Draft Taxation Laws Amendment Bill: hearings

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Finance Standing Committee

05 February 2001
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Meeting report

FINANCE PORTFOLIO AND SELECT COMMITTEES
6 February 2001
DRAFT TAXATION LAWS AMENDMENT BILL: HEARINGS


Chairpersons: Ms B Hogan (Portfolio); Ms D Mahlangu (Select)

Documents handed out
PriceWaterhouseCoopers submission
The Banking Council submission
Agri South Africa submission

SUMMARY
PriceWaterhouseCoopers suggested that the implementation of CGT be delayed until 1 March 2002. Large corporations will have to put systems in place to capture information relevant for CGT. A delay in the implementation would give all roleplayers, including SARS time to prepare for CGT.

They addressed material issues in the Bill such as estate duty, trusts, non-cash transactions and the primary residence exclusion.

The Banking Council supports CGT as it will broaden the tax base leading to a more equitable spread of the tax burden. In their oral submission they addressed:
- The effects of inflation and currency depreciation on capital gain
- Exemptions for securities lending
- Fiscal drag on statutory limitations

Agri South Africa indicated that there were still a number of problem areas for the agricultural industry with regard to capital gains tax. Given the need for investment, capital gains should not be taxed in South Africa. Instead, stricter criteria for the inclusion of speculative capital gains in income should be devised and applied.

MINUTES
PriceWaterhouseCoopers
Mr Seccombe (Director of International Tax) and Mr Louw (Director of Tax and Legal Services) at PriceWaterhouseCoopers (PWC) made the presentation. Mr Lermer and Ms Blackburn were present to assist with answering questions.

Introduction
Implementation date: Large corporations will require time to put in place systems to capture information from existing systems. Specific information such as acquisition costs and obtaining valuations need to be added. Data will also have to be collected for intangible assets such as goodwill and trademarks.

SARS has developed well over the past few years but this does not mean that it is ready to administer CGT. The first year of assessment for the new world-wide taxation rules is not finished yet so SARS may not have enough workable experience for implementation.

They suggest that the implementation of CGT should be delayed until 1March 2002. This will enable all roleplayers to prepare themselves.

Comments on the draft Bill
- The link between CGT and Estate Duty: SARS proposed that the deceased will be treated as having disposed of all his assets to the estate (at market value) on death. PWC believes that a rollover would be more equitable.
SARS are trying to link CGT to estate duty by saying that if CGT applies then the rate of estate duty will be reduced.
PWC says that because CGT is a tax on income and estate duty is a tax on wealth there is no justification to lower the rate of one to provide for the other. The rate of estate duty for example has never been adjusted for adjustments in the income tax rates.

- Trusts: there are various anomalies between the CGT treatment of a trust and the CGT treatment of a company. One example of such an anomaly is that a person who sells an asset to a trust and then becomes a beneficiary of the trust is deemed to be a ''connected person'' in relation to the trust. The same does not apply to someone who sells an asset to a company and then becomes a shareholder in the company.
(This person is not deemed to be a ''connected person'').

- Non-realisation and non-cash transactions: CGT is a realisation tax and not an accrual tax. However there are examples in the draft legislation where non-realised gains are subject to CGT. One example of this is in respect of share for share transactions (where shares are disposed of in return for other shares). In such circumstances no cash is realised and it would mean that assets would have to be sold for cash to pay the tax. This will cause harm to the economy.

- Primary residence exclusion - PWC proposed that the capital gain on the disposal of a primary residence which is in excess of R1million be subject to CGT.

Discussion
The Chairperson asked for a comment on SARS decision to reduce the rate of estate duty from 25% to 21%. Mr Lermer replied that estate duty is a tax on wealth while CGT is a tax on income. Tax on the one cannot be lowered to provide for the other. The two taxes cannot be related in this way. The rate of estate duty is not the issue the point is that there will be double taxation and this has to be eliminated.

Professor Turok (ANC) noted the Ministries comment that CGT legislation is an anti-avoidance measure. He asked what obligations there were on companies like PWC in respect of disclosure of anti-avoidance measures for their clients. He pointed out the difference between tax evasion and tax avoision (he referred to avoision in his question). Avoision related to tax planning and conversion. He asked how the legislation would affect them in assisting a client with estate planning. What are your obligations?

Mr Lermer replied that any professional person who advises his client to submit returns without full disclosure is breaking the law. The tax return states that there must be full disclosure. He added that as legislation becomes more complex tax morality would go down.

Mr Andrew (DP) commented that the Ministry said that CGT was complex and the returns are modest but its purpose is to reduce avoidance. However in terms of CGT there is still an incentive to reclassify revenue as capital (to pay a lower rate of tax). The taxpayer will save less but they still save. He asked if the distinction between capital and income (the cause of the avoision) could not be dealt with in the Income Tax Act. Mr Louw replied that in most cases the CGT collected would not be anti-avoidance related. Inserting a rider definition into the Income Tax Act is a good idea. Inserting a rider definition ''can be done''. Still, CGT will not stamp out avoidance.

Mr Andrew referred to the point made that a person who sells an asset to a trust and then becomes a beneficiary of the trust is deemed to be a ''connected person'' while a person who sells an asset to a company and then becomes a shareholder in the company is not deemed to be a connected person. He asked SARS to comment.
Mr Tomasek replied that he would hold over on this issue and respond to it in the response document.

Dr Rabie (NNP) asked for an elaboration on PWCs comment (in their original submission) that CGT would affect middle income earners more than the high income earners. Mr Lermer replied that richer people have a bigger portfolio and a bigger spread of risk. At the year end they have greater flexibility on how to deal with their assets. CGT is a realisation tax and the richer person has less of a need to realise assets than the person with less assets. In this way the high income earner can be less affected than the middle income earner.

Dr Rabie noted that this effect was universal and not unique to SA. Mr Lermer replied that there is a difference in applying the same rules to the SA context. In SA however growth is vital.

Ms Jumat (ANC) asked for a comment on the Treasury's contention that CGT would bring equity.Mr Lermer replied that this concept of CGT was valid. The question was the timing of the legislation. The economic implications of business in SA (not international comparisons) need to be taken account of. Such an analysis is necessary first. The Income Tax Act can deal with the recurring problem of avoision.

Dr Koornhof (UDM) commented that savings in SA were already low. He asked if there were studies on how much further CGT would affect savings.
The panel replied that they had no comment at this time but they would look into it.

Dr Koornhof also asked for an elaboration of the contention that an absence of CGT would provide a competitive advantage for entrepreneurs. They replied that there is a need to motivate business growth in the economy. If someone is penalised for growing his business (business is a form of savings) then it is disadvantageous. It is bad for SA if surrounding countries (like Botswana) are not implementing the tax and SA is. It puts SA at a disadvantage. CGT is quite possibly a tax for the future but not now.

Mr Koornhof noted that they only asked for a delay of the implementation date. Did this mean that they were not opposed to the tax? Mr Louw replied that once the tax was implemented it was supposed to remain in place forever - it is long term. All the roleplayers must be given time to study the nuances of the legislation before it is implemented. Before CGT is implemented, SARS must be ready. In respect of SARS readiness PWC noted that Mr Louw and Mr Tomasek (of SARS) might understand the legislation but it is the people who do the tax assessment who must understand it. They suggested a delay until March 2002. Readiness includes the ability to collect taxes and the ability of taxpayers to comply with the legislation. Mr Lermer added that readiness is a timing issue. Further he believed that only developed countries had been looked at in comparative studies.

Ms Mahlangu (ANC, Gauteng) commented that people did not have to comply immediately with CGT even if it was implemented on 1 April 2001, tax compliance need only be effected at the end of that financial year. SARS stated that they have an implementation plan and that they are ready. Even Professor Katz had noted that SARS capacity had improved.

Mr Louw replied that they have to assist business to get systems ready so that they can be in a position to comply with the new demands. This takes time. SARS is not geared up on every level to implement another tax. One example of this is that NITS
(New Income Tax System) is not functioning properly now. Mr Lermer agreed that SARS had changed for the better over the past years but they had to be clear on valuation rules and how they work practically. In practice nobody even knows if SARS can deal with the foreign dividend legislation yet. These returns have not been submitted yet. The implementation of CGT is being ''rushed''.

Mr Suka (ANC) commented that there were CGT exemptions and that these were noteworthy. The panel agreed that key exemptions for a tax are important but the issue for them was the timing of the tax. They repeated their request for a delay.

In conclusion Chairperson Hogan noted that the Minister had indicated that he was sympathetic to the issue of delay.

The Banking Council
Mr Kevin Daly said that the Banking Council supports the principle of a broader tax base leading to a more equitable spread of the tax burden and, hopefully a decrease in rates. Thus the Banking Council was not opposed to the introduction of CGT. A small number of comprehensive taxes was far better than a proliferation of taxes with limited application. This would make the income tax system more comprehensive. With the introduction of CGT it is hoped that taxes such as marketable securities tax and even donations tax, would go "so that we can rather tax comprehensively by way of one set of legislation".

The Banking Council addressed the following three issues in their oral submission:

How are gains measured?
The effects of inflation and currency depreciation can cause so-called capital gain to disappear when quantified in a stable international currency. "The question is, if we are serious about the global village then we must apply the principles of a global village in everything that we do economically in this country". South Africa had to be careful as CGT would discourage foreign investment in any asset attracting CGT.

On the issue of inflation, one needs to differentiate between the effect inflation has on the price of an asset and on its value. A R3 loaf of bread will cost R88.40 in 2051. In the case of property, there would be that same considerable increase not in the value of the asset but the cost of that asset. So the cost would be much more but the asset would be worth the same. This would attract a dramatic increase in CGT for something that has not increased in value. There has to be a provision for annual inflationary increases.

Mr Daly then looked at the argument made against inflation indexing:
Indexing is exceedingly complex and would impose an enormous administrative burden on the individual taxpayer and would require a mountain of data in respect of each asset. Different rates would have to be applied to different classes of assets.

Mr Daly stated that that he could not see a reason why there should be different rates for different classes of assets. Further, the argument that the failure to provide for inflation is compensated by the low rate of tax is wrong since the effective rate of the tax varies significantly according to the time period between acquisition and disposal. A low rate without provision for inflation might benefit those who realise gains quickly and penalises those who do so later. He said that even taxing at 5%, we are still taxing as if there had been no increase in real value, we are still not taxing the capital gain.

The Banking Council feels very strongly that unless the proposed legislation taxes real capital gains instead of illusionary inflationary gains, the tax is inherently flawed, is unfair and results in an arbitrary rate of taxation. As a result of this, the Banking Council believes that it will discredit our tax system, will lead to widespread disillusionment among the taxpayers and will further undermine the level of tax morality in the country.

Securities Lending
In this regard, Mr Daly referred the committee to the list of amendments in their submission that the Banking Council would want to be effected. Securities lending is when a long term strategic investor makes his shares available on a loan account to investors who want shares on a short-term basis. This is usually facilitated by a bank and is classified as a loan, but actually the loan is a loan for consumption. Since securities lending has been allowed in South Africa there has been a tremendous improvement in liquidity on the equities market. It enables both the strategic and speculative investor to meet their objectives as well as increasing liquidity which bolsters investor participation in the market.

Currently, there is a paper-based transfer of ownership that goes through the manual process of registration. An electronic system, STRATE, will be fully implemented in the latter part of 2002. The requirement in the exemption that certificates be re-registered back into the lender's name within the 12-month period is not practical as yet. Once STRATE is fully implemented it would be better to have such a requirement. Mr Daly appealed on behalf of the industry that the words "and registered" found in Schedule 8, Item 20(a) and (b) of the Taxation Laws Amendment Bill be taken out and only be imposed once STRATE is fully operational.

The effect of fiscal drag on statutory allowances.
In legislation there are specific amounts provided for either by way of exemptions, allowances or specific types of deductions. In terms of Item 5 in Schedule 8 there is the annual exclusion amount of R10 000. Secondly, in Item 34 there is the limitation of R1 000 000 of a capital gain on a primary residence. He indicated that Banking Council has formulated a simple way in which Parliament can, when enacting these types of provisions ensure that the allowance keeps in track with inflation. He added that they have not looked into the constitutional aspects of this.

Discussion
Mr K Andrew (DP) commented on the table dealing with a portfolio of shares on page 3 of their submission and stated that while he agreed with Mr Daly's line of reasoning he, however, felt that the calculation done of the effective rate was not the valid way of doing it because Mr Daly had not adjusted the CGT for its real value at day naught whereas he took it as a percentage of a real value.

Secondly, he noted a point raised in the paragraph 7.9 of the submission which he had not come across before and which he thought was very important: the issue of shareblock schemes where many of them have the elderly living in them. He said that he did not recall in the draft legislation any provision being made for the problems arising from that SARS should react to that.

He asked Mr Daly to make a comment on "Conversion of foreign currency" (7.11 of the submission document). Was Mr Daly suggesting that there should be different rules or the same rules applying to trading in respect of currency evaluation aspects?

Mr Daly replied that "the understanding was that if you're converting into a foreign currency for investment purposes and possibly you end up requiring less of an amount. It is not a trading activity. There is a genuine transaction and an intention to invest". It is a trading practice.

Mr Andrew asked if one sells one's shares and moves out a shareblock, is that not going to be taxable in terms of Item 33 of Schedule 8?

Mr Tomasek answered that a share block share could qualify as a primary residence and that would not be taxable.

Mr Nene indicated that he was confused by the first graph that referred to capital invested in South Africa which is in a foreign currency. He said he thought Mr Daly said it is based on the assumption that 100% of the capital gains is taxed because the inclusion rate has not been taken into account, and also that the rand will always depreciate. He asked "what would the picture be like if the rand were to depreciate?"

Mr Daly said that they had taken 15% which does accommodate the inclusion rate. This is in the scenario of depreciation. But it comes back on the very essential question of how one measures a capital gain, whether it works in one's favour or whether it doesn't work in one's favour

Agri South Africa (Agri SA)
1. Capital gains tax and equity
Mr J F van der Merwe recommended the identical treatment of capital losses and profits. This is specific to agriculture since land, which constitutes the bulk of assets of agriculture, has shown a decrease in value terms of up to 45%.

2. Capital gains tax and simplicity
The compliance burden is anticipated to be exceptionally high for the farming community.

3. Investment in agriculture - position of fixed improvements
Agri SA proposed that the any deductions for fixed improvements to farms that were not permitted from income, should be deductible from the proceeds of the sale of land as base costs for the purposes of capital gains tax (CGT). Further, given the problems that will arise with distinguishing between tax deductible expenses and "real" base values, they proposed that organised agriculture be involved in the preparation of guidelines in this respect.

4. Primary residence exclusion
The definition of a homestead needs to be refined. The valuation of on-farm residences is problematic as farms are normally traded as a unit. Agri SA suggested that the proceeds of the sale of a farm, for CGT purposes, be based on separated values at the valuation date. Since limited deductibility is available for worker housing on farms, for CGT purposes, this should be included in the base cost or should be treated on the same basis as primary residences.

5. Disposal to and from deceased estates
Agricultural land is, according to the Estate Duty Act No 44 of 1995, currently included in estates at either market value or values determined by the Land Bank. Agri Sa proposed that this option should also be available in the case of deceased estates for the purposes of CGT.

6. Disposal of small business assets.
In terms of paragraph 44(1), a one of lifetime exclusion of capital gains of up to R500 000 will be available in respect of disposal of a small business by reason of death, reaching the age of 55 or for reasons of ill-health. Agri SA assumed that if the asset value criteria is adhered to by natural persons in agriculture, this dispensation will also be available to the farming community.

Discussion
Prof B Turok (ANC) asked Agri SA how and to what extent does capitalisation of income occur in the agricultural industry. The response was that within the agricultural industry they are allowed certain capital deductions. It is a capital allowance being treated the same as depreciation.

Prof Turok pointed out that it was normal for income to be rolled over for a number of years, and that this was not depreciation but an allowance. Agri SA replied that the professor was referring to an averaging dispensation available to farmers. Farmers are allowed to calculate the tax rate on the basis of a five-year moving average income.

Mr Andrew (DP) inquired if there was lack of clarity with regard to schools on farms. Agri SA responded that the schools were part of the capital assets of the farm and as such they would be included in the CGT bracket. South African Revenue Services (SARS) added that they would not be classified as primary residences but they would be part of the base cost if the farmer effected improvements that gave rise to the school. If the Department of Education has paid for the school, then it is not part of the farmer's base cost.

Mr Andrew was concerned with CGT being a disincentive for farmers to have schools on their farms. SARS said that if it was on both sides of the equation then the impact should be very small.

Mr Andrew suggested that if over the years there are improvements to the school, which are not subsidised or where the cost exceeds the subsidy, one would look at this as a donation by the farmer to the community. However, upon the sale of the property, due to inflation and other improvements made to the farm, the farmer would then have to pay CGT. SARS responded that if the purchasing farmer does not see the value in the farm-school then the purchase price would be adjusted.

Agri SA added that the subsidy component would form part of current income and will be taxable as part of current income. The school will thus be a capital asset.

An ANC member asked SARS whether farmland would be evaluated separately from the homestead. SARS replied that the current proposal contemplates an apportionment so that up to two hectares would be taken as the homestead with the residential buildings there-on The remainder would be subject to CGT as the disposal of a business enterprise.

The Chairperson asked SARS whether there was going to be any synchronisation of valuation methods used by SARS and the ones used for property rates. SARS responded that there was an inter-link with the National Treasury, but they were unsure as to the extent of the inter-link.

An ANC member asked Agri SA to explain the statement that compliance costs may be extremely high. Agri SA responded that valuations would have to be done for homesteads and farms and that documentation would have to be kept for very lengthy periods. Furthermore, the extent to which it was deducted from current income and the extent to which it can be deducted from capital gains, creates complexities for Agri SA.

Dr Rabie (NNP) asked Agri SA about the Canadian and Australian policies for the exclusion of a primary residence on a farm. He also referred to relatives of farmers living on the farm. He inquired as to whether such occupation would be regarded as a primary residence for the relatives and whether that would be an exclusion for the farmer.

Agri SA responded that, to their knowledge, farms were totally excluded in Australia and Canada. With regard to the relatives of the farmer living on the farm, the title deeds of the farm would not allow for that type of a dispensation.

The hearing was adjourned.

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