National Treasury and the South African Revenue Service (SARS) presented to the Committee its responses to the public hearings on the Draft Taxation Laws Amendment Bill held on 22 August 2012. They reviewed the process for the Bill and noted especially the media release on 31 August on anti-avoidance measures, before outlining the main issues: foreign dividend conversion schemes (schemes involving actual shares/dividends, share derivatives, and dividend transfer mutations), debt/equity postponement (debt deemed to be shares/dividend yields, and deferral of deduction for interest/royalties incurred for the benefit of exempt persons), and financial sector issues (mark-to-market taxation for banks/brokers [effective date delayed until 2014], long-term insurer transition into policy review, and Real Estate Investment Trust [REIT] phase-in). National Treasury and SARS responses to specific comments were then indicated.
Specific aspects of the Response Document were highlighted: additional medical expenses converted to medical tax credits, fringe benefit valuation of rented employer-provided vehicles, revised “share” definition, share-for-share recapitalisations, debt-financed acquisitions of controlling share interests, depreciation of supporting structures for energy projects, rationalisation of withholding taxes on payments to foreign persons, relief from effective management test in the case of high-taxed controlled foreign companies (CFCs), South African fund managers of foreign investment funds, and revised currency rules for intra-group exchange items.
SARS reviewed administrative aspects of the Draft Response Document. There were two key issues: phase 1 of regulation of tax practitioners, and privilege for advice by non-lawyers.
An ANC Member noted that some billions of rands had been lost because of dividends arbitrage, and asked what this revealed about the current risk detection system, and, noting that retrospective application was not something to be encouraged, asked if the approach to it was still the same. A second ANC Member agreed strongly with National Treasury that it was critical to protect the fiscus in order to safeguard the survival and development of the country, before asking about the share as derivative proposal. If the South African Futures Exchange (SAFEX) existed and had the necessary information, why could it not provide the necessary information to Treasury? At the same time, Treasury could not be seen to act against global international laws. She also suggested that Treasury test its proposals thoroughly before presenting them to the Committee. How would Treasury implement its proposals on the dividends cession schemes? Referring to the Response Document, she noted that Treasury was giving an allowance to Eskom. However, what relief was offered to the landowner? A third ANC Member asked if the owner of a particular building used for rental purposes was taxed on the rent received or on the value of the property.
A DA Member disputed the special amendments now under consideration, for these indicated that Treasury and SARS were being over-ambitious in their lawmaking agenda. Their tendency to get the law enacted and then to fix it afterwards signalled uncertainty and legislative unpredictability, and spelled concern for South Africa's reputation for transparency on taxation, especially on the dividends issue. He wanted proper consultation to avoid last minute amendments and to ensure legislative predictability. The move from STC to Dividends Withholding Tax (DWT) was part of a global trend. Thus there was surely a significant amount of precedent that could have been considered. How did Treasury and SARS miss the loopholes and could they not have, in their drafting, anticipated them? There had not hearings on the Tax Administration Amendment Bill, At the end of the Response Document there were comments on that Bill.
National Treasury and SARS replied, among other things, that they wanted to develop tax laws in line with commerce. The aim was to tax economic profit, while making sure that the tax rules did not over tax that profit or under tax it. Much as National Treasury had the power of the law, the taxpayers had the power of the facts, and hence the power to restructure again and again. The bigger the taxpayers were, the more they had the ability to move around. One could only detect risk once it had started to emerge. One tried when developing legislation to anticipate obvious loopholes by way of international comparisons and past experience. The only time that Treasury and SARS applied measures retrospectively was in technical corrections. Such retroactive application generally favoured the taxpayer. Most of the Bill was effective from January 2013 onward. Sometimes it was difficult to catch tax avoidance. Sometimes one succeeded in stopping it, only to find that those concerned found new ways of avoiding paying tax. This was because people got paid to devise tax avoidance schemes. Drafting legislation was a complex art. Sometimes it was hard not to draft a measure in overly broad terms or in too narrow terms. SAFEX was under review. The property owner was taxed only on the net rental income from the property. National Government never taxed the land itself, except when the landowner transferred it, in which case there was a transfer duty, which fell on the purchaser. However, the municipality imposed a very low charge every year based on the value of the land. SACPRIF's proposal was to do away with all the other taxes, and just tax land; in that scenario, the landowner would be taxed whether making money on that land or not – so if the landowner could not afford to hold that land, it would have to be disposed of: SACPRIF's intention was to drive down the price of land.
The Chairperson clarified that there had not yet been public hearings on the Tax Administration Amendment Bill because it had not been formally referred to the Committee. However, Treasury and SARS advised that those who had submitted had imagined that the Committee was accepting comments on both Bills and had included comments in their submissions. Hence Treasury and SARS had responded to their comments in the Response Document. The Chairperson said that the well-prepared presentation, though highly technical, made the Committee's work easier. At the same time, the more Treasury and SARS tried to close the gaps in the tax system, the more Members were aware of the need for the Parliamentary Budget Office.
Draft Taxation Laws Amendment Bill 2012: National Treasury report-back
Process for the Taxation Laws Amendment Bill (TLAB) 2012
Prof Keith Engel, National Treasury Chief Director: Tax Legal Design, reviewed the process. He noted especially the media release on 31 August on anti-avoidance measures.
Outline of main issues
• Foreign dividend conversion schemes
– Schemes involving actual shares/dividends
– Share derivatives
– Dividend transfer mutations
• Debt/equity postponement
– Debt deemed to be shares/dividend yields
– Deferral of deduction for interest/royalties incurred for the benefit of exempt persons
• Financial sector issues
– Mark-to-market taxation for banks/brokers (effective date delayed until 2014)
– Long-term insurer transition into policy review
– REIT phase-in
Foreign Dividend Conversion Schemes
Foreign shareholder dichotomy
• Dividends received by foreign shareholders
– 15% rate
– Treaty relief (5% or 10%)
– Capital and ordinary gains foreign persons are tax-free
– Hence, the sale of a share by a foreign person is tax-free versus a dividend, which is taxable. The incentive is to convert dividends into exempt gains.
• Foreign person owns a share with a R100 value on 11 September.
– Share is expected to generate dividend of R15 on 12 September (having a R85 long-term value and R15 pregnant dividend value)
• Dividend, followed by sale
– The dividend of R15 is taxable in the hands of the foreign person at a rate between 5% and 15%
– No tax on the sale of the share at R85 by foreign person
• Sale, followed by a dividend
– No tax on the sale of the share at R100 by foreign person
– Foreign shareholder sells the right to the dividend before actual receipt
– The cash consideration received is proceeds from tax-free gain
• Share lending
– The foreign shareholder lends the share
– The dividend on the borrowed share is receive by an exempt person
– The cash consideration for the dividend is exempt
• Share repurchase agreements
– The foreign shareholder sells the share
– The dividend is paid while in an exempt persons hands
– The foreign sells receives tax-free cash for the dividend plus a comparable share (less the dividend)
Conversion scheme proposal
• All “in lieu of” consideration for the dividend will be treated as a deemed dividend
– The deemed dividend is taxable in the foreign person’s hands
• The rule applies only if the sale occurs after dividend declaration
– Dividend in specie is a hard rules for domestic parties and impacts pricing models
– Response document: Treat as a normal cash dividend with withholding
– Effective date currently all in lieu of payments from 31 August
– Response document:
– Effective for transactions entered into from 31 August
– All in lieu of payments after September
Share derivatives slide
• Investors increasingly rely on derivatives as an investment tool over direct holdings in shares
– Foreign person acquire a single stock future or a contracts-for-difference in respect of a share
– Local Broker acquires share as a hedge & pays dividend onto foreign person via a derivative adjustment
• Under current law,
– Local Broker receives the dividend tax-free
– Foreign receives the dividend derivative adjustment in respect of the derivative as a tax-free amount
He pointed out that there were many commercial reasons to use derivatives but that tax law had a preference for derivatives as an unintended consequence.
Share derivative proposal
• Initial Proposal
– Dividend adjustments in respect of a derivative will be subject to the dividends tax
• Revised proposal
– The dividends tax requires knowledge of the counter-party to determine tax status; however, counter-party knowledge is lacking for share derivative trades on South African Futures Exchange (SAFEX)
– Argument is that economic generally different and lack of intent (but not always)
• Long-term concern
– A tax preference now exists in favour of derivatives over direct holdings that will push investments toward derivatives
Dividend transfer mutations
• Dividends cession schemes
– Exempt (such as pension or foreign) passes its exemption to transferee
– Manufactured schemes
– Deduction is paid to an exempt entity (such as pension or foreign) (Table, slide 11)
Technical Correction: 2011 Closure of Dividend Cession Schemes
• 2011 Proposal
– Sought to close transfer of schemes by pension funds to export exempt dividends to otherwise taxable transferees
– Technically covered dividends from all purchased shares
• Initial 2012 proposal
– Required dividend recipient to own share
– Resulting in tax for all shares held in trust/CIS
• Revised 2012 proposal
– Dividend cessions without the underlying share
– Share lending dividends/share repos
– Trusts used to accomplish the same result
Tax paradigm of debt versus share
• Interest schemes:
– Payments to foreign persons, pension funds by taxpayers
• Dividend schemes
– Loss making or exempt entities pay domestic companies (Table, slide 14)
Debt versus shares: key commercial features
• Redeemable within a reasonable period
• Fixed Claim on Cash Flows (e.g. based on time-value of money)
– High priority on cash flows/collateral often required
• No management control over payor unless default
• Generally non-redeemable
• Variable claim on cash flows (payments based on profits)
– Low priority on cash flows/no Collateral required
• Management control.
“Hybrid Debt Instruments” Proposal (Sections 8F and 8FA)
• Two-fold regime
– Rules focusing on the nature of the instrument itself (the corpus)
• The proposal characterises the debt as equity if the debt has –
– features indicating that redemption is unlikely within a reasonable period (i.e. 30 years);
– Redemption is conditional upon solvency or liquidity of the issuer; or
– features requiring a conversion into shares
– Rules focusing on the nature of the yield
• The proposal characterises the yield as dividends if the yield is
– not determined with reference to the time value of money
– the yield is conditional on solvency or liquidity
– The yield is payable in shares
Hybrid Provisions Deferred
– Section 8F and 8FA have been pulled from the Bills (because of the 2014 effective date in any event)
– To be reintroduced next year
• Section 8F issues such as:
– Liquidity and solvency (especially if debt is issued as part of business rescue)
– Inadvertent timing
– Deemed conversion triggering a taxable event
• Section 8FA issues such as:
– Uncertainty of the meaning of time value of money
– Insolvency or liquidity limit
– Listed debt payable in shares if shares are a market value substitute
Suspended Interest/Royalty Deductions
• The tax system largely looks to actual payment/receipt and incurral/accrual partially to match accounting tax and partially to prevent avoidance
– Section 24J spreads income/deductions based on economic yield versus payment
– The rule operates as an avenue for avoidance with exempt payees
– Royalties are incurred before payment
– However, withholding is based on cash under the revised rules
– Interest and royalty deductions are deferred until cash payment (or due and payable) if an exempt payee is involved (such as pension fund and foreign investors)
Section 23L Postponed
• Section 23L is postponed like sections 8F and 8FA until next year for further discussion
• Proposal negatives impacts standard zero coupon bonds issued to pension funds and foreign residents
• Proposal can be undermined if the payor makes an artificial payment to payee
– Concerns exist in respect of pay-when-can loans (such as roll-up funds);
– Connected person transactions; and
– Cross-border withholding exists only at time of payment, not incurral/accrual
He noted the need to shut down avoidance but avoid law of unintended consequences.
Business (Financial Intermediaries and Vehicles)
Annual Fair Value Taxation: Background (Sections 24J(9); new Section 24JB)
• Income tax systems generally impose tax on a realisation basis
– Growing trend is towards notional realisation of gains & losses in respect of liquid financial instruments:
a. Listed and over-the-counter shares
b. Listed and over-the-counter bonds and
c. Derivatives in respect of the above
• Accounting (International Financial Reporting Standards (IFRS) (International Accounting Standard (IAS) 32/39 or IFRS 9) is the key driver behind this trend.
• Banks and other large financial institutions have adopted this method in their systems and expect similar tax treatment.
• Two problems
- Compliance burden of maintaining two separate systems (one for IFRS and one for tax)
- Audit much harder to follow books no longer have any bearing to tax (e.g. extensive reconciliations)
Annual Fair Value Taxation: Background
• IFRS fair value assets will be taxed annually on gains/loss:
- Trading assets; and
- Assets to be treated at fair value to prevent mismeasurement
• The new rules essentially place financial assets and liabilities into an IFRS framework for all gain/loss purposes
• The new regime applies to:
- Banks (including local branches of foreign banks)
- Brokers (i.e. authorised dealers)
• The new regime does not apply to unhedged intra-group derivatives
• A one-off transitional charge will apply
- Transitional charge to be spread over 4 years
- The charge applies to the deferred tax difference currently existing between tax and accounting
Effective date deferred
• Effective date of mark-to-market proposal for banks/brokers deferred until 2014
• Risk areas
– How to tax dividends in respect of shares held for trading?
– How to deal with mark-to-market accounting outside IAS 39 but within IFRS?
– How to deal with arbitrage for those inside and outside the system?
– Other entities seeking entry (certain financial asset pools)
– Comprehensive convergence in respect of other assets
– Overbreadth in terms of capital assets
He noted that there was the opportunity for arbitrage for only certain entities in the scheme in the new year.
Mark-to-market of long term policyholder funds (Sections 29A and new 29B)
• Insurers as “tax” trustees of policyholder investments must not only collect income tax but must also properly allocate tax to each policyholder investment.
– Insurers achieve this allocation amongst policyholders by applying continual mark-to-market approach (subtracting notional tax from the gain or loss policyholder investments on a continual basis)
• Any change in effective capital gains tax rates for policyholder funds creates complications for insurers as trustees (especially if higher rates apply only from a later date)
• The realisation principle for the taxation of disposals is becoming outmoded for financial institutions, including insurers.
• It is proposed that a deemed disposal and re-acquisition approach be applied to all policyholder fund assets that mimics mark-to-market taxation on 29 February 2012
- Other than dual-linked funds
- The gain or loss is spread over 4 years
• Annual mark-to-market system deleted pending larger review
New deduction formula for long term policyholder funds
• Old Individual Policyholder formula
– I + R + F/I + 2.5R + 4.75F + 4.75L
– Deductions for indirect (and selling/administration expenses) should be limited to amounts dedicated to the production of gross income
– The old formula took into account an implicit capital gain charge
• New formula
– Taxable income; over
– Taxable income plus dividends (less withholding taxes) plus capital gains without partial inclusion
– Fully effective from 2013 onward
• Liability transfer formula moved from 50% down to 30% because new formula will produce a larger percentage deduction for insurers
Larger Review of Four Funds Formula
• Four funds system
– Comparison with unit trusts (CISs)
– Low-income fund
– Application to risk products/mixed products
– Notional asset allocations
• Deductibility of investment expenses
– Investment expenses not generally deductible
– CIS use of deductions against profits
• Liability shift at year-end
• Differences between general larger insurers, dual-linked funds and risk insurers
Real Estate Investment Trust (REITs): Background (sections 1 (“REIT” definition) and 25BB)
• Property investors directly invest in immovable properties for rental streams or indirectly through property investment entities
- A steady rental stream acts as a substitute for interest income, and growth in the underlying property as relatively stable method of achieving appreciation.
- Ownership in property investment schemes is highly liquid
• Two main types of property investment schemes exist that operate as international REIT – the Property Unit Trust (PUT) and Property Loan Stock (PLS)
- Both the PUT and the PLS are subject to the same listing requirements for the purposes of the Johannesburg Stock Exchange (JSE)
- Only the PUT is subject to FSB regulation
• Two different tax dispensations
- PUTs have an explicit flow through of rentals and an exemption for capital gains
- PLSs have a “homemade” flow-through via dual linked units with debenture interest
- Debenture interest really operates as disguised “deductible” dividends that will violate the new debt equity rules (sections 8F and 8FA)
He explained a flow through regime.
• It is proposed that a unified approach for the property investment schemes will be adopted for financial regulatory and tax purposes.
- The new entity will be called a Real Estate Investment Trust (REIT) in line with the international norms.
- The purpose of the proposed REIT regime is to treat investors roughly similar to the situation in which these investors invested in immovable property directly (flow-through).
• New regime
- All distributions will be deductible if the entity mostly (i.e. 75%) generates rental and similar income (or REIT dividends from subsidiaries)
- Capital gains from immovable property will be exempt
- Financial instruments will generate ordinary revenue (other than REIT interests)
- REIT classification to be maintained by JSE rules
- All REIT yields taxed as ordinary revenue (with foreign persons exempt from dividends tax until 1/01 2014)
- Removal of dual-linked share set to begin from 2013
• Initial proposal
– REIT itself
– Controlled subsidiaries
– Now also 20 per cent or greater subsidiaries
• 2013 and beyond
– REITs wholly owned by pension funds
– REITs wholly owned by long-term insurers
– Incubator REITs to be traded over-the-counter
– Regulation of unlisted REITs absent and regulation of listed REITs uneven between PLSs and PUTs
Response Document highlights
• Additional medical expenses converted to medical tax credits
(Main references: Clauses 6, 7, 35 and 39; Amend Section 6A, insert Section 6B,
amend Section 12M, and delete Section 18) (see paragraph 5.1, pages 2-4).
Prof Engel noted that tax was not a subsidy system.
• Fringe benefit valuation of rented employer-provided vehicles
(Main reference: Clause 110; Amend paragraph 7 of the Seventh Schedule)
(see paragraph 5.5, pages 5-6)
Prof Engel said this was in relation to ongoing saga of employer-provided vehicles. A tool of trade, such as a taxi, should not be taxed, whereas a fringe benefit should be taxed. However, rental vehicles were overtaxed.
• Revised “share” definition
(Main reference: Clause 2(x); section 1)
(see paragraph 6.1, page 8); Introduction of a definition of “debt”
(Main reference: Clause 2(e); section 1)
(see paragraph 6.2, page 8);
Revised version of the hybrid equity and third-party backed share proposals
(Main reference: Clauses 11 and 13; Sections 8E and 8EA)
(see paragraph 6.3, pages 8-12).
• Share-for-share recapitalisations
(Main reference: Clauses 81 and 114; Section 43 and paragraph 78 of the Eighth
Schedule) (See paragraph 6.5, page 12)
Share-for-share recaps (page 12).
• Debt-financed acquisitions of controlling share interests
(Main reference: Clauses 54 and 63; Sections 23K and 24O)
(See paragraph 6.7, pages 13-15).
Prof Engel commented that one did not want to give local deductions to buy foreign shares unless earning a local income.
• Depreciation of supporting structures for energy projects
(Main reference: Sections 11(e)(iiA), 12B(1)(h)-(i) and further proviso to Section 12C(1))
(see paragraph 8.1, pages 26-27).
• Rationalisation of withholding taxes on payments to foreign persons
(Main reference: Clause 22, 72 and 75; Sections 35 and 37J through 37N) (See para 9.3, pages 33-34).
Prof Engel commented that companies were not ready. Moreover, comment had been received that the withholding tax on interest would negatively impact foreign borrowings by the Development Bank of Southern Africa and the Industrial Development Corporation.
National Treasury had responded that interest paid by the Development Bank of Southern Africa and the Industrial Development Corporation would be exempt. This exemption was in line with general exemption for interest paid by commercial banks. Both entities were designed to exist as lenders where standard commercial bank lending was unavailable. (See further paragraph 9.3, pages 33-34)
• Relief from effective management test in the case of high-taxed controlled foreign companies (CFCs)
(Main reference: Clause 2; Section 1 (para (b) of the “resident” definition) (See para 9.5, pages 35-36).
• South African fund managers of foreign investment funds (Main reference: Clause 2; Section 1(“foreign investment fund” and “resident” definitions) (See paragraph 9.9, pages 37-38).
• Revised currency rules for intra-group exchange items (Main reference: Clause 59; Section 24I(7A) and (10)) (See paragraph 9.10, page 38).
Mr Franz Tomasek, SARS Group Executive: Legislative Research / Development, reviewed administrative aspects (see Draft Response Document, paragraph 13, pages 47- 49). There were two key issues:
• phase 1 of regulation of tax practitioners (see paragraph 13.2, pages 47-49); and
• privilege for advice by non-lawyers (see paragraph 13.3, page 49).
Mr D van Rooyen (ANC) noted that some billions of rands had been lost because of dividends arbitrage What did this reveal about the current risk detection system? It was not the first time that measures had been introduced, only for one to discover that there were still leakages. He asked for clarity on the retrospectivity of the approach. Retrospectivity was not something to be encouraged, but at times it could not be avoided. Was the approach still the same?
Ms Z Dlamini-Dubazana (ANC) agreed strongly with Prof Engel that it was critical to protect the ficus in order to safeguard the survival and development of the country.
She asked about the share as derivative proposal. She understood that it was an international law, that it was impossible to tax derivatives, because the 'counterpart knowledge' was lacking, and the SAFEX was not providing the necessary information. If SAFEX existed and had the necessary information, why could it not provide the necessary information to National Treasury to assist it, since it was a problem for the Treasury. At the same time, Treasury could not be seen to act against the global international laws.
Treasury had produced the three proposals on the dividends cession schemes. She noted that Treasury had realised that the original proposal would damage the fiscus, so it had produced the three proposals. However, had Treasury tested them? Would it not be better for the Treasury to return to the Committee having tested its proposals thoroughly after it had gathered all the relevant information? Treasury had the technical knowledge, whereas the Committee was not aware how effective the proposals would be? How would it implement them?
For compliance purposes, it became very difficult to maintain the two separate systems – the IFRS and the 'one-off for tax', 'one-for-tax'. However, if National Treasury and the Committee continued saying that it was indeed difficult to maintain them, but these two separate systems had a tendency to dent South Africa's fiscus, it had to be asked what Treasury was doing about it. It was indeed a problem to maintain the two separate systems, but Treasury could not leave the banks uncontrolled.
On the four funds formula and policyholder funds, she asked, if one looked at those four funds systems presented, it was apparent that the four kinds of tax payer were taxed differently because of the funds that they were running. Did Treasury have an instrument to ensure that 'our eyes were on those four funds'? If such an instrument existed, the Committee did not know about it.
National Treasury had also spoken about the liability's being shifted for another year. 'Do we also manage that?' If so, then there was little damage to the fiscus. However, if not, there would be serious damage to the fiscus.
On page 12 or 13 of the Response Document, where Treasury spoke of the intra-group movement of assets, she was sure that National Treasury was attempting to offer an anti-avoidance measure. The initial proposal was that the book value was fine. The book value remained, but there were still problems, and one did not see another proposal. What was Treasury offering the Committee? Members could not be seen to be going backwards and forwards.
On page 26 of the Response Document, she noted that Treasury was giving an allowance to Eskom. However, what relief was offered to the landowner?
The Chairperson noted the presence of Mr Peter Meakin, Chairperson, South African Constitutional Property Rights Foundation (SACPRIF) as an observer with keen interest: as such he would unfortunately be unable to ask any questions or to respond.
Prof Engel replied generally. There were some difficult issues. What National Treasury wanted to do was to develop tax laws that were in line with commerce. Through the Income Tax Act (No. 58 of 1962) one aimed to tax economic profit, while making sure that the tax rules did not over tax that profit or under tax it. However, first it was necessary correctly to identify what that profit was. This was complicated in itself. The problem was, much as National Treasury had the power of the law, the tax payers had the power of the facts, and hence the power to restructure again and again. The bigger the tax payers were, the more they had the ability to move around.
One could only detect risk once it had started to emerge. One tried when developing legislation to anticipate obvious loopholes by way of international comparisons and past experience. However, there were many combinations, and there were limits to what the National Treasury could do. However, inevitably when one entered into a radical new tax, such as the dividends tax, a tax which was in line with international paradigms, it was difficult suddenly to take action on hearing rumours. Firstly one had to be aware of a problem, and the details of it. If one did not know the exact details, the only other response was to go overly broad. Last year, with Section 45, National Treasury and SARS knew that there was a problem, but did not know exactly the nature of it, hence the move to suspend Section 45. The unintended consequences were well-known, as the suspension hurt commerce. It was necessary to intervene like a surgeon. Also, at the time of intervention, National Treasury and SARS were not always given the full set of facts. The schemes at issue started from 01 April 2012. Three or four months was record time for most revenue authorities to catch up. Governments all around the world, in regard to tax, were always playing a game of catch-up. All one could try to do was to have a very active revenue service. One did one's best to engage with tax payers. There were some tax payers who were very aggressive. On the other hand, there were some who were very forthright and forthcoming. If one had a good relationship with tax payers, that could help considerably. In this case, there were some serious concerns on the part of tax payers, who said that National Treasury and SARS were losing so much money, that they were afraid that if this continued, National Treasury and SARS would have to raise taxes elsewhere. Someone had to commit the crime before National Treasury and SARS could take action.
Then there was an issue about retrospectivity. This amendment was not retrospective. It was sudden, but whatever tax payers had done before, in the previous few months, National Treasury and SARS would 'legislatively walk away from'.
Mr Tomasek said that this was the point: National Treasury and SARS were not 'walking away from it'. There were some other tools to challenge these actions, and National Treasury and SARS would be examining them to see if they could not use some of those tools to challenge those actions. The problem was that when one was dealing with stakes like this one could not just hope that the tool was going to work. One must be sure that the tool was going to work. So what National Treasury and SARS was doing here was to propose closing 'it' down absolutely from 01 August 2012, and then National Treasury and SARS would use the existing tools as best they could to pursue the transactions that had happened beforehand.
Prof Engel endorsed this point. The problem with some of the general doctrines was that there was a basis of law, but it was untested. The tax laws tended to better with bright line rules, but such rules created problems, while bringing irregularities to a dead stop. When one was dealing with a large amount of money one did not want to wait to go to court a year later, while another billion rands escaped the fiscus. At times like this one had to act. Even some tax payers agreed with that.
The only time that National Treasury and SARS applied retrospectivity was in regard to technical corrections of obvious little errors, in response, in many cases, to advice from stakeholders. Retroactivity generally favoured the tax payer. Most of the TLAB was effective from January 2013 onward. Increasingly, National Treasury and SARS followed that approach, except for technical corrections where National Treasury and SARS applied retrospectivity. The only time when National Treasury and SARS did a retroactive technical correction that the tax payers did not like was on another thing mentioned in the media statement of 31 August 2012. In this statement there was some wording in the law: one could obtain Secondary Tax on Companies (STC) credits under the new system, if one paid STC tax under the old system. National Treasury and SARS were explicit about that. It had been included in the Explanatory Memorandum and repeated in submissions to the Committee. National Treasury and SARS had drafted something but the wording was just not tight enough. They had met with the industry repeatedly, but nobody had said anything. Then National Treasury and SARS had heard, about a month or two previously, that tax payers had used this wording to obtain tax credits in the new system when they had not paid the STC tax in the old system. That wording was so obvious that National Treasury and SARS reverted to 01 April on that wording, for this was an obvious technical correction. National Treasury and SARS had pointed out that industry representations at stakeholder meetings could not be one-sided. If industry stakeholders wanted to point out all the flaws which they wanted to have fixed, they must, if the observed tax evasion on the other side, bring such misbehaviour to National Treasury and SARS' attention. That was the only place where National Treasury and SARS went retroactive. Every other amendment here was helping the tax payer. Moreover, there was no constitutional prohibition of retrospectivity, but it was generally to be avoided as far as possible. The date of announcement was 31 August. National Treasury and SARS would not be applying the measure retrospectively.
Sometimes it was difficult to catch tax avoidance. Sometimes one succeeded in stopping it, only to find that those concerned found new ways of avoiding paying tax. This was because people got paid to devise tax avoidance schemes. Ms Dlamini-Dubazana had referred to the dividend cession schemes. Sometimes National Treasury and SARS had trouble with words. Even though National Treasury and SARS had the power of the pen, drafting legislation was a complex art. One was allowed only to use certain words when one drafted. Sometimes it was hard not to draft a measure in overly broad terms or in too narrow terms. If tax payers were reluctant to tell National Treasury and SARS of ways of avoidance, then National Treasury and SARS tried to be perhaps overly broad just to be safe, and then tax payers complained that National Treasury and SARS had gone too far. At the same time the stakeholders did not inform National Treasury and SARS what the problem was because they did not want National Treasury and SARS to know. Sometimes it was this and mouse game that complicated everything.
With the banks, National Treasury and SARS was trying to deal with the 'elephants'. The 'elephant' was going down the IFRS path. National Treasury and SARS wanted to ensure that they followed the 'elephant' all the way. To go only part of the way would cause a problem, so they wanted to wait a full year in order to all the way.
It was because of the four funds that National Treasury and SARS required a review. If one had one tax payer whom one broke up into four parts, this tax payer became very hard to track. The tracking and the tracing between the four parts became very complicated. In all fairness, he said that the industry had been very forthcoming and helpful, but one of the difficulties in the area of insurance had been that the insurance companies were not just paying tax on behalf of themselves, but on the part of the policyholders. So, in effect, there were many tax payers. The insurance industry had been cooperative and open in assisting National Treasury and SARS to determine if the insurance companies' effective tax rate was reasonable. It was important to ensure the right balance. National Treasury and SARS had sought in this year's amendments to move to a win-win situation with the insurance industry. However, this system was overly complicated.
SAFEX was under review. At present, there was some concern at not knowing counter-parties that had nothing to do with tax. There was the Financial Markets Bill [B12-2012] and the issues around tracking and tracing derivatives. Mr Roy Havemann, National Treasury Chief Director: Financial Markets and Stability, had been quite involved in that. Getting some control over the derivatives market, in terms of identification, was very important to him. It was important to know both who the players were and the size of the market. Unfortunately this process took time. Once one obtained this identification, this question had to be revisited. This issue was definitely on the table.
Mr T Harris (DA) disputed the special amendments now under consideration, for these indicated that National Treasury and SARS were being over-ambitious in their lawmaking agenda. There seemed to be a tendency to get the law enacted and then to fix it afterwards. This signalled uncertainty and legislative unpredictability, and spelled concern for South Africa's reputation for transparency on taxation, especially on the dividends issue. He wanted proper consultation to avoid last minute amendments and to ensure legislative predictability.
In the cases that National Treasury and SARS was now aware of, what would the loss of tax revenue have been from those specific cases? Overall, what would National Treasury and SARS estimate the overall loss to the fiscus if one did not fix this loophole?
To what extent would the proposed amendments impose costs on legitimate transactions, and what would those costs be?
The move from STC to Dividends Withholding Tax (DWT) was part of a global trend. Thus there was surely a significant amount of tax precedent and systems that could have been considered. How did National Treasury and SARS miss those particular loopholes? Surely National Treasury could have drafted the law to anticipate those loopholes?
What could be the effect of the proposed amendments on South Africans who wished to borrow from foreign shareholders? Was there a potential effect on the liquidity of the market?
To what extend did South Africa's tax treaties mitigate some of the problems identified here? If there was a tax treaty in place, would it help with this particular loophole?
He was confused by the dividend in specie, Response Document, page 8. Were National Treasury and SARS suggesting that it needed to be taxed through the company paying the dividend, and that there had been a reversion to the old STC approach?
National Treasury and SARS had conceded that there was now a tax preference for dividends (slide 10). How did this play out? Now that there was a tax preference for derivatives over equity, how powerful was the effect and the incentive, and how did National Treasury and SARS envisage changing the way in which companies invested and held assets? If it was a significant tax preference, one could imagine that it would have quite a disruptive effect on the market. How did this play out, given that one had accepted that it would simply remain a tax preference?
The second set of last minute changes were mostly to the benefit of tax payers, as National Treasury and SARS had said. It was all very well to say that National Treasury and SARS were going to suspend the debt versus equity issue, the suspended deduction for interest on royalties, and the deferral of the annual fair value taxation, but, after several months of uncertainty as to whether these proposals would be enforced or not, now National Treasury and SARS were saying that they would not be enforced one welcomed the implied leniency, but he hoped that this set of issues could have been ironed out in the extensive set of consultations that National Treasury and SARS had had with the private sector. It was surprising that it was only now that there appeared to be a resolution. It could have been done much earlier and much uncertainty avoided.
He had not heard in the original presentation National Treasury and SARS' discussion of the issue of the STC credits, but there had been reference in the response to Ms Dlamini-Dubazana. What was the actual proposal on STC credits, and would it be retrospective? How many comments did National Treasury and SARS receive on STC credits?
There had been hearings on the TLAB 2012 on 22 August 2012, but he was not sure that there had been hearings on the Tax Administration Amendment Bill [B -2012] (TAAB). At the end of the Response Document there were issues from the TAAB.
Dr Z Luyenge (ANC) asked if National Treasury and SARS had any automatic inflation management consideration in respect of savings in the form of immoveable property, when the property owner was being taxed. If that particular building was used for rental purposes, was the owner taxed on the rent that he or she actually received in that particular financial year, or on the value of the property that he or she owned?
Prof Engel, observing that Mr Meakin had left, responded to the property issue. The property owner was taxed only on the net rental income from the property. So if one owned a piece of property and borrowed from the bank, one paid a levy and earned some rental income, one added up all one's profit so that one was taxed only on the net profit. If one lost money on the rental, one was not taxed at all. It was only when one started making money that one was taxed on one's net rental benefit (gross rental minus the expenses). National Government never taxed the land itself, except when one transferred it, in which case there was a transfer duty, which fell on the purchaser. There was, of course, the rates imposed by the municipality, which would tax just the value of the land. The municipality imposed a very low charge every year based on the value of the land. Mr Meakin's proposal was to increase taxes on land, just for owning the land, and so the more valuable the land which one owned, the more the tax was applied. Mr Meakin wanted to do away with all the other taxes, and just tax land; in his scenario, one would be taxed on the value of one's land whether one made money on that land or not – so if one could not afford to hold that land one would dispose of it: his intention was to drive down the price of land. Right now, under current law, one was taxed only on one's profit on one's land; one was not taxed very heavily on the value of one's land, because it was not the intention to force one to sell it (moreover, this taxation on the value of one's land was a local municipality tax, not a tax administered by SARS).
National Treasury and SARS had engaged on the dividends tax over three years. The tax had been announced and finalised and National Treasury and SARS had been adjusting it, in consultation with tax payers, over two or three years, but had implemented it only from 01 April 2012. It was a major change but it had not been rushed. In dealing with legislation, discussion documents were of only limited assistance. Unless people knew that the proposed legislation was imminent, they did not really respond. He noted that this was, in the interests of flexibility, an informal process. It would become formal only one month from now. National Treasury and SARS received requests for change all the time; some of these requests were motivated by the desire to help the tax payers, some by the desire to help the fiscus, some by the desire to help the economy, and some of the motivations were on the basis of political mandates. If National Treasury and SARS did not act, avoidance would creep in. Inaction had a price. Then there were those who maintained that National Treasury and SARS were taxing an activity so much that a business person could not enter into it. There were those who maintained that because a particular practice had become an established commercial practice, it would be harmful for them if National Treasury and SARS changed the rules. There were some, including Government departments, who wanted to use tax system as a grants system. The dividends tax was designed to align South Africa with international norms, and to make South Africa more competitive. In regards to certainty, he said that 'we're damned if we do and damned if we don't'. Just by announcing the draft legislation, National Treasury and SARS was accused of creating uncertainty. However, if National Treasury and SARS did not announce it, how could it be discussed? It was an argument that National Treasury and SARS could not win. It was rare for people to inform National Treasury and SARS about avoidance. It had to be detected and targeted exactly. If targeted incorrectly, there were unwanted consequences.
Mr Tomasek added that the double taxation agreements (DTAs) would not assist here, because the DTA's role was to allocate taxing rights, assist in the exchange of information, and in some cases assist in the collection of taxes which had been levied. There was nothing in particular in the DTA which would have assisted here. There were some who received relief under the DTA but would like to receive more.
Mr Tomasek added that Eskom stood to claim the costs of whatever it was that it had built. That was how it worked. The landowner might, of course, receive some rental income from Eskom for having use of one's property. The landowner would be taxed on that rental income, but would be allowed to claim the expenses of maintaining that asset in such a way that it could be rented out.
Prof Engel said that international comparisons were useful only if one fully understood the foreign tax system in question and its legal basis. International tax comparison was like a super-specialised tax expertise. South Africa had unique aspects in its law, for example, the Roman-Dutch law of dividend cessions. It was easier when introducing capital gains tax. One could do international comparisons for broad brushes.
The proposed amendment on foreign borrowing applied only to shares and not to debt. It might raise the cost of shares.
National Treasury and SARS were targeting the cessions, the share lending, and the repos, and only where the transfer happened after dividend declaration. So not all transactions were affected. The derivatives did pose a problem, because one had to do it in full or not at all. Because of SAFEX, it was necessary to tax all derivatives. The trend internationally was towards share derivatives. This was a trend that was happening, without regard for tax, for a variety of reasons. Pushing in favour of share derivatives over shares was not a desirable outcome. On the other hand, to go the other way might kill the market altogether. National Treasury and SARS thought it was choosing the lesser of two evils.
The debt proposal on the STC was only to take effect in 2014. However, tax payers needed draft legislation to respond to, because they might agree in principle, but not in detail.
The STC credit proposal was retroactive to 1 April 2012. The measures mentioned, in the media statement, to counteract the big losses were only effective from 31 August 2012 so these were not retroactive. Some commentators had seen defective language in Section 64J. The bulk of the firms, including the more reputable, had advised against it. They had spotted a real risk, and an obvious error. So most firms stayed away from the scheme. However, there were a few aggressive firms, who argued constitutionality. He did not think that these firms had a case, as some degree of retroactive application was allowed in appropriate circumstances and was constitutional under international norms.
A certain deal alone would have cost National Treasury and SARS about R400 million. There were many rumours in the market, and many deals going through, but SARS had not yet audited them. SARS could not intervene the moment someone planned a scheme. It could not audit one for thinking of ways of avoiding tax. SARS could act only once it had received a return, and then only when it had cause to act.
Dividends received by foreign institutional investors were the amount of the tax. It would have been several billion in the final analysis. The dividends tax this year was expected to yield about R3 billion.
The Chairperson said that there had not yet been public hearings on the Tax Administration Amendment Bill [B – 2012] because it had not been formally referred to the Committee.
Mr Tomasek thought that those who had submitted had imagined that the Committee was accepting comments on both the TLAB and the TAAB had included comments in their submissions. Hence National Treasury and SARS had responded to their comments in the Response Document.
Mr Van Rooyen, who had been Acting Chairperson at the time, had warned those who had commented on the TAAB, that the time for official comment on that Bill was still to come.
The Chairperson thanked National Treasury and SARS for a well-prepared presentation which, though highly technical, made the Committee's work easier. At the same time, the more National Treasury and SARS tried to close the gaps in the tax system, the more Members were aware of their need for the Parliamentary Budget Office to be up and running as soon as possible.
The Chairperson adjourned the meeting.
Ms P Adams (ANC), Mr E Mthethwa (ANC), Mr D Ross (DA), and Mr N Singh (IFP)
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