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FINANCE PORTFOLIO COMMITTEE
20 October 2005
DRAFT REVENUE LAWS AMENDMENT BILL: HEARINGS
Chairperson: Mr N Nene (ANC)
Documents handed out
South African Institute of Chartered Accounts: Consolidated Draft Revenue Laws Amendment Bill
Banking Association of South Africa: Written Submission
Banking Association of South Africa: Comment on the Revenue Laws Amendment Bill
South African Council of Churches submission
Non-profit Consortium submission
Draft Revenue Laws Amendment Bill
The Committee heard submissions from the South African Institute of Chartered Accountants, the Banking Association of South Africa, the Non-profit Consortium, PricewaterhouseCoopers and the South African Council of Churches on the Draft Revenue Laws Amendment Bill. All submissions contained significant recommendations on the substance of the Bill. The submissions by the Non-profit Consortium and the South African Council of Churches paid particular attention to the implications of the proposed amendments for public benefit organisations. Issues surrounding trade restrictions on public benefit organisations dominated much of their contributions. Members’ questions largely centred on points of clarity.
South African Institute of Chartered Accountants submission
The South African Institute of Chartered Accountants (SAICA) was represented by Ms J Arendse (SAICA Project Director: Tax) and Mr N Nalliah (SAICA Chairperson: National Tax Committee). Ms Arendse explained that the input for their submission came from the SAICA National Tax Committee, and focused the verbal submission on the following.
Transfer Duty Act No. 40 of 1949 Section 20 Clause 3
The SAICA proposed that the insertion of section 20(2)(b) under clause 3 on Tax Refunds be reviewed so that taxpayers who did not take part in legal action to overturn a practice generally prevailing, could also benefit from the determinations of the courts where such action was taken. This was to ensure that the taxpayers who did not have the necessary means to pursue legal recourse were not unjustly disadvantaged. In addition, since there was no time restriction within which the South African Revenue Services (SARS) had to recover funds owing to it from taxpayers, the SAICA saw the five year limit placed on tax refunds to be inequitable.
Income Tax Act No. 58 of 1962 Section 1 Clause 8(1)(b) and (c)
The SAICA proposed that the insertion of section 1(b) under clause 8 on the definition of "beneficiary" be reviewed so that the word "contingent" was replaced by the word "discretionary" for reasons of clarity.
The SAICA called the need for the separation of the definition of "beneficiary" from the definition of "connected person" into question. The amended definition was to apply only unless the context indicated otherwise. Yet, the context of provisions pertaining to the taxation of trusts (sections 25B and 7(5), and Part XII of the Eighth Schedule of the Income Tax Act), where the definition of "beneficiary" would have had applied, did in fact all indicate otherwise.
The SAICA queried the wording in the proposed definition of "dividend" in section 1(d) under clause 8, that referred to "...the market value of the asset as contemplated in paragraph 29 of the Eighth Schedule". The same wording was used in section 64B(5), which contained an exemption for Secondary Tax on Companies (STC). The objective was to align the wording in the two provisions. However, the wording in question had already brought substantial difficulty in the application of section 64B(5)(c), as it seemed to indicate that taxpayers were obliged to obtain a market value of their assets prior to 30 September 2004. This jarred with the Eighth Schedule, which fundamentally provided the taxpayer with the right to choose whether to use market value or another basis of valuation (e.g. time apportionment, base cost, or 20% of proceeds) in the valuation of an asset. Taxpayers were generally unaware of this obligation. Companies that did not obtain the evaluations timeously and since needed to liquidate were now liable for STC on the whole of their capital profit, instead of on the difference between the market value of their assets — as at 1 October 2004 — and the proceeds of their liquidation only.
The SAICA also asked whether the omission of the proviso regarding the definition of companies which became residents after 1 October 2001 from the proposed amendments was intentional.
Income Tax Act No. 58 of 1962 Section 1 Clause 8(1)(j)
The SAICA noted its concern over the ambiguity of terming "spot rate" to mean "...the appropriate quoted exchange rate at a specific time for the delivery of currency". Instead they proposed "...the quoted exchange rate at a specific time by any authorised dealer in foreign exchange for the delivery of currency".
Income Tax Act No. 58 of 1962 Section 1 Clause 8(2)(c)
Where a person had been resident in terms of the existing definition of residence, but not according to the new definition, such person was deemed to have disposed of all his or her assets for Capital Gains Tax (CGT) purposes. The SAICA felt that there was a need for amending paragraph twelve of the Eighth Schedule to exclude such a situation.
Income Tax Act No. 58 of 1962 Section 6
Prior to this amendment, the choice of business form for Public Benefit Organisations (PBOs) would not have been based on tax concerns. Should the amendment be executed, PBOs in the form of trusts would be taxed at a far more punitive rate than PBOs in the form of companies. A fixed rebate for both would be inequitable, as no reason existed for such discrimination. The SAICA suggested that a special tax rate for PBOs be introduced and applied regardless of what business form they chose.
Income Tax Act No. 58 of 1962 Section 6quat Clause 10
The SAICA noted with concern that per the amended section 6quat, South African taxpayers’ tax loss would be reduced by foreign income. Also, it would not allow taxes paid on the foreign income to be carried forward as a credit. This constituted a double penalty. The SAICA suggested that the necessary revisions be carried out to neutralise this situation.
Secondly, the requirement that a foreign tax credit may be allowed only where foreign tax was attributable to income that was from a non-South African source again would cause undue hardship. If the income was from a South African source, and the taxpayer had to pay foreign taxes on it, the income would be taxed in South Africa and no credit would be awarded for the foreign taxes. This was not in line with Government’s desire to support trade with Southern African Development Community (SADC) countries and the rest of Africa.
Income Tax Act No. 58 of 1962 Section 8B(3) Clause 13(1)(f)
If a taxpayer disposed of her or his right to dividends on shares, there needed to be a basis of allowing a deduction for part of the cost of the shares against the proceeds on the sale of the dividend income.
Income Tax Act No. 58 of 1962 Section 8C Clause 14
The SAICA suggested that the word "may" in "immediately before the taxpayer dies, if all the restrictions to that equity are or may be lifted..." be amended to read "will" in subparagraph (iv). The use of the word "may" implied that the restrictions to the equity could be lifted at the discretion of the executor of the taxpayer’s will. As long as this discretion was there, there would be tax, notwithstanding that the discretion may not be exercised in favour of the deceased employee. In other words, it could result that an artificial rather than a commercial gain may be taxed.
The gain or loss where the employee received an amount in cash to balance the exchange of instruments must be calculated by attributing a part of the consideration paid by the employee for the original instrument. The proposed amendments in paragraph 8C(4) made no reference to the basis of calculating the "consideration attributable to that payment". The SAICA suggested that this should be clarified to avoid uncertainty.
The SAICA urged the legislators to consider amending the definition of "restricted equity instrument" in paragraphs (h) to (k) of section 8C(7), as it presented an impediment to broad-based black economic empowerment (BBEE). This was so as shares distributed to employees that were historically disadvantaged individuals (HDIs) for the purposes of BBEE often came with the condition that the shares could only be sold to other HDIs. It meant that HDIs that came into equity in this manner would pay Income Tax on the benefit from those shares, rather than CGT as other investors did.
By the same token, it appeared that in terms of the insertion in paragraph (g) of section 8C(7), HDIs would pay Income Tax — as opposed to CGT — on further gains on shares subsequent to when the share option vested with them. The SAICA suggested that this also be amended.
Income Tax Act No. 58 of 1962 Section 9
The SAICA suggested that the "right to ownership" be defined for the sake of clarity, and that the envisioned eventualities be explained in the Explanatory Memorandum.
Noting the need for raising CGT on the sale of immovable property by non-residents in South Africa, the SAICA expressed the need for such laws to be enforceable. To this end it suggested the implementation of a permit structure.
Income Tax Act No. 58 of 1962 Section 9D Clause 16
Previously controlled foreign company (CFC) rules sought to attribute participation rights on the basis of voting rights. A subsequent amendment then eliminated voting rights in favour of equity interests alone. With the amendment in paragraph (a), voting rights would be reintroduced. Voting rights did not necessarily mean that a company was economically entitled to profits. The difficulty with this provision lay in that it proved difficult to tax residents on profits that they may never become entitled to.
With regards to paragraph (b), Mr Nalliah noted that the definition of the "foreign financial instrument holding company" in section 41 of the Act appeared to apply only to Part III of the Income Tax Act. In addition, if the definition of "prescribed portion" was to apply to section 9D, then the application of section 41 needed to be widened.
The practicalities of calculating a resident’s participation rights needed to be clarified in the proposed amendment contained in paragraph (c). The SAICA expressed its awareness of the complexities involved in drafting the legislation, but clarification — even if by way of an interpretation note by the SARS — had to take priority.
The SAICA pointed out that in some countries having more than 50% of the voting rights did not necessarily equate to effective control, as subsection (1A) of paragraph (d) sought to say. This needed to be revised to make allowance for the fact that, internationally, this requirement could be as high as 70%.
The SAICA also pointed out that it often happened that a company held preference shares, the dividends of which were in arrears. Such preference shares then carried a vote, which had to be excluded by legislation for taxing purposes as it did not arise normally.
With regards to the amended proviso (a) of subsection 6 in paragraph (h), Mr Nalliah noted the SAICAs concern and suggestions with regards to the confusion that emanated from between what constituted the "business establishment" and what constituted the "permanent establishment".
Income Tax Act No. 58 of 1962 Section 12C(4)(C) Clause 22 (h)
The SAICA questioned the necessity for sections 12C(4) and 11(e)(viii). Their purpose was to prevent companies selling assets at stepped-up values to one another so that the purchaser could claim greater wear and tear allowances, whilst deriving capital profit free of any taxation. Both these provisions were inserted prior to the introduction of CGT in 2001, which constituted a sufficient anti-avoidance measure to make the said provisions redundant.
Income Tax Act No. 58 of 1962 Section 18 Clause 27
In terms of the proposed amendments, section 18(1)(a) referred to medical aid contributions made by a taxpayer in respect of "him/herself, his/her spouse and any dependant of the taxpayer", whereas elsewhere it referred to "the taxpayer, his or her spouse or his or her children or stepchildren". The latter represented a much narrower scope and did not accord with the realities in South Africa. This also applied to paragraph 12(b) of the Seventh Schedule.
Finally, the SAICA stressed the need to constantly review the monetary caps imposed by the act.
Mr I Davidson (DA) asked the SAICA representatives for their views on the amendment of section 30 of Act 58 of 1962 contained in Clause 38 of the Revenue Laws Amendment Bill.
Ms Arendse referred Mr Davidson to paragraph 21 on page 15 of SAICA's written submission. She stated that there the trading rules for PBOs had been relaxed, and that this enjoyed the SAICA's support. However, the SAICA had found the limitations on the types of investments that a PBO may enter into problematic. Specific concerns included the prohibition of PBOs investing in private companies.
In response Mr Davidson indicated that he would like to hear the SAICA's view on the submission made by the South African Council of Churches (SACC) on this, and would welcome written feedback to this effect.
Mr K Moloto (ANC) asked for a clarification on what was meant by the "exercising" and "vesting" of share options. He also asked for further explanation on what was meant by the five year limitation on refunds in Clause 3 dealing with Section 20 of the Transfer Duty Act (No 40 of 1949).
Mr Nalliah explained that a shares option was the offer from a company to its employees to purchase shares at a fixed price. Normally, the fixed price would be equal to the share price at the date at which the option was granted. In addition, the option could only be exercised at the end of a fixed term, when the shares option vested. The SAICA was concerned that employees could be subject to income tax on gains from share options at the date that the options vested, and that CGT would be applied only to gains realised after the date on which options vested.
Ms Arendse said that in terms of the proposed amendments, the taxpayer forfeited the right to claim any refunds on transfer duty after five years from when the payment was made, while there was no similar limitation for government. The SAICA felt that this unjustly favoured the fiscus.
Banking Association of South Africa submission
Mr H Shaw (Consultant to the Banking Association) commended the National Treasury and the SARS for the way in which they had motivated for enhancements to the revenue law to achieve policy objectives. This was particularly so insofar it pertained to medical aid contribution allowances. He rated the financial assessment analysis of the various allowances and capping options as most persuasive. He stated that though sectarian interests informed the Banking Association’s submission, they were overshadowed by firm assessments of the financial benefits that would stem from achieving broader policy objectives. Hence, the Banking Association suggested that impact assessments became part of the explanatory memorandums to draft legislation in which policy objectives were sought. If adopted with the draft legislation at hand, the debate surrounding the stimulation of small businesses, the film production industry, PBOs and other policy-driven enhancements would have had benefited vastly.
Five principle issues underlay the Banking Association’s submission. In terms of equity, Mr Shaw said that taxation allowances were expanded in the Bill as an incentive to encourage social and economic development. Accelerated depreciation allowances, broad-based share ownership schemes, film production and PBOs were the main items introduced, or enhanced. Here, the Banking Association supported the limitation of medical allowances supported under the principle of progressive taxation. It was the impact assessment that prompted the question of whether the allowances should not altogether be dropped. If this was to be the case, the impact assessment suggested that vast amounts of funds could be made available for public health services. The Banking Association was concerned over the use of tax concessions, as it often facilitated arbitrage where unintended parties benefited from the allowances, or the allowances were abused. Instead, the Banking Association suggested the alternative of cost effective benefit grants.
In terms of the principle of Consistency, Mr Shaw made the following points. Where it was deemed appropriate to introduce or enhance allowances as suggested above, it became imperative that such incentives actually worked and were not negated by other restricted provisions of the Act. This was illustrated by existing restrictions on leasing allowances limiting the ability of small businesses to access the benefits of allowances intended. The Banking Association therefore supported accelerated allowances for small businesses, but only if it was accompanied by relaxing leasing restrictions. Restrictions on leasing would restrict the ability of small businesses to invest. Banks played an intermediary role and gave effect to policy decisions, but there were questions over whether the South African banking sector could furnish the necessary capital exchange to deal with the requirements of small business stimulation.
Where there was a stated desire to seek co-operation and convergence of taxation within the SADC region, the greater the number of allowances and exemptions, the more difficult it would become to achieve consistency in the other member countries. The taxation of share incentive schemes and estate duty taxation (farming versus other types of property) were two examples of differential tax treatment.
In terms of the principle of simplicity, Mr Shaw acknowledged the complexity of taxation and the amount of resources devoted to tax collection and administration. Foreign jurisdictions, particularly the USA and the UK, had moved towards greater convergence between tax and accounting treatment. This process had greatly reduced arbitrage opportunities, which could favour shareholders over the fiscus. The valuation, timing and taxation of employee share incentive schemes had proved complex to determine and administer. Accounting for share incentive schemes had been translated into international accounting standards. These standards had now been adopted in South Africa, and through the requirements of the Companies Act, would ultimately obtain the force of law. Companies had begun to account for the cost of share incentive schemes.
Convergence between accounting and taxation treatment of income and expenditure would greatly enhance South Africa’s reputation for certainty and simplicity in its fiscal regime. In this respect, the Banking Association suggested that a task group be formed and mandated to make recommendations within the framework of current legislation and international best practise to simplify the taxation of derivative transactions. Work of this nature would further facilitate not only international convergence, but also SADC convergence. The Banking Association urged the SARS and the National Treasury to consider selectively adopting generally accepted accounting practice, now becoming the international norm, as the basis for revenue and expenditure recognition. The precedent had been set in the Income Tax Act for such adoption, and sections of the Companies Act are expected to make generally accepted accounting practice mandatory. Wider adoption of generally accepted accounting practice could facilitate greater certainty in tax affairs and reduce regulatory arbitrage in the long run.
In terms of the principle of certainty, Mr Shaw stated that though it was not an absolute possibility, improvements of certainty in application and interpretation was possible. The clarification of Reportable Arrangement requirements and Advance Ruling implementation were but two illustrations. The Banking Association had continued concerns over the interpretation of the practical requirements of the Reportable Arrangements section in the Income Tax Act. The intention of this section was to identify financial arrangements that could give rise to excessive tax benefits. These requirements needed to be clarified. Varied interpretations that frustrated the reporting intentions had to be eliminated. Proposals were already before the SARS for consideration and discussion in this regard. For the interim, the Banking Association requested that penalty revisions for failing to report either be suspended, or that the Commission be empowered to remit additional charges and penalties.
Mr Moloto asked for a clarification of the issues facing PBOs in terms of the Banking Association’s submission.
Mr Shaw stated that there was differentiation of what PBOs could invest in or not. Part of these were that, either wilfully or inadvertently, PBOs could now compete with other taxpaying organisations by arbitraging off tax benefits.
Mr M van Dyk (DA) noted the comments in relation to Clause 30 of the Revenue Laws Amendment Bill on page six of the Banking Association’s written submission. He asked for an elaboration on the desired additions that would make the list of activities that did not qualify for deductions from income more complete. He asked this question in relation to the principle of denying deductions for bribes, penalties or fines.
Mr Shaw replied that the intention was to point out that the list of activities that did not qualify for deductions from income could vary, and therefore, so could the administration of the list. The appropriate punishment for crimes had also become an issue for debate. Mr Shaw stated that he questioned the necessity for the inclusion of this in the Income Tax Act, when the objective was merely to try and ascertain whether expenses reflected were incurred in the production of income, or not.
Non-profit Consortium submission
The Non-profit Consortium was represented by Ms T Brewis and Mr J Selakoanyane.
The Non-profit Consortium welcomed the proposed amendments to sections 6, 10(1)(cN) and 30(3)(iv)(b) to the extent that they separated the requirements for tax exemption from the regulation of the economic activities of PBOs. However, the minimum threshold of income generated from irregular activities for the exemption of income tax was now more narrowly determined.
The Non-profit Consortium focused their effort on the proposed amendments under section 10(1) clause 18 of the Income Tax Act 58 of 1962. It (The Non-profit Consortium) believed that the scope for PBOs to earn up to 15% of gross receipts from non-related business or trading activities tax free had to be retained. The percentage threshold was removed under the proposed amendments. Similarly, the monetary threshold of R25 000-00 on gross income had been converted to a rebate of R10 800-00 and a threshold on taxable income of R37 241-00. The Non-profit Consortium felt that it was contrary to the policy of promoting public benefit activities to tax the profit of PBOs.
Mr Selakoanyane stated that it was not obvious why the SARS wished to restrict PBOs from trading, through the proposed section 10(1)(cN), if the income derived was utilised to fund public benefit activities; and, if the trading activities had beneficial economic multiplication effects. To this end, the Non-profit Consortium also submitted that the words "carried out on a basis substantially the whole of which is directed towards the recovery of cost" should be omitted from section 10(1)(cN)(ii)(aa)(B) of the proposed amendments. This would then eliminate the problem of unfair competition with taxable entities that did not run on a substantially cost recovery basis.
Mr Selakoanyane pointed out that it would be more appropriate to refer to the "objective" or "objectives" of a PBO, rather than to its "sole objective" in subparagraph (ii) of section 10(1)(cN). Furthermore, the Non-profit Consortium wanted to see the words "integral and directly related to the sole object of the organisation" in section 10(1)(cN)(ii)(aa)(A) be changed to read "incidental to the objectives of that public benefit organisation", as it saw the proposed requirement as too demanding.
Mr Selakoanyane motivated for a uniform taxation rate for PBOs regardless of whether they took the form of charitable trusts, section 21 companies or voluntary associations. He also expressed the Non-profit Consortium’s disappointment over the fact that no amendments were proposed for section 30 that would provide for simpler registration procedures and reporting requirements for smaller PBOs on the one hand, and that would align the reporting requirements for PBOs with those prescribed in the Non-profit Organisations Act of 1997.
Mr N Nene (ANC) asked for a clarification on the nature of the amendments that were desired by the Non-profit Consortium for section 30.
Ms Brewis pointed out that the Non-profit Consortium’s proposals in this regard were contained in annexure A to their written submission.
Mr James Aitchison (Price Waterhouse Coopers Senior Tax Manager) conveyed the positive overall impressions held by Price Waterhouse Coopers (PWC) of the Revenue Laws Amendment Bill process. The only concern noted related to effective dates proposed in the amendments which were never made available in time for public commentary.
Income Tax Act No. 58 of 1962 Section 1 Clause 8
PWC proposed that the reduction to a 70% common ownership requirement be backdated to accommodate refund applications from companies that had sold off stakes of 26% to 30% in conformance with Government’s black economic empowerment (BEE) policy and thereby incurred a degrouping charge.
Income Tax Act No. 58 of 1962 Section 9 Clauses 15(b) and 75
PWC noted that non-residents were subject to South African CGT on disposals of their immovable property and interests in South Africa. Such interests would include companies where more than 80% of the value was attributable to immovable property in South Africa. However, PWC motivated that mining rights, though capital assets, be regarded as trading stock for the purposes of this CGT test. The justification for this was that mining rights devalued significantly as they were made use of.
Income Tax Act No. 58 of 1962 Section 9D Clauses 16(1)(a) & (b)
PWC recommended that a foreign company and its subsidiaries should not be regarded as CFCs in instances where, by reason of the de-minimus exception, no resident had any amount inputed.
Income Tax Act No. 58 of 1962 Section 41 Clauses 41(c) and (d)
PWC felt that the definitions of "domestic financial instrument holding company" (DFIHC) and "foreign financial instrument holding company" (FFIHC) needed to be relaxed so that any financial instrument where repayment of the principle amount of a loan, without any reduction or discharge, would give rise to neither a gain nor loss for tax purposes. Furthermore, the definition of FFIHCs needed to be extended and clarified to take cognisance of companies that dealt in multiple territories and not only in their countries of residence.
Income Tax Act No. 58 of 1962 Section 41 Clause 41(h)
With regards to the recovery of capital distributions in group transactions, PWC recommended that section 41(8)(a)(b)(ii) be restricted to instances other than section 45 transactions. The justification for this was that section 41(8)(a)(I) covered section 45 transactions such that any distributions would be included in the calculation of a subsequent disposal by the transferee.
Income Tax Act No. 58 of 1962 Section 45 Clause 45(h)
It was now possible to transfer shares in an influenced group company in terms of the relief offered in Part III of the Income Tax Act. As such, PWC submitted that the permissible transaction within a group of companies, whereby certain shares could be transferred, be extended to include the associated group of companies or influenced companies, rather than just the 70% holdings. This would then eliminate the anomaly that one was able to transfer a company holding a 20% holding, but not the 20% holding directly.
Income Tax Act No. 58 of 1962 Section 46 Clause 46(g)
PWC felt it inappropriate that the financial instrument holding company (FHIC) test be performed immediately after an unbundling transaction and not before it occurred. In addition, Mr Aitchison expressed PWCs desire to investigate the possibility of introducing unbundling relief by reference to the value of the company being unbundled to the relevant criteria.
Income Tax Act No. 58 of 1962 Paragraph 12 of the Eighth Schedule Clause 78(a)
PWC had a number of concerns surrounding undesirable CFC exit charges. Firstly, it thought it incongruous that legislation would provide an exemption in paragraph 64B of the Eighth Schedule, whilst applying a section in paragraph 12(2)(a) which imposed a potentially punitive tax. PWC further noted that the tax paying community was never notified of this move. It (PWC) submitted that to have deemed disposals taxable on residents holding a CFC could severely discourage the sale by residents holding such CFCs, notwithstanding the participation exemption in paragraph 64B. In this manner, currency inflows to South Africa from such transactions would be impacted upon.
Thirdly, it was noted that in the case of the disposal to a non-resident of a CFC with multiple tiers of companies beneath it, the probability existed that the total tax suffered by the South African resident could be well above the effective statutory rates. It could even exceed the proceeds of the sale. This was so due to the deemed disposal at each tier of the CFC.
Fourthly, a deemed disposal for South African purposes would not be a disposal in the foreign jurisdiction and so carried no underlying tax credit. As a result, the South African shareholder would face tax now, with the foreign company then only paying tax later on a subsequent real disposal, which would not be creditable.
In the international arena, the situation delineated above would render South Africa comparatively uncompetitive. Finally, a much greater degree of certainty was needed in terms of the interpretative positions adopted on the amendments contained in Clause 78(a).
Mr K Moloto asked for an indication on an appropriate period to which the application of the proposed reduction to a 70% common ownership requirement had to be backdated. He also sought clarity on the rationale behind the recommendation that mining rights be regarded as trading stock for CGT purposes.
Mr Aitchison indicated that a group of companies would often target a BEE partner for a specific part of its operations where it could add value. Where the BEE partner took more than a 25% stake, the original owners did not get tax rollover relief. As these issues only arose from 2001 onwards, the 70% common ownership requirement needed not to be applied further back than that.
Mr Aitchison explained that where an off-shore company wanted to sell off a South African-based company, and more than 80% of the value of that company was made up of immovable property in South Africa, then the off-shore owner would be liable for South African CGT. The recommendation that mining rights be regarded as trading stock for the CGT test in this regard was aimed at relaxing the requirements of the latter, since exploited mining rights had a much reduced value in real terms.
South African Council of Churches submission
The South African Council of Churches (SACC) was represented by Mr Doug Tilton (formerly from the SACC Parliamentary Office), Reverend Keith Vermeulen (SACC Parliamentary Office Director) and Doctor Ben du Toit (Dutch Reformed Church Information Officer). The SACC maintained a tax policy working group that included faith groups other than Christian.
In terms of trading restrictions for PBOs, Reverend Vermeulen noted that clauses 9, 18 and 38 of the Bill proposed amendments to sections 6, 10 and 30 of the Income Tax Act 58 of 1962. These changes proposed to affect the status of trading restrictions with respect to PBO founding documents; the potential for a PBO to engage in trading; and, the implications of trading for both a PBOs exempt status and tax liability. Currently, PBOs were required to incorporate within its constitution the trading restrictions that appeared in section 30 of Act 58 of 1962. Clause 38 of the Bill would delete most of these provisions, while clause 18 would reintroduce most of the provisions. In this position, the trading restrictions would no longer determine whether an organisation qualified as a PBO or not. Instead, limitations were only placed on the extent of a PBOs income tax exemption. It was therefore no longer necessary for the limitations to be reflected in a PBOs founding instrument. The SACC supported this revision.
In terms of taxation on trading income, Reverend Vermeulen stated that the revised configuration made for a more flexible system of partial taxation. The SACC also applauded the proposed amendments to sections 6, 10(1)(cN) and 30(3)(iv)(b) to the extent that they separated the requirements for tax exemption from the regulation of economic activities of PBOs.
Reverend Vermeulen indicated that the introduction of a partial taxation system also helped to resolve the issue of the relationship amongst the various types of permitted income from trading. Originally, the SARS ruled that PBOs may engage in three categories of trading. These were currently identified in section 30 of the Income Tax Act as directly related trading; trading of an occasional nature conducted by volunteers; and, activities explicitly permitted by the Minister of Finance. These three could be concurrently applied.
In addition, the de-minimus clause in section 30(3) allowed PBOs to earn the greater of up to 15% of its gross annual receipts, or R25 000-00 from unrelated trading without jeopardising its tax exempt status. However, in voting this clause was deemed to preclude the possibility of earning income in any of the other categories. In 2004 the SARS made an administrative concession that effectively allowed the de-minimus clause to be invoked in conjunction with income from the other categories of permitted trading, but only if a reduced concession of 5% of gross annual receipts in terms of unrelated trading was applied.
The amendments now being proposed provided a much clearer and more elegant solution to the problem. A PBO's receipts and accruals would be exempt from income tax only to the extent that it had not derived from any business undertaking or trading activity. Where it did derive from business or trading, receipts and accruals would be exempt from income tax only to the extent that it fell into one of the three specific categories currently defined in section 30. All other income from trading was liable to be taxed subject to certain exclusions.
The de-minimus clause was one such exclusion. Although most of the trading restrictions in section 30 were simply relocated within the Income Tax Act, the existing de-minimus clause would fall away all together. Instead section 9 of the Bill would introduce a general tax rebate of R10 800-00, which was equal to the rebate granted to individuals aged 65 and older. Assuming a tax rebate of 29%, this effectively meant that a PBO would be able to earn up to R37 200-00 in income from unrelated trading in any given year without being liable to pay tax. It also needed to be noted that where the existing de-minimus clause applied to gross receipts, the calculation of tax would be calculated on taxable income. For some organisations this change could be advantageous. They would no longer face loss of their exempt status if they were successful in exploring more commercial fundraising strategies. At the same time the income basis of the taxation may help to reduce their tax liability.
Two types of organisations were most likely to be adversely affected by this change. Firstly, larger PBOs and groups that were registered as single entities in terms of the Income Tax Act section 30(3)(a) would have to earn much less than 0.2% of their income from unrelated trading before they became liable for tax. The use of the individual tax basis for the PBO rebate did thus not serve public interests, as it discouraged PBO growth.
Secondly, collections of PBOs — faith based PBOs in particular — registered as a group, would only be entitled to a single rebate while a collection of similar bodies that registered independently would enjoy multiple rebates. PBOs were therefore incentivised to register in as decentralised a manner as was possible. This was likely to increase the administrative burden on the SARS and the PBO sector alike. Indeed, section 38(1)(e) would introduce a provision compelling any group member that earned taxable income to withdraw from the group and register independently if the rest of the group wished to retain PBO status. These changes harboured difficulty for faith communities, as their institutional structure, governance and constituent relationships had to be shaped by their beliefs and not by tax considerations. It would also disadvantage faith groups that were not sufficiently decentralised over faith groups who were.
The SACC proposed that section 38(1)(e) be deleted and that a variable tax rebate be introduced that took the size of PBOs into account.
More general concerns about the impact of the trading restrictions on PBOs related to international best practise. Research on non-profit sectors stressed the diversification of funding sources and the exploration of relevant commercial and marketing options to promote long term organisational sustainability. While the SACC appreciated that commercial activities must not be allowed to eclipse the PBOs primary focus, it (the SACC) would like to see a legal and regulatory environment that enabled PBOs to try out innovative fundraising strategies. To the extent that the SARS hoped to prevent profit-seeking businesses from avoiding taxes by masquerading as exempt PBOs, the SACC submitted that there were sufficient safeguards built into section 30 of the Income Tax Act. The SACC was of the opinion that the SARS's caution seemed to be motivated primarily by the concern that PBOs would gain competitive advantage over profit-seeking businesses. This understanding was at odds with the values that underpinned the notion of PBO tax exemptions. The SACC felt that the role PBOs played in society was all the justification needed for them to be advantaged over profit-seeking organisations when it came to trade.
The SACC accepted that it might be impractical to abandon all trading restrictions on PBOs, but did envisage that the categories of permitted trading could be broadened. If the Government was reluctant to relax restrictions in a general way by increasing the taxation threshold, or the de-minimus rule, the SACC would urge the introduction of new categories of permitted trading. PBOs would then still be required to devote any income generated to public benefit activities, so there would be limited scope for abusing a more lenient tax regime. The SACC had already made several proposals in this regard.
In particular, the SACC urged the Committee to consider designating income accruing to a dwelling owned by a religious community for the purpose of housing a religious leader that officiated at a place of public worship, but which was not being used for that purpose for a period of time, as permitted trading. If an individual congregation was recognised as a PBO, the income earned was likely to be near or below the effective tax threshold proposed for PBOs. If a more centralised denomination was required to aggregate this trading income from a few dozen of its member congregations, then their tax liability would become quite substantial.
Section 16 of the Income Tax Act allowed donors to deduct contributions for certain public benefit activities from their gross income before calculating tax. Currently, the donor became liable for the tax from such a donation if it was not used for the designated activity. Clause 28 of the Bill would place the responsibility on the receiving PBO to ensure that the funds were properly spent, or to pay the relevant tax on the misspent funds. In addition, clause 58 of the Bill would introduce criminal penalties for fiduciary officers of a PBO who intentionally failed to comply with the provisions of the Income Tax Act. The SACC believed it was more appropriate and practical to place the onus of compliance on the PBO rather than on the donor.
In terms of investment liabilities, the SACC noted that clause 38 of the draft amendments altered section 30 of the Income Tax Act to limit the range of financial institutions in which a PBO could invest. An earlier draft of the legislation proposed to limit the range of institutions approved for investment by PBOs much more severely. In response to submissions received by the SARS these restrictions had been reconsidered. The current formulation was much less constrictive and more appropriate to the circumstances.
Clause 88 of the Bill would limit a PBOs exemption from CGT to capital gains accruing from the sale of assets used exclusively to carry out public benefit activities. The SACC believed that this was consistent with the logic of the partial taxation policy reflected in the Bill. However, the SACC was concerned about the potential impact where property was used for more than one purpose, whether simultaneously or consecutively. The SACC proposed that the test be primary use, rather than exclusive use of the property.
Mr Moloto complimented the SACC on the substance of their submission.
The meeting was adjourned.
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