TLAB, TALAB, Rates Bill & Income Tax Amendment Bill: public hearings

Meeting report

Co-Chairperson Carrim said that Select Committee Members were also involved in hearings on another Bill, so only half of that Committee could attend the tax hearings.

Co-Chairperson Maswanganyi reminded presenters that the Committee had a very tight schedule and they would be allowed to speak for only ten minutes on their submissions.

Several presenters raised concern that some of the proposed amendments were vague and too broad in their application and would affect investor confidence. .

The South African Institute of Chartered Accountants (SAICA) said some of the proposed changes amounted to retrospective legislation which undermined certainty and confidence in the tax system. They could also result in penalties and interest being levied on some legitimate transactions. The effectiveness and efficiency of some sections of the laws should be reconsidered in order to reduce the cost of complying with them.

Concerns were raised about the implications for Special Economic Zones (SEZs), Venture Capital Companies (VCCs) and Public Benefit Organisations (PBOs). A call for a freeze on cigarette excise duties provoked considerable debate about tax lost to the illicit tobacco industry.

Special Economic Zones

Ms Sharon Smulders, Tax Project Director: South African Institute of Chartered Accountants (SAICA), said investor stability would be affected by a change to the regulations providing tax deductions for investing in Special Economic Zones (SEZs). Only new companies established after the introduction of the SEZ Act would benefit from the incentive. Those operating before the Act became effective would not qualify. This meant that some companies which were set up in anticipation of the SEZ Act would not get the incentive. Another condition was that, in order to qualify, a company’s gross income must have increased by100% compared to its income in the previous three years. This was too stringent.

Mr Kyle Mandy, Tax Technical Partner: Pricewaterhousecoopers (PWC), said the accounting firm shared SAICA’s concerns. The new measures proposed by the National Treasury (NT) were not needed as there was already effective regulation of companies setting up in these zones. While there was a valid concern about shifting profits from outside the SEZs, the way in which the Treasury was introducing a hard, objective test could make the investment incentive less attractive. The solution would be to apply transfer pricing rules.

Venture Capital Companies

SAICA and others raised concerns about amendments to section 12J of the Income Tax Act, which allows investments in venture capital companies to be deducted from income tax. The amendment would cap the deduction at R2.5 million.

Ms Smulders said some investments would have been based on the legislation as it read previously, and would now be non-compliant with the new s12J. Rather than limiting investment in VCCs, there should be limits on what they did with the money.

Mr Dino Zuccolo, Chairperson:12J Association of South Africa, said the Association opposed the proposal to cap 12J investments. The association had been established earlier this year by 25 asset managers representing more than 40 Section 12J companies, with R5.7 billion in assets.

He said Section 12J had been introduced in 2009 to boost investment in small, medium and micro enterprises (SMMEs). It had not had much effect until the Treasury removed a cap on the investment amount that could be deducted. This had resulted in a really good uptake, and to date R8.3 billion in capital had been raised and about R3 billion had been invested. He described this as the birth of a vibrant SME sector funded by high net worth individuals.

However, there had been an abuse of the process and the National Treasury had taken steps in 2018 to stop this. Because Section 12J companies had 36 months to invest their funds, it would take some time for the impact of those steps to become apparent.

Section 12J was one of the few mechanisms in South Africa which provided “five-year lock-up capital.” It had created a mechanism for high net worth individuals to keep their money in South Africa. Funds raised through 12J had been invested in renewable energy, student accommodation, hotels, agriculture, education and tech start-ups.

Treasury was now trying to manage its cash flow by imposing a cap of R2.5 million per investor per year.  Attention had been focused on the fact that 12J gave investors an up-front tax deduction of the amount they invested in a VCC. There had been less focus on the fact that a lot of tax was paid within the five-year investment period. For example, the 12J company manager paid tax, the underlying investments paid tax, VAT was paid on income earned, withholding tax was paid on distributions and when an investor exited a company, there were capital gains tax consequences. The actual cost to the fiscus was much lower than the initial up-front deduction.

The Association agreed with the logic of a cap, but did not agree with the way in which it had been calculated by basing it on simple averages. If this cap had been applied in the past, the size of the 12J industry would have been reduced by 70%.

Because 12J companies had 36 months to deploy the capital they raised, the introduction of this cap now had a retrospective impact for 12J managers who had not finished raising capital..

Mr Zuccolo said the minimum viable size of a 12J fund was R200 million. The Association

proposed that a cap be set at 10% of this amount, or R20 million per investor. Alternatively, it proposed that provision be made for an anchor investor who could make an investment 20%, or R40 million, with the remaining investors limited to smaller amounts of 5%, or R10 million.

The 12J industry needed policy certainty. As currently written, the incentive would expire in June 2021. Should the new cap be introduced, the industry would have less than two years to adapt business models. Although it had initially been envisaged that 12J would run for 12 years, it had been commercially effective for only four years, and its impact on the economy had yet to be worked out. If it was extended, it would have a significant impact on the economy.

Directors of the 12 Cape investment holding company told the hearing that they raised 12J funds for investment in local hotels and associated service providers. The cost of managing a 12J fund was high. Previously it had been possible to achieve economies of scale with a few investors. The proposed cap would increase the cost and administrative burden by at least 20 times, because a minimum of 100 investors would now be required to achieve a sustainable size. The Treasury should address abuse where it occurred and create a stable regulatory framework which would reap the long-term tax benefits of investment in tourism.

The SA Venture Capital Association (SAVCA) called for the cap on 12J investment to be increased to R10 million, and for the introduction of an accelerated tax allowance over three years for amounts invested above the cap. A cap of R2.5 million would reduce the number of fund managers who were able to raise funds for sustainable investment in SMMEs. SAVCA viewed R200 million as the minimum sustainable fund size. Eighty investors would be required for a fund of this size, significantly increasing administration costs.

Mr Gavin Reardon, Partner: Kingson Capital. described a cap on 12J investments as a “bad idea” that would discourage anchor investors, limit foreign investment and make existing funds economically unviable. Instead, he proposed an accelerated tax allowance over three years.

He said the 12J allowance should be seen as an investment by the government. As an example, a R3.5 million investment by Kingson would cost the fiscus a maximum of R1.575 million in lost revenue. However, in two years the fiscus would have collected R7.1 million -- a net return of 351%.

PWC implored the Committees to consider the broader impact of the Treasury proposals on the funding of small and medium businesses. Mr Mandy said the Treasury was taking a short -term view about the impact on tax revenue without fully considering the longer-term implications.

Discussion

Dr D George (DA) said the impact of the Section12J impact had not been fully felt in the economy because it had not been there for very long. He asked whether any research had been done on this.

Mr Zuccolo responded that of the R8.3 billion raised through Section 12J, R3.5 billion had been spent so far in accordance with the rules, which gave 12J companies 36 months to spend that money. The 12J Association had retained PWC to do a survey, and the results would be presented to Parliament and the Treasury. Initial indications were that the incentive had created or sustained 27 000 jobs. Every R1 million invested through 12J resulted in R270 000 in tax foregone by the fiscus, taking into account other taxes paid on that amount. In a similar scheme in the UK, the amount of tax paid by the underlying investee companies was the same as the aggregate deductions granted.

Mr Zuccolo said his association understood the Treasury’s need to manage cash flow. However, the very nature of 12J was that it took money from high net worth individuals and gave it to 12J managers who then invested it in SMMEs, which generally were run by less wealthy people. At R2.5 million, the reality was that most high net worth investors were not interested. “Our view is that a R2.5 million cap undermines the very purpose of the incentive, and will have a substantially negative impact in South Africa,” he said.

Mr G Hill-Lewis (DA) said the rationale of 12J was that the fiscus would forego taxes in the hope that new investments would in the longer term deliver higher economic growth and tax revenues.

Dr George added that while there were concerns about abuse of the scheme, the principle remained that there should not be an incentive to encourage venture capital. The South African Revenue Service (SARS) should do more to prevent abuse. He thought it was being abused because he saw quite a lot of advertising for it, and clearly it was possibly a tax evasion scheme.

Mr Z Mkiva (ANC, Eastern Cape) appealed to the 12 J industry to diversify its investments to include rural areas, and not to “romanticise” hotels and tourism. He called for statistics about the jobs created in the hospitality industry, saying there was a perception that the industry paid low wages and employed non-South Africans.

This view was echoed by Ms M Mabiletsa (ANC).

Ms Yanga Mputa, Chief Director; Tax Policy, National Treasury, said the proposed investment cap was based on the fact that of the R8.4 billion given in deductions, only R3.5 billion had been invested in VCCs. The Treasury would be guided by the Committees on the cap, but the issue was that of the initial cost to the fiscus, only a third had been invested. When 12J was first introduced, there had been a cap of R750 000. When there was no uptake, the cap had been removed. The uptake had then become too much. High net worth individuals would, just before the year-end, invest disproportionately into 12J to get tax deductions. She said the Treasury was open to considering whether the size of the cap should be changed, but a cap was required.

Public Benefit Organisations (PBOs)

Mr Pieter Faber, Senior Tax Executive: SAICA, raised concerns about the new treatment proposed for Public Benefit Organisations (PBOs). This would remove the SARS Commissioner’s power to grant approval for tax exemption retrospectively. PBOs would be taxed as normal taxpayers, with penalties and interest, and the applications for tax exemption would be deferred until the normal tax liability had been settled.

He said South Africa had a high need for PBOs. They lacked resources to deal with complicated tax matters, yet tax legislation for them was more complex than for normal taxpayers.

Discussion

Dr George asked whether the complexity was because the tax process was manual and time-consuming, or whether it was due to the type of information required by SARS. If the process could be done by e-filing, for example, would it still be a problem?

Mr Faber replied that the process was “actually highly complex for a very un-complex taxpayer to understand.” It was a misonomer to describe PBOs as tax-exempt entities. Many did actually pay tax and had to separate their income streams. The process was done manually. There were about 56 000 tax- exempt entities and about eight assessors. The proposed amendment would make the problem worse by turning these entities into companies.

Ms Mputa said the Treasury would consider legislation to assist small PBOs with this problem.

Cigarette excise duty

The Tobacco Institute of Southern Africa (TISA) called for a three-year freeze of excise duty on cigarettes.

Mr Francois van der Merwe, Chairperson: TISA, said the Institute represented the legal tobacco sector in the SA Customs Union (SACU) region. While this sector was tax compliant, there was a large illicit sector which was not. About 35 billion cigarettes were smoked in South Africa every year, but tax was paid on only about 19 billion. This cost the fiscus more than R11 billion.

Tax on a R35 legal pack of cigarettes amounted to R21.22, or 60 per cent. TISA supported the principle of using high prices to discourage tobacco consumption, especially among young people. However, the price of legal cigarettes had now reached a peak which consumers could not afford, and which caused them to buy cheaper untaxed products. The legal industry had shrunk by 22% in the past three years, causing job losses. Any further excise duty increases would result in an even larger differential between compliant and illicit products. The excise duty should therefore be lowered, or held at current levels, for at least three years or until law enforcement had caught up with non-compliant producers.

TISA’s submission was supported by the British American Tobacco (BAT) company.

Discussion

Dr George said the illicit cigarette industry was a huge problem, but alleviating the tax on the legal industry was unlikely to resolve the problem. Given the unfunded National Health Insurance (NHI) proposals, he wondered whether TISA would be opposed to a tax on their industry to offset the damage it did to the health of the nation.

Co-Chairperson Carrim said TISA had raised complex matters. There could be differences of view on the health issues, but given that smoking tobacco was legal, the Finance Committee’s job was to ensure that the state got the tax due to it. A lot of money was being lost due to illicit tobacco.

Ms Mabiletsa said that, much as she appreciated that tax revenues were produced by smoking, her personal wish was that everyone would stop smoking.

Mr Van der Merwe responded that Mr Carrim’s summary of the situation was “spot on.” It was not a question of whether one liked tobacco or not. It was a legal product and adults over the age of 18 had a right to choose whether to use it or not, well knowing that it was harmful to health. The legal industry represented an important value chain of farm workers, manufacturers and wholesalers. Cigarette manufacturers who were evading tax could not claim to be small independent players. He said illegal cigarettes had made billionaires of the owners of those companies.

On the question of a health tax on the industry, he said he understood that the Treasury did not support the ring-fencing of taxes. Tobacco was highly taxed, and it was up to National Treasury to decide how taxes were used.

SARS Commissioner’s powers

The Banking Association of South Africa (BASA) and PWC raised concerns about proposals to curb the SARS Commissioner’s discretionary powers in making VAT rulings.

Mr Ian Cloete, a member of BASA’s tax committee, said Section 72 of the VAT Act gave the Commissioner discretion in dealing with difficulties and anomalies in the application of the Act. BASA understood that there had been some abuse, with this discretion being taken too far in the past. However, the proposed changes were drastic and would tie the Commissioner’s hands in making pragmatic decisions on, for example, zero rating. The Association urged the Committee to consider alternative measures to prevent abuse of these powers -- for instance, by opening such decisions to public scrutiny.

Mr Mandy said PWC understood the rationale for the amendment of Section 72. However, they were concerned that the effective date of the legislation was retrospective to the date on which it had been published for comment. SARS was now effectively applying this new legislation before it had become law. A transitional process was required.

SAICA called for greater clarity on the proposed changes.

Carbon Tax

The Minerals Council of South Africa and Business Unity South Africa raised concerns about the implementation of the Carbon Tax,

Mr Nikisi Lesufi, Senior Executive: Environment, Health and Legacies, said the Mineral Council, formerly known as the Chamber of Mines, represented 70 large and small mining companies. Its members accounted for 90% of the country’s mineral production by value, and they fully supported the lowering of greenhouse gas emissions. However, the transition to a lower emissions economy had to be balanced with a competitive tax system, which was critical for capital-intensive, high-risk industries like mining.

Ms Ursula Brown, the Council’s head of legal matters, raised objections to several amendments relating to the Carbon Tax, describing them as badly aligned, confusing and causing uncertainty.

She said the Council did not support the blanket repeal of section 12K of the Income Tax Act, which provided for tax exemption for certified reductions in greenhouse gas emissions. The proposal was based on a mistaken assumption that the person qualifying for exemption under 12K would always be the same taxpayer qualifying for a carbon offset under the Carbon Tax Act, resulting in a double benefit. This would not always be the case. For example, the carbon offset generator might sell the carbon credit to a foreign entity not subject to the Carbon Tax. The generator of the carbon credit would be denied the tax exemption, even though the recipient could not use the credit to reduce its carbon tax liability.

The Council welcomed the extension of the period of the energy efficiency tax incentive to 2022. However, this should be extended further, given the long lead times for energy-efficient projects.

BUSA called for implementation of the Carbon Tax to be deferred. It said revision of the Act less than three months after its promulgation showed that it was not yet ready for implementation. The proposed amendments also did not address flaws repeatedly raised by BUSA, and to which adequate responses had not been provided. The required secondary legislation was not in place. There was a lack of alignment between the Carbon Tax and the carbon budget regime currently being developed under the Climate Change Bill by the Department of Environment, Forestry and Fisheries.

Discussion

Co-Chairperson Carrim commented that there were no indications from the majority party and the government that they had regrets about the Carbon Tax. There might be a case about alignment and consistency of issues.

Ms Brown said concerns raised in past still remained. There would have to be constructive engagement with the Treasury to see how they could be addressed.

Co-Chairperson Carrim said they could engage with the Treasury, but in the end it would be Parliament that decided on the changes.

Customs and Excise Act

BMW objected to a proposed amendment to section 65 of the Customs and Excise Act which, it said, would increase the ad valorem duties on vehicles it produced. This would affect the company’s competitiveness in export markets. It would also deal a blow to confidence in government programmes aimed at ensuring a viable motor industry.

Vague regulations

PWC questioned an anti-dividend stripping rule aimed at the practice in which a company, instead of selling shares, stripped out the value of those shares through tax-free dividends. Mr Mandy said the application of the rule was overly broad and could affect legitimate transactions.

On transfer pricing, the Treasury was proposing a new associated enterprise test for cross-border transactions because it was concerned that the definition of connected persons did not go far enough. The proposal to extend it to include associated enterprises was broad and vague, and would create uncertainty. A better way would be to expand the definition of connected persons.

SAICA shared the concerns about vague definitions and broad application of the regulations on associated enterprises and asset stripping. It also called for clarity about tax exemption for foreign remuneration. Mr Faber said there was a lot of fear and misinformation in the market about this issue.

Co-chairperson Maswanganyi gave an assurance that, in spite of the National Assembly and NCOP Committees’ tight schedules, they would work together in properly processing all the presentations that had been made.

The meeting was adjourned,