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FINANCE PORTFOLIO COMMITTEE
10 October 2000
REVENUE LAWS AMENDMENT BILL: PUBLIC HEARINGS
Documents Handed Out:
South African Federation of Civil Engineering Contractors - letter of 14/09/2000
South African Federation of Civil Engineering Contractors submission
South African Association of Consulting Engineers submission
Association of General Contractors of Southern Africa
South African Association of Mining Contracting Companies
South African Chamber of Business submission
National Treasury's Response to the Hearings - 10 October 2000
Minister Manuel's slide presentation - text outline only
SARS on Section 9D: Investment income of controlled foreign entities
Letter from the Non-Profit Partnership
Several organisations appeared before the Committee to express concerns with the Revenue Laws Amendment Bill. The South African Federation of Civil Engineers, the South African Association of Consulting Engineers, the Association of General Contractors for South Africa, and the South African Association of Mining Contracting Companies made submissions on the impact of the Bill on engineers and miners working internationally. It would result in major tax costs for companies trying to keep their workers at the same after-tax income, resulting in a loss of competitiveness. Through a variety of mechanisms, the Bill would result in unemployment, increased brain drain, and other negative consequences. As the Bill had no phase-in period, contracts entered into on the basis of the old legislation would become unworkable, with the companies affected having no recourse and suffering a major hit. These organisations proposed several changes to the Bill so that it would give better consideration to their industry, its role in South Africa's economy, and its role as part of the African Renaissance. The South African Chamber of Business expressed concerns that there had not been enough consultation on all of the unintended business impacts of the Bill.
Following this, the Minister of Finance appeared before the Committee to present the Treasury's response to the public hearings. Mr Manuel emphasised the principles of fairness between taxpayers and intersectoral neutrality and challenged the special pleadings of small groups of taxpayers. Several members challenged him, asking why he would not recognise the industries heard from this morning as a special case.
The South African Revenue Service briefly presented a document intended to help clarify some aspects of the legislation. Following this, a PricewaterhouseCoopers representative criticised the Ministry of Finance as lacking tax expertise. Mr Manuel, Mr Andrew, and the Chair rejected this insinuation. The meeting concluded with some brief discussion of process issues.
South African Federation of Civil Engineers
Mr Rohan Sheppard, tax adviser to the organisation, made the main presentation, accompanied by Mr Collin Mester, executive director. Mr Sheppard explained that the latest draft of the Bill still does not contain the clauses that would enable it to deal properly with the construction industry's special characteristics.
Mr Sheppard began by explaining the context of the construction industry, with South Africa's construction industry playing a major role in Sub-Saharan Africa. Indeed, South Africa is the only country in Africa outside Egypt that has established a solid skills base, and there is a need to ensure that this industry continues. Many projects in the region are funded by aid agencies, and many depend on special tax arrangements. The countries whose companies work in Africa are those with a more favourable tax treatment for their people.
There are two major concerns with the Bill's effect on the construction industry. First, Mr Sheppard explained by way of an example how, by taxing South African construction workers on projects abroad, it would increase costs to companies and make them uncompetitive for projects. Second, he noted that the tax legislation made no provision for extra costs on contracts coming up that had been entered under the current system. Without a phase-in period, construction companies would suffer an immediate and direct hit. There will be knock-on effects throughout the economy.
Mr Sheppard explained the case for special treatment for the construction industry as based on its need for an equal footing to maintain competitiveness and its mobile nature. He thought there should be exceptions for it as there were for seagoing staff. He asked for three specific changes in the wording of the legislation, which currently requires 183 days in a tax year of continuous residence abroad to avoid South African residency. The requirement of Section10(1)(o) that workers be abroad for a "continuous period" to escape taxation as South African residents was problematic for workers who might be generally abroad but want to see their families who remained behind. Second, the time of 183 days was to be in a tax year, but this had no relation to reality. Third, that 183 days is too long compared to other countries. The other issues he raised were the difficulty of defining fringe benefits in the context of workers abroad and the need for a transition period. Finally, he suggested a sparing clause for tax-free projects and a concern about the need to keep separate books in order to apply both South African law and the law of the foreign country.
Mr Sheppard summed up by stating that the industry is asking to be taxed in a manner that keeps it internationally competitive on a level playing field.
Prof Turok (ANC) stated that the presenter had made a very compelling case, especially in light of goals related to the African Renaissance. In one sense, he suggested that it amounted to saying that the fiscus should subsidise construction elsewhere in Africa. He asked the presenter to expand on the state of the industry as a whole in terms of finance, profitability, and the presence of fat. Mr Sheppard replied that work outside South Africa is not that profitable but that there is not much work within South Africa, especially from the civil engineering side. He stated that if the industry were confined solely to South Africa through non-competitiveness, it would collapse into one major company and a few smaller companies.
Mr Andrew (DP) stated that in the Committee's broader evaluation of taxes, it should be having a hearing with the Director General of Trade and Industry rather than relying on second-hand information about the views of Trade and Industry. The Chair indicated that she had not yet been able to speak to this Director General but that she had spoken to his secretary. The Chair indicated that she would be following this up and agreed on its importance.
Mr Nair (ANC) asked if the labour component constitutes a major part of the contractual price. Mr Sheppard replied that the primary impact of the tax changes would be on this salary component rather than through equipment prices but that there would still be an impact on equipment purchases because South African construction companies tend to source their equipment purchases in South Africa.
Mr Mofokeng (ANC) stated that these changes to the tax system were being proposed in order to protect the South African tax base after the changes that had been made to the exchange rate control system in 1997. He asked if the presenter's position amounted to a position that taxes are too high. After a lengthy pause for discussion with Mr Mester, Mr Sheppard replied that South African contractors bring foreign income back to South Africa so from a foreign exchange control perspective, the business has the impact of bringing foreign currency into the country.
Ms Joemat (ANC) asked how the presenter got a 60% increase in labour costs in his example, noting that this seemed a rather high rate of taxation. Mr Sheppard replied that applying a 40% tax rate to a salary of 160 gives a tax of 64. Thus, earning 160 and paying 40% tax means that one is left with 96. In order to get an after-tax income similar to the pre-tax income of 100, the new pre-tax income must be in the area of 160 to allow for the payment of a 40% tax. Thus, the effect is to increase the labour cost by 60%.
Ms Joemat asked for clarity on the concern about keeping separate books, stating that any company would keep separate books for its operations in each country to keep track of how its different branches are doing. Mr Sheppard replied that it is obvious that a company would keep separate books in each country. However, normally, books in Botswana would have to be appropriate only for Botswanan tax law. Now, the effect of the new taxation system would be that these books would have to be recomputed for different systems of taxation because they would also have to be used for South African tax law. The effect is that the company has to keep the same books twice.
Mr Andrew asked if it would be possible to have some figures on the size of the civil engineering industry, activity levels, turnover, employment, and domestic and foreign breakdown in order to see its magnitude along with relevant trends. Mr Sheppard replied that the association certainly had statistics for South Africa and could produce these quickly. He stated that information on off-shore activity would take more time, and might be more intuitive, but that he would see what he could put together.
South African Association of Consulting Engineers
Graham Pirie, Executive Director, briefly stated that South African engineers can teach the world a lot and that the legislation before the Committee will be quite detrimental and interfere with this task. He asked the Committee to take into consideration this industry as one that has special needs and that makes a special contribution toward South Africa and the African Renaissance.
The Chair invited Mr Pirie to expand on his views on the time lengths in the legislation. Mr Pirie replied that they are problematic because consulting staff go cross-border on projects and are a skilled resource that moves for short times. The Chair asked if most staff in the industry are on cross-border projects. Mr Pirie replied that they are. The Chair indicated that more detail on the organisation's position would be welcomed at a later stage.
Association of General Contractors for South Africa
Mr P Crowley, Chairperson of the Association, stated that the South African Federation of Civil Engineers had covered much of what he wished to cover. He indicated his organisation's strong support for the submission of that organisation.
Mr Crowley also provided some information in relation to Mr Andrew's request for statistical data: the size of the industry is around twenty billion Rand and the cross-border component is twenty to thirty percent of this.
Mr Crowley stated that the Committee must understand that construction is an export industry. To be competitive, it needs appropriate assistance. The present state of the industry is very serious, with South African contractors having to go outside South Africa to get work. However, internationally, there is strong competition, and the tax as proposed would make South Africa's industry uncompetitive. Contractors believe they are playing a major part in the African Renaissance and that they will be prevented from doing so under the legislation.
Mr Crowley stated that one of the biggest concerns is the hardship it will cause to individuals. A contractor working in Maputo will now have to spend 180 days away from his family or else face serious tax repercussions. The legislation will encourage them to base their families in a tax-efficient country outside South Africa, which is where they really want to be, thereby increasing the brain drain. Mr Crowley stated that a 91-day rule would make much more sense.
Mr Crowley stated that the industry is not looking for a subsidy but for a level playing field that will keep the South African construction industry from being handicapped. The industry wants to remain one of South Africa's major export industries.
Mr Leeuw (ANC) stated that South Africa usually negotiates double taxation agreements and asked to what extent these would prevent the problems described in the submission from arising. Mr Crowley responded that they would not give any relief at all and that they do not address this issue. The Chair invited officials from South African Revenue Services to comment on this point. An official from that body indicated that there are no double taxation agreements with many of the relevant countries and that they would not address the problems in any case.
An ANC member asked how soon South Africa will feel the impact if there is no relief for the construction industry. Mr Crowley responded that the legislation will have very serious effects. On contracts already in existence, there will be an immediate impact on construction companies. The lack of a phase-in period means that there will be an immediate loss and this lack is entirely inappropriate.
Mr Andrew asked how much better a 90 day rule would be compared to the 183 day rule and whether 90 "continuous days" would really be that much of an improvement. Mr Crowley replied that it would be preferable that they not be continuous but that reducing the time could still make an improvement.
The Chair asked South African Revenue Services to answer later what other categories of professionals, such as health care professionals, might also have temporary overseas contracts.
South African Association of Mining Contracting Companies
Mr George Parker, Managing Director of RUC International, explained that his association consists of major companies that undertake international mining work. Off-shore work is more profitable than local work, so the industry has to go for it. The association's main concern is with paragraph (o) in the amendment of section 10. Mr Parker asked why an international miner should not be in the same position as either a sailor or a miner who works at sea, for both of whom there is special recognition under the proposed legislation.
Mr Parker explained that the draft legislation will have a major impact on this industry. Given that it includes no phase-in period, it will have an undue effect on current contracts entered into under the old tax system.
Mr Parker explained that the draft legislation extends the definition of gross income to include "fringe benefits". Applying the South African concept of "fringe benefits" in the context of miners working internationally may work gross injustices, as the high cost of accommodation, food, laundry, medical, transport, and security services may seem to be a "fringe benefit" but actually simply reflects the needs of miners at inhospitable and remote locations.
Mr Parker explained that the new tax legislation will tend to force skilled South African mining expatriates to move out of South Africa. There will be adverse knock-on impacts throughout South Africa's economy.
In the absence of questions, the Chair commended the presenter on the clarity of his presentation.
South African Chamber of Business (SACOB)
Dr Wessels, Chair of the Cape Chamber of Commerce, spoke briefly to indicate SACOB's concern for the state of the economy, poverty, and unemployment. One of the major reasons for South Africa's economic problems is lack of investment. Over the 1990s, the real return on South African shares was around 8,5%, whereas on American shares it was 17,5%. This is the real reason that there has been a flood of capital to the United States. In this context, it is imperative that consideration be given to the economic consequences of the proposed legislation.
Mr Mering, Chair of the SACOB Parliamentary Liaison Office, made the main presentation. He began by noting strong support for the Committee's record in bringing taxation to public debate. However, in the middle of tax reform, the change to a residence-based system and the introduction of the capital gains tax are widely treated as faits accomplis. SACOB makes a strong plea for hearings on the capital gains tax and considers that it does not reflect international best practice, will not achieve the desired effects, and warrants great caution.
Turning to the matter at hand, Mr Mering stated that SACOB agrees with most of what has been said at the public hearings on the residence-based taxation system. Parliament must consider very seriously the unintended economic consequences of this shift. International headquarters in South Africa have a major role to play and are part of the African Renaissance. The contracting and mining industries are very important. Parliament must find a way for residence-based taxation to work for rather than against South Africa. There must be more debate.
Minister of Finance
The Chair indicated that time remained for an element not provided for in the agenda and that the Minister of Finance had a submission to make on the residence-based taxation system.
Mr Trevor Manuel, Minister of Finance, made the presentation personally. He began by quoting a Business Day report of September 18, which had described the change to residence-based taxation as "welcomed by experts as pragmatic, moderate, and less harsh than expected". For Mr Manuel, this quote stood in contrast to the representations at the hearings. The hearings reflected the reality that tax is like death in that everyone tries to avoid it.
Mr Manuel began by noting that he wanted to take issue with SACOB, which had misquoted him. Early in its written submission, SACOB had quoted him as saying that South Africa had experienced "a loss of skills". In reality, he had said only that South Africa had "low skills".
Turning to his presentation, Mr Manuel explained that he wanted to refer to two very important principles. First, the principle of fairness between taxpayers is related to the realisation that special treatment for some taxpayers always means higher taxes for others. This fairness principle has to be considered in every case. Second, intersectoral neutrality and efficiency are also key. There is a need to reduce artificial incentives for capital flight. The tax plan is not capricious but reflects a carefully developed strategy geared toward intersectoral neutrality and equality.
Mr Manuel stated that part of the process has been ample notice and very extensive consultation. But there is no point to consultations without draft legislation, so consultations now go on with a draft.
Mr Manuel indicated that he wished to address the matter of wealthy retirees. He stated that there has been a window in terms of sections 9(c) and 9(d) since 1997. The question is whether this should be reopened or whether the three years given to retirees to effect necessary adjustments is enough. Mr Manuel stated that the window must be closed in order to give effect to the policy announced in 1997 and thus promote certainty. The property market is robust. There should be no special incentives for this narrow group of taxpayers. Mr Manuel stated that the submissions presented at the hearings on 6 October had been based on nothing but anecdotes. They contained numbers with no empirical backing.
On the matter of the employment income exemption, Mr Manuel stated that the competitiveness argument had been overstated and that there is no evidence that employees will not take up part of the burden. He asked if we really want to provide incentives for highly skilled workers to leave our shores. And he spent some time explaining that emigration arguments have been overstated in that tax is not the only factor in whether individuals decide to emigrate. The Chair interjected that emigration was not the main argument here. Mr Manuel stated that the Chair was conflating the arguments. He repeated the principle that lower tax for some means higher tax for others.
On the corporate issue, Mr Manuel made some remarks about transactions between connected parties, stating that transfer pricing legislation is very difficult to enforce.
On the issue of headquarter companies, Mr Manuel stated that the OECD has studied these issues. There are very serious questions about the merit of trying to provide selective tax incentives. There are risks of falling afoul of trading partners' tax laws. This is a very complex issue. The Ministry is looking at it in conjunction with the South African Reserve Bank.
On the matter of STC credits, Mr Manuel stated that there is an attempt to simplify the system by exempting income taxed on a similar basis as in South Africa. There should be few instances where this applies, so this balances simplicity and fairness.
On the matter of assessed losses, Mr Manuel stated that the Ministry follows a "bird in the hand" principle. Again, with its relations to anti-abuse rules, this is a very complex matter. There is a need to avoid an erosion of the tax base. The matter is not so serious that companies will change their location based on this.
Mr Manuel began to close by thanking the Committee. He indicated that he wished to add a special pleading on behalf of the teams of professionals in the Treasury and Revenue branches - he found the suggestion that there was tax expertise everywhere but in government objectionable.
He also indicated briefly his perspective on hearings on the capital gains tax. He stated that this is in the Committee's domain. Questions of detail on the capital gains tax will be referred to the Committee. But there is no issue of whether we will have a capital gains tax. We will. There will be attempts to accommodate legitimate concerns on questions of detail, but we need to remember always that nobody likes to part with money. Mr Manuel noted that everyone wants to go to heaven, but nobody wants to die; everyone wants a bright future, but nobody wants to contribute.
Prof Turok (ANC) stated that there is sympathy on the ANC side of the House for the Minister's statement. Nobody wants South Africa to become a tax haven. South Africa is not trying to be New Jersey. However, he stated that he had two comments. First, he stated that he has several times asked for data on the burden on different income classes of taxpayers and that it would be a great help if he got it and if there were at some point some scientific analysis on this issue. Mr Manuel replied that this data is published annually in the Budget Review.
Second, Prof Turok (ANC) asked if Mr Manuel could give some sense of his answer to the evidence that had been presented on the engineering industry and whether it might be a special case. There were suggestions that it was part of South Africa's industrial base as well as part of South Africa's interaction with the rest of Africa, and he wondered if this might influence Mr Manuel at all.
Mr Manuel said that we have to go back to the principles of fairness and intersectoral neutrality. We must ask when engineering is engineering, as there are many similar industries. We must avoid granting a platform for too much special pleading or we will soon be unable to administer the legislation. It might be possible to engage with the industry on the short-term phase-in issue, but we must defer to the Commissioner of the South African Revenue Service.
Mr Pravin Gordhan, Commissioner of the South African Revenue Service, stated that there are concerns with providing any special principle because it can always function as a loophole for others or serve as an example for other industries to come and plead for special treatment as well. There needs to be an open dialogue on these issues, but the Chair was quite correct in her earlier observation that the hearings had been an effective "lobbying session". It is appropriate to hear concerns but without changing the main legislation.
The Chair stated that there is something of a problem in dealing with tax reform legislation in the Committee because the Committee has asked for but not received an overall picture of the tax reform programme. It is tough to look at the merits and demerits of tax incentives when there is no complete picture. The Committee hears now from the Minister of Finance that tax incentives impair the integrity of the tax system, but this same argument could be made about other tax incentives, so even the Minister must admit that there are sometimes special situations. She added that there is a serious need for a dialogue with Trade and Industry.
Mr Andrew indicated that he had a concern about the yardsticks with which we measure the tax system. There are half a dozen of these in tax theory, and almost any tax policy can be justified if we cherrypick our yardsticks. For the Minister to simply mention a couple of these yardsticks and then draw conclusions about tax policy is not sufficient, because all of these are a matter of degree.
Mr Andrew also stated that there seem to be two categories of issues before the Committee: fairly technical issues of fine-tuning; and concerns about broader implications and business effects. We strive for the best policy, but the best policy in theory or in First World application may not give the best outcomes. As a general rule, tax relief for some means others pay more tax. But part of the argument here was that if there is no relief for certain categories, there will be fewer jobs and less tax. Thus, with no relief, there might well be more tax for others.
At this point, the Chair allowed Mr Osman Mollagee of PricewaterhouseCoopers to speak in response to Mr Manuel. Mr Mollagee made very critical comments. He stated that the three-year window of which Mr Manuel had spoken did not exist and that people had not been warned appropriately of the impending change in the tax system. Despite what the Minister says, transfer pricing rules are and can be effective. There remain concerns on the international headquarters issue, although it is nice that it will be looked at. Mr Mollagee concluded that the Bill in front of the Committee remains testament to the fact that tax expertise does not exist in the Ministry of Finance. For all the Minister's comments on death and taxes, Mr Mollagee reiterated that there is a difference because death does not get worse every year. There was laughter at this.
Mr Manuel replied by attempting to make a joke that this depends if one is an undertaker or not; if one makes money out of death, it may not be a bad thing. Several members had noticeably puzzled looks on their faces. Mr Manuel stated that the Ministry has no blanket opposition to tax incentives but says that they must be carefully targeted. There is an appropriate apprehension about incentives for their own sake. There can be a litany of errors when countries are poorly advised. Mr Manuel indicated that he would thank the last speaker but added that he considered him to represent a duel between private sector tax experts and government.
Mr Andrew indicated that he wished to add that very many people giving evidence have complimented the South African Revenue Service on the quality of its work and that there has been collective recognition to this effect. The Chair stated that any notion that the Ministry had no tax expertise had not been reflected in the hearings before the Committee.
South African Revenue Service on Section 9D
Mr Louw of the South African Revenue Service stated that the presentation document breaks some items up into different categories and gives a better feel for certain sections to help people understand it. Two flowcharts in the document show simply how the section should be interpreted to apply to active income as opposed to passive income.
Prof Turok asked whether this document contains a substitution for the section in the draft Bill. Mr Louw answered that it is just explanatory and that the provision in the draft Bill remains the same.
The Chair stated that she still has a problem with a section that nobody can understand and that this raises issues of transparency. Mr Louw said that the explanatory memorandum will be expanded as well.
The Chair indicated that she wished to note one thing. Although the South African Revenue Service did engage in extensive consultations, the legislature is separate from the executive, and it is fully appropriate for people who spoke to the Revenue Service to present also to the Committee. This is a democratic right. Although she did not want to think that anybody was under any impression otherwise, she indicated that she did wish to clear the air given that there had been a statement that might have suggested otherwise.
There was some discussion of when the Committee would next meet, with discussion of various time constraints. The Committee agreed to hold a meeting that evening following on that afternoon's debates. This would be a work session largely to sort out processes, but the public was also welcome to return, as were the stakeholders who had made presentations before the Committee at this morning's meeting.