and a company requested a bridging loan from the bank for the purpose of injecting the money in the target company. For some reason the very same acquiring company established a new establishment which was the new company. However, the National Treasury was saying that the new company went and obtained a loan from a second bank. If it acquired another loan from a second bank, then it found itself indebted. The connection here was difficult to find. The banks had a good system of information technology (IT). When the acquiring company moved that bridging loan to the new company, the movement of that money was absolutely not clear. She needed to understand the connection.
She found it unacceptable that the courts would not be able to give a correct judgement in the situation of narrowed discretion.
There was a potential tax leakage. Would the court be able to understand that? Was there a set of criteria to determine what a potential tax leakage was? Was there a regulation that defined it?
As to the limit on interest deduction (slide 26), if one went to Standard Bank and acquired 5% of the shares, that was not deductible. However, if the investing company, from the United Kingdom (UK) came and acquired 5% of the Standard Bank's shares, it had to be asked what the situation there was. Was it a different picture?
Dr D George (DA) agreed that action had been necessary on Section 45. It was often forgotten that, if there was enormous leakage through the use of potential loopholes, it was individual taxpayers who ended up paying at the end of the day, and people did not receive delivery of services because the country ran short of money; there was thus a strain on the social contract that had to be fixed. He had made known his views on the process followed by the National Treasury on the so-called suspension of Section 45. He asked if the National Treasury had learnt any lessons from this process specifically about the consequences of its actions. Earlier this year the Committee had examined the revenue proposals that the Minister had tabled, and considered the fiscal framework. We had now gone through a process and there had been a couple of changes which would now enter into law. Was there any impact on the fiscal framework from these changes? He could not find in National Treasury's document anything about the employer contributions to retirement funds that would be regarded as fringe benefits. There had been a concern raised that this was a disincentive to saving. However, there was no commentary in the document. He did not understand National Treasury's response on the correlative adjustments to transfer pricing, especially on who was determining the appropriateness of the adjustment.
Mr E Mthethwa (ANC) asked for an explanation of the structural issues on page 11 and sought in particular clarity on the difference between Section 45 and Section 47. He also sought clarity (with reference to slide 23) on the mathematical formula and zero interest.
Mr Momoniat replied to Dr George that there would be some changes to the fiscal framework, but these changes would be quite marginal. Because the tax impact was felt in later years, there might be a bigger effect in 'after years', but the theory was that the big amounts were around the current tax rates. If Parliament were to reject those, there would be a significant impact. Yet Parliament had the right to adjust those rates. Beyond that, most of the other changes dealt with the tax base. They had more of a future year impact than on this year. Sometimes what you lost here you gained somewhere else. There was still the economic cycle. There were many factors that came into play. Hence one made an adjustment at the time of the medium term budget policy statements (MTBPS) and again at the time of the budget. So there was some impact but these were still marginal.
Section 45 was a big enough issue and there was tax avoidance. In June would could say that the cycle was improving, but the last gross domestic product (GDP) figures had not been so optimistic. The cyclical figures would be of bigger concern than these adjustments. National Treasury did not think that these adjustments would change the picture in any significant way.
Generally National Treasury tried to have a very open process. It published, it issued the draft laws, it received comments, and it engaged. However, once in ten years abuses were detected, and it was necessary to take action. It was understandable that people would be unwilling to tell all their tax affairs to SARS. However, both sides had to follow the rules. This was like a game of chess. National Treasury had had to show that it was serious. Since the concern about Section 45 was detected after the budget, the decision not to go ahead with the suspension would not affect the new proposals. For sure, there were lessons to be learned. However, it was not a step that National Treasury took lightly. It did touch on bigger issues of tax morality and on ensuring that all tax payers paid their due taxes. Many funding practices had led to the kind of crisis experienced in 2008. There were indeed lessons, and even today National Treasury was still learning them. Perhaps the process could have been better. However, possibly if National Treasury had not been so forceful, people would not have been so forthcoming.
National Treasury had issued a discussion paper on medical credits. Aside from the difficulty in doing this in two phases, there was the big national health insurance proposal. That would have a major impact on whatever tax proposals National Treasury had. However, the national health insurance (NHI) was still a discussion paper with a particular approach to deductions and credits. It was better to let that process finish. National Treasury thought that the credit system would facilitate the NHI, and thought that this was more equitable. However, it had to be asked if National Treasury should stand still while this major reform took place. National Treasury had the same issues with the retirement and saving issues while waiting for retirement reform. There were a whole lot of other urgent measures that needed to be dealt with.
Mr Morden illustrated the benefits of the reforms for people such as teachers and nurses, and those in the lower income bracket (slide 6). However, Mr Morden was worried about the affordability of it. The whole purpose of the reform was to provide a more equitable subsidy.
Mr Morden gave the example of a married couple whose deduction was R1440 per month. On an annual basis the maximum one could claim was R17 280. However, if one were in the 20% marginal bracket, that benefit to one was R288 per month. However, for someone in the 30% bracket, the benefit for the same deduction was R432. So the higher the income in terms of the marginal bracket, the higher the tax relief. Now everyone in that category would receive R432. The conversion of the 'out of pocket' would be 25%. National Treasury had been a little generous in working with 30%.
The self-employed 'out of pocket' person would be treated as any other person. Whether employed or not, the same rules would apply. If you were not a member of a medical scheme, you would obviously not receive a credit during the year. However, on assessment, all of it was regarded as out of pocket, and then you could claim it in terms of the normal rules.
The issue of the over 65s needed special care. At the moment there was no limit. However, that discrepancy according to income group would apply to over 65s. So, if one were over 65 in the 18% bracket, or in the 40% bracket, there was still that discrepancy. The question was, if one wanted to achieve equity, did one bring everyone up to 40% or bring everybody down to 18% or go for the middle? To bring everybody up to the 40% would be quite costly to the fiscus. The same rules applied to the disabled. These were some of the consultations with which National Treasury was now busy. There was a strong view that we should make that as high as possible to bring it as close as possible to 40%, but it remained to be seen if that was achievable.
The NHI document said that we should phase out deductions completely. However, Mr Morden did not think that possible within the next five to 10 years. As the Chairperson had suggested, this was perhaps the subject for a debate with the Portfolio Committee on Health.
If you were between the 25% and 30% marginal rate, you would be in a neutral position. If you were at the lower margin rate, you would actually be better off. So it was at the margin of where we made that conversion that people would be neither worse off nor better off. If you were at the higher rate, then you would be worse off. That was what tax neutrality meant.
Mr Momoniat emphasised that once the NHI discussion paper was complete, there might be a change of mind on the credit, but it would take NHI some years to take effect. Once people were contributing to the NHI, there would be no need to subsidise medical schemes in addition. This was the theory. National Treasury had to take into account the reality as it was now, but once the NHI took effect, in five or six years, National Treasury would have to implement a different policy. This was the kind of thing that was up for discussion.
Prof Engel referred to slide 15 and explained tax neutrality at length. If there was no mismatch, there was not any leakage. We were talking about a small category of transactions, and that was the issue around small business. All these proposals probably would not have much effect on small businesses. Banks typically did not do preference share funding for smaller businesses. Preference share funding required more expertise and more services. This was a big person's game.
National Treasury had flagged in its media statements that it did not mind giving interest deductions, as long as National Treasury knew that they were not excessive.
Ms Dlamini-Dubazana asked how one then identified whether the transaction became the debt or became the shares.
Prof Engel said that one should look at the bank and whether it was lending one money or shares. One should also look at the terms. One had to ask whether one should repay the loan. If one had to repay the loan within a short time that would appear to be debt. So one was not looking so much at the transaction, but at the money that one obtained from the bank, and one asked oneself what the terms and conditions were If one had to repay the loan within five years, it looked like debt; but if one never had to repay the loan, that looked a lot like shares. If one invested in a company and set up a new company, the company never had to repay one, because one owned the company. So one had to look at the terms of the debt to determine if the debt was really debt or was really equity.
The issue was that sometimes debts had other features. Typically when one knew that there were other players involved, 'that debt started looking funny'. There were shareholder loans. The terms of such a loan were that it was a very soft loan, and as that loan became softer, it looked more and more like shares. It had to be asked why it was called a loan. The reason was that by calling it a loan it became tax-deductible.
Typically the shareholder would be a foreign person and there would be a deduction on the one side and an exemption on the other. However, one needed to see the variety of the transactions. This would probably provide material for a workshop in itself. These deals looked greatly different from what one might expect. To be a tax lawyer, one had to be an expert on finance. This would be difficult for a judge and for all of us. The judge would have to determine whether the deductions on the one side matched the taxable income on the other.
Mr Momoniat commented that a Tax Administration Bill [B – 2011] was in process as well, and this focused on some of these issues.
Prof Engel said that the tax itself was not so difficult to understand. It was, however, necessary to understand business and commercial relationships. It was necessary to have 20 lectures on basic business, before adding a course on tax.
Prof Engel noted a question on liquidation. In Section 45 it was a group transaction. Typically there was a triangle. There were three companies. The assets of one company simply moved to another company in a typical Section 45 situation.
Prof Engel explained that in a Section 47 situation, it was a liquidation. There was a parent company and a subsidiary, and the latter simply went into liquidation. It looked easier in the diagram. In a normal Section 47 situation the acquiring company borrowed the money from the bank, used the money to acquire the target, and then the target was liquidated. The difference between the Section 45 and the Section 47 situation was this Newco (new company). This was the essential difference. The reason for using Newco was to isolate risks. When one was trying to out-manoeuvre the tax man, one had to worry about the bank, about the risks and liabilities, about the Competition Commission, so to be a deal adviser meant that one had to know eight or 10 different laws, know where to get the funding, know what the business was about, and put all the combinations together, so that everything worked. That was why deal advisers were paid what they were paid. It was not an easy business. However, all that was happening in all of these deals was borrowing money from the bank to spend on the shares and thereby obtain a deduction. This was fine, as far as National Treasury was concerned, so long as people did not become greedy. It was important to make sure that it was really debt and not something else.
The dividends tax should not affect small business. The big difference with the new dividends tax was that it actually helped foreign investment and shares. National Treasury' wanted to make to make the treaty system worked. Then there were other advantages, but generally the new dividends tax helped across the board.
The Chairperson noted that the parent company took money from Standard Bank to acquire the target company – with the sole purpose of liquidation. If that happened, what happened to the loan from the bank? Also, why would somebody acquire a company only to liquidate it? It sounded like auctioneering.
Prof Engel replied that there were two things that one had to watch. There were two flows to follow. The acquiring company acquired a target. When the acquiring company obtained the money from the bank, it gave that money to the selling shareholders of the target. 'My company borrows the money from the bank; that money goes to you; I get your company; my company takes over your company. That money is now gone. The acquiring company owes the bank. They've got to satisfy the bank out of the profits of the acquiring company and the newly acquired target that I've got from you.' This is why it was confusing in the Section 45 chart as well.
Mr Momoniat said that the question was where the liquidation was taking place.
Prof Engel said that it was the target that was liquidated.
Mr Tomasek said that the point there was that it was the target that was liquidated. The acquiring company which had obtained the loan remained. So the loan was not disturbed. This was going to be a voluntary liquidation not a compulsory liquidation. It was the target that went, and it went on a completely voluntary basis. The acquiring company stayed in place. The bank's claim on the acquiring company remained in force at 100% of its original claim.
The question about the corresponding adjustments in the transfer pricing space was relatively simple. A foreign company had overcharged a South African company by R100 million. This meant that there was R100 million that should be in South Africa which was now no longer in the country. Two things happened in the transfer pricing world. At the first level, there was R100 million too little profit in South Africa. That needed to be taxed. However, this did not change the fact that offshore there was R100 million that should be here in South Africa. What was that R100 million? Was it a dividend? For simplicity's sake one said that it was an interest-free loan. The South African company had made an interest-free loan offshore. Now there was a secondary adjustment, whereby there should be a tax of 7% or 8% on that interest-free offshore loan. This needed to be charged every year until that money came back to South Africa. From the National Treasury's perspective it was best that the money be refunded back to South Africa.
The employer contribution for pension funds was an administrative issue that did not change the underlying benefit of the deduction.
Prof Engel had dealt with the question of the administrative impact to a significant extent. National Treasury was trying to create safe harbours in the Section 45 space where simple transactions could go through simply. It was the more complicated transactions that would require more scrutiny. These tended to be the bigger deals. There would be some more administration involved from SARS' side and the taxpayer's side. But given the amounts of money involved, Mr Tomasek thought it a reasonable trade-off.
The Chairperson observed that Mr N Koornhof (COPE) had been silent.
The Chairperson thanked the presenters. There was much thought in the process. He commended Professor Osman Mollagee, Director: Tax, PricewaterhouseCoopers and Associate Professor, University of the Western Cape, and his tax practitioner colleagues, who were present today as observers, for having added much value to the process. The ball was now in the Members' court and they would enter into their own deliberations. The final draft of the Bill would be part of the October presentations on the medium term budget policy statements (MTBPS).
Mr Momoniat observed that the tabling of the draft Bill was not meant to coincide with the MTBPS, but it was likely to coincide.
The Chairperson valued also the knowledge that Mr Momoniat and his colleagues had imparted to Members.
The Chairperson adjourned the meeting.
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