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FINANCE PORTFOLIO AND SELECT COMMITTEES: JOINT MEETING
16 February 2001
NATIONAL TREASURY REVIEW ON CAPITAL GAINS TAX ISSUES
Chairperson: Ms B Hogan
Documents handed out
National Treasury's outline of Major Policy Issues contained within the Proposed Capital Gains Tax Legislation (Final Edition)
A number of issues are still under review by National Treasury on Capital Gains Tax. Treasury has made no conclusive decisions on issues such as the level of the annual exclusion, rules for the distinction between capital gains and ordinary income, comprehensive rules for company restructuring, and extended relief for deemed sales on charitable donations. A revised draft Bill should be available on 13 March.
Treasury expressed certainty on the provisions regarding the purchase and sale of assets with a foreign currency. They feel that specific relief for assets purchased with foreign currency would provide taxpayers with an incentive to invest in assets acquired through foreign currency over domestically acquired assets. Treasury also believes that the current relief in respect of business reinvestment assets is sufficient.
Summary of presentation
Mr Groote (Chief Director: Tax Policy, National Treasury) and Professor Engel (Advisor to the National Treasury) made the presentation.
Major Policy Issues omitted from the Legislation
Capital versus Revenue Distinction
There is no economic rationale for the distinction between the two. Both forms of income should be taxed. However, although both forms of income will now be taxed they will still be taxed at different rates. This means that there is still an incentive for conversion. Thus drawing a distinction between the two is relevant. The test for determining the difference between the two is currently governed by case law. This test is based on the intent of the taxpayer and lacks any meaningful economic rationale.
There are various approaches which can be taken to deal with this and Treasury must review the different options. They must understand the whole system before they pick one for South Africa. The distinction between the 2 should be re-examined in the coming months as the capital gains legislation comes into effect.
Discussion - The Chairperson asked if this meant that Treasury is going to introduce a way to distinguish between capital income and ordinary revenue at a later stage.
Mr Groote replied that it would.
In certain circumstances there must be CGT exemptions. These circumstances include share for share exchanges, mergers, intra-group transactions or unbundlings on listed markets. Taxation of these events is perceived as unfair because many of the shareholders receive no actual cash (for example, surrendering shares in one company for shares in another).
Professor Engel noted that in light of this there would have to be some form of company restructuring. This is a vital part of any CGT system. It has to be done either now or it has to be done at a later stage but the National Treasury is committed to taking action.
The present draft has limited restructuring relief provisions. Treasury can either provide interim measures to deal with the issue or there could be a wholesale re-examination of the company restructuring rules over the coming months as the CGT legislation comes into effect.
Professor Engel said that personally he preferred to have no interim rules and rather a full re-examination over the coming months.
The Chairperson asked if this meant that companies would still experience cascading in the interim. Professor Engel replied that something must be done in terms of company restructuring. In the current draft legislation there are limited options. Treasury must be careful that with company restructuring they do not end up giving away revenue where they did not intend to. There will be company restructuring. They are thinking of ''how'' and not ''if''.
The Chairperson asked what would be done in the interim. Professor Engel replied that they could either keep things off the table and do nothing in the meantime or they could develop ''rough and ready'' interim rules. The problem with the latter approach was that they would have two sets of rules. The question they must ask is how quickly does the taxpayer need the provisions. Then they must decide on the best option.
Mr Andrew (DP) said that they would have to cater for it in some way in the interim.
The Chairperson felt that two potential sets of rules could ''muddy the water''. Mr Groote commented that he did not think that no rules in the interim would cause any damage. The Chairperson agreed with him that they should rather wait a while for good, well-thought out legislation rather than using ''patch-up'' legislation in the interim. Professor Engel added that they are trying to help the taxpayer in this regard - the question is: how best they provide assistance.
Mr Andrew said that the problems for companies in terms of cascading would be aggravated by CGT. It is desirable to have levels of certainty which would come with interim rules.
Professor Engel replied that SA is moving quickly. Company restructuring in the USA and in Australia only came years after CGT was introduced. In SA they will take action quickly. There will be comprehensive action taken now or a few months down the line but SA will not wait for years before doing something.
Major Policy Issues Within the Legislation
The annual exclusion
Some have criticised that the annual exclusion of R10 000 is too low. Treasury tried to get the middle and lower classes out of the system. Personal use assets and home sales have been pulled out of the system in lieu of a higher exclusion for all assets. This level of exclusion is currently under review.
The Chairperson asked how the National Treasury had arrived at the R10 000 figure.
Mr Groote replied that the IMF suggested that the level of exclusion be R20 000 but this would have excluded too many people. The IMF focus was concentrating more on the administrative concern of taking people out of the system. From a tax policy point of view however it is better to have a low inclusion rate.
Mr Andrew, echoed by Mr Koornhof (UDM), asked if there was a chance that the inclusion rate would move from a low to a high exclusion rate.
Mr Groote replied that it would be problematic to adjust the threshold on an annual basis. This would be cumbersome therefore they were coming in at a reasonable level. If the inclusion level is increased then there is certainty below that level anyway. Therefore there would not be such a big shock effect. Professor Engel added that if there were a big exclusion then that money would be tax free which meant that they were back at square one. Getting the money into the system is important.
Combined impact of the Estate Duty/Other taxes
Some criticise that CGT is sometimes duplicative of other taxes. If it is applied together with estate duty for example then it will amount to double taxation. Treasury however says that these two are different taxes for different forms of wealth. CGT is a tax on gain while estate duty is a tax on long historical wealth. Without a deemed disposition on death there would be a lock-in effect as people would not want to sell their assets when they become old, they would simply pass it on to their heirs.
Treasury concedes that an element of double taxation does exist. How will Treasury address this? They can either waive CGT on death or they can provide some kind of relief elsewhere. They are considering providing some form of relief by adjusting the rate of estate duty. Professor Engel said that they cannot abandon estate duty because then all the old wealth will go free. Also, for estate duty there is an estate exclusion of R 1million which exists. Insurance proceeds are also exempt. This is a big exemption because one would receive a tax free payout.
Mr Andrew said that he was thinking particularly of tax on savings (not insurance policies). He suggested perhaps a higher exclusion rate upon death.
Mr Groote replied that all countries have problems of preferential tax treatment. He noted that they were discussing a higher exclusion rate at death with SARS.
Ms Jumat (ANC) asked what happened when inheriting an asset such as land. There was no actual cash inflow but the asset was taxed.
Mr Groote replied that the tax must still be paid. Ideally the heir should be taxed and not the estate because it is the heir who gets an increase in wealth. This would however present an administrative problem because there would be more taxpayers with which to deal.
Professor Engel said that the same problem exists with deemed disposals. Introducing exclusions however will create a lock-in effect. He added that Treasury understood the concern and that they were thinking it through.
Professor Graaf of the Katz Commission commented that in the UK and in the USA they do not combine CGT and Estate Duty and that there are good reasons for this.
Professor Engel said that the IMF supported a deemed disposal upon death. CGT on death is a big income.
The Chairperson commented that a person does not know when they are going to die. This means that a person cannot do asset planning around this event in the same way that they can plan with their assets around other events. The government does not want to throw people into bankruptcy. If there is going to be CGT upon death then there must be some form of relief.
The purchase and sale of assets with foreign currency
If assets are bought with a foreign currency then the base cost and the sale proceeds must be determined according to the currency conversion value at the time of purchase and the time of sale respectively. Critics say this is unfair because the gain will then come mainly from the devalued Rand. However Treasury believes that specific relief for assets purchased with a foreign currency would provide taxpayers with an incentive to invest in assets acquired through foreign currency over domestically acquired assets.
Expenses relating to capital assets
SARS is considering utilising a formula whereby all expenses related to capital gains shares will provide an upward cost base adjustment equal to two thirds of the actual expense.
The R1million cap on the Home Sale Exclusion
In terms of this only R1million of gain on the sale of a primary residence is excluded. This knocks out the middle class and below. The cap will decrease with inflation and should be adjusted accordingly. The issue has not been raised with the Minister yet but if it is an important threshold then it should not remain there and never be adjusted.
Mr Andrew suggested that they rather say gains in excess of R1million for a period of 5 years or 10 years. If government then decides to change the caps over time they can change it with reference to the years and not the amount.
Professor Engel said that this was a good suggestion and that they would discuss it with SARS.
Mr Andrew also asked at what point SARS is required to challenge a private valuation of the owner? When in the continuum can SARS object to the valuation?
Mr Groote replied that in tax law they should have a minimum amount of discretion. They should have a benchmark where a particular amount will spark an enquiry.
In reply to Dr Rabie (NNP) request for examples of other countries which exempt primary residences up until R1million, Prof Engel replied that different caps apply throughout the world.
Ms Taljaard (DP) noted that the Ministry had promised that it would draw up a Taxpayers Charter. She asked what the status on this was.
Mr Groote replied that SARS was going to do this but he could not ''speak for them''.
Business reinvestment relief
If one sells a particular business asset then it is exempt from CGT if the money is used to buy new business assets. This relief is provided because any tax on the sale in such instances would prevent full reinvestment and the sale gain will be eliminated by the depreciation of the replacement asset. This relief however only picks up certain assets. Critics say that the assets eligible for relief must be widened.
Treasury believes that the current relief regime is sufficient.
Small business/retirement relief
If a person over 55 years sells his business then that sale will be excluded from CGT. This relief is given to promote small business. It is limited per business and not per person in the business. The problem is that there could be a lock-in effect.
In reply to the Chairperson's query about how broad their definition of small business was, Mr Groote said that they would look into this.
Deemed sale on Charitable Donation
SARS will allow a deduction if the charitable donation is made to a qualifying PBO (Public Benefit Organisations) and if the donations are deductible under clause 18A of the Income Tax Act. All other charitable donations will be treated as a deemed sale of assets. The public has suggested that the exemption be expanded.
The problem with wholesale tax relief is that it could generate tax avoidance. This issue is under review.
The Chairperson noted that PBOs contribute substantially to the welfare of South Africa. Under apartheid, they did not receive tax breaks because they were perceived as being against the government so they had no tax relief for a long time.
Mr Andrew commented that donations are also made upon death. How would this tie in to a deemed disposition on death.
Professor Engel said that this was a good point and they would look into it.
Ms Jumat asked if it was possible for someone to overvalue an asset, donate it to a PBO and then get a tax deduction benefit on that.
Professor Engel replied that value does not matter for the deduction. The price cannot be inflated because the base cost is used for the valuation of an asset.
Deemed sale upon expatriation
This is a pretend sale. They are trying to limit South African accrued gains by protecting the taxing jurisdiction.
Connected party losses
The proposed legislation provides that connected party losses can only be deducted against connected party gains. The scope of the proposed connected party loss rule may have to be reviewed as the definition of connected party may be too broad.
In response to Mr Andrew asking if the relatives of the spouse were also considered the relatives of the tax payer, Prof Engel said that they would have to think about this.
In conclusion the Chairperson noted that there were a number of issues which must still be decided upon. A draft Bill could possibly be available on the thirteenth of March. The meeting was adjourned.
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