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FINANCE PORTFOLIO COMMITTEE
6 October 2000
REVENUE AMENDMENT LAWS: PUBLIC HEARINGS
Scientific Committee of South African Fiscal Association
South African Institute of Chartered Accountants
Chairperson: Ms B A Hogan
The committee was briefed by Pricewaterhouse Coopers on the impact of the resident-based taxation system on the South African economy. The presenters gave a detailed illustration on how the proposed rules would affect the various facets of our economy. A point of major concern to the presenters was the lack of consultation with the public. They felt that public participation had been minimal and recommended that there should be an extension of the time period for consultation as the proposed rules are highly complex. Tying in with the issue of time, committee members including the Chair felt that they were rushing things a bit. The Chair stated that many of the departments that would be affected by the proposed legislation had not even consulted with each other or the committee on some of the issues. She therefore felt that they should not get ahead of themselves in trying to pass legislation that is not of the required quality.
The Scientific Committee of South African Fiscal Research and the South African Institute of Chartered Accountants (SAICA) leveled some criticism against the draft laws. They also made a few alternative suggestions.
In response, SARS emphasised that that the reason for the shift to residence based taxation was to make the South African tax system more internationally competitive. SARS accepted a few suggestions which were made by presenters. These suggestions include:
- drafting a document which summarises how the rules around the definition of resident have been built up.
- SARS will elaborate on the objective time-based rule by stipulating that the first day and the last day must be counted in.
- The way section 6 quat is currently drafted gives it the meaning that an individual resident who holds less than 10% of shares in a foreign entity (but together with connected persons owns more than 10%) is not entitled to a credit because the resident holds less than 10%. SARS is going to redraft this to clarify the position.
Mr Osman Mollagee assisted by Mr David Lerner made the presentation to the Committee. The issue at hand was the proposed switch over from a source-based form of taxation to a residence-based form of taxation. Mr Mollagee however stated that his presentation would not be focussing on which of the two systems is best, rather he would highlight how the proposed legislation would affect the economy of South Africa. Mr Mollagee pointed out that in implementing a residence-based form of taxation one must ensue that the proper exceptions are in place.
Mr Mollagee admitted that the proposed legislation is pragmatic but had major concerns over certain issues that would impede economic growth in South Africa. He felt that the concerns were extremely valid, as economic growth is the biggest tax generator in South Africa.
Mr Mollagee stated that he would firstly want to deal with the issue of lack of consultation with the public before dealing with how certain portions of the proposed legislation would impede economic growth. He felt that there should be an extension of the time period for consultation as the proposed rules are very complex. He added that at the end of the day all interested groups would want the legislation to be appropriate. Mr Mollagee said that at present the time period does not allow for public participation. He feels that there must be a sustained period of public debate. Mr Mollagee acknowledged that there has been great participation with the South African Revenue Services (SARS) over the proposed legislation but he felt that the period within which to review SARS recommendations is too short. He therefore implored the committee to see to it that the proposed legislation is properly scrutinised by the public.
Mr Mollagee then proceeded with his presentation on the economic implications of the proposed legislation on our economy. His discussion was split into four categories:
the rules could result in adverse economic implications for South Africa (from an inward investment perspective)
the rules could result in adverse economic implications for South Africa (from a promotion-of-exports, outward investment, and 'African Renaissance' perspective);
the rules are harsher than those of other jurisdictions - the United Kingdom or the United States of America has generally been used as a benchmark for this purpose;
the legislation results in anomalous situations or does not cater for certain scenarios.
[For detail on the issues raised and recommendations made, refer to the attached document.]
The Chair asked SARS if they wished to respond. Mr Kosie Louw (General Manager: Law Administration, SARS) stated that they would want to respond at the end of all the submissions. Mr Andrew (DP) said that SARS should respond to the submissions in the presence of the presenters in order for discussions to be meaningful. The Chair agreed to SARS giving their responses after all the submissions had been made.
Mr Andrew stated that South Africa wants individuals to bring in foreign income but what Pricewaterhouse is suggesting, is taxing these foreigners on their foreign income. He said that this would not encourage foreigners to come to South Africa.
Mr Lerner explained that what they are suggesting is only taxing the income or assets acquired after becoming resident in South Africa and exempting those acquired prior to residency. Mr Mollagee added that they are trying to find a middle ground between equity and exemptions.
Prof Turok (ANC) asked SARS if they have had discussions with the Department of Trade and Industry on the issue of incentives. He also asked the presenters whether it is possible to exempt flow-throughs and whether they make a substantial contribution to tax income.
Mr Mollagee replied that vasts amounts of tax income could be generated by allowing flow-throughs. He stated that countries like Belgium and the Netherlands are thriving on these. Mr Mollagee emphasised that large amounts of peripheral income could be generated in this way.
SARS stated that they have had discussions with the Department of Trade and Industry. They stated that they are using infrastructural models to deal with the issue of incentives. The Department felt that a coherent network must be implemented to ensure attracting foreign investment. The point was made that you cannot make tax policy by providing for a whole range of tax incentives. He felt that it is better to broaden the tax base than to have a whole list of tax incentives.
The Chair said that what the committee wants to know is whether the Department of Trade and Industry is satisfied with the proposed legislation. She however did not wait for SARS to respond, as she stated it is unfair to pose this question to them since they had not yet communicated with the Department of Trade and Industry. The Chair rather proposed that the Department of Trade and Industry make a briefing to the committee on how the proposed legislation affects them. Mr Turok agreed with the Chair.
Mr Nene (ANC) asked SARS to react to Pricewaterhouse's concern over the lack of consultation with the public. He also asked the presenters as to how one distinguishes between private visits and business visits by SA nationals working abroad.
Mr Louw (SARS) stated that they had tried to consult as widely as possible. He explained that they are also being pushed for time as they also have deadlines to meet.
The Chair interjected that it was actually the Department who had set up the timeframe for the period of consultation. The Chair stated that she also has concerns over the time frame.
In terms of distinguishing between private and business visits by SA nationals working abroad, Mr Lerner answered that you need to look at what is incidental. He felt that you have to look at whether the person has come back to South Africa for a holiday or for a business meeting. What is crucial is identifying whether it is incidental or not.
Mr Andrew complimented SARS on their efforts but added that he did feel that at a time when South Africa wants to increase foreign investment, the committee should not implement legislation which is ambiguous. Mr Andrew stressed that the committee should not put legislation in place in haste. He felt that they should take their time, as leaving the existing legislation in place would not cripple the country economically. The Chair agreed with him and stated that the committee must ensure that the quality of the legislation be appropriate.
Dr Koornhof (UDM) asked the presenters what sort of time period were they thinking of for consultation.
Mr Lerner stated that his major concern is the public. He feels that the public must be given the opportunity to make inputs and in order for this to happen more time is needed. Mr Lerner made a general comment that the resident-based system of taxation might have been successful in countries like the UK and the USA but this does not mean that it is the best system for South Africa. He stated that it must be remembered that these countries are First World countries and that South Africa is a Third World country.
Mr Lerner stressed that the needs and capabilities of these countries and South Africa are vastly different. The point he was trying to make was that South Africa should not be in a hurry to adopt the proposed legislation without checking on its viability first.
Scientific Committee of South African Fiscal Research
Mr Marius van Blerck, Chairman of the Scientific Committee of South African Fiscal Research made the presentation. Mr van Blerck made various suggestions:
- in respect of offshore costs the measures which limit the deductibility of foreign costs to foreign income should not apply on a company by company basis. It should rather apply in the aggregate.
- the requirement that the individual be absent from SA for a ''continuous'' period of 183 days a year during the year of assessment should rather refer to an ''aggregate'' period or provision should be made for allowing intervening presences.
- the foreign tax credit should continue to apply against STC (secondary tax on companies).
- reserves that accumulated in the period to February 23, 2000 should be able to be repatriated to SA at any time without a tax charge. This should be subject to an external audit certificate verifying the quantum of the reserves at that date.
South African Institute of Chartered Accountants (SAICA)
Mr Groome of SAICA made the presentation. Some comments made were:
- the Bill refers to a person ''ordinarily resident'' in SA. SARS must clarify this term to eliminate uncertainty. Other countries for example have issued information brochures to taxpayers. They urged SARS to issue a detailed explanation of the meaning it will attach to the term.
- reference is also made to ''place of effective management''. They urged SARS to expand on the meaning of this term.
- the current wording of section 6quat has the effect that a resident who owns less than 10% (but together with connected persons owns more than 10%) will not be entitled to a credit.
- Section 9D(9) grants the Minister the discretion to treat one or more foreign countries as one (subject to certain circumstances). SAICA argued that this creates uncertainty for taxpayers. It also removes parliamentary oversight. Thus they do not support this provision.
The Chairperson tried to ascertain whether they were asking for the definition of resident to go further than the time definition.
Reply: No. They want a definition of ordinary resident (as it is used in phase 1 of the new test - the subjective part of the definition). Case law should be enshrined in statute in such a way that it is clear what ''wanderings'' as it is referred to in case law means.
Mr Andrew (DP) asked in which era this court decision was made as the words sounded rather archaic.
Reply: The most recent decision was in 1991. It has an old origin but in 1991 it was revisited in the Patel case.
The Chairperson referred to the clause which stipulates an absence of 91days in each year for each of four years or an average of 183 days. She said that according to her calculations 91 days per year added up to 273 days. Mr Feinstein (ANC) added that many members of the ANC tried to calculate this and everyone came up with a different answer.
Reply: Mr Louw (of SARS) said that 183 referred to an average number of days and not a total number of days.
The Chairperson said that she did not understand why it was necessary to include an average in the clause at all.
Professor Turok commented that the Committee should ask the Treasury to visit the Committee at some time and lead them in a discussion as to whether SA is a favourable place for multinationals to come and invest.
SARS response to the comments
Mr Kosie Louw of SARS gave a general response to themes which arose in the submissions. He made the following comments:
SARS introduced the legislation:
- to make the South African tax system more internationally competitive.
- It is an internationally accepted standard.
- It takes care of such problems as those around e-commerce.
- There are currently diversionary transactions where income is diverted to low tax countries. This causes the South African tax base to suffer. The proposals address this problem.
The idea with residence based taxation is to pull all foreign income into the SA taxbase and then take out what should not be in there by means of the exemptions. Exemptions have been applied to countries with acceptable tax rates (like the UK and the US). These have similar tax rates to SA therefore they are out of the system.
Where a company operates in a country with a lower tax rate than 27% and it is operating as a subsidiary (and not a branch) and is a proper business establishment (not a fly-by-night operation) then SARS will not impute the income immediately. They will tax it on a deferral basis. Thus the income will only be taxed when it is remitted to SA.
Section 9D sets out the rules to deal with avoidance in the case where there is a diversion of income to a low tax country. If the requisite circumstances are present then SARS will not divert the income, they will impute it immediately.
Where income is taxed, provision is made to allow for a foreign tax credit. Thus a large percentage of income is not in the SA tax net. Hence only companies in low tax jurisdictions and diversionary transactions are taxed.
SARS have elaborated the definition of resident by adding a time-based rule (objective test) to the existing subjective test. Mr Louw said that there was a good suggestion from one of the presenters that SARS summarise how the rules around this have been built up. In this way people do not have to go and read up on it.
They can also elaborate on the objective time-based rule by stipulating that the first day and the last day for example must be counted in. SARS will clarify this.
SARS disagrees with the contention that they are taxing retroactively. They are taxing from a current date onward.
There has been some criticism around the credit provisions in Section 6 quat. Some say that the foreign tax credit should continue to apply against STC (secondary tax on companies). SARS has made a trade off between simplifying the provisions and relaxing the provisions. They do not allow the tax to be set off against STC but they have extended the carry forward period from 3 years to 7 years. They are also allowing onshore mixing.
Operations in high tax countries are out of the system. Thus it is unlikely that income which was taxed at a higher rate than in SA will be taxed again in SA. SARS believes that they have made a fair trade-off.
SARS will accept the SAICA suggestion on the 10% rule between connected persons. They will build this into the legislation. The way Section 6 quat is currently drafted the individual resident who holds less than 10% (but together with connected persons owns more than 10%) is not entitled to a credit because the holding is less than 10%.
Section 9D (Controlled Foreign Entities) contains diversionary rules to deal with diversionary transactions. There are 2 types of diversionary rules:
- one based on the general transfer pricing rule, and
- provisions targeting high risk transactions.
SARS tried to soften the rules with the discretions given to the Minister. However SAICA criticised this amendment on the grounds that the discretion given to the Minister removes parliamentary oversight.
In respect of one of the exemptions SARS accepts SAICA's suggestion relating to the foreign civil service. In this regard they will stick to the old definition of ordinary resident and not the new one.
In respect of offshore work Mr Louw said that there was a possibility to soften the requirements in respect of absence. Under certain circumstances they could build in a de minimus rule to deal with incidental returns.
The decision to tax foreigners on passive income was decided three years ago. They have already allowed a grace period. From 1March this year all SA residents will be taxed on their worldwide income (although the second objective time rule does not apply). If they continue with a concession like this, then foreigners will get a better dispensation than local residents. If they tax a foreigner then they will allow a tax credit for foreign jurisdictions.
There has been no contention on the three year grace period for taxing foreign pensions. There could be more clarity on the definition of ''social security system''. It will entail a social security system based on laws of that particular country.
Controlled Foreign Entities are to be taxed in their own right because they are separate legislative entities. Therefore losses should be ringfenced. It is common international practice. SARS concern is the impact that not ringfencing losses can have on the existing taxbase. They do not know what the impact will be. Therefore SARS will ringfence foreign losses in terms of CFEs and branches.
Mr Louw said that SARS would make a full report on their responses to all the submissions. It will be made available to the Committee on Tuesday. The Treasury will also make such a report available.
In conclusion the Chairperson commented that in light of the tight processes it is unlikely that the Bill will be tabled on 30 October.
The meeting was adjourned.