National Treasury presented its responses to the submissions on the Employment and Learnership Tax Incentives following public hearings. The Learnership Tax Incentive was introduced to encourage skills development and job creation, by providing an additional tax deduction for formal, SETA-registered training programmes. The incentive was currently available for learnerships registered before 1 October 2016 but National Treasury proposed the continuation of the programme until a sunset date of 31 March 2022. None of the comments were accepted and the reasons for each were provided. The Employment Tax Incentive (ETI) was introduced to promote employment, particularly of young workers. The incentive could only be claimed by employers up to 31 December 2016 but government saw a higher-than-expected take up, which meant that the programme exceeded its initial cost estimates. However, evidence suggested that the incentive had a positive impact on youth employment, especially amongst smaller firms. Government proposed to extend the ETI for a further two years until 28 February 2019 and put a cap on the incentive of R20 million per annum per employer. However, submissions indicated that business enterprises, tax practitioners, payroll authors and one labour federation opposed the proposed cap of R20 million per year per employer. The cap was viewed as an impediment to large-scale employment creation initiatives and an unnecessary administrative impediment. National Treasury accepted this comment as a compelling case was made that the proposed cap would come at the cost of higher levels of unemployment. This presented two options for the cap: increase the level of the cap or delete the proposal for a cap. National Treasury proposed removing the cap on the incentive.
Members wanted more data to be collected and regular reporting to take place to evaluate the effectiveness of these incentives.
The Independent Regulatory Board for Auditors (IRBA) presented some highlights: it celebrated its 10 years of independent audit regulation, South Africa achieved first position for its auditing standards in the World Economic Forum’s 2016 global competitiveness rankings for the seventh consecutive year and IRBA issued its first Public Inspections Report: Striving for Consistent, Sustainable High Audit Quality. In May 2015 the Audit Development Plan was launched and IRBA also managed to publish its third Integrated Report and started a project that researches measures to strengthen auditor independence.
With regards to financial performance, there was a decrease in the government grant IRBA received by R5 million. Other income also declined by R2 million. Expenses increased by R4 million and although income was cut, IRBA had to strengthen its inspections department. In total, IRBA went from a surplus of R7.4 million in 2015 to a deficit of R3 million in 2016.On IRBA income sources, government grants decreased by 13.2%. Uncontrollable fees increased by 200.6%. With regards to controllable expenses, there was an increase of 1.3%. Overall income sources decreased from R95 million in 2015 to R88 million in 2016.
The report from the Auditor General showed a clean audit for seven consecutive years. A breakdown of performance information indicated that IRBA achieved almost all its targets.
IRBA gave a background to the B-BBEE accreditation system in South Africa. Approximately 300 auditors registered with IRBA for the purpose of providing B-BBEE certificates. In May 2015 the rules for BEE certification changed. The Department of Trade and Industry (DTI) realised that the BEE certification was burdensome on businesses and DTI took a different approach by changing the requirements. As result of these legislative changes, the work of some auditors changed overnight. Those auditors specialising in BEE certificates suddenly had far less work. When DTI made these changes IRBA and the South African National Accreditation System (SANAS) were the two bodies responsible for verifying the auditors who did the certification. The IRBA board decided that in the light of the coming changes, it was better to have one body deal with BEE verification. On 1 October 2016 IRBA withdrew and SANAS took over the entire BEE verification.
The IRBA board had a meeting in July and decided to introduce mandatory audit firm rotation. The backlash was major and audit firms were not happy with this proposal. The IRBA consulted with, and reported progress to the Ministry and Treasury throughout the process. Proposed requirements are that an audit firm shall not serve as the registered auditor of a listed company for more than 10 consecutive financial years, with effect for financial years commencing on or after 1 April 2023. If at the effective date, the listed company has appointed joint auditors and both has had audit tenure of 10 years or more, then only one audit firm is required to rotate at the effective date and the remaining audit firm will be granted an additional two years before rotation is required.
IRBA’s study found that 96% of the market capitalisation companies listed on the JSE was audited by a member of the “Big 4”. This was a shocking discovery, which clearly indicated the resistance to change within the audit space. One of the significant findings was the familiarity threat between the Chief Financial Officer (CFO) or Financial Director (FD) and incumbent auditors. Analysis revealed that 18% of the CFOs/FDs of the JSE Top 40 listed companies were previously employed by the audit firm that was listed as the appointed external auditor to that company and another finding was that 25% of Audit Committees of the JSE Top 40 listed companies were chaired by a member who was previously employed by the audit firm that was appointed as the external auditor to that company.
Members were concerned about the level of transformation at audit firms. They felt that the proposed mandatory audit firm rotation was a great initiative but some members felt that there would be a risk of companies being unstable due to the change in audit firm. The Committee felt that it was important to engage with the Big 4 audit firms to find out why it was not accepting of the proposed firm rotation. There were risks associated with one audit firm auditing a company for more than 10 years which questioned transparency and independence. Members commended the good work done by the IRBA.
Employment & Learnership Tax Incentives: National Treasury response to submissions
Ms Yanga Mputa, Chief Director: Legal Tax Design, National Treasury, reminded the Committee of the consultation process for the draft Tax Laws Amendment Bill (TLAB). The 2016 Draft Taxation Laws Amendment Bill, the second batch, was published for public comment on 25 September 2016 (following the first batch TLAB of 8 July 2016). This Bill contained changes to the Learnership Tax Incentive and Employment Tax Incentive. National Treasury and the South African Revenue Service (SARS) briefed the Committee on the second batch draft bills on 11 October 2016 and received written comments from 17 organisations. Oral presentations were made to the Committee on 9 November 2016. The Solvency Asset Management (SAM) task group also made an oral presentation that day on the tax treatment of long term insurers due to the introduction of SAM. This issue was not contained in the second batch but was dealt with on the first batch of the 2016 Draft Taxation Laws Amendment Bill. National Treasury and SARS now wanted to present a draft document to the Committee containing a summary of responses to comments received on this Bill.
Responses to submissions on the Learnership Tax Incentive
Mr Chris Axelson, Director: Personal Income Taxes and Savings, National Treasury, explained the Learnership Tax Incentive was introduced to encourage skills development and job creation, by providing an additional tax deduction for formal, SETA-registered training programmes. In its current form, the incentive would only be available for learnerships registered before 1 October 2016. National Treasury proposed the continuation of the programme until a sunset date of 31 March 2022. The values of the claims were adjusted in order to target the incentive to crucial training, in line with the Department of Higher Education and Training (DHET) policies. While all registered learnerships would still qualify for the incentive, the proposed targeting prioritised learners without basic to intermediate qualifications by providing a higher value of claims. The prior qualification of the learner entering into the learnership agreement would determine the value of the claim.
Mr Axelson said that a comment received was that the Learnership Tax Incentive must be granted even to employers who engage in internships and graduate programmes. These youths would not necessarily obtain a qualification during the duration of the programme, but could always attend industry specific training programmes that would enhance their knowledge over and above university qualification. Usually the training programmes were not NQF aligned, but it was very critical in areas of specialisation. The response from National Treasury was that this comment should not be accepted. He explained that one of the objectives on the Learnership Tax Incentive was to encourage skills development and job creation, by providing an additional tax deduction for formal training programmes that upon successful completion provide learners with an accredited qualification that would improve chances of finding employment. There was currently no mechanism in place to verify the quality of internships and National Treasury and SARS could therefore not provide a skills based training incentive for training that could not be verified.
Mr Axelson said another comment received was that the 1 October 2016 implementation date would create uncertainty with regards to existing learnership agreements. It was recommended that the wording be clarified such that the new provisions apply to existing learnership agreements and learnership agreements entered into on or after 1 October 2016. He said that National Treasury’s response was not to accept this comment. He explained that there was no reference to existing learnerships being subject to the new provisions, as this was not the intention. Learnership agreements entered into before 1 October 2016 would still be subject to previous legislation, even if the agreement continued beyond 1 October 2016.
There was a comment that more clarity was needed on the tax consequences of a person obtaining a higher degree during the year of assessment, and as a result moving from NQF 6 to NQF 7. Based on the current wording, it was assumed that the allowance would have to be claimed on a pro-rata basis with R40 000 apportioned for the period prior to the date of graduation, and R20 000 apportioned for the period after graduation. Treasury “noted” this comment. Such claims would be calculated on a pro rata basis where the period spent on NQF level 6 would be calculated on R40 000, and the period during the same assessment year spent on obtaining a NQF level 7 would be based on the new proposed amount of R20 000.
There was a comment that the proposed reduction was questionable in light of the market demand for Training Outside Public Practice (TOPP) training, and big companies commitment to achieve this. Chartered Accounting (CA) candidates were currently on NQF level 8. It was proposed that the deduction for learnerships with NQF level 7 to 10 should remain in line with the NQF 1 to 6 deduction or the previous amount should remain as it was at R30 000. The amount of the incentive should also be doubled to reinstate value in real terms.
National Treasury’s response was to not accept the comment. In line with the priorities of the DHET, government was of the view that there should be a more focused targeting of the incentive by prioritising agreements with learners who had basic to intermediate skills levels and qualifications. This was aimed at incentivising employers who would otherwise not have trained or employed people with these skills levels and qualifications, compared to more highly qualified people, who had a comparatively better chance of finding employment. Within this context, focusing on and providing more support to encourage artisan development was in line with the goals set out by the National Development Plan in terms of producing 30 000 artisans annually by 2030. In the current fiscally constrained environment, it would be difficult to increase the value of the incentive further.
There was a comment that the SETAs were a main stumbling block to the efficiency and effectiveness of the incentive. This was also demonstrated in the disparity that functional SETAs like FASSET tended to create more opportunities for their members and also better skills development standards. A medium term policy question was whether Treasury should continue to couple the Section 12H allowance to SETAs. Rather, it could be linked to Treasury’s listed specified training areas and minimum level of content, whose content must also be accredited by the South African Qualifications Authority (SAQA) under the Quality Council for Trades and Occupation, and which disclosures should be done only to SARS to minimise duplication. Treasury’s response was that it noted this comment. However, it did not have the mandate to perform this role which correctly rested with the DHET. It would liaise and work with the DHET in achieving the reforms needed to improve SETA functionality.
Responses to submissions on the Employment Tax Incentive
Mr Axelson explained the Employment Tax Incentive (ETI) which was introduced in January 2014 to promote employment, particularly of young workers. In its current form, the incentive could only be claimed by employers up to 31 December 2016. Government saw a higher-than-expected take up, which meant that the programme exceeded its initial cost estimates. However, the evidence suggested that the incentive had a positive impact on youth employment, especially amongst smaller firms. He said that government proposed to extend the ETI for a further two years until 28 February 2019 and put a cap on the incentive of R20 million per employer.
He noted that comment received through submissions indicated that business enterprises, tax practitioners, payroll authors and one labour federation opposed the proposed cap of R20 million per year per employer. The cap was viewed as an impediment to large-scale employment creation initiatives and an unnecessary administrative impediment. National Treasury accepted this comment. He highlighted that employment growth was a key aspect of government’s inclusive growth objective. During the public hearings a compelling case was made that the proposed cap would come at the cost of higher levels of unemployment. This presented two options for the cap: increase the level of the cap or delete the proposal for a cap. He noted an analysis done by National Treasury which indicated that a higher cap would only affect a handful of claimants, and would therefore be ineffectual. National Treasury proposed to retract the cap during the next phase of the ETI, given the need to address rising unemployment. This would also lend support to the emerging commitment by key stakeholders to extend employment to a large number of young work seekers, including a commitment to support work seekers with structured training programmes. He said that SARS and National Treasury would monitor the affordability of the programme as an input to the fiscal framework and should cost containment of this programme be required, the imposition of a cap would be revisited.
Mr Ismail Momoniat, Deputy-Director General: Tax and Financial Sector Policy, National Treasury, added that it was engaging with business and labour to explore the Youth Employment Service (YES) Initiative. Business was trying to create an additional 330 000 to 500 000 jobs for young unemployed people. So in the light of that, National Treasury decided it would be in the best interest of the unemployed to leave out the R20 million cap. The stakeholders in the YES Initiative were willing to come and brief the Committee.
Mr Axelson said comments made indicated a range of alternative targeting suggestions to shift the targeting of the incentive beyond employees that were currently eligible. In particular:
(i) increasing the eligible range of incomes
(ii) including apprenticeships
(iii) short run work experience programmes
(iv) historically disadvantaged mid to senior groupings serving in private sector organisations, and
(v) longer term employment.
He noted that National Treasury rejected these comments. The current targeting was based on the objective of the incentive, namely encouraging employment in young, inexperienced workers. Adjusting the eligible salary bands would result in adjusting the target beyond the most vulnerable work seekers, including more qualified and experienced workers. Few other government programmes offered an intervention of this nature for the intended target group while other government programmes offered interventions that fit the suggested targeting such as the Learnership Tax Allowance which covered apprenticeships. The targeting was also informed by fiscal limitations, since adjustments to the formula had revenue implications.
Another comment showed that one labour federation did not support the extension due to concern about the eligibility of labour broking firms, with a suggestion to exclude firms engaged in labour broking from the incentive. National Treasury rejected this comment. The tax system was broad in reach by design and the ETI did not provide support to employment that did not comply with the existing labour regulatory system. Labour practices that were perceived as unfair were addressed in labour legislation like the Labour Relations Act (LRA), the Basic Conditions of Employment Act (BCEA) and the Employment Equity Act (EEA), under guidance of the Department of Labour. In addition, National Treasury and SARS were guided by the principles of equity, efficiency, simplicity, transparency and certainty in designing the tax system. He explained that excluding a sub-grouping of employers based on the form of sub-contracting would impede the principle of horizontal equity. National Treasury would rather exclude problematic labour practices in a manner that was consistent with labour legislation and tax principles.
There was a submission that proposed proposal a three year extension of the ETI. National Treasury said that it “noted” this. Treasury had proposed an extension of two years, in part to provide an opportunity to assess the impact of the incentive over a longer period of available data. A further extension of the programme would require assessment of revenue implications and affordability of the programme, given the existing fiscal framework and fiscal pressures.
Another comment was the proposal of more regular policy impact evaluations, ranging from assessments every six months to annual reviews. National Treasury partially accepted this comment. It was committed to proper reviews of incentive programmes. While it would like to move toward more regular reviews, full-scale reviews were reliant on the availability of data. The micro-level data that was used in the review became available once a year after final reconciliation, and at a lag of approximately 18 months. Full scale reviews required large data sets and were time-intensive.
Tax treatment of long-term insurers due to the introduction of SAM
Ms Mputa highlighted that in order to cater for the tax treatment of the long-term insurance industry as a result of the introduction of the SAM Framework and the new Insurance Act, the following amendments were proposed through submissions:
(1) alignment of definition of “value of liabilities” three policyholder funds and risk policy fund
(2) new definition of “adjusted IFRS value” applicable to three policyholder funds and risk policy fund
(3) transitional rules: phasing-in amount and period of phasing-in
(4) anti-avoidance measures for calculating the phasing-in amount.
On 9 November 2016 the SAM Task Tax Group made representation to the Committee. National Treasury, SARS and the Financial Services Board (FSB) met with industry representatives on 14 November 2016 to discuss the matters raised by the SAM in its submission. Given that these provisions were driven by the regulatory requirements determined by the FSB, National Treasury and SARS together with the FSB agreed with industry representatives on the need to continue to engage over whether technical corrections were required in the 2017 tax bills, given the complexity of the SAM reforms and the coming Insurance Bill.
SAM made a comment in its submission that the industry needed clarity on the interpretation and application of the amendments.
National Treasury accepted this comment. Proposed amendments to the valuation of liabilities in the Taxation Laws Amendment Bill were explained in the Explanatory Memorandum to the Bill. The Explanatory Memorandum contained a number of examples to clarify the policy intention of the proposed amendments. Aspects that may cause the most confusion were the treatment of negative liabilities set off against policyholder liabilities and which negative liabilities disclosed as assets should reduce the amounts recognised for International Financial Reporting Standards (IFRS) purposes in calculating phasing-in amounts. It was proposed that technical corrections to the definition of ‘adjusted IFRS value’ be effected in the 2017 Taxation Laws Amendment Bill. The proposed technical corrections aimed to align the policy rationale for the new basis of determination of the valuation of liabilities of long-term insurers for tax purposes as explained in the Explanatory Memorandum to the 2016 Taxation Laws Amendment Bill.
Another comment submitted by SAM was that the proposed wording of section 29A(15) and (16) may create potential risk to the fiscus by allowing insurance companies to defer tax payments by receiving both a deduction from assets as well as an increase in value of liabilities from the phase-in provisions.
Ms Mputa said Treasury’s response was that the comment was misplaced. In essence, the profits of long-term insurers were taxed by way of transfers from the different funds to the corporate fund of an insurer. The amounts of the transfers were determined as the difference between assets and liabilities. The purpose of section 29A(16) was to clarify which assets did not qualify for tax purposes to be allocated to the different funds and could not be transferred between the funds. It was intended as a general rule and was not limited to the six year phasing-in period. Also, liabilities were determined in the definition of ‘adjusted IFRS value’ and in paragraph (a) of that definition all negative liabilities were recognised for financial reporting purposes, disclosed either as a set-off or as an asset, and reduced the amount of liabilities for tax purposes. The phasing-in amount determined under section 29A(15) reflected the difference in treatment of negative liabilities between the statutory basis used for tax purposes and financial reporting in 2016.
A final comment made by SAM was that the proposed addition of section 29(15) required an adjustment of 2016 amounts to the manner of disclosure of policy liabilities and assets in the audited annual financial statements for 2015 and the manner of disclosure of policy liabilities for tax for the 2015 year of assessment. It was proposed that the adjustments to the disclosure that applied in 2015 be removed. National Treasury noted the comment. There were still areas of concern given the complexity of SAM reforms, so National Treasury, SARS and FSB would engage with the industry on whether further corrections were required for the 2017 tax cycle.
The Chairperson noted that there were outstanding matters which National Treasury had to attend to. He wanted it to give feedback to Witzenberg PALS as its submission warranted attention. He felt it was important for Parliament to engage with organisations that contributed positively to society. He wondered if the YES Initiative could be included in future discussions on the incentives. Also, he felt that it was important to invite some of the ETI beneficiaries to the Committee but he did not know how it could be done.
Ms T Tobias (ANC) said that the amount of money being given for people at NQF level 7 should be resolved in conjunction with the DHET. Perhaps other government departments could build on the incentive.
Mr D Maynier (DA) said that according the principal Act the Minister of Finance had to publish reporting information on the ETI twice a year, but the Act did not specify the content of information to be published. It was important that the information be specified according to the reasonable data available. Also, this published information had to be tabled in Parliament.
Mr Axelson replied that the Minister made provision for reporting in the Act and this information had to be published twice a year so since the introduction of the incentive National Treasury had done that. National Treasury felt that was sufficient and unfortunately could not do more.
Mr Momoniat added that National Treasury would like to have all incentives evaluated more to assess their effectiveness and to get more reporting on them. The problem with any tax incentive was that Treasury only got information once people have filed their final tax returns or completed certain forms, and then it still took a long time before SARS could process that information and submit it to National Treasury. Even when the year ended it took many more months before that information became available. Initially, there was supposed to be a mid-year report employers had to submit but that information never came through. The only other information National Treasury got was the monthly return to show the deduction.
Ms Gloria Mnguni, Finance Analyst, Parliamentary Budget Office (PBO) asked how National Treasury was going to report data in two years’ time given the already ineffective quality of current data. She also wanted to know more about the skills level and the uptake in the R2000 to R4000 range. How will the evaluation on the effectiveness on the two incentives take place?
Mr Axelson replied that only one year of data was available at the time but from this year going forward Treasury would be able to follow beneficiaries and see what happened after two years of the incentive. It would be able to look at progress through tracker studies. In respect of evaluations, Treasury would like to do one but resources would not allow. Going forward it will be considered.
Ms Catherine Macleod, Chief Director: Macro Economics, National Treasury said that it would be looking at providing a potential employment impact report in the next reporting document. This would indicate whether beneficiaries were allowed better employment opportunities as a result of working under the incentive.
Ms Tobias commented that she did not want National Treasury to rush with its report. Instead of reporting from year to year it was more important to look at the data in totality and assess the impact.
Independent Regulatory Board for Auditors (IRBA) on its 2015/16 Annual Report
Mr Bernard Agulhas, Chief Executive Officer, IRBA, presented some highlights for the year. IRBA celebrated its 10 years of independent audit regulation. Also, South Africa achieved first position for its auditing standards in the World Economic Forum’s 2016 Global Competitiveness Report for the seventh consecutive year. The IRBA issued its first Public Inspections Report: Striving for Consistent, Sustainable High Audit Quality. In May 2015 the Audit Development Plan (ADP) was launched. IBRA managed to publish its third Integrated Report and started a project that researches measures to strengthen auditor independence. He highlighted that IRBA conducted an independent survey to explore and quantify factors driving and limiting professional advancement in auditing, to explore transformation and to find out why young professionals chose not to stay in the auditing profession.
Ms Willemina De Jager, CFO, IRBA, presented the financial statements. She highlighted the drop in government grant IRBA received by around R5 million. Other income also declined by around R2 million. Expenses increased by R4 million and although income was cut, IRBA had to strengthen its inspections department. As a result, staff costs increased by R8 million due to the addition of the new inspections department. In total, IRBA went from a surplus of R7.4 million in 2015 to a deficit of R3 million in 2016. In 2015 IRBA had to surrender R2.7 million to National Treasury and in 2016 IRBA was not able to surrender any funds to National Treasury.
Ms De Jager said on IRBA income sources, government grants decreased by 13.2%. With regards to controllable expenses, there was an increase of 1.3%. This was mainly due to inspection fees and monitoring fees. Overall income sources decreased from R95 million in 2015 to R88 million in 2016. She noted that auditor fees increased by 14% for 2016 in order to make up more revenue for IRBA.
She said that the report from the Auditor General showed a clean audit for seven consecutive years regarding reporting on financial statements, reporting on other legal regulatory requirements such as predetermined objectives and compliance with laws and regulations, and internal controls. A breakdown of performance information indicated that IRBA achieved almost all its targets. With regards to the programme on education and transformation, the objective was to implement processes to manage the development and assessment of professional competence of candidate auditors. IRBA managed to achieve 90% adherence to the workflow process because the Audit Development Plan (ADP) process was changed and therefore the objective not achieved. With regards to inspections, there was 100% adherence to review plan and 93% of targets achieved. On investigations, the target was to have 80% of complaints received closed within 18 months. IRBA overachieved this by having 92% of cases closed within 18 months.
Mr Imran Vanker, Director: Standards, IRBA, gave a background to the B-BBEE accreditation system in South Africa. He said that IRBA got involved in the industry due to its verification of B-BBEE. Approximately 300 auditors registered with IRBA for the purpose of providing B-BBEE certificates. In May 2015 the rules around the BEE certification changed. He explained that the Department of Trade and Industry realised that some of the work around the BEE certification was burdensome on businesses and DTI took a different approach by changing the requirements. For businesses earning less than R10 million per year, it no longer required a BEE certificate but could make use of an affidavit. For businesses with a turnover of up to R50 million, some streamlining was introduced for BEE certificates. Businesses with a turnover of more than R50 million per year, had to go through the whole BEE certification process. As a result of these legislative changes, the work of some auditors changed overnight. Those auditors specialising in doing BEE certificates suddenly had far less work.
When DTI made these changes, IRBA and SANAS were the two bodies responsible for the verifying the auditors that did the certification. The IRBA board decided that in the light of the changes that were coming, it was better to have one body deal with the BEE verification. On 1 October 2016 IRBA withdrew and SANAS took over the entire BEE verification. Even though 300 auditors were registered, only about 100 were active.
Mr Vanker said with regards to transformation at the IRBA, there were approximately 40 000 chartered accountants in the country. That figure changed every six months by 2 000 when there was an examination. Most recently, 26% of them were black which was approximately 10 000 of the 40 000 CAs in the country.
The Chairperson said that “black” was considered to be people of colour. So it was necessary to break it down even further by distinguishing between black Africans, coloured people and even Indians. According to the law all people of colour were black, and it was important to break down the demographics of “blacks” to be correct.
Mr Vanker continued by explaining the demographics of registered auditors (RAs) which indicated 24% of them were black which was a total of 4 000 auditors. About 10% of all CAs in South Africa were RAs. A new registration category was for Candidate Registered Auditors (CRA’s), and 28% were black. Some of the initiatives IRBA was doing were a board transformation project plan. It also created awareness with students, did university level recruitment to the profession and trainee-level retention as part of its ADP.
IRBA Strengthening Auditor Independence: Mandatory Audit Firm rotation
Mr Agulhas said that the board had a meeting in July and decided to introduce mandatory audit firm rotation. The backlash was major and continued to be challenging due to this decision. He then gave an overview of the four pillar strategy. The first pillar was comprehensive regulator and the World Bank required regulation of not only auditors but all accountants. At this stage 4 500 accountants were regulated as auditors while all the other accountants, tax practitioners, forensic auditors and consultants were not regulated. IRBA believed that all those providing financial services should be regulated. IRBA made a proposal to the Minister of Finance that in order for it to regulate all these additional groupings would not mean IRBA had to increase its staff component, but IRBA then just had to change its mandate. The second pillar was independence and there were two aspects to this: the independence of IRBA from the profession and the independence of the auditors from its clients. He highlighted that this was exactly what mandatory audit firm rotation was about. The third pillar was transformation which was being addressed through the mandatory audit firm rotation. The last pillar was leadership Africa which basically meant that if IRBA was doing so well in South Africa, it had a responsibility to support the rest of Africa. Although it was not in IRBA’s budget or mandate, it had to look at ways to make this happen.
Mr Agulhas said that by promoting integrity in financial reporting and building a basis for providing confidence, auditors reduced financing costs and contributed to the efficiency of capital markets, thereby promoting economic growth. If investors had confidence in South Africa’s financial markets, they would invest in the country, create employment and grow the economy. South Africa was considered as a world leader in auditing standards, as measured by the World Economic Forum’s Global Competitiveness Report. It was the seventh consecutive year that the country holds this position. He highlighted that this signalled a robust standards setting process, sound inspections methods and “right touch” regulation. Recommendations from the World Bank in 2013 also assisted IRBA to maintain these standards. IRBA was trying to create a competitive market place because currently the market was dominated by large firms. There had been a number of audit failures in South Africa as well as globally and IRBA was of the view that a reason behind this was the lack of competition to these firms. Competition increased quality and with the audit failures, IRBA was concerned should one of the “Big 4” firms fail, then the country will be left with the “Big 3”. It all started with the “Big 8”, so if the number of firms that the public can rely on became fewr, the quality of auditing would drop.
Mr Agulhas said IRBA had introduced some measures such as the prohibition of non-audit services, which meant that an audit firm could not do any other services, and mandatory audit firm rotation which still had to be implemented. Corporate failures continued to shape regulatory reforms because when an audit failure took place regulators stepped in and this posed the question as to whether regulators were doing enough to address and respond to such failures. IRBA also looked at global developments. The European Union (EU) introduced measures such as mandatory audit firm rotation, mandatory audit tendering and joint audits in order to strengthen auditor independence effective from 17 June 2016 across 32 countries across Europe. He highlighted that in 2016 alone, all the “Big 4” firms globally have been fined, sued or settled court cases with amounts running to billions of dollars.
He spoke about current measures in place by government to support mandatory audit firm rotation, but IRBA believed these measures were not enough. In terms of Section 92 of the Companies Act, the same individual (engagement partner) may not serve as the auditor or designated auditor of a company for more than five consecutive financial years. Section 90(2) prohibited an auditor to provide audit and certain specified services to the same client. IRBA published a rule that made it mandatory that all auditors’ reports on Annual Financial Statement of all public companies shall disclose the number of years that the auditor has been the auditor of the entity (audit tenure).
The objectives of mandatory audit firm rotation were to address market concentration, provide access to markets and to promote transformation in the profession. The scope of the project considered the following three measures: Mandatory Audit Firm Rotation (MAFR); Mandatory Audit Tendering (MAT) and Joint Audits.
Consultations and workshops were held with audit firms, regulators and other relevant stakeholder and research conducted to assess the perception. The results on MAT indicated a 50/50 split between the Big 4 audit firms. The same results came out for Joint Audits. MAFR results indicated that only one of the Big 4 agreed to the implementation. A result that came from the research indicated that 67% of JSE listed companies did not agree with MAFR which was strange for IRBA as it thought these companies would encourage independence. For regulators and other relevant stakeholders, there was an overwhelming 82% agreement to MAFR.
Mr Agulhas went on to explain what the EU initiatives aimed for:
• Clarifying and better defining the role of statutory audit regarding public-interest entities
• Improving the information that the auditor provides to the audited entity, investors and other stakeholders
• Improving the communication between auditors and audited entities
• Preventing any conflict of interest arising from the provision of non-audit services
• Mitigating the risk of any potential conflict of interest around selection, fees, and appointments, and
• Broadening the choice and improving independence.
IRBA conducted research into independence and found threats to independence, which indicated:
• Familiarity threat between CFOs and the incumbent auditors
• Familiarity threat between audit committee chairs and incumbent auditors
• PIC concerns regarding the independence of auditors and company directors
• Inspection findings relating to ethical requirements
• Long audit tenure, and
• Global developments on strengthening auditor independence.
Mr Agulhas said one of the significant findings was the familiarity threat between the Chief Financial Officer or Financial Director (FD) and incumbent auditors. Analysis revealed that 18% of the CFOs/FDs of the JSE Top 40 listed companies were previously employed by the audit firm that was listed as the appointed external auditor to that company in the annual report. Another significant finding was that 25% of Audit Committees of the JSE Top 40 listed companies were chaired by a member who was previously employed by the audit firm appointed as the external auditor to that company. This raised a familiarity threat between the Audit Committee and the Audit Firm. In this regard, the PIC, which held 12.5% of the market capitalisation of the JSE Top 40 listed companies, highlighted that it had voted against the reappointment of auditors where the audit firm had been auditing an entity for more than nine years as it believed that after nine years there was a familiarity threat, which may impair auditor independence.
Mr Agulhas said a review of Audit Firm Inspections in 2015 revealed significant deficiencies in 68% of firms inspected, thereby significantly raising concerns regarding the independence of auditors. These inspections were performed in terms of Section 47 of the Auditing Profession Act. While a variety of deficiencies were identified, the root cause of these findings was the failure to maintain independence as an underlying principle for high audit quality. In 2015, to address the threat associated with long audit firm tenure, IRBA made the decision to require the mandatory disclosure of audit tenure, which was consistent with measures implemented in other jurisdictions. A review done revealed that in the most extreme case the audit firm tenure was 114 years, with others at 91, 87, 48 and 40 years. In terms of concentration of the market, IRBA’s study found that 96% of the market capitalisation companies listed on the JSE, whose audit reports are signed off by South African Engagement Partners, were audited by a member of the Big Four. This was a shocking discovery, which clearly indicated the resistance to change within the audit space.
Mr Agulhas said further solutions suggested from consultation was strengthening of audit committees, public disclosure of firms’ inspections report, enhanced audit committee reports and auditor reporting. He said IRBA faced challenges which included resistance to change in age old practices and patterns. There was little acceptance of IRBA’s authority as the audit regulator appointed to deliver on the State’s mission. He said the timeline of the consultation process included the initial research phase and the consultation process which spanned from July 2015 to July 2016. The Public Consultation Process would take place from 25 October 2016 to 20 January 2017. IRBA consulted with, and reported progress to the Ministry and Treasury throughout the process. Proposed requirements were that an audit firm shall not serve as the registered auditor of a listed company for more than 10 consecutive financial years, with effect for financial years commencing on or after 1 April 2023. If at the effective date, the listed company had appointed joint auditors and both had audit tenure of 10 years or more, then only one audit firm was required to rotate at the effective date and the remaining audit firm would be granted an additional two years before rotation was required.
Ms Tobias said that she agreed with IRBA on the mandatory rotation and urged it not to lose focus on the issue. It was in the public interest to know who was recommended to the company as an auditor and why. These audit firms did not want scrutiny. She felt that if transformation was to be achieved there had to be some level of competition. She commended the IRBA for its hard work and told it not to lower auditing standards as that would open the door for corruption.
Mr Agulhas thanked Ms Tobias for her comment.
Mr Lees thanked IRBA for its presentation. He wanted to know whether the Auditor-General South Africa was also a member of its organisation. What would happen about AGSA when rotation came into play? Those JSE listed companies protected its shareholders and others so with the State there would be an even stronger protection. With regards to investigations, if someone lodged an objection, would there be any feedback to the complainant?
Mr Agulhas replied that the AGSA was the only audit firm not under IRBA. AGSA was the supreme audit institution accountable to the President. With regards to investigations, there was a process of feedback and any member of the public was allowed to complain. It went through a formal process whereby the complainant was kept informed on the progress of the case.
Mr S Buthelezi (ANC) wanted to know whether the IRBA Board was a balanced one as in the Annual Report it indicated only one CA. Also, why was the “Big 4” focused in Africa?
Mr Agulhas replied that the board consisted of mostly accountants. The board had one lawyer and one auditor, to maintain its independence. The reason IRBA was focused on Africa was because of the moral obligation to assist South Africa’s neighbours. The firms that IRBA assisted were also global but the focus had to be on the continent. IRBA was a founding member of the International Forum of Independent Audit Regulators (IFIAR) which consisted of 15 member countries. IRBA also helped Botswana and Zimbabwe to become members of IFIAR.
The Chairperson said nothing stopped Parliament from calling in those companies where transformation was low and asking them the reasons for that. He wanted to have a meeting with IRBA and National Treasury present to discuss these issues and suggested that emerging companies join in as well.
Mr Maynier wanted to know about the progress on the African Bank investigation.
Mr Agulhas replied that the Independent Investigation Committee was meeting in November to look at the charge sheet against African Bank. Thereafter the Investigations Committee would decide whether to add to the charge sheet or not.
Mr B Topham (DA) felt that transformation and independence were two different things. Why had the number of investigations doubled in the past year? The prices of inspections were very high. Saying that 96% of audit firms were white was incorrect; the number of black people employed in those firms was increasing. The “Big 4” was not an unusual phenomenon as the same thing happened in many countries around the world. He was concerned about the possible collapse of audit firms as longevity was not necessarily related to independence. The existing notion of a rotation was happening currently as the CFO position in companies was already rotated on a five year basis. He felt that reason for the increase in audit firm changes was because most auditors considered first year cost when it tendered and spent more time and money on its first year of operation at a new company.
Mr Buthelezi wanted to know if there were any other measures which could be used to make audit firms transform.
Mr Agulhas said there were no other measures in place and IRBA could not force firms to transform.
The Chairperson said that the Committee would have to plan public hearings for the first quarter of 2017. With 96% of auditing work going to the “Big 4”, he felt that the auditing space was “captured”. The Committee supported IRBA and wanted to hear from those who opposed the mandatory audit rotation.
The meeting was adjourned.
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