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FINANCE PORTFOLIO AND SELECT COMMITTEES
19 October 2004
DRAFT REVENUE LAWS AMENDMENT BILL: HEARINGS
Chairperson: Dr R Davies (ANC)
Documents handed out
FINANCE PORTFOLIO AND SELECT COMMITTEES
Draft Revenue Laws Amendment Bill [B - 2004]
Banking Council: Comment on Proposed Amendments to the Income Tax Act
Banking Council: Comment in Respect of Annexure 16
Banking Council Aide De Memoire
South African Institute of Chartered Accountants (SAICA): Comments on the Bill
SAICA: Reply to Call for Comment on Rulings
SAICA: Monetary Limits in Fiscal Legislation
Price Waterhouse Coopers submission on the Bill
Price Waterhouse Coopers PowerPoint Presentation on the Bill
Business South Africa (BUSA) written submission
Johannesburg Securities Exchange written submission
Mr F Gormley's written submission
The Banking Council commented in detail on the Draft Bill. Particular concerns were raised about the administration of the broad-based employee share initiative. Concern was expressed that the scheme might become a deferred remuneration tool and it was suggested that the motivational aspect be removed. The provisions in respect of hybrid financial instruments were seen as highly complex, but it was felt that substance and form were ignored. Tax equilibrium was also an issue. It was requested that both this issue and the section on deferred instalment sales be deferred until all the implications had been considered. It was emphasised that it was unreasonable to place the onus on the buyer to withhold monies in respect of property sales by non-resident sellers. In respect of reportable arrangements, it was proposed that the Commissioner have discretion in the imposition of penalties and sanction in an unintentional failure to report.
The South African Institute of Chartered Accountants (SAICA) made a detailed submission. In addition to several technical proposals, they shared similar concerns about the broad-based employee share initiative. This was felt to be too restrictive and a possible deferral rather than a concession. Strong reservations were expressed about the R3 000 limit and the requirement that shares be issued to 90% of employees. Throughout the submission, it was noted that effective dates were unclear in the Bill. The issue of hybrid financial instruments was addressed in detail and the corrective measures proposed seemed punitive. The introduction of advance rulings was addressed, and it was suggested that the exclusions were too broad. In addition, a timeframe was needed for the rulings, and a period of 90 days was suggested. They concurred that it was unreasonable to place the onus on the buyer in respect of the withholding of tax as above.
Price Waterhouse Coopers also expressed concern at the limit of R3 000 and suggested it be increased. It was felt that some of the anti-avoidance measures contained in the Bill were too harsh and that these might have to be relaxed in the future. Particular attention was paid to the issue of advance rulings, and it was again suggested that the scope of the rulings be broadened. It appeared that the issues that most needed clarity were in fact excluded.
Banking Council submission
Mr H Shaw represented the Banking Council and raised concerns about equitable tax treatment of taxpayers and transaction and sought clarification of areas subject to different interpretations.
With effect from 1 January 2005, the costs of employee share schemes would change from shareholder cost to company cost, thus making them deductible under the general deduction provisions of the ITA. The need for special provision for deductibility was therefore superfluous. Three disadvantages of broad-based schemes including 90% of employees were noted: the scheme could become a deferred remuneration tool, effectively reducing employees' take home pay and locking them in to the current employer; the limitation of R3 000 created administrative hardship; and broad-based participation reduced the incentive benefit. It was suggested that such a scheme be de-linked from performance, and that an allowance be created as proposed in Section 8B as well as recognising the deduction under Section 11A. The other disadvantages would, however, remain. For equity in tax treatment in both executive and employee share schemes, it would make sense for the share to be taxed as a fringe benefit or remuneration and the company to be allowed a deduction.
A number of concerns were raised over hybrid financial instruments, particularly the need to match substance and form, and to match tax on income and allowance for expenditure. Most deferrals related to a mismatch of tax and the aim was further for a convergence of accounting and taxation treatment, which was increasingly the practice internationally, for example in the United Kingdom. In essence, instruments were generally issued as debt instruments and later converted to shares. It was felt that related parties had little relevance as transactions could be structured at market rates. The three-year cut off was also of little relevance as most convertibles were for long-term capital formation. Hybrids were an issue on which the Banking Council and its member banks had expressed grave reservations, and they requested the issue be deferred or the question of hybrids and derivatives be dealt with comprehensively under a separate section.
In respect of deferred instalment sales, it was felt that the selling price was a function of the revenue generated by the sale and the proposal appeared to be a deviation from generally accepted accounting practice. A deferment was again suggested.
The only reservation expressed in respect of tax administration was a caution that the term "provision of advice" had not yet been defined and the powers and scope of the proposed Board had not bee established. The Board should be independent and regulated.
The SARS difficulties regarding tax on non-resident sellers was understood, but the onus should be placed on the conveyancer and/or the agent, who should be familiar with the formalities, not the seller, who would not be so familiar.
An omission was raised regarding reportable arrangements in Section 76A. This was designed to provide SARS with information on arrangements to defer income tax. SARS and the Banking Council were working to produce a brochure on this Section. A plea was made for some discretion for unintended failure to report an arrangement. Provision was currently made for discretion on penalties where a company wilfully or recklessly failed to report an arrangement.
Dr P Rabie (DA) referred to the stated need for time for the legislation on reportable arrangements to be implemented and asked what timeframe the Banking Council considered practical.
Mr Shaw replied that the discussions with SARS were close to completion and felt that workable arrangements would be in place within three to four months. The issue was that greater co-operation was likely if the penalties were less punitive.
Ms B Hogan (ANC) asked what was proposed to prevent the broad-based employee share initiative from becoming a deferred remuneration tool.
Ms Hogan said that she was not clear on the double deduction proposed and asked what was meant.
Mr Shaw replied that the double deduction was suggested if it was acknowledged that the motivation for the share issue was not employee motivation, but to give employees a degree of ownership, provided it was not part of the remuneration package. A double deduction might provide a de-linkage from remuneration. One deduction would be for the shares and the other as incentive for the company.
Ms Hogan referred to the call for a further extension on the Section on hybrid instruments and said that this would have to be a judgement call as it was a very complex issue. She asked whether the three-year cut off was irrelevant as it could be reworked or re-jigged.
Ms Hogan asked SARS whether the legislation was definitely placing the onus on the seller in the sale of property by non-residents and wondered if there were ways of improving this system.
Mr K Durr (ACDP) agreed with the submission on the withholding tax, but for a different reason. If the onus was shifted to the agent or conveyancer, they would have interest bearing trust accounts. Because sales were often delayed, SARS would be better off knowing its money was in an interest bearing account, the buyer would be in a better position and the seller would not know the details as a conveyancer would.
Professor K Engel (National Treasury) clarified that the withholding tax placed the onus on the buyer if s/he knew or reasonably should have known that the seller was a non-resident. The conveyancer and agent were obliged to report to the buyer if they believed the seller to be a non-resident.
Mr Shaw said that the reality remained the same. The onus should not be on the buyer. He accepted that trust accounts were a mechanism by which funds could be held but said that payment was not always made through trust accounts, particularly in commercial transactions.
Ms Hogan asked SARS whether there was an intentional omission of discretion on penalties in the case of unintentional failure to disclose.
Mr F Tomasek (SARS) replied that two sanctions arose. Where there was any failure to disclose, a slightly stricter anti-avoidance test was applied. If the lack of disclosure failed the remaining parts of this test, sanctions would apply. An additional penalty was applied where the failure to disclose was intentional. The penalty was the amount of tax saved as a result of the transaction. This penalty could be waived wholly or in part at the discretion of the Commissioner, but the first penalty would still apply.
Dr Davies took the point about deferred payment and asked whether there was a contradiction between that and the restriction of R3 000. This would be a control measure.
Dr Davies asked whether there was any economic logic to hybrid instruments or whether they were simply tax avoidance devices. If they were the latter, it was urgent to get the legislation out and not defer it. Other issues could be dealt with at a later stage.
Mr Shaw replied that hybrids were not designed for tax avoidance. They had become an opportunity to defer tax because the tax regime regarded them differently from an accounting regime. An organisation wishing to raise capital in future, but able at present to pay interest would issue convertible debentures. This was a real economic transaction. These transactions could, however, be structured to cause inequity between the holder and the issuer. The Banking Council suggested that legislation target the forward sale rather than disallowing interest on genuine debt instruments.
Ms J Fubbs (ANC) asked whether the Banking Council would prefer the legislation on hybrid instruments be deferred or dealt with comprehensively under another section.
Mr Shaw replied that Banking Council members felt it would be a good idea to consider all instruments. They had made themselves available to discuss derivatives and all other instruments with SARS. A quick fix for hybrid instruments would be better achieved by taxing recipient interest rather than disallowing interest.
Ms Fubbs said that she understood problems were created by circular cash flows and asked what the Banking Council suggested to overcome the problem of circular cash flows.
South African Institute of Chartered Accountants (SAICA) submission
Ms J Arendse (Project Director: Tax) welcomed the inclusion of shares in unlisted companies for the broad-based employee share initiative. She expressed a number of reservations about the Section, however. It applied only to free shares and this was too restrictive. The Companies Act, 1973, also precluded a company from issuing shares for no consideration. Tax concessions might prove more of a deferral. In addition, Section 9B did not include unlisted shares. The R3 000 limit was too low and it was recommended that it be increased to R8 000 or more, or to allow the Minister to gazette an amount from time to time. The 90% requirement was felt to be extremely onerous and would result in limited application. It was a consideration that trusts were often used to administer such schemes and this might give rise to tax implications. It was suggested that fair market value be defined, particularly in respect of re-acquisition of shares. In respect of executive equity, it was suggested that a corresponding deduction be allowed for the employer, and that the taxpayer be allowed to defer tax until the shares had been disposed of.
Mr N Nalliah (Chairman: National Tax Committee) recommended that Section 24J be rewritten as it was very unwieldy and difficult to comprehend. He proposed that S 24J define a "transaction, operation or scheme", the sole or main purpose of which was avoidance or deferral of tax liability, and recommended that hybrids be split into debt and equity components which was accounting practice and easier to achieve. He asked for clarity on effective dates as specified in the Bill, and emphasised that the three-year period could be subject to manipulation. He commented that the measures seemed very punitive.
Ms Arendse referred to the provision on deferred instalment sales but queried why not all allowances had been provided for in Section 24M. In terms of relief for interest-bearing investments held by Namibian, Swaziland and Lesotho investors, it was believed that Section 10(1) should simply refer to "resident". She queried why the old wording had been incorporated. In respect of public-private-partnerships, would it not be appropriate to amend Section 11(f) as well.
Mr Nalliah suggested the exemption for stamp duty be extended to cases where the duty does not exceed R250 or a higher amount. The removal of the limit in respect of rentals was prejudicial in cases of long-term leases and he recommended that the old provision be retained.
Ms Arendse recommended that interest rates on late payment of transfer duty be linked to a rate in the Public Finance Management Act, to avoid regular amendments to the Transfer Duty Act as a result of interest changes in the market.
It was felt that the registration of tax practitioners had limited application. It was believed that the exemption of persons providing such services incidentally to their main business, and advice from attorneys and advocates was unfair in application or unclear in implementation. A further concern was the definition of a tax practitioner as a natural person as many did not work as sole traders, but worked in close corporations or in entities. The definition of natural person was unnecessarily restrictive. There were also not details about what SARS intended to do with the information received. It was of particular concern that this be properly legislated, not governed by regulation.
In terms of advance rulings, Mr Nalliah said that he could not see a reason for an applicant to give reasons for applying for a ruling, nor why advance pricing was excluded. Rulings would generally be sought on complex matters, therefore they were likely to be time consuming. This was again not a reason to refuse a ruling. He expressed concern at the possibility of retrospective withdrawal and asked whether costs would be reimbursed should a ruling be made in error. The taxpayer's view should prevail in respect of publication as well. The open timeframe was a concern, and 90 days was seen as reasonable.
In respect of share for property transfers, it was felt that the wording "transaction, operation or scheme" should be extended to include only transactions, operations or schemes that had the effect of avoiding, postponing or reducing a tax liability, and that had as their sole or main purpose, the avoidance, postponement or reduction of tax liabilities.
Ms Arendse stressed the importance of a taxpayer education campaign to ensure that purchasers were adequately informed of their new obligations, if the legislation regarding CGT withholding for non-resident sellers was passed. In addition, a one-page return was proposed for any non-resident or any person who had no other source of income or assets in South Africa, that would obviate the need for them to register as a taxpayer in the normal way. It was further proposed that the buyer or SARS to forward proof of payment to the seller of payment of the tax, and it was felt that the payment terms of the withholding tax were very restrictive and out of step with general tax compliance legislation. Concern was again expressed at the transfer of the onus to the purchaser. No time restriction had been placed on the estate agent's obligation to inform the purchase that the seller was a non-resident, and it was also unreasonable to place such a heavy onus on conveyancers, as the conveyancer had virtually no contact with or prior knowledge of the seller.
Mr Nalliah expressed disappointment that the Draft Bill did not contain any amendments to Section 10(1)(d)(iii) of the Income Tax Act specifically insofar as the date by which professional organisations and similar bodies were required to reapply for tax exemptions. He proposed that the deadline be extended to a further year or two years, as the conditions with which applicants were required to comply had not yet been made public. He also referred to the question of interest payable to the taxpayer. In the event of a dispute with SARS, if the objection was substantially allowed, the taxpayer was not entitled to interest. He asked the National Treasury to revise this.
Dr Davies hoped that the National Treasury and SARS would answer whether the issue of no price shares was in fact a violation of the Companies Act. He also questioned the stipulation of natural persons for tax advisers. In respect of advance rulings, he asked whether SAICA had any sense of the augmentation to SARS capacity that would be needed and suggested that the limitations were reasonable.
Ms Fubbs said she would have thought the cost of rulings would have been considered by SAICA as SARS would be doing the work usually done by Chartered Accountants.
Mr Nalliah acknowledged the resource limitation but felt that certain fundamental issues had been excluded, such as the pricing issue. It would be preferable to defer the legislation until the skills were in place.
Ms Fubbs asked for clarification on the use of trusts to administer employee share schemes, and asked whether SARS could address the issue of the JSE requirements for disposal of shares in employer or group companies, and asked SAICA to clarify its reference to the JSE and its shares.
Mr Nalliah replied that JSE rules prohibited officers from dealing in their shares during certain periods. He asked when vesting would happen in this closed period.
Ms Fubbs felt that clarity was needed on the definition of the date of issue. She hoped that SARS would address this when they replied the next day.
She expressed surprise at the emphasis on Section 8F and said she thought the main point of the legislation was to make it less blurred. She asked whether SAICA was suggesting that South Africa follow the same route as the United States of America.
Mr Nalliah said that that had not been the intention, but that aspects of other systems were noticed in the global arena and the question was why some things were legislated for elsewhere but not addressed in South Africa.
Ms Fubbs said that the legislation was supposed to address the circular routing of debt and interest, but SAICA seemed to suggest that it was making it more complicated, and she asked for clarity. She queried whether the proposed one-page tax return was common practice and asked how it would be implemented.
Ms Arendse said that she was not suggesting this for all non-residents, just those not registered as it would simplify administrative procedures. It would also be appropriate for residents who inherited shares, for example. It would not apply in every case.
Mr Durr said he felt SAICA's concern that the tax practitioners would be governed by regulation not law to be valid, and asked SARS to address this.
Mr F Tomasek (SARS) said that no enabling power for regulation had been included, there was simply provision for registration. In respect of the interest payable, he said that timeframes had now been built into the dispute resolution process and delays were not as long.
In respect of hybrids, Professor Engel said that it was felt to be better to include interest income rather than denying deductions.
Mr Nalliah replied that he understood the mischief in hybrids but felt that a double penalty was being imposed.
Professor Engel remarked that, on the issue of the free shares for employees, these shares had been set at no cost because they were aimed a low-income employees. He asked what kind of transactions SAICA envisaged at a discount to give access to rank-and-file employees.
Ms Arendse said SAICA envisaged a situation where individuals were required to pay the par value of the share.
Price Waterhouse Coopers submission
Mr D Lermer (Director: International Tax) highlighted some areas of remaining concern. In some instances, anti-avoidance was considered to go too far and there was a concern that very strict measures would later be relaxed. He stressed the need for the early inclusion of suggested effective dates, and that timing remained an issue. There was insufficient time for feedback. There was also a concern that this was a money bill and as such would either have to be allowed to go through or thrown out entirely.
Mr J Aitchison (Senior Manager: Tax Services) addressed the broad based employee share incentive. Perceived issues included the fact that large groups often used a single employment company, the reporting requirement on employees seemed at odds with the intention of the Bill, and the onus should remain with the company. He expressed concern at the absence of related stamp duty exemptions, and said that R3 000 was not enough, but could be worked with.
The taxation of executive equity schemes could result in double taxation in some instances and inappropriate taxation in others, for example where an employee purchased restricted shares at market value, with a buyback. If they were third party shares, they would attract CGT, but would be taxed at normal rates if shares in the employee's own company. All concerns in respect of hybrid instruments had been covered by other submissions, but there was also a fear that the true fees might be tainted.
In terms of deferred instalment sales, the wholesale exclusion of connected party transactions was not considered justified, and carve outs for connected party transactions done at arms length were required. The amendment in respect of share for property transfers was welcomed, but exclusions for bona fide commercial transactions and / or time limits were needed. A simple example was that of capitalising a company then reorganising ten years later. In Section 45(4), the degrouping did not trigger a gain / loss in the transferee company previously, and this mix needed correction. Concern was also expressed that the provision on foreign trusts (S 25B(2A)) converted capital amounts and exempt amounts into normal income.
In terms of advance rulings, it was submitted that the anti-avoidance exclusion should be removed. Anti-avoidance was the main benefit of asking for a ruling. Timeframes should be put in place, and the 90 days suggested by SAICA was seen as too generous, with 45 days being the ideal. The possibility of retrospective revocation also created uncertainty and cast doubt on the value of the system, although it was appreciated that this applied in limited circumstances. Advance rulings needed to be extended to transfer taxes. The detailed discussion document had made provision for all taxes excluding customs taxes. Transfer taxes were now missing. The excluded circumstances given in Section 76G(1) were queried. How did SARS intend to police serious intention? Vexatious issues were in fact those items that most required a ruling, and clarity was sought on the exclusion on draft legislation. Would this preclude applications from February to September? Rejected circumstances were also queried. If similar rulings were not binding, or the law had changed in the interim, it was unreasonable to reject requests for similar rulings. The discretion of the Commissioner was also seen as going a step too far. Finally, the issue of publication dealt with what precisely was disclosed. Broad consensus was that publication was the way to go, but cognisance needed to be taken of taxpayer comments.
Mr Lermer said that the STC credits (S 64B(3A)) were still work in progress. Branches were an issue - branches did not pay STC but Branch Tax. Investments were often made via South African branches not subsidiaries, and care must be taken not to create a loophole. The 10% equity holding requirement would create problems for groups as well. These structures were authorised by the Reserve Bank and there was a concern that companies would not bring dividends back to the country until the legislation had been fixed.
Other issues included the administration and encouragement of foreign investment, which was seen as placing an unnecessary burden on the investor and SARS with no benefit for either. Share for property transfers were also welcomed but the issue of the effective date was vital. A plea had been made for a retrospective date but the law was not clear. In respect of the withholding of sales proceeds re non-resident property sales, administrative issues were raised. How would payment be allocated to non-residents who were not registered, and what would happen if foreign estate agents, not subject to FICA, were used.
Dr Davies agreed that timeframes were a problem and said that they were impacting on the Committee as well.
Mr B Mnguni (ANC) said that he felt that the issue of shares to company directors came to corporate governance. If the issue was below market value, it would dilute the value to investors, and he asked whether this was not contrary to good governance.
Mr Aitchison replied that share issues were usually structured at a future purchase at today's value. This was not to dilute but to incentivise.
Ms Fubbs asked for clarification on the example given, of a company regrouping after ten years.
Mr Aitchison said that a parent company subscribing for shares in a company would have a base cost at that stage. If at any stage, the parent company transferred the shares for shares in another company, the base cost would be zero.
Ms Hogan said that she would like to hear more about the issue of R3 000 for the employee share initiative. She asked whether it was derived from 5% of R60 000.
Professor Engel said that the R3 000 limit had referred to an affordability concern. When a company issued shares there was no deduction, but this was exempt in the R3 000 case. It was also an attempt to keep it accessible to the rank and file employee, at 5% of the SITE base. This was also the Treasury's first foray into this area, and it went narrow. The issue was still being discussed but affordability was the main concern.
The meeting was adjourned.