Revenue Laws Amendment Draft Bill: hearings

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Finance Standing Committee

14 June 2001
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Meeting report

FINANCE PORTFOLIO COMMITTEE

FINANCE PORTFOLIO COMMITTEE
15 June 2001
REVENUE LAWS AMENDMENT DRAFT BILL: PUBLIC HEARINGS

Chairperson: Ms B Hogan

Relevant documents:
Revenue Laws Amendment Draft Bill, 2001
Explanatory Memorandum on the Revenue Laws Amendment Bill, 2001
12G. Additional industrial investment allowance in respect of industrial assets used for qualifying strategic industrial projects + Regulations under section 12G(7)

SUMMARY
The economist, Professor Brian Kantor of the University of Cape Town, the Cosmetics, Toiletries and Fragrances Association of SA and Revlon SA made presentations to the committee. Prof Kantor greatly favoured a free market economy with limited government intervention. The emphasis being on open competition so as to encourage foreign investment. He did not support strategic intervention by government except if it was across the board in the form of lowered effective corporate tax rates.

The Cosmetics, Toiletries and Fragrances Association and Revlon SA raised concerns over the disparities that exist in the ad valorem excise duty on materials for locally produced goods and that on fully finished imported goods. The latter being much lower than the former. This would impact on local manufacturing and jobs in that sector. National Treasury justification for the proposed amendment did not allieviate the Committee’s concern about the impact of this amendment. Another point of contention was the categories of goods regarded as luxury goods. The Committee agreed that the process for classifying luxury goods was not clear-cut.

MINUTES
Prof Brian Kantor
Called in at short notice, Prof Kantor said he was pleased to provided input on the Bill but reminded the Committee that he was not a tax expert but a "big picture" person, an economist. He has an interest in the progress of the South African economy and the strategies appropriate for that progress. He noted that he is an optimist about South Africa and believes it has done many things that are very helpful for this. He felt that SA is still to see the full rewards of its policy positions that are very encouraging to investment generally. His approach would be to see policies that encourage investment generally rather than interventions by government in the investment process. He is not a big believer in industrial strategy by government. Instead he sees winners coming out of competition in the open market place for capital.

He does not like policies of this kind. However he conceded that the scale of this intervention is a limited one. It is not going to be the most important thing that will influence investment spending.

The strategic industrial policy of 100% investment allowances is not unusual as the mining and agricultural sector have always qualified for the 100% investment allowance. It is only in the manufacturing and distribution sectors that there is the policy of depreciation (less and a 100%). The appropriate amount of allowance for investment according to economic theory is the equivalent of its economic depreciation. You are not interfering in the investment decision but merely providing an allowance to cover the economic depreciation – the wear and tear in the economic life of the capital investment as a tax expense. The 100% investment allowance is more than the economic depreciation or the capital consumption incurred.

Prof Kantor has noticed a very satisfactory pick-up in gross fixed capital formation investment spending in SA. The Reserve Bank Governor has referred to the buoyancy of investment spending because of favourable policies. In all countries, investment expenditure tends to be financed from internally generated cash flows of business enterprises. 60 to 80% of investment spending comes from established businesses that plough back their profits and cash flows into expansion of their capacity. In SA there is a surge in the profitability across the economy particularly in the mining sector and investment spending is picking up. Most of the weakness in investment spending in SA in the past was due to international forces weakening SA resource prices (platinum, gold, diamonds, coal, and iron ore). SA is a specialist resource producer and resource prices dropped. The slow growth between 1995 and 1998 was not due to particularly South African factors but rather explained by unhelpful international factors – the emerging market crisis and weakness in resource prices. These prices are picking up on international markets (platinum, diamonds, coal, and iron ore) and with that investment spending is picking up.

His tendency would be to minimise the sense that SA has a crisis of confidence or a fundamental failure to invest. Investment is picking up and the encouragements to invest are in place: freedoms to run businesses, invest, attract foreign companies and generally competitive corporate tax rates. Large multi-national corporates are rather mobile tax payers and escape taxation through concessions/inducements of this kind.

However, Prof Kantor said that the devil in the detail of which there is a lot. Applying these measures is going to put a huge administrative burden on the Department of Trade and Industry because the judgements and measurements that will have to be undertaken are formidable. He wondered if SA has the capacity to do this and he foresaw a boon to the consulting industry. It also requires a continuous monitoring to ensure that companies are playing by the book as failure to comply imposes penalties. However he conceded that the scale is not huge and thus it could be seen as an experiment that DTI wishes to undertake with industrial strategy. He repeated that one should not underestimate the administrative demands and the quality of supervision and decision-making required.

He illustrated the complexity of the administration by looking at the measurement demands of subsection 4a. Treatment as a strategic industrial project occurs only if the expected loss in production for other SA businesses in that sector do not exceed 40% of the production expected from the industrial project. Prof Kantor said that the fact that new projects might compete with established industries is a concern. He wondered how was the figure of 40% arrived at. Why is 40% an acceptable loss? How does one measure expected loss in production and isolate that from other factors affecting it’s profitably. What about claims, if it exceeds 40%.

He gave another example of subsection 7.2 where the ways to measure the requirements. Again it will involve high level and continuous engagement. Further he asked how one confidently determines the long-term commercial viability required by 12(g).

Finally once the industry is in place, how is one going to be able to close the strategy down when in fact removing the concessions might mean life or death for that particular sector.

Prof Kantor repeated that the devil is in the detail. However this is an initiative of DTI that must believe that there are industrial development projects that they can initiate this way and these concessions will make a difference for. However it is a dangerous path to follow. It is fraught with difficulty. He would not personally wish to recommend this.

Discussion
Mr Andrew (DP) asked for examples of other countries that have had success with this policy and at what cost.

Prof Kantor said that he could not think of a success or a failure. Industrial strategies especially for less developed regions were popular in the Fifties and Sixties but they did not have a conspicuous success. Costs include lost revenue, plus when you introduce systems like this, one cannot easily measure the change of response to these opportunities by ordinary business as opposed to other opportunities.

Prof Engel then asked what route would Prof Kantor take, being mindful of the long-term viability and lost revenue issues.

Prof Kantor replied that he would do nothing except perhaps offer general incentives that would treat potential investors in the same way, that is, low taxes and economic depreciation. He believed that there is a case for 100% investment allowances for everybody across the board. This would be moving towards a consumption-based as opposed to an income-based tax system – relying less on income as a source of tax revenue. However he said there is no case for particular projects that take the fancy of DTI officials or projects that some particular investors are able to convince DTI that this is what SA needs.

All the provisos written into the regulations show how vulnerable this concession system will be. The complication is that there are all these opportunities for abuse and so all these complex regulations. They may help provided that your administration is highly competent and honest. However the system provides temptations – that is for sure.

Ms Hogan asked about the displacement effect of such an incentive. Surely this strategy disadvantages going concerns?

Prof Kantor readily agreed that every new business represents a competitive threat to established businesses. Every time you establish a new industry, you threaten the existing patterns of production and consumption. You are not offering this tax advantage to the established sector so the playing fields are not quite flat. Measuring this displacement effect, admitting some obligation about it and meeting compensation demands that emerge is complicated. That is the argument against such industrial policy.

In answer to further questions, Prof Kantor said that trying to measure displacement within a dynamic economy is a huge task. And why choose 40%, he asked? You cannot say that competition is limited to a particular industrial sector given the general competition for the budgets of the consumers. Except if the project is directed at external markets, then you would not have to worry about the costs of displacement.

You cannot offer any guarantee about these projects. The concern of a would-be investor is that these concessions will be taken away and this adds uncertainty to any investment decision. The adjudicators "will be taken out to many lunches". It is not going to be a simple process of adjudication.

DTI’s response
Prof Kaplan of DTI said that some of Prof Kantor’s reservations are well founded. There are judgements and assessments and costs and miscalculations involved in this. We are conscious of those and want to minimise them. He agreed that perhaps they had not given quite enough thought as to how they can reduce the complexities of the procedures. There are various ways to address these.

Looking at the "bigger picture" from the DTI perspective, he said that DTI had assessed what was happening to investors and its assessment was not as positive as Prof Kantor’s. There are a number of potential investors who are concerned that South Africa does not cxompetre when it comes to investment incentives. It is very hard to attract investments because SA does not have incentives.like competing countries. DTI can provide many examples of where SA has lost substantial investments because of no incentives. It had to take into cognisance what SA’s competitors were doing.

He said that Prof Kantor’s position was sustainable in a perfect world but not in a market where there is the distortion of major incentives

The alternative as Prof Kantor said is a general reduction in the corporate tax rate. But DTI’s reading of the situation and literature showed that a marginal reduction in the tax rate would not have brought in the very big investments which the strategic investment project is meant to attract.

He agreed with Prof Kantor that it is " a bit of an experiment" involving moderate amounts of money over a short period of time. He agreed they needed to pay more attention to the regulations and how they are going to assess this. The potential weaknesses and problems that Kantor outlined are pertinent and they will take note of those and come back to the Committee on those. DTI has some thoughts about how to simplify the procedures, particularly the issue of displacement and the sectoral measurements thereof and the assessment of long-term viability and how it needs to be built in. DTI will come back with adjustments and changes.

Prof Kantor requested that they give serious thought to broadening the 100% investment allowance to general industry without accompanying it with this industrial strategy. This was currently provided to the mining and agricultural sectors. It would mean reducing the effective tax rate. If the argument is good for investment strategy, it might be good in a general way.

National Treasury’s Response
Mr Martin Grote first clarified that the mining sector does not offer a 100% investment allowance. He agreed that they would look at the international trends of a consumption-based tax system but not this year as the budget is already in place and it is a revenue loss they cannot afford now. He agreed with Prof Kantor that one does want to achieve neutrality in the tax system by providing incentives for all new capital on an equal basis. One can do that by lowering the effective tax rate. Many countries are doing this now: reducing the incentives but also reducing the total effective tax rate. But Treasury cannot do it this year as the budget "is gone".

Discussion
Dr Rabie asked DTI to provide a list of the investments that SA had lost out on.

Mr Andrew noted that it had been said that the scheme "is a bit of an experiment". He noted two previous experiments: the tax holiday scheme and the accelerated depreciation scheme. He requested that the Committee be given a report on the positive and negative lessons learnt from these two experiments. He also requested an estimate of the tax revenue foregone if the mining industry’s capital investment regime were to apply across the board. He added that Mr Grote might not know but the DA has obtained legal advice that "we can amend the budget".

These information requests would be provided later.

Cosmetics, Toiletries and Fragrances Association of South Africa
Mr R Lichkus (Senior manager: Indirect Tax at PriceWaterhouseCoopers) noted that this legislation would introduce an inequitable ad valorem duty to the cosmetic industry. The local manufacturers will pay more duty than the importers of fully finished cosmetic goods. This would lead to job losses as cosmetic companies would choose to import fully finished goods instead of manafacturing them in South Africa. He requested that equity be returned to this duty.

Revlon SA
Mr S Maddock (Managing Director: Revlon SA) noted that Revlon SA employs 440 South Africans and utilise 350 local suppliers in Johannesburg and buy over R250 million goods and services annually to support their local factories.

Some of the products that Revlon produce locally are shampoos, conditioners, hair sprays and deodorants. The manufacturing facility in Johannesburg is used as a springboard to supply the rest of Africa. Mr Maddock stated that the decision to import finished products or to manufacture them locally is entirely based on cost. Whichever option is the cheapest is the one that the company would opt for. Revlon like many international companies have also consolidated their businesses all over the world. Consequently, many of its manufacturing plants in Argentina, Mexico and Canada have closed down. Mr Maddock stated that it would be a pity if the Johannesburg plant had to close down in view of the fact that production has steadily been growing. If the proposed legislation is to go ahead Revlon would have no other choice than to close down the plant as it would be more cost effective to import finished products from the US and the UK. If this route is followed Revlon would save R10m annually but on the other hand they would lose their local manufacturing base in Africa. Of greater consequence to SA are the vast amounts of employees that would have to be retrenched when the plant closes down. Mr Maddock made a plea that the duties on the importation of finished goods and on locally manufactured goods should be on par with each other.

Discussion
The Chairperson asked for clarity on what is and what is not a luxury good. She asked Mr Lunt what his view on the subject was.
The Chair asked if it was correct to assume that if cosmetic goods were not seen as luxury goods, they would not be liable for ad valorem tax.

Mr Lunt stated that the legislation seems to be unclear on what a luxury good should be. He added that even computers and laptops that are used daily for business purposes are seen as luxury goods. He felt that the definition of what constitutes a luxury good should be reconsidered.

The Chair asked SARS and the National Treasury to comment on the possibility of reviewing the definition of what constitutes a luxury good.
Ms Hogan felt it ludicrous that a necessity like shampoo is seen as a luxury good.

Mr Morton (National Treasury) offered by means of a slide show to explain what constitutes a luxury good.

The Chair declined stated that he would be given a chance later to explain it. Ms Hogan asked Mr Lichkus to comment.

Mr Lichkus stated that the problem of what constitutes a luxury good has not only emerged because of the proposed legislation. He pointed out that the CTA has been trying to engage the issue for the last ± 20 years. It is a living evolution of the problems associated with ad valorem tax. Mr Lichkus stated that if the proposed legislation is to go ahead the Commissioner (SARS) would no longer have the discretionary power to step in to assist the industry.
He stated that parity on the rates between imported and locally produced goods is easily attainable but conceded that it would not be possible with the goods listed in Schedule 1 Part B of the Bill. Mr Lichkus however strongly felt that this should not deter their efforts in finding an equitable rate for both duties. He emphasised that it is not their intention to have the legislation thrown out but problems would surface on its application and implementation in the future.

The Chair asked if it was correct that even though the rates for ad valorem duties had decreased the contentious issue seems to be the change in the manner in which discounts would be calculated.

Mr Lichkus pointed out that discounts have been taken away altogether. At present when a manufacturer sells to a wholesaler he receives no discount. However when goods are then sold to a retailer a 60% discount is given.

The Chair asked for clarity on the basis on which a discount is granted.

Mr Lichkus stated that the criterion seems to be the type of sale that is entered into.

National Treasury input
Mr Morton is the National Treasury expert on customs and excise matters. He stated that he would be discussing the ad valorem duty as well touching on VAT issues.

He said that the industry had vastly changed since the introduction of the ad valorem tax in 1969. Consequently, the legislation has to keep up with the times, which therefore necessitated the changes that have been made to it. At the time of VAT’s introduction, South Africa had the choice between a single VAT rate or a multiple Vat rate. The argument in favour of the multiple rate was that it encouraged equity as VAT was perceived as a regressive tax. In the end the single rate was opted for, as the administrative burden for a multiple rate was too great. Mr Morton stated that the Katz Commission had found that an ad valorem tax on luxury goods would assist in addressing the regressivity of the VAT system.
He also pointed out that the administrative burden of ad valorem tax obtainable from locally produced goods is so much greater than it is on imported goods. It is thus not surprising that 2/3 of the revenue generated by ad valorem tax is obtainable from imported goods.

One of the main reasons why ad valorem tax is being reviewed was because of its high administrative burden and cost. It is for this reason that the Minister had in his budget speech announced the abolition of the complex range of discounts for determining the ad valorem value of domestically produced goods. From the 1 July 2001 the duty would be calculated on the invoice price of the product. Mr Morton also stated that the ad valorem rate had also been decreased from 37% in 1996 to 10% at present. He stated that it is envisaged to even decrease further. What was alarming to National Treasury was that even though the rate had been lowered, the prices of goods had stayed the same or even increased. The benefits of the reduction in the ad valorem rate had not been passed on to the consumer.
Mr Martin Grote (National Treasury) added that in the cosmetics industry it is not uncommon to see mark ups of up to 150%. He pointed out that in order for any industry to grow prices need to be reduced. The figures of National Treasury do not reflect that there was a reduction in prices.

Mr Morton stated that the review on ad valorem tax was two-fold. Firstly, to address its heavy administrative burden and secondly to classify luxury products. The economic definition of a luxury product is one that has an income elasticity of greater than one. The explanation given was that if a person were to receive a 10% increase in his wage and he decides to spend this increased wage on a product then the product would have an income elasticity of greater than 1 ie luxury good. Mr Morton stated that very few people would spend increased wages on food, therefore food is regarded as a necessity. Reference was made to an Income and Expenditure survey that was done in 1995 in which it had shown that cosmetics had an income elasticity of 0.8. LSM data for the year 2000 showed that cosmetics have an income elasticity of 1.01. Mr Morton stated that it is evident that a cosmetic is a borderline case for being a luxury product. He pointed out that he is still awaiting the latest survey figures from Statistics SA but that it would only be available in February 2002.

Discussion
The Chair asked the relevance of the prices of goods to the discussion on ad valorem tax.

Mr Grote stated that when taxes are reduced the benefits must be passed on to the consumer in the form of lower prices. Mr Morton stated that it was the cosmetics industry themselves that had brought up the issue of prices.

Mr K Andrew asked what percentage of the retail price is the ad valorem duty on cosmetic products if the rate is at 10%.

Mr Maddock stated that they pay 4% of their invoiced sales to a retailer. The consumers’ price is 60 -70% higher that the invoice price. The duty would thus be 3 – 4%.

Mr Andrew asked if it would amount to 30 – 40 cents on R10.

Mr Maddock stated that it was correct.


The Chair asked if a decision on the inclusion of cosmetics as a luxury product would be kept on hold until the figures are made available by Statistics SA in February 2002.

Mr Morton stated that they could make a decision without the figures but that it would be useful to substantiate their decision.


Mr K Moloto (ANC) asked if there were not other methods to determine whether a good is a luxury good or not. He felt that mathematical equations sometimes ignore realities.

The Chair stated that a distinction should be made between products that everybody uses like shampoos and deodorants and those that a select few use like fragrances.

Mr Andrew pointed out that peoples’ perceptions change over time on what a luxury good may be. For example thirty years ago deodorants were seen as a luxury and not as a necessity.

Mr Lichkus stated that it is easy to isolate various products. For example soap is not regarded as a cosmetic. The same methodology used to exclude soap could be used to exclude other products.

Mr T Mofokeng (ANC) asked why the industry had not reduced their prices when the ad valorem rates had been lowered.

Mr Lund disagreed with the figures that National Treasury had presented to the committee. He stated that prices had been reduced. Mr Lund felt it unfair of the committee to believe that they make large profits. He stressed that they have large cost factors.
Mr Lund noted that the issue is not on price but rather on equity between the rates for locally manufactured goods and imported goods.


The Chair was concerned about the large number of people that are going to lose their jobs as a consequence of the amendments to the legislation going through.

Mr Andrew concurred with the Chair and pointed out that he was also concerned about the disparity between the figures of the National Treasury and that of the cosmetics industry. How is the committee supposed to make an informed decision? Mr Andrew felt it difficult to support the changes to the legislation in view of the major impact that it would have.

The meeting continued for a further 15 minutes on this issue. It was not monitored

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