Draft Revenue Laws Amendment Bill: briefing

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Finance Standing Committee

14 October 2004
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Meeting report

FINANCE PORTFOLIO COMMITTEE


15 October 2004
DRAFT REVENUE LAWS AMENDMENT BILL: BRIEFING

Chairperson: Dr R Davies (ANC)

Documents handed out
 

Draft Revenue Laws Amendment Bill [B - 2004]
Draft Explanatory Memorandum: VAT treatment of grants paid by public and local authorities
National Treasury Presentation on Bill, October 2004
National Treasury: Further aspects of the Bill - Deferred Installment Sales in Sections 24M and 24N

SUMMARY
The National Treasury and the South African Revenue Services (SARS) briefed the Committee on the proposed amendments to the Revenue Laws Bill. Proposed income tax amendments involved the broad-based employee share initiative, the executive equity scheme, hybrid financial instruments, taxation on sales based on contingent income as well as contingent share sales. There was also a proposal to allow CMA residents to fully participate in South African interest-bearing investments. The law on public-private partnerships had been clarified to allow such partnerships to claim depreciation on the cost of buildings and fixed improvements on government land, redressing a Roman-Dutch law anomaly. Tax would now be levied on non-proprietary exchanges, such as the Johannesburg Stock Exchange (JSE) and the Bond Exchange. Two sections of the Bill addressed enhanced tax administration, providing for the registrations of tax practitioners and the introduction of advance rulings. A general rule was also introduced for share-for-property transfers.

Some technical corrections were introduced in terms of Annex C of the 2004 Budget Review, in respect of Secondary Tax on Companies (STC), foreign discretionary trusts, urban development zones and Capital Gains Tax (CGT) real property withholding. Proposed VAT amendments were intended to provide clarity in regard to the VAT treatment of grants / transfer payments / subsidies by Government to Public Entities, PPPs, municipalities and private businesses. The issue of customs warehouses and VAT was also addressed to facilitate South Africa's growth as a distribution hub for Africa. The proposal in respect of Industrial Development Zones (IDZs) aligned the VAT Act to the Customs and Excise Act eliminating the import and double import anomalies. Other noteworthy VAT amendments were also introduced, as well as revisions to stamp duties on leases and estate agent reporting on transfer duty. The proposal sought to impose reporting obligations on estate agents involved in the sale of residential property to companies and trusts.

MINUTES

National Treasury briefing
Mr M Grote (Chief Director: Tax Policy), Professor K Engel (Director: Tax Policy), Mr C Morden and Ms L Mashigo represented the Treasury. Mr F Tomasek (Assistant General Manager: Legislation), Mr Frank and Ms L O'Connell Xego represented SARS.

Sections 8B; 8A; and 8E of Act 58 of 1962

Insertion of clause 8B in Act 58 of 1962
This amendment was based on the idea that employees with shares in a company were more motivated. Another school of thought felt that, since the company was benefiting from higher output, there was no need to incentivise the company. The employee share initiative promoted shareholder activism and started an income stream. The taxation options gave employees an automatic incentive to retain shares.

Substitution for section 8A of Act 58 of 1962, as inserted by section 11 of Act 89 of 1969 and amended by section 8 of Act 88 of 1971
Tax avoidance had been created vertical inequality in the taxation system. Certain employees were able to defer their tax while lower income earners were not able to. This situation was offensive in an equitable tax system. This had also created a different class of employee and related to the social order function of tax policy. It had been realised that the salary gap between employees and executives was out of control.

Amendment of section 8E of Act 58 of 1962, as inserted by section 6 of Act 70 of 1989 and amended by section 19 of Act 45 of 2003
The anticipated revenue potential of this amendment was R3-R6 billion.

Discussion
Mr K Durr (ACDP) asked how retrospectivity would apply, or when the tax would come into effect.

Professor Engel said that the effective dates were going forward. Any person entering into a scheme after the implementation date, envisaged as December 2004 / January 2005, they would fall into the new taxation.

Ms R Joemat (ANC) referred to Annex 1 s8E and was concerned at the holding period of five years. She asked whether this was a deferral, rather than an incentive.

Ms J Fubbs (ANC) referred to the dividend period of companies and asked if the five-year holding period would be linked to companies delaying dividends and then dividends being paid later. Was this a new measure of tax avoidance? She asked how this had been covered to ensure a reduction in aggressive avoidance. If 90% of employees received shares, but an employee was later transferred to another company within the group, would that employee then lose his tax option?

Ms Joemat asked about oversight of shares transferred back to employers and referred to the Saambou issue. She asked how it was possible to ensure that share issues did not work to the detriment of workers.

Mr S Asiya (ANC) referred to the employer's right to get shares back, for example to counter a hostile takeover. He asked whether there was any mechanism to protect employees and whether this would be fair.

Mr Grote said that the deferral was the incentive. If an employee was allocated shares in terms of the R3 000 allocation, s/he would previously have been taxed at ordinary rates. Wealth increase was therefore in the hands of the employees. If the shares were retained for five years and then sold, there would be no tax consequence if the shares were under R10 000 (CGT exemption) when they were sold. There was also an incentive for the employer who could deduct the price and this would be seen in the company tax paid.

Professor Engel said there were two five-year rules in respect of empowerment shares. The purpose of the first was to incentivise the employee to stay with the company and be more productive. If an employee received a share s/he could sell it the next day, but this would be taxed as if it was salary. After five years, it became a capital gain. The second five-year rule was an option for employers to prevent employees selling shares for up to five years. If the employee left the company or died, the employer had to let the share go. The rules had been designed so that only shares were involved, as they were much easier to value. Options or derivatives were not included. The requirement was designed to ensure that the rank and file employee had access to shares, which had to be completely free. Requirements were in place to protect the employee.

The executive share scheme was the exact reverse. The broad-based employee share initiative involved simple share schemes. The executive share schemes were getting out of control and had generated a series of complex self-help options to get schemes at minimal tax cost.

Mr Tomasek said that, if an employee was transferred to another company in the group, it would make no difference as the shares were owned by the individual. While the company had the right to re-acquire shares, this had to be at market value. Collective bargaining structures would be involved in such a case. A company could not force an employee to sell his/her shares, but it could impose a requirement that it had first option.

Dr Davies said that a number of companies had shifted their listings overseas and wondered about executives of those companies. What was the situation in terms of the double taxation agreements (DTAs)? If the executives were South Africa residents, would they be liable for this tax?

Mr Tomasek said that, in terms of the impact of DTAs, if shares were awarded for work done in South Africa, South Africa retained its right to tax them.

Ms B Hogan (ANC) referred to the restrictions on the employee's right to dispose of shares. She agreed that the employer should have first option on the shares, but there had been a problem of people selling shares immediately. Could employees however use their discretion if share prices started to plummet rapidly? She asked whether the definition of an employee followed in the Labour Relations Act, and whether the 90% of employees referred to included management.

Mr Grote replied that plummeting prices was a worldwide problem. Share options had stabilised relations between employer and employee, and the trade unions saw it as a real incentive in asset ownership. Trade unions had also expressed concern about people changing employment to cash in on their pensions funds. The tax system however could not be paternalistic.

Professor Engel said this point was valid and referred to the case of the Enron company in the USA. The share issue had to have good points for employers too. Ms Fubbs added that, as employees were given shares, she was concerned that during the five-year term, the employees' conditions of employment could be linked to this. That situation might be used by the company as leverage to retain the employees in their existing conditions of employment. This became a tricky issue in labour relations.

Mr Durr asked whether the 'law of unintended effects' could come into force. People might terminate their employment to get the share money. One option might be to sell the shares and transfer the money to a 'portable' provident fund.

Dr Davies asked about the trend in this respect in the UK. Were there discussions underway about closing this loophole?

Mr Tomasek said he saw this as difficult and said it might be an idea to restrict it to retrenchment, death etc.

Dr Rabie (DA) referred to the requirement that shares be given to 90% of permanent workers, and asked about the common international norm.

Professor Engel replied that employee share schemes were prevalent in the First World and most were option schemes, designed before the Enron experience. Most were continuing on these lines. South Africa had chosen a different path. Non-discrimination requirements might vary from group to group.

Mr B Mnguni (ANC) asked what the State would forfeit in terms of revenue.

Mr Grote said that the cost was very difficult to determine at present. Incentives were monitored on a yearly basis. There was a risk, but it was not a large one.

Sections 8E, 8F, 24J; 64B; 24M; 24N; s 10(1)(h); 11(g); and 10(1)(d) of Act 58 of 1962

Amendment of section 8E of Act 58 of 1962, as inserted by section 6 of Act 70 of 1989 and amended by section 19 of Act 45 of 2003
Professor Engel said that some people wanted one benefit and wanted the tax to be another. They tried to mismatch labels to get the best of both worlds and hybrid financial instruments blurred distinctions. S 8E put them in the worst of both worlds. The three-year rule had been extended slightly.

Insertion of section 8F in Act 58 of 1962
The proposed section 8F now treats debt disguised as shares as dividends for the payor. There was an attempt to ensure that the label followed the substance.

Amendment of section 24J of Act 58 of 1962, as inserted by section 21 of Act 21 of 1995 and amended by section 14 of Act 36 of 1996, section 19 of Act 28 of 1997 and section 27 of Act 53 of 1999
Mr Tomasek said that people were trying to use capital repayments as interest and gambling the system. SARS was having to recreate linkages.

Insertion of section 24M in Act 58 of 1962
Mr Grote said that this could impact economic empowerment. The Treasury was working on a system for small and medium enterprises to pay tax on a cash basis, for example in a business take-over.

Mr Tomasek said that this was particularly useful for small businesses. A large business would be in a financial position to have due diligence done, but a small business would not and could thus structure a deal of up-front payment with top-ups.

Insertion of section 24N in Act 58 f 1962
Professor Engel referred to the concept of 'receipt and accrual' in the tax system. Accrual was a promise of money over time. This money was accrued but at times not quantified. S 24N addressed the situation where a business was sold for a fixed sum to be paid over time. The timing might be unsure, but the assets would revert back to the seller if the money was not paid. This was an issue in a variety of empowerment deals. Sections 24M and N were 'doing the same thing' economically.

Mr Grote said this was underpinning company re-organisation rules.

Annex 5: s 10(1)(h): Mr Grote said that many countries were debating this issue. Five years ago, Germany had introduced a tax charge and investors had pulled out to Belgium and Luxembourg which did not have this tax. CMA investors had originally been excluded because they were in the common monetary area. As the worldwide tax system developed, exchange controls could be relaxed. There had been much discussion between Treasury, SARS and the three jurisdictions. The taxation had a retrospective effect to 2000 for retirement funds if there was no refund involved.

Section 11(g) of Act 58 of 1962
This had the full support of the Public-Private-Partnerships (PPP) Unit in the Treasury and SARS.

Section 19(1)(d) of Act 58 of 1962
The JSE and Bond Exchange had been assured that the effective date of this tax would be the date of promulgation of legislative change.

Discussion
Ms Fubbs asked whether the Treasury had also looked at hidden interest in respect of losses, and whether overdraft had been factored in as well.

Mr Tomasek said that bank charges were not involved in s 24J, but where discounts and premiums were at issue, this had been addressed by the section.

Section 67A and 76B to 76S of Act 58 of 1962
Professor Engel said that two things were involved in enhanced tax administration: registration of tax advisors and advance rulings. Company reorganisations were complex and rulings would be important. Each ruling would say "Only applies to the party who receives it". Each ruling had to be 100% correct and it was important that no ruling could be used against SARS.

Insertion of section 67A in Act 58 of 1962
Mr Tomasek said that a framework had been proposed for the registration of advisors. A great deal of comment had been received and the question was how to move forward. SARS was looking for people to make themselves known to them, as they wanted to build a picture and tailor the regulations more appropriately. There were no grounds for SARS to refuse to register a tax practitioner.

Insertion of Part IA in Chapter III of Act 58 of 1962 (sections 76B to 76S)
Mr Tomasek commented that with certainty came huge risks, and the workload could be substantial. In addition, if a ruling was retracted, SARS would have to balance who would suffer the greatest disadvantage. Private rulings were binding on SARS but not at all binding on the taxpayer, except in extremely narrow circumstances. A fee would be charged for any ruling other than a general ruling. SARS would be looking at cost recovery because the benefit would primarily be to the person receiving the ruling, and there would be a high level of skill required.

Discussion
Dr Davies said that he could see the need for general and class rulings, but wondered to what extent SARS was equipped to make private rulings. The proceedings were also complex. What was the SARS capacity?

Ms Joemat asked whether the individual employee or the service would carry the risk if a ruling was given that there were no tax implications - but it was later discovered that there were, and SARS was bound by its ruling.

Mr Tomasek said that capacity would have to be built. There were some exclusions, such as product rulings. He appreciated that this would be an issue. Any error was SAPS' problem. They could withdraw the ruling going forward but had very restricted circumstances under which they could withdraw going back, such as where the amount was so great that it posed a threat to the national revenue base. There was thus a need for great care.

Sections 24B(1), (2); 64B(3A)(d), 64B(5)(f); 7(8), and 13quat(6) of Act 58 of 1962
Annex 12: ss 24B(1) and (2): Professor Engel said there was also a cross-issue of notes such as financial instruments and hybrids. Companies in the same group were cross-issuing shares and notes. An example of this could be seen in 24J.

Amendment of section 64B of Act 58 of 1962, as inserted by section 34 of Act 113 of 1993 and amended by section 12 of Act 140 of 1993, section 24 of Act 21 of 1994, section 29 of Act 21 of 1995, section 21 of Act 36 of 1996, section 13 of Act 46 of 1996, section 25 of Act 28 of 1997, section 35 of Act 53 of 1999, section 39 of Act 30 of 2000, section 42 of Act 59 of 2000, section 18 of Act 5 of 2001, section 48 of Act 60 of 2001, section 25 of Act 30 of 2002, section 36 of Act 74 of 2002 and section 58 of Act 45 of 2003

This was an attempt to simplify the tracing method. Work still needed to be done on it. Mr Grote added that the STC system was very complex.

Mr Tomasek said that each company was able to claim its dividend received against the dividend paid. Problems arose where companies elected to defer the STC where the second company in the loop was not resident in South Africa. SARS did not accept that the current provision was in contravention of the DTA, but had amended the provision. The test would now be whether the recipient was taxable in South Africa. If not, the company could not elect to defer.

Amendment of section13 quat of Act 58 of 1962, as inserted by section 33 of Act 45 of 2003 and amended by section 12 of Act 16 of 2004
Mr Grote said that, in engagements with local government, certain issues had been deemed too touch. Applications from Tshwane, Mfuleni and Sol Plaatjie were being processed.

Discussion
Dr Davies asked how much revenue was currently being lost or would be gained through the revisions.

Mr Grote said that SARS had built up a database on contested transactions that amounted to R6 billion. There was no indication of how much had been lost on property sales by foreign parties.

Mr M Johnson (ANC) asked for more clarity on the urban development zones, and particularly on requirements.

Ms Mashigo said that the requirements had 'softened' the original criteria. For example, zones had initially had to have all three components, i.e. residential, commercial and industrial, which was unrealistic.

Mr Johnson asked for clarity on the liability of the estate agent or purchaser to determine whether a seller was a non-resident. How would they do this? He suggested it could be an industry matter and be a routine question on forms. He was unhappy that the onus had been placed on the purchaser.

Mr Tomasek replied that the wording was "known or should have known". He realised that it was difficult and said that SARS was relying on estate agents and conveyancers to make enquiries and to pass on this knowledge to the buyer. They had an obligation to know their clients. A request to have the purchase price transferred to an offshore account might also give an indication.

Mr Frank said that the transfer duty forms had been redesigned and now asked for residence status.

Ms Hogan noted the rapid escalation in property prices and said that estate agents had now raised the limit on middle class homes to R1.8m. Would this be factored into tax legislation?

Mr Tomasek said that SARS might well have to consider this, but suggested that this varied according to area.

Annex 15:
Discussion
Ms Hogan asked how museums, which were both subsidised and in trade, would be dealt with.

Mr Morden said that museums fell under 3A and were completely out of the VAT net. If their trading activity was substantial, however, that subsidy could fall away.

Ms O'Connell Xego said that SARS could pre-empt the PFMA if it was seen to be necessary from a VAT perspective.

Mr Johnson asked whether the PPP concession would apply to water projects and the outsourcing of prisons. These were agencies, such as Group 4, that had a concession to run prisons for a certain period.

Mr Morden confirmed that the examples were all PPPs. Prison management had received a VAT-able grant from Government.

Mr Johnson said that it was Government policy to integrate and unify all spheres of Government. He asked how the Municipal VAT classification could be reconciled with this.

Mr Morden said there was a difference between the roles and responsibilities of the various spheres of Government. Fees at state hospitals were not VAT-able, for example, but water and refuse from municipalities were VAT-able.

Dr Rabie asked whether the NSRI would be liable for VAT.

Mr Morden replied that the NSRI was an 'Association Not For Gain' and was not dealt with in this proposal.

Ms Fubbs asked whether the municipal zero VAT rate was retroactive, for example for arrears, and asked how it would work.

Mr Morden replied that municipalities paid VAT when they received money, so outstanding money would not attract VAT.

Sections 21 and 21A of Act 58 of 1962
Mr Grote said that this had the huge benefit of creating a hub for re-export. In respect of Industrial Development Zones (IDZs), the framework legislation was very enabling.

Ms O'Connell Xego explained that VAT would be levied but exempted, so technically there would be no VAT.

Annex 14
Discussion
Ms Fubbs asked whether donkey carts were classified as vehicles, referring specifically to their use as hearses.

Mr Frank said that both the cart and donkey would form the hearse and would receive input credits. A commercial licence would be required.

Sections 1 to 5, 9, 9A; 9B, and 22 of Act 58 of 1962
Mr Frank said there was currently no differential provision for negligence or attempted evasion. Late interest at 10% per annum was not provided for. SARS had also experienced problems with home-made adhesive stamps, and were thus moving away from stamps. There was an intention to stop stamp duty on middle-income leases and offer relief for low-income earners. Electronic receipts were envisaged for amounts over R200, with a R100 de minimus exclusion.

Discussion
Dr Davies referred to schemes for people with HIV/Aids rendered off-site, especially in small companies. He asked whether any solution was being offered and whether this was being attended to. The issue carried fringe benefit implications. Questions had been received from Cosatu and the Treatment Action Campaign.

Mr Grote said that the Minister had not yet been briefed on Treasury's progress on the issue. Treasury and SARS had been in discussions with the Department of Health. He was unable to comment at present and was not authorised to give feedback. Treasury was in the process of revising tax proposals for next year and had engaged with the private sector as well.

Professor Engel said the law had not been drafted to deal with this type of issue, but had envisioned other fringe benefits. A more holistic solution was sought.

Dr Davies said that there would be 1.5 days of public hearings on the Bill. Closing date for submissions to these hearings had been 14 October 2004.

The meeting was adjourned.

 

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