Draft Taxation Laws Amendment Bill: hearings

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Finance Standing Committee

29 January 2001
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Meeting report

FINANCE PORTFOLIO & SELECT COMMITTEE: JOINT MEETING
30 January 2001
DRAFT TAXATION LAWS AMENDMENT BILL: HEARINGS
Chairperson: Ms B Hogan

Documents handed out:
Life Offices Association submission
Presentation document by Professor Matthew Lester (Rhodes University)
Free Market Foundation submission

SUMMARY

The Life Offices Association requested that the implementation date be postponed for one year so as to address several issues with which the draft legislation does not deal sufficiently. Also they anticipate a high level of systems development changes that still need to be effected for them to comply with legislation.
Rhodes University - Professor Lester presented statistics on how success could be achieved in applying CGT. However the public needed assurances that tax increases would not take place even if CGT is introduced. CGT does not have to be a wealth tax. Its implementation will increase tax collection but the public needs to be shown that it will in fact broaden the tax base.
The Free Market Foundation
proposed the introduction of the Flat Tax system which they argued is easy to administer and is progressive, as opposed to the Capital Gains Tax. They argued that CGT does not look at the needs of emerging business, it is a developing country system. Their submission centred around basic principles underlying the introduction of the Bill, they did not focus on the actual details of CGT.

MINUTES
Life Offices Association (LOA)

The LOA panel stated that they had held discussions with the South African Revenue Service (SARS) and the Ministry of Finance to highlight issues that the draft legislation does not address sufficiently. They stated that more time and debate was needed to address these concerns, which include the following:
· The appropriateness of Capital Gains Tax (CGT) in South Africa
· Specific issues for long-term insurance companies (Double Taxation, Intermediate Investment Holding Subsidiaries, Modification to Section 29A of the Income Tax Act, Implementation, Second-hand Policies, Annual Exclusion for Natural persons and the Removal of Subjective Rules).
· Retirement Industry implications
[See LOA submission for detail on these points].

The LOA stated that they are committed to continuing discussions with SARS to address these issues in order to ensure complete and comprehensive legislation. This can only be attained if the implementation of CGT is postponed until 1 March 2002 at the earliest.

They also expressed concern that they would require amendments to a variety of their systems. As this will involve other software suppliers, the task at hand becomes even more complex. They therefore believed that the level of systems change required to comply fully with legislation, justifies a postponement of the introduction of CGT for at least eight months after it has been promulgated by Parliament.

Discussion
Ms R Taljaard (DP) referred to the LOA’s concerns regarding second-hand policies. She asked for an explanation regarding the size of the second-hand policy market and what percentage this represents of national savings.

Ms Wasserman, a member of the panel, replied that she did not have that information at hand but was willing to make it available at a later date. She stated that very often the Life Officer cannot distinguish between first and second-hand policies. For example, if A sells a policy to B, the Life Officer is not necessarily informed of this transaction.

Ms Taljaard also referred to the third party providers of software and asked how many will be involved.

The LOA replied that they did not know the exact figure. However there were three large life offices in South Africa who use one overseas provider. This makes the situation very complex.

Mr K Durr (ACDP) asked what the practice is in other jurisdictions when dealing with the concerns raised by the LOA.

Ms Wasserman replied that in Australia second-hand policies are not subject to CGT (though she indicated that she was uncertain of this fact and stood to be corrected). She emphasised that South Africa has a unique system and it is difficult to compare it to other jurisdictions. She offered to make this information available to the Committee if they felt that it would be helpful.

Mr N Nene (ANC) wanted to know why they asserted that CGT on second-hand policies would cause withdrawals. He argued that if a person withdraws he does not realise a gain and therefore will not be taxed. If he sells however, he is taxed on a portion of the gain.

LOA’s reply was that they had referred specifically to second-hand policies.

Mr Nene asked how it could encourage withdrawals if the original owner would not be affected.

LOA replied that the wording of the Bill has the effect that the original owner will, in fact, be affected. In addition, those with existing second-hand policies will no longer find them attractive and would want to withdraw and obtain new policies that would perhaps be more attractive. While CGT may not necessarily encourage withdrawals from second-hand policies, it will act as a disincentive to the second-hand policy market. This is a useful way of dealing with lapses and surrenders as instead of lapsing, the policy will continue.

Ms Q Mahlangu (ANC) stated that the Director-General and SARS had referred to the broad consultation process which had taken place. She wanted to know if LOA had been part of that process. She also stated that very often decisions have to be made in accordance with worldwide trends. Delays would often mean that South Africa is unable to be in line with these trends – but if a person wanted to be ready, they would find a way to be ready. She asked why they were inappreciative of government’s efforts.

Mr Joubert of the LOA stated that they had in fact given submissions during the consultation process by SARS and the Treasury. The problem was that although they had made their input, there had never been debate regarding the issues. He said that he understood that they had probably been very busy at the time and he was therefore not pointing a finger at them.

On the question of the implementation date, LOA had in September 2000 discussions, stated that if they were to be ready by 1 April 2001, they required the final details immediately. They were however only given these details with the release of the draft Bill in December. There had clearly been changes to the details which had been discussed. He had also heard SARS say that further changes could be expected. The problem with which they are faced is the high cost of systems changes. He said that they could not afford to change their systems every time the draft changes.

Ms Themba of LOA stated that they understand that South Africa needs to achieve a lot within a limited time frame. All they wanted was the chance to work together rather than being faced with retrospective changes.

The Chair asked how much time they needed.

The panel stated that they would need approximately eight months.

Ms Taljaard (DP) referred to the overseas service provider, which has to deal with all three life offices. She suggested that they give the service provider the details regarding what is needed and bring them into the discussion.

LOA agreed, but stated that they had in fact approached them about timing of systems changes, but the service provider had refused to give a definite date that might be held against them later.

Ms Taljaard also asked to what extent the legal uncertainty and the fact that the valuations are still to come in legislation affected them.

They stated that they were very concerned about this and that they need finality as soon as possible.

Professor Lester of Rhodes University
Professor Lester stated that South African citizens earning R8000 per month and above number only 318,000 people, a figure representing 0,78 per cent of the total population of forty million people in the country. The contribution of this Personal Income tax, in value terms, is about R40bn and excludes other contributions such as corporate tax, retirement funds tax, vat, sin tax, estate duties, and customs and excise charges.
Professor Lester told the Committee that this money supports the following people: 2,657 million disabled people, 4,671 million unemployed people, 4,066 million children not attending school and 4,000 million people infected with AIDS. .
To find out how much money South Africa has to support all these people Professor Lester looked at the Actual Budget for the year 2000. According to him, the Income Tax revenue was R196bn and to make up for the expenditure of R224bn the Government borrowed R28bn. The projected figures for the year 2001 is Income Tax revenue at R205bn, borrowing at R38bn with expenditure at R243bn.
The Revenue for 2001 is expected to come from the following categories:
 

 

2001

2000

Individuals

R 97bn

R 86bn

VAT

R 51bn

R 46bn

Corporate & STC

R 27bn

R 24bn

Customs & Excise

R 9bn

R 9bn

Fuel

R 16bn

R 15bn

Other

R 5bn

R 16bn

Total

R 205bn

R 196bn

 

Other taxes where the revenue will be derived from are:
2001 2000
Estate & Donations tax R0,3bn R0,3bn

Transfer Duty R1,8bn R1,7bn
Marketable Securities R1,2bn R1,0bn
Stamp Duty R1,7bn R1,6bn
 
According to Professor Lester, the expenditure from this revenue will be as follows:
2000
Protection R 37bn R 33bn

Social Services R 109bn R 103bn
Economic Services R 21bn R 20bn
Unallocated R 30bn R 24bn
Interest R 46bn R 44bn
TOTAL R 243bn R 224bn
With the HIV population standing at 4 million, Professor Lester said that the death rate from AIDS by 2005 would increase by 64% of the present rate, or AIDS death figures over 5 years would amount to 2,56 million people projected from the recorded figures. Presently, it costs R2000 per person per month to treat HIV/AIDS victims. AZT costs R1500 and other drugs amount to R500.
Professor Lester then looked at the problems faced by Trevor Manuel, the Minister of Finance. He asked whether he is a big bully. "Has he achieved anything?" Professor Lester thought that he is one of the most accomplished Finance Ministers. For instance in his budget speech last year he gave tax breaks of R16560 to people earning R500000 p.a. and above. Professor Lester asserted that people could not say that they had not gained anything out of Trevor Manuel. Other tax brackets affected by this reward were as follows:

 

2001

1999

R 60 000 p.a

R960

R776

R 100 000 p.a

R2760

R1476

R 160 000 p.a

R6060

R1476

R 200 000 p.a

R7560

R1476

R 250 000 p.a

R9060

R1476

R 500 000 p.a

R16560

R1476

 

 
Professor Lester told the Committee that in 1995 the Katz Commission was asked to make an inquiry on CGT. On 23 February 2000 a discussion paper was released and 1 April 2001 is the effective date for implementation.
Professor Lester then asked a number of questions. He asked whether CGT could be implemented? "Can it be achieved? Can we cope with it? Can SARS train its staff in time for CGT?" Professor Lester felt that these and other questions need to be addressed by SARS.
To understand the CGT in its proper perspective he gave an example of a holiday home worth R250 000 in 1991 and sold for R850 000 on 1 April 2006. With a maximum marginal tax rate of 42 per cent and with the CGT coming into effect on 1 April 2001, can one say this transaction is a disposal capital or revenue? Is it exempt? No – It is not a primary residence.
To calculate the capital gain, Professor Lester used the following examples:
(a) Individual
CG = (R850 000 – R250 000) = R 600 000
 
Calculate pre/post effective date
10 years prior
5 year post_______________
15 year period (max 20 yrs)
Gain = R600 000 x 5/15 = R200 000
Primary Rebate (R10 000)
Adjusted gain R190 000
Add 25% to the adjusted gain to normal taxable income

Tax at marginal rate
R190 000 x 25% = R47 500
Tax @ 42% = R19 950
Effective rate: 3,325% on R600 000 gain
But we already have Transfer Duty @ 6 – 10%

We are generally replacing the asset and have to pay
Estate Agents
Legal costs
Moving & relocation costs
(b) Capital Gain on Corporate was another example used where 50% to the adjusted gain to normal taxable income is attached:
Calculate the capital gain = (R850 000 – R250 000) = R600 000

 
Calculate pre/post effective date
10 years prior
5 years post
15 year period (max 20yrs)
Gain = R600 000 x 5/15 = R200 000
Primary rebate (R10 000)
Adjusted gain R190 000
 

 
Calculate pre/post effective date
10 years prior
5 year post
15 year period (max 20 yrs)
Gain = R600 000 x 100/100 = R600 000
Primary rebate (R10 000)
Adjusted gain R 590 000

 

Add 50% to the adjusted gain to normal taxable income
Tax at marginal rate
R590 000 x 50% = R295 000
Tax @ 42% = R123 900
Effective Rate: 20,65% on R600 000 gain
Professor Lester continued that taxpayers in South Africa are extremely frightened that the rates would increase in time. If rates are low the public would be more open to accepting CGT. Individuals need to be given assurances that the rates would be kept low. And to do that, he stated that the CGT effective rate should be 10.5% and it would be calculated as follows:

 

Individual

Corporate

Capital Gain

100

100

Less: Allowance

(75)

(50)

Taxable portion

25

50

Maximum tax rate

42

30

Effective Rate

10.5

15

Professor Lester urged Government to publicise the benefits of CGT more vigorously.
 
Relating to CGT effective individual rates, Professor Lester stated that if an asset was acquired before 1998, the CGT rates would be lower provided that the prorating stays the same. A problem however is that the prorating can be increased by the legislature and therefore assurances are needed that it would not be increased.
If the prorating is increased, the CGT Potential Effective Rate will look as follows:

 

Individual

Corporate

Capital Gain

100

100

Less: Allowance

(50)

(20)

Taxable portion

50

50

Maximum tax rate

42

30

Effective Rate

21

24

 

Professor Lester said that when a business has to provide for increases in inflation and CGT, this could stump growth and investment in South Africa.
Professor Lester illustrated by way of a CGT Decision Tree said that a problem arises when one deals with roll overs. Example, when you sell shares and receive other shares in exchange for it, a problem arises when you have to sell the newly acquired shares in order to pay the CGT applicable to it. Professor Lester emphasised that the issue of roll overs need to be revisited as they relate to payment in species.
Benefits of CGT
Professor Lester said that the public generally is afraid of VAT inspectors or for that matter any persons that is linked to SARS. On the Corporate side there are not many tax specialists out there. However true this may be, the reality is that the amount of tax fraud in the corporate world is very low. A problem of tax evasion lies with the individual man in the street not wanting to pay taxes. CGT would therefore try to broaden the base so as to include more persons in the tax net. Furthermore the rates would be lower and this should serve as an incentive for people to pay their taxes.

The Tax Morality Spectrum
Professor Lester stated that individuals breach the tax system in varying degrees:
Professor Lester stated that there are people out there not registered for tax at all

He said some persons try to register revenue gains as capital gains so as to evade the paying of taxes
He said some employers refuse to structure employee wages because if a fault is found the tax return the employer would be held liable to the taxman.
Records
Professor Lester said that Section 73A would force people to keep proper records. It would make it easier for the SARS to do its work. Other benefits accruing from Section 73A according to Professor Lester is that tax planning on Estate duty and Donations tax should be clearer. The identifications of future income streams should also be easier. Overall it will force people into the tax net.

Conclusions
CGT does not have to be a wealth tax

CGT implementation will increase the collection of
Income tax
VAT
Estate Duty
By far more than SARS can ever hope to get from CGT
CGT needs to be sold as a way of broadening the tax base so that further reductions in tax rates can be achieved
Rates must be at the lowest possible level. Recommended – 5 percent
Punitive rates must be imposed for non-disclosure of any gain – Recommended 20 percent of a CG
The effects of inflation cannot be discounted. Either drop the rate or introduce "tapering"
Replace the Primary residence exemption with an overall CGT free allowance. (Say R1 million of disclosed gains) + Commitment to annual review for the effects of inflation
Extend the Roll Over provisions to cater for payment in specie
Encourage immediate disclosure and payment of CGT through a disclosure rate.
Above all – sell the concept. Taxpayers need to know that CGT can benefit everyone by sharing the load
This can lead to the cuts in taxes on revenue income that South Africans so desperately need.

Discussion
Ms R. Taljaard (DP) pointed out that CGT does not cater for inflation. She asked Professor Lester to comment on CGT as it relates to secondary taxation of companies and foreign investment. If the secondary tax rate of companies decreases what would this rate be? Ms Taljaard also asked if CGT could negatively affect listings on the JSE.
Professor Lester said that in the context of listings, listings cause a capital gain. So the SARS is entitled to part of the gain. These shares must be sold to get to get money to pay the tax. So if everybody dumps shares on the stock market its value will drop. Secondary tax only makes up R1bn of the R200bn revenue generated on taxation. Secondary taxes on companies (STC) also cause companies to retain cash thus negatively affecting the cash flow in our economy. Professor Lester feels that if we broaden the tax base we can get rid of STC.
Mr. Durr (ACDP) said that his understanding of CGT is that one family would have to choose one primary residence in order to qualify for the exemption. A problem arises as to how the wife and husband are going to be taxed on the same primary residence. He asked if there are any remedies to this problem.
Professor Lester said that a complex provision is being created by the inclusion of the primary residence exemption. He illustrated its complexity by stating what happens if the husband and wife reside in separate residences. The same applies to a Member of Parliament who has more than one primary residence. Another problem that Professor Lester identified is that pensioners complain that the primary residence exemption has no benefit to them. He recommends a once off allowance for all taxpayers as opposed to the primary residence exemption.
The Chair reacted to this by stating that perhaps the primary residence exemption was included in the bill because most people in South Africa only have one primary residence.

Professor Lester replied that an overall once off allowance would be simpler so why complicate matters.
Mr. Durr (ACDP) asked what figure Professor Lester had in mind for the once off allowance.
Professor Lester stated that R1m would be an appropriate figure as it would be
equal to the Estate Duty allowance of R1m.
Mr. Nene (ANC) feared that CGT might escalate over time. He asked Professor Lester where he would like to see assurances published that it would not escalate over time.
Professor Lester felt that such assurances could be published in the Hansard.
An ANC member asked what Professor Lester’s feelings were about the implementation delay.
Professor Lester replied that one had to be wary of the people component. Specifically referring to whether SARS would be capable of training everyone within the one-year period (1 Feb. 2002). He also added that certainty over the implementation date of 1 April also needs to be ascertained.
The Chair asked whether there are provisions in the bill for non-disclosure.
Mr Tomasek (SARS) stated that Professor Lester proposed a 300% penalty for non-disclosure. Professor Lester stated that taxpayers must be rewarded for disclosure and be punished for non disclosure.

Presentation by the Free Market Foundation
This organisation was represented by Mr Themba Nolutshungu, Director: Cape Town, Mr Eustace Davie, Director: Johannesburg, and Professor Brian Kantor.

Mr Nolutshungu said in South Africa we want to see an African renaissance that will be contexted on a sound economy. To achieve this we need to engage in constructive thinking. He said in South Africa we have a robust business sector. However with the Capital Gains tax system, blacks are the ones who will bear the brunt, especially emerging black businesses. We must ask ourselves who is going to benefit at the end of the day? South Africa already has a complex tax system, now it is overburdened by the rather complex Capital Gains Tax. The proposed Bill will tax pseudo gains from inflation price increases. Decreasing the percentage of the amount taxed does not eliminate the inequity but merely reduces it. Inflation indexing is the most equitable solution, especially in a high inflation country like South Africa. He said he does not regard CGT as a "wicket keeper", but an unfair piece of legislation.

Mr Eustace Davie said that there’s a general view that South Africa is a highly developed country. The present government has inherited a lot of complex systems, this includes the tax laws. This government is making them more complex by introducing laws such as CGT. He said South Africa is copying what is done in developed countries. In actual fact the highly developed countries themselves have a very low growth rate, at about 4%. In South Africa we need a growth rate of at least 6%. Or like South Korea which managed to have a growth rate of 7,2% in the last ten years. In the draft Bill emerging black business like spaza shop owners are not exempted from the system. He proposed the flat tax system which he argued was easier to administer and is progressive.

Flat tax (basic features)
The flat tax is generally progressive because it exempts low-income people from the tax. Flat tax taxes consumption, in fact it taxes what people take out of the economy and not what they put in it. A low flat rate can be maintained because it is comprehensive and has such a wide base. What is important as well is that it is easy to administer. All income is classified as either business income or wage income.

The Chairperson Ms Hogan warned Mr Davie that their presentation was not in line with the procedures of the meeting. General policy submissions had been made in 2000 and their argument could have been helpful if it was brought to the attention of the Katz Commission and SARS then. She said this meeting is not supposed to discuss alternative tax systems but to deal with the details of the CGT. Nevertheless she allowed them to continue.

Mr Davie argued that he did not think that MPs are aware of some of the important issues in the Bill. FMF is trying to bring out other critical aspects of CGT so that the MPs can look at them very carefully. He added that the MPs had not been represented in 2000 and the people involved in the Katz Commission and those who drafted the Bill are experts in the field of taxation.

Ms Hogan (ANC) said she expected very substantive inputs on the CGT, not on alternative tax systems. But she would not interfere with their presentation, she would allow them to continue anyway.

Mr Davie concluded by stating that he would recommend all the MP’s to have a look at the book by Hall and Rabushka on how to calculate flat rate on business and wage income.

Mr Nolutshungu (FMF) added that the MPs must look at the book very carefully in order to have a well-informed perspective.

Prof Brian Kantor (FMF) said CGT is very complex and flat tax is the best. CGT would not generate any revenue. South Africa is still seeking capital, we are still appealing to investors to come to South Africa. This means we have not yet managed to generate capital. CGT would not tax capital but will tax realized capital. There’s a difference between the two. It will not help South Africa to adopt this system when we know for a fact that this system has failed in other countries. Why do we want to adopt it when we see that CGT does not promote economic growth?

Prof. Kantor concluded by urging the Portfolio Committee to postpone the Bill, or make it lighter by putting in exemptions, especially for small businesses.

Mr Nolutshungu said that as FMF they have issued a number of questionnaires to various countries asking them about CGT. They have asked business people there whether there is any basis to lobby for CGT. The answers were a resounding no. The countries ranged from developed economies to developing economies, these countries included United States, New Zealand, Australia, Chile, Sweden, Singapore and Turkey. The type of questions that were asked were:

- Are there cases where the Capital Gains Tax has been implemented and then subsequently repealed, if so, which countries?
- Where a Capital Gains Tax has been implemented, what have the implications been vis-à-vis investments and savings?
- What is the position in your country?
- Where the Capital Gains Tax is operational, is there a strong lobby in government which cites evidence campaigning for a major review or amendment or repeal of the tax?
"So what is the moral behind introducing this tax" Mr Nolutshungu asked.

Discussion

Mr Lekgoro (ANC) noted the perception that CGT would bring equity. He asked the FMF to comment on this.

Prof Kantor replied that CGT would not generate much revenue so it could not help much on the equity front. CGT is not a wealth tax. The realisation of the wealth is taxed (at the time of selling). If one does not sell then there is no tax. In this light there is not much equity as people who accumulate wealth but do not sell will not be taxed. Thus CGT offers very little and there is not much equity. It actually harms economic growth, it really promotes inequity.
Ms Mahlangu (ANC) asked SARS if there were any studies to give an idea of the extent of tax evasion schemes in South Africa.

SARS replied that these schemes cost SARS approximately R1.5 billion in revenue. Because of the non-taxation of capital income the distinction between capital income and other income is important as it determines whether money is taxed or not. The incorrect characterisation of income as capital is a source of revenue loss for SARS. Twenty percent of the litigation (court cases) that SARS is involved in deals with the boundary between capital income and other income.
How will CGT affect entrepreneurs, especially spaza shop owners, who operate their businesses from their home?

Mr Nolutshungu replied that it would hit people who are on the periphery of the economy. An example is a Khayelitsha businessman who starts a small spaza shop where he lives. Such an individual will need an army of lawyers to deal with CGT. People who start these small businesses and make a success of it will be hit by CGT when they try to sell the business and move out of the townships into more affluent areas. The intent of the legislation may not be to hurt these people [who are disadvantaged now] but this will be an unintended consequence of the Bill.
Ms Mahlangu noted that indexation in Australia was abolished because of its complexity. She asked the FMF for their view on indexation. How can indexation help CGT?
Mr Davie replied that there was no precise way of eliminating inflation gains. When people invest in assets it is because they are trying to protect them against inflation. If one eliminates inflation gains, then what is left? How much of the profit is a real gain? There are really only two things which will increase in value in real terms. These are (1) land in the cities and (2) entrepreneurship.

Prof Kantor said that he did not see why it would be hard to accommodate CGT around inflation. He gave the example of government bonds. There is interest and there is inflation. Inflation is accommodated for. This is complex to do but it is something that they know how to do. If it can be done for government bonds then it can be done for CGT too.
Chairperson Hogan joked that perhaps this was the difference between an economist and an accountant -an economist does not see the difficulty of practical implementation and the accountant does.

Ms Hogan asked Prof. Kantor whether he had studied the draft Bill, especially the area which deals with indexation. She was quick to point out that the argument about indexation is complex and that is why it has been avoided in previous meetings.

Ms Taaljaard (DP) asked about capital lock-in effects in developing countries. Are there any empirical studies dealing with this from a developing country perspective?

Prof. Kantor said there are no studies looking at before and after the introduction of CGT. He said taxes are mostly consumption based in developing countries Sometimes in such instances you have to rely on your instincts, there are no precise explanations.

Mr Nene (ANC) commented that the panel was looking at CGT in isolation and not holistically as a back-up to income tax. Chairperson Hogan asked if the panel’s understanding of CGT was that its only advantage was direct revenue collection.

Mr Nolutshungu said that their input was not on technical issues but on basic principles. He said that it was regrettable that input was limited to the issue of delaying the introduction of CGT and to refinement of the Bill.

Ms Hogan (ANC) asked FMF how much exemption would they like to put in place?

Prof. Kantor said all the smallest capital gains should be out of the system - in fact, up to R1 million rand. South Africa’s tax system should encourage savings, the CGT system discourages savings and investments.

An ANC MP asked the FMF why they are making this submission at this stage of the process.

Mr Nolutshungu said any information that is submitted, even in the eleventh hour, should be considered.

Mr Durr (ACDP) said he had expected Prof. Kantor to have looked at the details of the Bill and not deal with principles only - detailed analysis is very important.

In conclusion the Chairperson said she did not want to entertain the flat tax issue as it was not appropriate at this stage. But she had allowed FMF to make their presentation because she felt it was important to do so.


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