Taxation Laws Amendment Bill: hearings

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Finance Standing Committee

25 May 2000
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Meeting report

FINANCE PORTFOLIO COMMITTEE
26 May 2000
TAXATION LAWS AMENDMENT DRAFT BILL: HEARINGS

Relevant submissions and documents:
Price Waterhouse Coopers
Anglo American
Mr Chait
Law Review Project
The Non-Profit Partnership
United Community Chests Of South Africa
Taxation Laws Amendment Bill (draft)

SUMMARY
There was general consensus amongst the presenters that the provisions in the legislation for taxing foreign dividends would result in most profits being left in offshore investments to avoid the imposition of South African tax. Tax incentives offered in foreign states to compensate South African companies for taking risks by investing in their country will be lost to companies.

It was submitted that if the Bill were implemented in its present form, the result would be a tax system that was more onerous than that of developed nations. South Africa was best suited to an outward-looking system where South Africans were not penalised for investing offshore.

Retrospectivity should be avoided and reserves accumulated prior to enactment of the legislation should be exempt from taxation. It was suggested that SARS generate an A-list and a B-list of countries so that investments in A-list countries, where tax was levied at a higher percentage than in South Africa, would not be double-taxed. The legislation discouraged investment by South Africans in other countries, especially African countries.

With regard to the taxation of NGOs, it was submitted that the basic principle was there should be tax exemption when private people did things which were for public benefit. NGOs had to be allowed scope to generate tax-free income in order to sustain themselves since donor funding was not eternal. The following concerns were identified:
- The discretion of the Minister in deciding whom were exempted from tax. Parliament, as opposed to the Executive, should lay down fixed and objective criteria to be applied in respect of tax exemption.
- Transfer duty exemption would only be applicable where acquired property was used "exclusively" for public benefit.
- The SARS Commissioner would decide what "prudent investments" of Public Benefit Organisations were.
- The proposal that 75% of the net revenue derived from funds had to be distributed in the year after they were derived.
- The proposed amendment to section 18A (tax deductible donations to public benefit categories) ignored a whole range of health and social development categories.
- Limitation of the amount distributable to not more than 10% of gross receipts.

MINUTES
Taxation of Foreign Dividends
Price Waterhouse Coopers (Mr Osman Mollagee and Mr David Lermer)
The proposed taxation of foreign dividends was complimented as a good piece of legislation, notwithstanding certain reservations. The development of the draft by the South African Revenue Service (SARS) was a transparent process with sufficient opportunity available for comments to be made on the draft. However most of these submissions were not taken into account by the SARS, although this was considered to be mostly due to time constraints.

The primary concern of this submission was that the Bill serves to make the South African tax system more onerous, an effect that was probably not intended by the legislature. In developing the legislation, the South African economy is benchmarked against developed economies such as those of the UK and the USA, and South Africa as a developing nation, is clearly not at the same stage. Some of the legislative proposals are harsher than those of the US, and the result is that some South Africans may effectively be taxed at 56%. This will drive both individuals and capital away from South Africa, which again was surely not the intention of the legislature.

The legislation will not produce the publicised 'tax bonanza' effect, as most profits will be left in offshore investments to avoid the imposition of South African tax. The penalising of South Africans for bringing home money from offshore investments will therefore be counter-productive. If the implementation of the legislation is delayed until January 2001 this will allow for an inflow of currency into South Africa. Such a delay would be normal by international standards.

The 10% equity requirement should be imposed at each chain of holdings and not as an effective 10% at the end of the chain. Without some form of exemption system, South Africans would be at a disadvantage as compared to the UK and US, against which the system is benchmarked. The intention should be to reduce the need for complex calculations by SARS and the South African citizen, and this legislation does not result in any reduction of administration by SARS.

In imposing tax on the receipt of foreign dividends at the time of accrual, as opposed to at the time of the transaction, double taxation far in excess of 56% may occur as the same dividend is taxed both abroad and in South Africa. Tax incentives offered in foreign states to compensate South African companies for taking risks by investing in their country are effectively lost and end up being paid as tax in South Africa, which again was surely not the intention of the drafters.

Anglo American (Mr Marius van Blerck)
It was noted that South African taxation of foreign dividends is a policy decision that is probably not within the bounds of the SARS to make - and any request to reverse this decision would have to be referred to the Ministry. If the Bill were implemented in its present form, the result would be a tax system that is more 'draconian' than most other tax systems. It engenders an inward-looking attitude to the South African economy. It was submitted that South Africa would best thrive on an outward-looking system where South Africans are not penalised for investing offshore. More appropriate would the approach advocated by the Katz commission with an emphasis on curbing abuse of the tax system.

No precedent exists for the immediate implementation of a new tax system with retrospective effect, especially where the relevant parliamentary committee has already accepted recommendations against such a system less than three years ago. Reserves that have been accumulated offshore can, under this draft legislation, no longer be repatriated to South Africa without being taxed. Some of these funds have already been taxed in the foreign states. A constitutional matter may be involved in this retrospectivity, and reserves built up prior to the enactment of the legislation should be exempt from such taxation. These reserves should be stringently certified and audited.

The most important point is that the system will negate all tax incentives offered by other countries. The approach is understandable in terms of developed nations, but is not appropriate in South Africa where the Reserve Bank is used to regulate currency control. The result would be a decline in investment.

The designated country system will not work, as it is seldom that money is transferred from one country to many. Rather money is transferred from one country to a holding company, and from there it is distributed to other countries. SARS could rather choose to generate an A-list and a B-list of countries so that investments in A-list countries, where tax is levied at a higher percentage than in South Africa, will not be taxed again in South Africa. This will involve less administration for the SARS. In many countries, including certain African countries, royalties are paid to the state wholly or partially in lieu of income tax. These royalties should earn tax credit in South Africa or the result may be an effective taxation in excess of 70%.

Mr Anthony Chait
The retrospective application of the legislation to accumulated offshore investments stems from a history of retrospective legislation in South Africa and is to be avoided. If these reserves were free from tax the result would be a large inflow of money into South Africa. The legislation discourages investment by South Africans in other countries, especially African countries.

The last time that South Africa was confronted with a change in taxation system was when the changeover was made from GST to VAT ten years ago. On that occasion extensive opportunities were available for comment and suggestion and the process was generally very transparent. The capital gains tax is to be announced on 1 April 2001 and it is only next year that there will be opportunity to submit opinions on the subject, leaving insufficient time for these submissions to be adequately considered. Mr Chait pleaded that the committee take cognisance of this fact and address the issue.

In terms of SARS responding to the issues which had been raised, it was agreed not to pursue this in the meeting. It was agreed by those making submissions to meet with the SARS the following week to sort through the technical issues and to engage in discussion on this. The committee would thereafter receive a report outlining the technical issues which could or could not be resolved as well as the policy issues which were not under the purview of SARS. The policy issues would have to be referred back to the Ministry.

Taxation Of Non-Government Organisations
Law Review Project
Mr L Louw explained that the Law Review Project was an NGO concerned with legal drafting. It was a privately financed service to government on the status, nature and drafting of law.

The NGO sector was extremely important and when people with their private resources did things like caring for orphans or the aged, or built houses, saw to education and training as a public service for public benefits, it made no sense to tax them. They were doing for government what government would normally take taxes to do.

The basic principle was that there should be tax exemption when private people did things which were for public benefit. The essential test should not even be a list of criteria published by the Minister or the department, but rather the essential nature or character of the NGO. It had to be determined whether its essential purpose was the pursuit of profit in the interests of its owners or management, or whether its essential character was a public service.

Corporate philanthropy and private charity had to be regarded as desirable. It had to be encouraged and exempt from taxation since it was a good end in itself. If one did not grant this exemption, Public Benefit Organisations would be taxed for taking on Government's responsibilities.

The Law Review Project emphasised the principles of good law. This was where it really had a problem with the proposal. Firstly, due to South Africa's legacy, there was no respect for the separation of powers. The discretion of the Commissioner or the Minister to be judge in their own case was a bad conception of jurisprudence. Parliament had to make the law and should not pass on this law-making function to the Executive. Unfortunately the granting of discretion to the Commissioner and Minister amounted to making law, since they decided what categories did or did not qualify for tax exemption. This had to be in the legislation and decided by elected accountable politicians.

Secondly, law had to be objective with a minimum of discretion. For example, bureaucrat should not be able to decide to whom to award licences. Corruption was an inevitable consequence of discretion.

Thirdly the law had to be certain. Anyone applying should be certain that they qualified for exemption and not be dependent on some discretionary power whereby some NGOs could arbitrarily be rejected and others approved. There was too much focus on the entry point of becoming an exempt organisation. Instead of creating an entry barrier or obstacle, the issue should rather be whether or not one continued to satisfy the conditions for exemption. Thus there simply had to be normal policing activity. With public benefit organisations there were numerous whistleblowers who would police them (including the best whistleblower - the donor).

The onus of public benefit organisations having to prove their bona fides had to be taken away as had been done in other cases such as licencing laws. (If one wanted to run a shoe shop one used to have to apply for a licence and satisfy that there was a need for such a shop. Now one could simply go and operate).

Producing a list of defined categories, Mr Louw suggested, was an improper power to give a Minister. It was a law-making function and not an executive function. He proposed that there be a single definition (with general criteria) which captured what the essential nature of an NGO was. Any NGO satisfying this essential character was automatically exempt. If it was for public benefit, and not the pursuit of profit or the distribution of dividends, then it should be exempt from tax.

He stressed that NGOs had to be allowed to trade and generate income in order to help sustain themselves, since there was a new trend amongst donors which required an assurance that the organisations being funded would try and become sustainable and self supporting. Thus they could not totally rely on donor funding.

The Non-Profit Partnership
Ms Karen Nelson from The Non-Profit Partnership, assisted by Mr Richard Rosenthal, raised a number of concerns and suggested solutions.

The amendment of Section 9 of the Transfer Duty Act meant that the transfer duty exemption was only applicable to property acquired "exclusively" for purposes of public benefit activity. Many Public Benefit Organisations sublet part of their property for rental income, whilst the property was substantially for their own purpose. It would be unfair for the exemption not to apply to them. They therefore recommended that "substantially" should replace "exclusively".

There was reservation about the constitutionality of the amendments to Section 11D(17(a)) of the Transfer Duty Act and Section 8D(17(a)) of the Estate Duty Act, 1955.

The amendments to Section 10 of the Income Tax Act were generally welcomed. However some concerns were expressed:
The difficulty with the differentiation between "fund" and "institution" in Section 10(1)(fA). Section 10 (1)(fA)(C) articulated the only material distinction between the regulatory regime affecting "Funds" as distinct from "Institutions". It was proposed that the prescription be eliminated.

Section 10(1)(fA)(iii) was largely approved of but there were reservations about the arbitrary limitation of the amount distributable (to not more than 10% of gross receipts).

In Section 10(1)(fA)(aa) "allocated" was ambiguous. It was recommended that "distributed" replace it

In terms of Section 10(1)(fA), (B) said: "funds had to be utilised solely for the object for which it had been established or be invested" and (CC) said "in such other prudent financial instruments and investments as the Commissioner may approve". Mr Rosenthal stated that it was the fiduciary responsibility of Governing Bodies of Funds to select their investments. If they were reckless, they could incur personal liability for breach of trust under common law. It was not the function of the Commissioner to act as arbiter of what may be perceived from time to time as "prudent investments". If the Commissioner did choose to decide what constituted a "prudent investment" then the State could incur liability for resultant loss.

It was thus suggested that (CC) be reworded as follows: "in other prudent financial instruments and investments."

Section 10 (1) (f(A)(E) was problematic as Non-Profit Organisations were compelled to become more self reliant in income generation and "trading activity" was one way to ensure their sustainability. They did concede that a distinction had to be drawn between related and unrelated trading activity, but felt that the Minister could not be the one to define what permissible trading activities were. They proposed that there be a capping of R100 000 on net income (alternatively that the activity was integral and related to the main object of the public benefit organisation or further, if not integral and related to the main object, then it had to be of an occasional nature or undertaken in compliance with prescribed conditions).

In Section 10 (1)(fA) the second proviso appeared to criminalise a failure to conform to the terms of a Trust Deed or other constituting document. This is a draconian consequence for what may be a relatively minor administrative transgression. It was proposed that this criminal sanction only relate to a failure to comply with the provisions of the Act.

With regard to the insertion of Section 30 in the Income Tax Act, which dealt with the definition of "public benefit organisation", it was felt to be problematic since the attempt to list the activities would inevitably exclude certain categories. Thus
it was suggested that the phrase read "having regard to the…best interests and well-being of the general public.

There were also a few comments on other subsections of Section 30 and the amendment of Section 56.

United Community Chests Of South Africa (UCCSA)
Due to time constraints, the UCCSA were not able to present their submission. Their main concerns did however come out during the discussion.

Discussion
75% of the net revenue derived from funds have to be distributed within one year
The Chairperson, Ms Hogan, said that one substantial issue which needed attention was the amendment requiring that 75% of net revenue in each fiscal year derived from funding of Public Benefit Organisations had to be distributed in the year after they were derived. She could not see why SARS would cling onto this because it defeated many purposes of many NGOs.

In the report that the Committee had endorsed, it had stated that the 75% should not be included as a conditionality.

Mr Kosie Louw from SARS said that if the concept of a fund was to be retained, then the funds should not be allowed to build up huge capital reserves. The fund only existed to flow through to the organisation in order to be spent on the ground for public benefit activities. He felt that perhaps when there was another discussion with Non-Profit Partnership, the possibility of collapsing the two entities of "funds" and "institutions" into one entity had to be explored.

The Chairperson said that this would be the solution and in any case this was the solution brought by The Non-Profit Partnership.

Limitation of the amount distributable to not more than 10% of gross receipts.
Mr Kosie Louw said that this was where money flowed to an entity not registered with or approved by SARS. He felt that SARS had made a considerable concession in this regard. SARS felt that initially it had to leave in some kind of limitation or de minimus rule and monitor the situation. The percentage could be lifted in the future.

Mr L Louw (of the Law Review Project) said that his organisation would strongly argue on both the 75% and 10% issues that one could not regulate these kinds of minutiae and should not try to. In terms of the 75% issue, the great charities of the world including ones that did much good work in South Africa, existed precisely because of no such limitation. One of the problems in South Africa was that funding and benefit organisations were underfunded and had few resources. Without such funds it was simply impossible to operate. It was impossible to plan ahead when one had no idea of what one's revenue could be. It could leap from zero in one month to half a million rand the next month. It was quite unhealthy to generate a state of affairs where revenue had to flow through, as opposed to ordinary prudence in building up a reserve fund in order to be able to maintain stable services. He gave the example of rural development or training scheme projects. In terms of the 10% issue, one could not try to regulate both sides of the equation. Grant making could be regulated and when the grant maker broke the rules then this should be dealt with. One did not need to regulate the grant receiver as well. This would simply impose an unnecessary and intolerable burden on SARS. One could not possibly police and supervise the thousands of organisations involved.

Mr L Isaacson from the Community Chest said that the 75% issue did not tie in with any international norms related to capital building processes. It could lead to a process where international organisations, dedicated to building up foundations, do not allow capital to flow into South Africa because of the constraints which would be imposed upon them.

The Chairperson said that the Committee was of the opinion that 75% was too onerous a requirement. She said that the various parties needed to re-visit this matter.

Mr Richard Rosenthal, speaking for The Non-Profit Partnership, said that the 10% issue penalised the very people one ought to be trying to benefit. These were the small, impecunious, disorganised and less formal grant recipients. The opposite needed to be done.

Approval of prudent financial instruments and investments by the Commissioner The Chairperson noted that in the committee's report on taxation of NGOs, it viewed this provision as granting the Commissioner almost a policing role in terms of NGO activities. This should be a matter of good governance by NGOs.

Professor Ben Turok (ANC) said that, according to Mr Rosenthal's submission, the members of a board could be personally liable. He said that his understanding was that there were legal ways for a board and its individual members to escape liability.

Mr Rosenthal replied that members of boards were entitled to make mistakes and did not incur personal liability for error unless the error amounted to recklessness or there was an element of fraud or dishonesty. There was thus a qualified liability based upon recklessness or dishonesty.

The Chairperson felt that SARS and the Ministry of Finance should be relieved not to be given the task of defining what a prudent investment was. The committee was of the view, when it gave its report, that this was also a question of good governance by NGOs.

Trading income
The Chairperson felt that the issue of unrelated trading income could be open to tax abuse and had not been adequately addressed by the Non-Profit Partnership.

Due notice concerning an NGO's failure to comply
Mr Rosenthal said that it was necessary that the Commissioner, on becoming aware of a transgression and before invoking the penalties, should give notice of this transgression. If there was a transgression then there were obviously sanctions including the loss of tax-exempt status. What the Non Profit Partnership was asking for was that before the penalties were invoked, the organisation should have an opportunity to rectify matters and rehabilitate itself.

The Chairperson replied that the section said that the Commissioner had to be satisfied that there was failure to comply in any material respect. She said that the Commissioner could not be expected to decide that one NGO would be allowed to rehabilitate itself and another would not, nor could he decide which had and which had not rehabilitated itself.

Ken Andrew (DP) said that what one wanted to obviate was that the Commissioner withdrew his approval of the Fund and then the following week the Fund made application to be recognised again. This process would be more efficiently handled by the giving of due notice. It was very likely that unless the Fund was closing down, they would try and put right what the Commissioner did not like, and then immediately apply again to qualify. The Commissioner would then have to investigate. Reference was made to this by Mr Louw of the Law Review Project when he complained about raising an entry barrier as opposed to monitoring the operation. Mr Andrew did not know which would be less work for the Commissioner.

The Chairperson said that the NGO could continue to exist after the Commissioner withdrew his approval. It just did not qualify for tax exemption status.

Ken Andrew (DP) said the question which then arose was once approval was withdrawn, how soon could the NGO reapply to qualify for tax exemption again?

Listing of additional public benefit categories for tax-deductible donations
When the Minister had made the tax announcement, he had listed certain organisations such as those dealing with HIV and children. The Chairperson felt that since the Minister had said this, it might be useful to have it in the legislation so that at least those organisations could go ahead and make arrangements in order to qualify for tax exemption. Perhaps at a later stage an additional list could come in as an amendment.

Mr K Louw said that SARS was fully in agreement with the Law Review Project that ultimately the guidelines had to be in the legislation itself. The only reason for creating the possibility for the Minister to set those guidelines was to provide a bit of time in order to reach agreement on the final wording. In Section 18 A, although the Minister had made the broad announcement in the Budget Review itself, some of the wording still needed refinement. If there was agreement on this in the coming week, the possibility was that the amendments could go straight into the legislation.

Mr Isaacson said that having an arbitrary list which specified only five categories would have a similar distorting effect that the current Section 18 A had. He pointed out that a business survey of the top hundred corporations in South Africa had shown that 49% of their donations went towards education, simply because of the wording of the current Section 18A. If this kind of distortion was created again, one would disadvantage important categories which have not been identified by this arbitrary listing of five categories. It would be a simple exercise to expand the list to sectors which had been commonly identified (there were about ten or twelve of these in the White Paper for Social Welfare).

The Chairperson agreed that this was a very valid point.

Mr Andrew said that whilst this was the right route to take, there were two interim measures. One was that the legislation provide that within a period of one or two years, the list would be extended. The less preferential option would be as was done with Customs and Excise, that the Minister publish items during the year which would come to Parliament for ratification.

Mr L Louw said that when one had a list there was a principle in law that said "what you include implies that you exclude other things." The difficulty with a list is that inevitably important items are excluded such as youth development, road safety, drug rehabilitation and rural development projects. The list included AIDS but had excluded TB and Hepatitis B. Disabled children were also excluded. One had to come up with a generally approved description of the type of organisation one had in mind - a bona fide public benefit organisation. He stated that a list distorted public benefit activity to the disadvantage of deserving causes. One had to get away from the idea of a list - as suggested by the Non-Profit Partnership. There rather had to be a description of a type of activity which was exempt from tax and define it well.

The Chairperson interjected and said that the discussion was at cross purposes. The one list being referred to was a list which described what was a public benefit organisation/activity. She said that the committee would agree on a general definition of a public benefit organisation.

The other list dealt with categories for tax-deductible donations. What she was hearing now were important points that if the list was now included in legislation, it would distort the flow of funding because these items would be seen as the only categories. SARS was assuring them that they would include a broader list in legislation once it was finalised. She wanted to know whether the NGO sector could not discuss with SARS these kinds of organisations.

Mr Andrew (DP) said that in both these lists, it may be advisable that one tried to get the best generic definition rather than a list. Provision could then be made (if necessary) for specific exclusions.

Mr Rosenthal said that this was an interesting idea as what was really being spoken about were two different types of fiscal privilege. The one was tax exemption which would be conferred upon a broad range of organisations that fell within the definition (be it a list of adjectives or no list at all). The other type of fiscal privilege referred to Section 18A. This was a list of organisations which would have the right to confer upon their donors, the ability to deduct from their pre-tax income, the amounts which they had donated.

In the past this list had been very restrictive and available only to tertiary and secondary educational institutions. Now it was proposed to enlarge this category. The principle which arose was whether it was appropriate that Parliament should be in a position to confer this special fiscal benefit on organisations engaged in particular categories of activity.

A SARS spokesperson pointed out that in terms of Section 18A, if donors donated roughly one billion rand to these organisation, the state's tax revenue would drop by about 300 million rand.

The Chairperson told Mr Rosenthal that in principle the committee had endorsed the notion that there should be universal application. The question which arose was what the impact would be on the fiscus. Thus there had to be a cautious approach.

Mr L Louw said that one had to understand that the revenue loss was offset by that money being transferred to causes that the state would now be relieved of. There was therefore in fact no loss.

The Chairperson was concerned that there was very limited timeframes for the Bill. She was mindful of the fact that the NGO sector urgently needed to have their taxation issues addressed. All the Committee could do was to expedite a the process as far as possible, so that some agreement could be reached on a sound framework which could then be adjusted over time through on-going consultation with SARS. Whilst she would have preferred a process where the Committee could have gone through each submission, this process would only have been successful if the Committee had powers to actually amend the Bill -which it did not have [as this was a money Bill]. The Committee was thus totally reliant on the negotiating parties coming to some agreement. She asked Mr Isaacson of UCCSA whether he had any thing to add, seeing that he had not had an opportunity to present.

Mr Isaacson said that serious damage in the NGO marketplace could be caused if the amended Section 18A went through as is. For if one created a situation where these five categories had exemption for a limited period, one would cause a short-term swing in corporate donations towards these five categories. This would then be amended in a year or two's time where there would be a swing away from these categories to a larger group of categories. The impact of this would be that government to plan initiatives to combat poverty alleviation, unemployment and health problems would be hampered by these swings.

Karen Nelson agreed with the Chairperson's emphasis on the need for further refinement to be enacted as soon as possible. She also welcomed SARS' invitation to engage in further deliberations in the following week.

The Chairperson thanked the NGO sector for their crisp and clear submissions. She also thanked SARS for their flexible attitude. The meeting was adjourned.

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