Clause 12G (Revenue Laws Amendment Draft Bill, 2001): briefing; SACOB Submission on Bill

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Finance Standing Committee

11 June 2001
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FINANCE PORTFOLIO COMMITTEE; FINANCE SELECT COMMITTEE: JOINT MEETING
12 June 2001
CLAUSE 12G (REVENUE LAWS AMENDMENT DRAFT BILL, 2001): BRIEFING; SACOB SUBMISSION

Chairpersons: Ms B Hogan (NA); Mr Lucas (Acting Chair, NCOP)

Documents handed out
12G. Additional industrial investment allowance in respect of industrial assets used for qualifying strategic industrial projects + Regulations under section 12G(7)
SACOB submission (see Appendix)

Delegation: Mr Grote and Professor Engel (National Treasury); Mr Louw and Mr Tomasek (SARS); Mr de la Rey (Acting CEO: Department of Trade and Industry)

SUMMARY
National Treasury briefed the committee on the newly drafted Section 12G together with the regulations for 12G(7). The clause deals with the 100% industrial investment allowance in respect of industrial assets used for qualifying strategic industrial projects. The objective is to encourage investment in strategic industrial projects. The incentives apply to manufacturing and ICT industries. Various criteria and thresholds have been set in order for a project to qualify. Treasury emphasised that the incentive is not only for foreign but also for domestic investment.

The Committee were concerned about one of the qualifying thresholds for a project: a project may be considered a strategic industrial project if its displacement does not exceed 40% of that industrial sector’s existing production. Treasury says that the clause is there because they do not want to destroy established South African industries. However committee members from the ANC and the DP indicated that a displacement of up to 40% is undesirable.

MINUTES
Briefing from the National Treasury on tax incentives
Mr Grote provided an introduction:
- One of the reasons for this shift in policy comes from the President's State of the Nation address. The tax incentives will also complement schemes announced in the previous budget. It is part of ongoing tax policy reform.
- The Department of Trade and Industry (DTI) wants to cater for a broad range of industries. DTI needs maximum flexibility. How to package this in comprehensive legislation was difficult. The process was protracted and the negotiations were tough. In terms of the incentives the fiscus is foregoing a considerable amount.
- There was a need from all negotiation sides to learn from experiences in other jurisdictions. There is no substance to the argument that there is a policy vacuum within government.
- A package has been designed that avoids the many pitfalls that these instruments usually encounter. There are clear benefits for South Africa overall.
- When one introduces tax incentives one must be aware of drawbacks and risks. It is a fact that tax incentives impact upon economic efficiency. The Government does not want to subisidise investment projects which will displace domestic firms and labour. Therefore they have looked at international best practice to avoid this.
- The administrative concerns of SARS are paramount.
- As a backdrop to the tax package there should be a system which will generally bring a reduction of the rate.

Mr Grote went through the Draft Section 12(G) and the Regulations. The following questions and comments arose during the presentation:

Objective
The preface clearly states the objective of the clause is to encourage investment in strategic industrial projects by granting an additional industrial investment allowance in respect of industrial assets used for such projects. Various criteria have been set order for a project to qualify. Professor Engel added that the incentive is not only for foreign investment but also for domestic investment.

(1) Definitions
''industrial project'' is defined as manufacturing and ICT industries. They would also like to incentivise the new technologies which are explained in Point 3 of the Regulations: hardware and software consultancy and supply, data processing (other than standard secretarial services), database activities, and maintenance and repair of office, accounting and computer machinery.

The Executive decided that services are excluded. This is because services are highly labour intensive and therefore would need a different system.

(2) Tax benefit
Ms Hogan (ANC) asked what the difference between the 100% and the 50% was.

Mr Grote replied that the 100% is the preferred status. The 50% is for any other qualifying stategic project. The preferred status is determined according to criteria. The Minister of Trade and Industry will take advice on what this should be.

(4) Minimum threshold for any form of strategic industrial incentive
- The project must sink investment of at least R50 million.
- It must limit the displacement effect on established business in that sector. The Regulations state that if the expected loss in production exceeds 40% of existing production then the industrial project will not be considered a strategic investment. They do not want to destroy established South African industries.
- The company must expand existing production by at least 35% to qualify. There must therefore be a substantial increase.
- The company will not receive any concurrent benefit in terms of Clause 37E and 37H. Clause 37E deals with additional deduction for value-added processes. Clause 37H deals with the tax exemption (tax holiday). If one has one of these then one cannot qualify for this benefit too. This prevents a doubling up of benefits.
- the requirement under subclause 4(f) indicates that the project must have long-term commercial viability. They do not want something that will continuously rely on the incentives.

Mr Andrew (DP) commented that in matters concerning tax, certainty is important. He said that he did not understand why they want Regulations for "flexibility". He does not follow the argument.

Mr Grote replied that they still have to report the Regulations to Parliament. They would like maximum certainty in the legislation but they were convinced by DTI that they need that kind of flexibility afforded by the Regulations.

Mr Andrew asked them to explain their rationale for being prepared to put 40% out of business.

Mr Grote replied that if one was going to adopt a purist view then one must get rid of all tax incentive schemes in SA.

Professor Turok (ANC) commented that wiping out 40% of industry could be a hazard. He observed that DTI should be jointly presenting this new section with Treasury.

Mr Andrew referred to (4)(h) "the industrial project will not contravene government policy in terms of morals, safety, and health" and said the use of the word ''morals'' is very unclear. It must be defined because it can relate to anything.

The Chairperson reminded the Committee to hold over criticism. Right now everybody simply had to get a clear understanding of the clauses.

In response to Mr Durr (ACDP), Mr Grote replied that they had debated at length the issue of clean technology. The DTI said that South African legislation on environmental issues is sufficient that one cannot get projects up and running unless one has the requisite environmental certificates. Therefore environment is not included in 4(h).

(5) Factor Criteria for Qualifying Strategic Industrial Projects with Preferred Status (100%) or without Preferred Status (50%)
Point 7 in the Regulations provides the detail. The criteria are that the project:
a) upgrade existing industry. One key factor will be utilising processes or supplying products never before available in SA. Professor Engel said that they do not want to favour any one person with new product X over any other person who comes out with new product X at the same time so they will all qualify. They made it more flexible by taking out the two years.

b) create general business linkages. There must be a focus on business linkages. A company will get one point out of ten if ten percent of its total purchases are from SMMEs (with employees below 200). Purchases of 20% are awared 2 points and if it is increased to purchases of 30% then 3 points are awarded. Thus for the project to qualify it must have linkages to SA. Another aspect is how much the project adds to the physical infrastructure of SA. It must satisfy the Adjudication Committee that it will bring a benefit to the locality where the project will be established.

c) creating direct or indirect employment

The points that will be awarded are set out in Point 7 of the Regulations. To qualify as a strategic industrial project the project must achieve four out of the ten potential points. To get preferred status the project must achieve six out of ten potential points.

These are all matters which must be illustrated to the Adjudication Committee on the application form. All the criteria are linked to each other.

(6) R10 Billion Maximum
The total amount of investment is approximately R 10 billion. The Adjudication Committee must keep a record of how much it has approved. There is a sunset clause.

(13) Adjudication Committee
The Adjudication Committee will function with six permanent members. The Minister of Trade and Industry will appoint three and the other three will be appointed by the Minister of Finance. The Committee will have the power to co-opt additional expertise.

(14) Functions of the Adjudication Committee
Their functions will be to look at applications, make recommendations, investigate, see if the requirements have been complied with, and advise Ministers on amendments.

The penalty for misrepresentation or omissions can be a withdrawal of benefits unless it is due to a change in circumstances that is reasonable.

(15) Powers of DTI
The Adjudication Committee must prepare a report on the granting of applications to individuals. They must keep a record of successful and failed applications. There must be a clear description of projects, description of benefits received, and any material changes of fact. This clause also deals with the feedback to Parliament in the form of an annual report.

Discussion
Mr Andrew said that it is easy for investors to create a particular picture with figures on paper. He is skeptical that officials who are dealing with people who know their product can assess the long-term viability of a project.

Mr Grote replied that the Minister of Trade and Industry can review the facts if there are any unforeseen circumstances. The officials who review the application have broad experience. It is really the same as asking an accounting firm to assess a project.

Mr Andrew asked what the definition of morals is in (4)(h). Does the WTO define it? He noted that SA has environmental laws so Treasury said it had not included environmental concerns in (4)(h). Yet SA has safety and health laws so why were safety and health included in (4)(h)?
He noted concern in respect of the impact of the proviso of 40% displacement on existing industries.

Mr Grote replied that he understands the concerns about displacement. On the safety and health wording, Mr Grote said that they had received this input from DTI. Mr de la Rey (DTI) added that if there is doubt about this then they will seek help from the Tourism Department. They are not experts on this. The experts can tell them.

Mr Andrew commented that he understood why they left environment out but he could not understand why they would then put safety and health in. Why are some in and some out?

Dr Rabie (NNP) referred to the employment criteria in the Regulations. He said that industries become more capital intensive therefore they shrink employment. He asked if the incentive is in line with international best practice. He also asked if employers can abuse the incentive for short-term gain.

Professor Engel replied that they realise that it is a capital intensive incentive. Creating employment is a factor and not a minimum requirement. As such it is not a necessity. They felt that employment is an important criteria therefore they have this. The incentive is also designed to upgrade business. Therefore there will necessarily be displacement. The 40% proviso is balanced with the need to upgrade. Mr Grote added that if it is an existing company it must also increase productivity by 35%.

Mr Nene (ANC) said that the criteria to qualify for 100% is six points. He asked if one could score six points by only satisfying some (and not all) of the criteria. Secondly he asked about a monitoring mechanism. He was concerned about the potential problem where a project could score the points and then suddenly the employment level drops.

Mr Grote replied that one can get six out of ten points without any consideration in terms of employment. Employment creation only counts for three points. He emphasised that they are incentivising capital (and not labour). To incentivise labour one should put a different incentive in place.

Chairperson Hogan asked if there was anything in the legislation to ensure that the Adjudication Committee is not improperly influenced.

Mr Louw (of SARS) said that 12G(14) spells out the Adjudication Committee's powers. All the proceedings of the Committee must be properly recorded and minuted.

Chairperson Hogan said that she would like this point followed up.

Professor Turok said that he welcomed the new measure but there are some concerns. Is the main purpose of this measure to drive SA into the sphere of the "knowledge" economy or does it cover all manufacturing. The "knowledge" economy is not labour creating. With manufacturing, employment creation and job preservation is very important.

Mr Grote replied that the Code covers all kind of manufacturing. Clause 12G will fully support the manufacturing set out in the Code. It should stimulate growth in the sector. Computer and computer related activities are important.

Mr Taabe (ANC, NCOP) commented that there has to be deliberate interventions from state institutions to facilitate SMMEs from historically disadvantaged sectors.

Mr Grote replied that by way of approximation it has been covered. Mr de la Rey said that a lot of SMMEs can be assisted by big industries. They tried to integrate total manufacturing linkages so that the previously disadvantaged sectors can grow. It will bring this to the fore. Controlling measures will be in place to ensure that they comply.

Dr Conroy (NNP) referred to purchases from small business (in terms of general business linkage criteria). He asked if an SMME should be defined in terms of having no more than 200 employees or if it should rather be defined in terms of turnover (because some companies with few staff have a high turnover).

Mr Grote replied that they will work that in and they will try to cater for it.

Mr Andrew commented that they should have a stipulation that the Ministers must be impartial. There should be penalties for anyone who tries to influence the Ministers.

SACOB submission
Mr D Kruger (Chairperson, SACOB Taxation Committee) raised the following issues:
- Rates of tax: There are restrictions on reductions that personal service companies are entitled to. In this regard they have had discussions with SARS.
- Directors of private companies: the Director will be required to pay employees tax. It does not take into account that there are significant fluctuations in income from year to year (high income can lower drastically). Income can become less than the tax. It will also lead to additional record-keeping. They question the necessity of this.
- Capital Gains Tax: They have had discussions with SARS. They request that the changes which will be made before implementation are made timeously. A problem was also raised in respect of a foreign national who takes out a foreign life policy before coming to SA.
-
Customs and Excise: There are a number of initiatives that SARS has taken. It is welcomed if it will prevent smuggling.
In addition to these there are also a number of technical changes which SACOB said they would raise directly with SARS.

SARS Response to SACOB
Mr Louw gave a brief response. Points made include:
- Rates (personal service companies): SARS can make a change if possible.
- Directors of private companies: They want to bring them into the PAYE system. They have now changed the formula and have thus taken care of the problem identified by SACOB.
- CGT: the problem in respect of life policies can be overcome if the policy was taken out prior to valuation date.

Mr Louw said that SARS would come with a more comprehensive response. Chairperson Hogan said that the changed formula should be made available as soon as possible. The concern in respect of PAYE for directors come out of many submissions.

The meeting was adjourned.

Appendix:
SACOB Submission to the Portfolio Committee on Finance:
Revenue Laws Amendment Bill, 2001

Rates of tax
SACOB continues to be concerned that the taxation laws unfairly discriminate against so-called personal service companies. However, SACOB is mindful of the potential abuse that has lead to the present basis of taxation and is engaged with SARS in trying to find a solution to this conundrum. Proposals are in the process of being formulated and should be submitted to SARS in the near future.

Incentive for small business corporations
While the accelerated deduction provided for in respect of manufacturing plant and machinery is to be welcomed (clause 12 of the Bill), it is recommended that the concession be extended to all small businesses. There does not appear to be any compelling reasons why small businesses engaged in farming and the service industry should receive the same incentive. Tourism, which is generally regarded as one of our most important growth industries, is driven by a large number of small operators. The sugar industry has embarked on an initiative to empower small farmers, and these small farmers should also benefit from this incentive.

Amounts distributed by a trust
We previously commented that the introduction of section 25B(2A) was unjust in that it had the effect of bringing within the South African tax net amounts that would not have been subject to SA tax in the past. Thus, for example, the capital in a foreign trust may consist of income earned many years before the introduction of the residence basis of taxation. Any distribution of that capital will now attract South African income tax in the hands of the beneficiary. This result is confirmed by the proposed amendment to this section (clause 13 of the Bill). This impost is surely of a retrospective nature.

Directors of private companies
The provisions of the Fourth Schedule are amended (clause 16 of the Bill) to bring directors of private companies within the ambit of employees' tax (PAYE). SARS has previously attempted to include directors of private companies within the PAYE system, but it proved difficult to do given the fact that such directors' income is very uncertain in many cases. It should also be borne in mind that Director's salaries/fees are often only determined once the financial results for the financial year have been finalised. Essentially the proposal is to deem the director's current remuneration for purposes of PAYE to be equal to his/her previous year's income. That is, PAYE will be imposed in respect of a notional amount of income. While the liability for the payment of the relevant PAYE rests with the employer, the employer has a right of recovery against the director.
Problems that may arise in this regard are that -
· It ignores the real fluctuations in income earned each year, which often take place in practice. It may be that the director's notional income for PAYE purposes is based on particularly good results in a previous year. The company may be experiencing declining fortunes, whereas the director's notional income would always be in excess of actual.
· The proposed system would require additional record keeping in relation to the notional and actual income earned by the director and the reconciliation thereof.

It should also be borne in mind that the director would in any case be required to meet his tax liability in respect of any year within 7 months of the end of the tax year under the provisional tax system.

Capital Gains Tax
The reason for the different treatment afforded proceeds from foreign life insurers is unclear. In effect, a foreign national who takes out a foreign life policy before coming to SA (and who was obviously not in a position to take out a policy in SA at that time) will become subject to CGT on the proceeds (clause 27). This is the result regardless of whether the foreign insurer is located in a high tax jurisdiction or not. It is recommended that proceeds derived from a foreign insurer located in a so-called "designated country" should similarly escape SA CGT.

Customs and Excise
The various Siyakha initiatives are to be welcomed, albeit that the necessary procedures will place an additional burden on trade and industry.

VAT
The simplification of the provisions relating to commercial accommodation establishments is welcome (clause 60), as is the making available of information relating to VAT registration (clause 61).


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