Draft Taxation Laws Amendment Bill: hearings

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Finance Standing Committee

01 February 2001
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Meeting report

FINANCE PORTFOLIO AND SELECT COMMITTEE: JOINT MEETING
2 February 2001
TAXATION LAWS AMENDMENT DRAFT BILL 2001: HEARINGS

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

Relevant Documents:
Consolidated LISPA submission

SUMMARY
The Link Investment Services Providers Association were critical that Capital Gains Tax was to be introduced without a proper consultative process. Substantive issues such as the lack of indexing and the complexity of the draft Bill were discussed.

The Association felt that there was inadequate time allocation for discussion of the legislation, training of SARS staff and for the education of the public. They requested a delay of six to nine months for the introduction of Capital Gains Tax.

Thereafter the Committee, National Treasury and SARS deliberated on some of the issues specific to the draft Bill that had been raised in the public submissions. These issues included the non-taxation of gains made through shares held by foreigners and the decision to tax unit trust holders rather than taxing the unit trust itself.

Notably, the National Treasury undertook to revisit the issue of the lifetime exclusion based on an asset register. However a commitment to re-examine the issue was all the commitment that Treasury was prepared to give.

MINUTES
Linked Investment Service Providers Association (LISPA)
Mr F.Jooste introduced LISPA by stating that the association represents 50% of the unit trust industry. As the business of this industry is administratively complex and intensive, Capital Gains Tax will impact strongly on them.

He dealt with the following issues:
Process
1) The process followed should be transparent and inclusive involving the public in a proper consultative process on the implementation of Capital Gains Tax.
2) The person to be affected by the tax must have sufficient time for preparation of administration of the tax.
3) The new legislation has to be comprehensive. Thus, the absence of regulations to be promulgated in terms of the Bill is a serious shortcoming.

Substantive Principles
CGT should only tax real gains in capital. However, it is possible that the failure to index will result in CGT becoming a tax on capital, which is not what was intended.
The tax should be easily understandable. They commended the South African Revenue Services for the simple and clear style in which the Bill is written. However, they had a problem with the complexity of some of the issues for example determining the base cost of assets.
SARS has a duty to educate taxpayers on the intricacies of the tax as it develops. This is to ensure greater compliance and a more effective process of collection.
A new tax affects the equilibrium of the forces and factors of a financial system.. Much greater detail is needed in order to determine the exact effect that CGT will have on these systems.
There are two types of costs involved. These are: (a) direct costs, which are incurred by the collectors of the tax and (b) compliance costs, which are incurred by the industries affected by the tax. A comprehensive cost benefit analysis should be made and disclosed to enable an objective assessment of the proposal.

The Consultative Process
In February 2000 the Minister of Finance announced the Government's intention to introduce CGT in 2001. Comments were then invited on vague proposals and these were provided. LISPA met with SARS representatives but Jooste stated that they were unable to reach finality on many issues. Important aspects were not discussed such as the question as to whether CGT would be levied in the fund or on the unit holder himself.

Nature of the Consultation.
Prior to the introduction of both General Sales Tax and Value Added Tax the government had ensured that the public had been involved and informed. This did not take place with CGT.

In conclusion, the implementation date by SARS for CGT is the April 1 2001 was unrealistic as specific details on adaptation and implementation of systems need to be addressed. He stated that LISPA is not ready to comply and that another round of consultations would be useful. They therefore suggested that the implementation date be deferred until 1 March 2002.

Mr Jooste added that if indexing was not allowed many problems would result. Referring to Clauses 22 and 23 of the Bill, he stated that the indexing cost should be added to the base cost from the beginning of discussion on CGT. In addition, there are seventeen possible permutations regarding base costs. LISPA has offered to work with SARS on this issue.

Discussion
The Chair asked if Mr Jooste was aware that the Minister had invited input regarding the implementation date.

Mr Jooste answered that he was unaware of this. The Chair said that he could be provided with a copy of this statement.

The Chair referred to Mr Jooste's statement that many issues had not been addressed. She asked him to elaborate by stating what these issues are.

Mr Jooste referred to sections 70B and S8 (2) and S8 (3) of the Income Tax Act and stated that they needed clarity on those issues. Significant problems have not been addressed. The following problem could arise: A client has R100 000 worth of investments and pays R500 per month. Some of these units can lie at a loss while others can lie at market value. What one is dealing with is a variety of base prices. If one wishes to sell one year later, how does one calculate the gain?

In addition, they are faced with technical issues. Since the introduction of the Wrap Fund system, the situation arises where the Asset Manager has to balance the Fund by, for example, selling a small number of units from Client A to Client B. Thus, because of this rebalancing, the calculation has to take place per fund, per client. Thus, what they are faced with is a huge administrative load.

Further, management expenses are deducted from each unit sold from the portfolio. Each transaction is a CGT event. One then has to add to that the complexity arising from the fact that each client can elect different methods according to which way he wants to have his tax calculated. This could amount to hundreds of calculations per client, per portfolio.

Mr K. Andrew (DP) asked questions based on the individual submissions of LISPA members in which they set out their grievances. He referred to Mr Jooste's concluding comment and if this was the basis for the statement by the members that Section 23 undermines the viability of the Wrap Fund and link investment services industries.

Mr Jooste answered in the affirmative. Previously, clients had made their own elections and later left it to their financial advisors when it became too complicated. However, now financial advisors will not be able to make elections unless they are registered in terms of the Financial Advisors Bill.

In answer to the Chair's query whether SARS and LISPA intended to engage in further discussions, SARS responded in the affirmative.

Mr K Andrew asked what effect CGT will have on corrections of the unit trust transactions.

Mr Jooste explained that it would depend on whether the company was at fault.

Mr F Tomasek (SARS) stated that if the client suffered a loss, he would be allowed to claim for this loss. Thus it will be treated like any normal transaction. This was the Management Company's problem.

Mr Andrew referred to the provision in terms of the delay in reporting a death to LISPA and ensuing consequences.

Mr Jooste agreed that this was not such a serious problem as it could be dealt with in the tax return, which the executor has to file.

Dr P Rabie (NNP) wanted to know how to calculate the difference between WRAP Funds and Funds of Funds.

Mr Jooste replied that with Funds of Funds, the portfolio manager is responsible for the end structure. With WRAP funds, the client has ownership of each individual unit. Each transaction on the client's account is a CGT event.

Mr Andrew asked whether annual fees paid to the Management Company would be added to the base cost.

Mr Jooste stated that it was difficult to answer at that point, but according to the current Act, it is not added. This is being reconsidered.

Mr Andrew asked why all disposals to connected persons are deemed to be mala fides. He stated that to suggest that each transaction that falls into this category must be punished is inappropriate.

Mr Tomasek stated that the loss suffered by the person is offset by other gains of the connected person.

Mr K Andrew insisted that the requirement is too onerous.

Professor Engel (SARS) stated that parties are often collusive, thus one cannot look at their intent. He said that the practice is based on a well-established principle in other jurisdictions.

Mr Jooste stated that, as an anti-avoidance measure, this principle is 'over the top' and that there has to be other ways of dealing with it.

Prof. Engel stated that the problem is a timing issue and not a valuation issue. He stated that parties would time the transaction in order to avoid CGT. One had to make sure that the losses they claimed were real economic losses.

In response, to the Chair's suggestion that SARS and LISPA meet during the break in order to set dates for meetings, Mr Jooste stated that SARS had contacted him the previous day in this regard.

Dr G Koornhof (UDM) referred to their assertion that they would need six to nine months in order to get their systems in place. He wished to know how they arrived at this date.

Mr Jooste stated that they had done a survey among their members among whom many were employing three of four systems of various complexities. In addition, new data fields have to be imported. In addition, many are faced with other projects that arose from other statutory interventions as well.

Mr Andrew referred to the individual submissions by LISPA's members and stated that it is clear that many of them need more time to put their systems in place.

Mr Jooste stated that the Bill should be discussed in the abstract. Instead they should discuss it as it affects their business. In this way, consultations will lead to legislation which is workable.

General discussion on public submissions
The committee, National Treasury and SARS proceeded to deliberate on some of the issues specific to the draft Bill that had been raised in the written public submissions (such as by Mr T Williams and the South African Numismatic Society).

Here follows an outline of the issues the committee highlighted in their discussion:
1) Non-taxation of gains through shares held by foreigners
Mr Andrew (DP) raised the issue of not taxing foreigners for shares held by them yet taxing them on immovable property. The reason given for taxing them on immovable property is that if South Africa does not tax them then they will be taxed in their home country anyway and the taxpayer will be ''no worse off''. Mr Andrew asked why the same logic did not apply to shares which were held by the foreigner.

Professor Engel replied that technically both immovable property and shares should be taxed. However it is administratively difficult to achieve this. With shares it is administratively impossible to get the necessary enforcement mechanism in place. Thus the logic behind the decision was administrative. Choosing to tax real estate is a policy call. Tax on real estate will need a withholding regime to protect it but putting a withholding regime in place is not a burden. Mr Tomasek added that there is a higher turnover in the share market than in property making it harder to follow up.

2) Exclusion of sale of small business
If a person over 55 years sells a small business to retire then that person is entitled to a R500 000 exclusion from CGT. Also, if this person is deceased then the executors can disregard R500 000 of the capital gain made on the disposal of the business.
However there are many people who are over 55 who have built up a portfolio of investments (in unit trusts, RSA bonds and so forth) for the purpose of providing an income for retirement. Such persons do not get a similar exclusion. Mr Andrew said that often a person's unit trust savings and their home were their biggest assets. If someone had intended to retire off the income from the unit trusts then this should be taken into account as the benefit is lacking, unlike those who sell a business.

Mr Tomasek replied that if an exemption is given to people who invest privately for retirement in this way then that will amount to giving them preference over people who have pension funds. Professor Engel added that if one creates such exemptions then it creates a lock-in effect for people to hold onto such assets until they can claim the exemption. The small business exemption was felt to be distinguishable because it was felt that they would be incentivising small business.

Mr Andrew said that perhaps a lifetime asset register would be a better way to go then. It need not be an administrative problem to do this as one could simply look at an individual's asset balance each year.

Mr Grote said that they would revisit the issue of the lifetime exclusion as there was currently ''no level playing field''. He added that the commitment to re-examine the issue was the extent of the commitment that Treasury could give.

3) Taxation of unit trusts
The Chairperson raised the issue that in SARS's original proposal the unit trust was to be taxed. Now SARS has decided to tax the unit trust holder. This means that the unit trusts can trade for capital gains without paying tax. She asked SARS to comment.

Mr Tomasek replied that ideally the tax should be levied at both levels (namely the unit trust and the unit trust holder). However this is extremely complex. They have made the decision to tax the unit trust holder because there are more advantages to this than taxing the unit trust. The disadvantage of the method is that transactions within the unit trust are not subject to tax. If however the holder makes the transaction then it will be subject to tax.

4) The exclusion of coins from CGT
The South African Numismatic Society has noted that it is unfair to exempt collectors of works of art and personal belongings from CGT but not to exempt collectors of coins where ''the intrinsic value is mainly attributable to the material from which it is minted or cast''.

Mr Tomasek said that he would respond to this issue at another time.

Conclusion
As a matter of interest Chairperson Hogan asked how CGT would affect the value of property (someone had mentioned to her that it would increase the value of property).

Mr Groote replied that the price of property would go down or at the very least it would remain stable. People would now have to pay Capital Gains Tax in addition to transfer duty. Mr Andrew agreed saying that the price would go down and the seller would now get less money in their pocket.

Chairperson Hogan noted that the budget hearings were coming up. She asked the committee if there were any particular issues which they would like addressed.

Mr Andrew said he would like addressed the impact of the budget on broad issues such as poverty, unemployment, growth, investment, savings, and so forth.

The Chairperson said they were trying to find a range of economists to address the committee.

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