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FINANCE PORTFOLIO & SELECT COMMITTEE: JOINT MEETING
23 January 2001
DRAFT TAXATION LAWS AMENDMENT BILL (CAPITAL GAINS TAX): BRIEFING
Chairperson: Ms B Hogan (Portfolio Committee); Ms D Mahlangu (Select Committee)
Documents handed out
Briefing Presentation by the National Treasury
Briefing Presentation by SARS
Statement by the Minister (see Appendix 1)
SARS Implementation Plan
The National Treasury, the Katz Commission and SARS noted their support for the introduction of Capital Gains Tax. Introducing the tax is justifiable on the basis of equity and consistency in the tax system. Capital gain is simply another form of income and not taxing it amounts to blanket exclusion of a form of income which is generated primarily by the wealthy. Although CGT will be generated primarily by the wealthy it is not a wealth tax, it is merely a tax of a particular form of income. Katz is emphatically opposed to retrospective application of CGT.
There have been suggestions to delay the implementation of CGT. The Treasury noted that the implementation date may be an issue – it is dependent on what needs to be changed and how long it will take to change. In the end CGT will be introduced.
Much discussion revolved around issues relating to the cost of implementing CGT, the impact it would have on investment and the its ability to interface with other spheres of our tax system. The cost implication not only referred to how it would affect SARS but also the private sector and the ordinary businessman. Concerns were raised that CGT would encourage disinvestment rather than investment due to the tax base being broadened. Even though assurances were given that appropriate measures would be put in place for CGT to interface with other spheres of our tax system, committee members remained sceptical about the process being completed by 1 April 2001.
Summary of presentation by National Treasury Director General (Ms Maria Ramos)
When making tax decisions the Treasury must consider fairness, equity, consistency, and efficiency. Even with CGT in place the government will still not be taxing a broad measure of income.
Equity relates to horizontal equity and vertical equity. In terms of horizontal equity all forms of income tax earnings should be taxed equally. Without CGT one form of income remains untaxed and this is unfair.
Vertical equity relates to the fact that the South African tax system is based on a principle of progressivity. This means that the greater the individual’s income, the greater the tax on that income. Research shows that CGT generally stems from wealthy individuals. If there is no CGT then one significant form of income generated by the wealthiest remains untaxed. Without CGT, the vertical equity principle is undermined. Failure to tax capital gains in the modern world makes no economic sense.
Ms Ramos noted a statement in the Katz Commission Report which said that it was very important to have a comprehensive tax base. The report also stated that CGT would prevent tax avoidance schemes where individuals incorrectly characterise income as capital gain to avoid paying tax.
The Treasury believes that CGT will equalise the tax treatment of passive speculative investments versus ordinary business investments. Example, some shares are subject to secondary tax on companies (STC) while other shares are not. With CGT, shares will be subject to the same level of tax. The Treasury believes that CGT will create an environment where people are more comfortable to invest.
The low rate of CGT will offset the ‘’bunching effect’’ whereby the bunching of income takes place in a single year. The low rate of CGT is also intended to offset the effects of inflation.
Response to criticism against CGT
CGT is vanishing across the world and the system of CGT is too complicated to administer.
It is not true that countries are abandoning CGT. Many ‘emerging market’ countries also have CGT. Countries retain CGT because of globalisation. It is an important tax to have because of its potential to counter avoidance. The Treasury acknowledged that the system of indexation is complicated. The administrative burden which comes with indexation is big. To exclude the complexities of indexation they have opted for a lesser form of indexation instead of full indexation.
CGT is a wealth tax.
This is not the case. CGT is a tax on income. It is imposed on accumulated profit not on the gross value. Thus it applies to profit on the sale and not the gross. For this reason it is not a wealth tax. The objective of CGT is equivalence between different forms of income.
CGT will discourage investment.
Investors do not make investment decisions on the basis of one tax or another. The tax system is ranked low on the list of variables considered by investors when making investment decisions. Investors are more likely to consider things like political stability and whether the government has adhered to its macro-economic policy. In any event, investment decisions which are based on the exploitation of a tax system are probably not sustainable investments. Therefore the impact of the tax on investment will not be substantial.
This applies to foreign investment and capital investment. CGT will not dissuade investors from investing. CGT will not destroy investment in the economy.
CGT will impact negatively on savings.
Research shows that the impact of CGT on savings has not been significant in any country. In the US for example less than 40% of savings produces capital gains. Every return other than income is not necessarily subject to capital gains.
The arguments in favour of CGT come from an economically sound point of view. The arguments against CGT are of an administrative nature.
CGT will bring in approximately 1 – 2 billion rand in revenue within a year or two. Presently SARS collects R 216 billion in tax. Compared to this the estimated CGT revenue is not big. However CGT is intended as a back-up to income tax.
There is a long history of having considered CGT. The consultation process has been open and sufficient.
Some have suggested a delay in the implementation of CGT. The implementation date may be an issue. However, they will have to ask what needs to be changed and how long it will take to change. In the end however CGT will be introduced.
They must now try to improve the legislation by focusing on any unintended consequences which legislation might have. The Treasury believes that CGT will improve the way the tax system in SA is run.
Summary of presentation by the Commissioner of SARS (Mr Pravin Gordhan)
With any new tax policy the wisdom of the policy is considered. There was consultation with stakeholders within government and outside of government. Public submissions were made terms of the parliamentary process.
CGT will improve reporting of capital transactions. It will improve the fairness of the tax system especially for low income groups. It will also combat erosion of the tax base.
People reduce their taxable income by characterising taxable income as capital income, example sportspeople. Sometimes this is legal. This is why CGT is necessary. Much of SARS litigation revolves around a dispute as to whether income is capital or not.
Capital gains is a form of income which is unjustifiably excluded from tax. CGT will provide for the equitable treatment of income.
In SA CGT will only be as complex as the avoidance schemes which people design to work around CGT. The complexity of the system will depend on how people respond to CGT. If people come up with schemes then government will have to come up with additional legislation to combat it these schemes. If SARS tries to anticipate these schemes now and then legislate for it now then the Act will be between 200 – 300 pages long. This is why they did not go this way.
SARS has an implementation plan. In it they address issues such as service to taxpayers, reducing compliance costs, organisational structures, training requirements, communication requirements, and office readiness.
In conclusion Commissioner Gordhon said that he hoped that the public hearings took place in the spirit of co-operation and assistance.
Summary of presentation by Professor Michael Katz, Chairperson of the Commission of Enquiry into Taxation
The validity of the concept of CGT involves looking at the design and content of the law, the rate of CGT, and the implementation date and transition issues.
CGT must be viewed in the context of globalisation. In SA there was previously blanket exclusion in that capital gain and income from a non-residence source was not taxed.
SARS has commented to the Katz Commission that if CGT is an appropriate form of tax then it must be introduced and government must simply create the capacity to do it. If for example the health system was in an unacceptable state, would government be justified for not improving the health system simply because there were not enough health officials. If it is a good system then government has a duty to implement it.
The old age attempt to achieve tax simplification can be at the expense of the ‘’better concept’’. There is tension between simplification of the tax system and sacrificing a policy. Is there philisophical justification for the blanket exclusion of a particular type of gain? There is not.
Professor Katz said that he had called a friend in the US personally and asked whether there had been a movement to abolish CGT there. It appears that there is no movement there or elsewhere to do this. There is no movement to abolish, only a movement for a reduction in rates.
CGT is not a tax on wealth it is a tax on income. It acts as a back-up (‘’wicketkeeper’’ in cricket terms) to the income tax. On this ground alone CGT is justified. There are sometimes arbitrary distractions between Income Tax and CGT. This is where the wicket-keeping occurs. Thus one must look at it as a back-up to income tax. One must not look at the yield of CGT in isolation but as a back up. What will it do to the system, the totality of the system.
The total fiscal burden must remain globally competitive. The transition must be implemented with care. There is no justification for the blanket exclusion of one form of gain.
Professor Katz continued elaboration on the design issue. He stated that there were concerns over capital losses being allowed against revenue gains. Another point of concern highlighted by Prof Katz was the application of the proposed legislation. Especially whether it would apply retrospectively. He emphatically stated that he opposed retrospective application.
Prof Katz proceeded to make certain observations about the proposed Bill. He was impressed by the simplicity of the Bill but he felt that certain issues needed clarification. Amongst those that he mentioned was how CGT would interface with estate duty, donations tax etc.
Another point of concern to Prof Katz was how institutions would have to adapt their systems software to accommodate CGT. He remarked that it is an issue that could easily be overlooked.
Prof Turok (ANC) asked whether CGT encourages equity in the different sectors of our economy.
Prof Katz stated that a speculative gain is already regarded as revenue. CGT would therefore not impact on the speculator but rather on the non-speculator coming into the sector.
Mr Andrew (DP) commented that Lithuania had scrapped CGT in December 2000. He was convinced that even though CGT could be justified philosophically and theoretically, its compliance could not be justified given the realities in SA at present. Mr Andrew pointed out that not enough attention was given to the relationship between capital gains and inflation. Especially the fluctuations that they experience over time. He strongly felt that CGT would serve as a disincentive to investors as opposed to it being an incentive to them. The fact that a taxpayer could offset capital losses against capital gains would still not make it advantageous to the average person making investments. He asked whether the cost of compliance had been thoroughly researched - specifically the cost implications to the private sector and smaller businesses.
Ms Maria Ramos stated that no evidence suggests that investment and savings would be adversely affected by CGT. Further there would be no real ‘appropriate time’ to apply CGT to SA. It has been in the pipeline for a while. Ms Ramos emphasised that SA has a fairly sophisticated economy and that we should have confidence in it. She encouraged stakeholders to view the system holistically in the spirit of equity and fairness.
Ms Ramos explained that CGT was never perceived to be a greater revenue generator but rather to curtail abuses currently taking place. The essence of CGT is to broaden the tax base and to decrease the rates of taxation. The impact of inflation on capital income is not only specific to CGT. She explained that they had introduced minimal indexation in relation to inflation.
Relating to the issue of investment, Ms Ramos briefly outlined some of the factors that investors look for in considering investing. Amongst those that she highlighted are certainty, fairness and the possibility of any obstacles being present that would burden them. In view of the aforementioned Ms Ramos stated that their aim is to bring SA tax system in line with international standards.
Mr Pravin Gordhan commented that for the past year they have researched the cost of compliance to different stakeholders. He however conceded that their research is incomplete but that it is ongoing.
Dr Koornhof (UDM) asked whether a cost-benefit analysis of the system as a whole has been done. He remarked that thus far much of the discussion only revolved around the administrative cost of CGT.
Ms Ramos replied that it would not be practical to do a cost-benefit analysis, as the list of variables to take into consideration may be endless. A few of the variables she referred to are avoidance measures, equity, fairness etc. Ms Ramos was also concerned that in doing a cost-benefit analysis one would be making value judgements.
Dr Koornhof relayed the concern of committee members to the presenters about how well CGT would interface with other spheres of our tax system and additionally whether the scheduled CGT implementation date of 1 April was overly ambitious.
Prof Katz assured the committee that appropriate measures would be put in place to facilitate the interfacing of CGT with other spheres of the tax system.
Ms Ramos stated that 1 April is only a proposed implementation date. She added that if additional time were needed to sort out the complexities of the Bill, the implementation date would be extended.
The Chair pointed out that SARS had included provisions relating to same-sex couples in the Bill but had omitted provisions relating to same-sex couples. She asked SARS to address the issue.
Ms Fubbs (ANC, Gauteng) asked whether a framework existed for value shifting. She stated that brief mention had been made on the issue of value shifting but that the discussion had stopped short of the direction that it was going to take.
Mr Kosie Louw (Department) stated that they would be clarifying them in detail later. He added that they do envisage including anti-avoidance rules in the Bill at a later time.
The meeting was adjourned.
STATEMENT BY THE MINISTER TO THE JOINT SITTING OF THE PORTFOLIO COMMITTEE ON FINANCE AND THE SELECT COMMITTEE ON FINANCE
I regret that I am unable to attend the joint sittings as I am taking part in a Cabinet Lekgotla this week. Nevertheless I wish to thank the committees for this opportunity for individuals and organisations to air their views on the proposed capital gains tax legislation.
The committees and Parliament have shown that they have a valuable role to play both in lighting the way for tax changes and in fine tuning proposals. Recent examples were the rationalisation of the income tax system for non-profit organisations and the switch to the residence based system of tax.
Turning to the question of why South Africa needs a capital gains tax, there are several answers. Perhaps the three most important are that the current tax exempt status of capital gains;
• Is fundamentally unfair to the ordinary salary or wage earner whose income is fully taxed;
• Encourages the wealthy and the corporate sector to engage in many and varied tax
avoidance schemes to convert what would otherwise be taxable income into untaxed
capital gains; and
• Distorts the economy by artificially enhancing the after tax returns of capital gains as opposed to other forms of income.
The design of the proposed capital gains tax system has been guided by international experience. Capital gains tax is alive and well in very many countries. While there may be moves to reduce the rates in certain of these countries, there is certainly no indication that capital gains tax will be abolished. However, there is a move to simplify certain aspects of the capital gains tax systems as is demonstrated by the move away from indexation in both Australia and the United Kingdom.
It is precisely for reasons of simplicity that indexation does not form part of the proposed capital gains tax system. However, the base costs of assets acquired before the valuation date are effectively indexed to the valuation date. This follows from the fact that assets may either be valued at that date or the total gain on the disposal of such assets may be reduced for the period held before the valuation date using the time apportionment option. Both these options effectively exclude the historically high inflation rates experienced in South Africa from the capital gains tax system. The low inclusion rates proposed then provide effective relief for the lower inflation rates projected into the future, without the complexity of indexation.
The design has also been guided by the submissions and industry discussions that followed the release of the Guide to Capital Gains Tax on 23 February last year. This has been a long process given the potential for capital gains tax to be an intricate tax that is difficult for taxpayers to comply with and for SARS to administer. The hearings by the committees will play a valuable role in taking this process forward.
One of the concerns coming through in the comments on the draft capital gains tax legislation is that business will not be ready to implement the tax on 1 April 2001. This is a concern that I can appreciate, especially when I reflect on the amount of effort that
SARS has put into gearing up for capital gains tax. However, many of the comments have been vague on what steps have been taken since 23 February 2000 to prepare for the implementation of capital gains tax, what remains to be done, and the projected timelines for doing it. I hope that these hearings will throw some light on these questions so that this issue may be considered fully.
Another concern that seems to be coming through is that capital gains tax is a wealth tax It is not. It is a tax on income that the wealthy are more likely to receive. This is not a theoretical distinction but is one that is both intuitively correct and recognised by international tax practitioners.
In conclusion, I wish the committees and participants well in the hearings that lie ahead and look forward to the constructive proposals that will flow from the hearings. Maria Ramos and Pravin Gordhan will represent me at the sitting on 23 January 2001 and will report back to me with your initial comments.