Revenue Laws Amendment Draft Bill [B33-2006]: hearings

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Finance Standing Committee

17 October 2006
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Meeting report

 

 

FINANCE PORTFOLIO & SELECT & JOINT BUDGET COMMITTEES
18 October 2006
REVENUE LAWS AMENDMENT DRAFT BILL: HEARINGS


Chairperson: Mr N Nene (ANC)

Documents handed out:
Draft Revenue Laws Amendment Bill as of 29 September 2006
Presentation by the Non-profit Consortium
Presentation by the South African Institute of Chartered Accountants
Presentation by the Club Management Association
Presentation by Banking Association South Africa: Tax Avoidance and Section 103 of the Income Tax Act, 1962, Revised Proposals
Presentation by Banking Association South Africa: Draft Revenue Laws Amendment Bill
South African Council of Churches

SUMMARY
The Non-profit Consortium said that the proposed rate hike from 29% to 34% should be revisited as the reason given for it: that trusts were not exposed to secondary tax on companies was not relevant to Public Benefit Organisations. They did however support the amendment to section 30(3)(g). In addition however, they proposed that such foreign charities should be required to have at least one person who was authorised to accept service on behalf of that charity, to be resident in South Africa.

With regard to exemption from Donations Tax, the question of whether donations tax should be levied in respect of donations that were made to non-profit organisations, that were not registered Public Benefit Organisations should be reviewed.

There was a great need for an awareness drive to make small non-profit organisations aware of the simplified registration requirement. Registration as a Public Benefit Organisation could currently take up to 18 months because of the delays and backlogs at the tax exemption unit. The administration of the unit needed to be improved.

The South African Institute of Chartered Accountants said that the amendment to section 3(4) did not include section 80S that dealt with reportable arrangements. As there was a discretion here also, this section should also be subject to objection and appeal, especially given the penalty of R1 million per alleged transgression. Section 9D contained provisions that were meant to curb tax avoidance. Unfortunately, these anti-avoidance provisions also hampered South African companies from conducting genuine business activities which were not aimed at avoiding tax.

The proposed section 10(1)(cO) was unnecessarily punitive. Sub-paragraph (iv) allowed a general exemption of R20 000 per year, which would have to be applied to investment income as well as other income such as hiring out facilities to non-members. The exemption of R20 000 was too low and would result in many recreational clubs facing substantial tax liabilities that could be the cause of their demise as these clubs were self-funding and were heavily reliant on alternative sources of income.

They were extremely concerned about the powers that may be imparted to the Commissioner through the provisions of section 80B, notably the ability of the Commissioner to “re-characterise” steps or parts of an “impermissible avoidance arrangement”. In effect, this empowered the Commissioner to change any transaction from its existing components or format into some other component or format.

The Club Management Association said that the exemptions in section 10(1)(cO) for income derived from members and occasional fundraising activities were welcomed. However, the taxation of all other income subject to a de minimus exemption of R20 000 per year was extremely harsh and would have severe negative financial implications for many clubs.

They said that the provisions of the Bill that related to clubs should not be implemented until the impact of the proposed amendments had been properly assessed through inter alia, a cost-benefit analysis and an impact analysis of the effect on the underlying balance sheets of clubs.

Banking Association South Africa said that the overriding concern with the Reportable Arrangements proposals was that a number of them would result in a very substantial number of routine transactions becoming Reportable Arrangements, thus making the proposals impractical. In terms of the revised proposals for the tax avoidance provisions, it was concerning that they characterised a number of everyday transactions as impermissible tax avoidance, and had the effect of transferring a significant amount of power governing tax law from the Legislature and Judiciary to the Executive.

The proposed section 80E contained a prescriptive test where a party could be deemed to be accommodating or tax-indifferent if an amount derived was “substantially offset” by expenditure incurred in connection with the arrangement. In many financial trading transactions, margins of 0,5% or less were common. Expenditure of 99,5% or more of the related income would seem to be “substantial”, but it was absurd that routine financial transactions could result in a party to an arrangement being regarded as accommodating or tax-indifferent.

MINUTES
Presentation by the Non-profit Consortium (NPC)

Mr Ricardo Wyngaard, the Programme Manager, said that at present, non-profit trusts were taxed at a rate of 40% while voluntary associations and section 21 companies were taxed at 29%. The Bill was aimed at remedying unfair treatment and proposed a tax rate of 34% for all Public Benefit Organisations (PBOs).

With regard to the proposed amendment to Schedule 1, the NPC proposed that the rate be kept at 29%. The motivation for the higher taxation rate of trusts was because the beneficiaries of trusts were not exposed to secondary tax on companies (STC). STC was relevant to companies that distributed profits and declared dividends. Dividends were not declared by PBOs and they were specifically prohibited from “distributing any of its funds to any person (otherwise than in the course of undertaking any public benefit activities) and were required to utilise its funds solely for the object for which it has been established.” PBOs are also prohibited from promoting the economic self-interest of any fiduciary or employee of the organisation.

The proposed change also gave rise to another anomaly in that trading activities of section 21 companies and voluntary associations not approved as PBOs would be taxed at 29%, the trading activities of non-profit trusts not approved as PBOs would be taxed at 40% and trading activities of trusts, section 21 companies and voluntary associations approved as PBOs would be taxed at 34%. Their conclusion was that since STC was not relevant to PBOs, the effect of introducing a taxation rate of 34% would discourage PBOs from carrying on trading activities aimed at promoting sustainability.

With regard to the proposed amendments to section 30(7), they proposed that this sub-section be left unchanged. The proposed change which is motivated by administrative reasons could result in organisations having to close down after PBO status had been withdrawn. The withdrawal of PBO status was a penalty in itself. The ancillary tax benefits that went with PBO approval such as exemption from donations tax, transfer duty stamp duty and estate duty amongst others, would be lost to an organisation that lost its PBO status.

A further penalty was that the organisation would now be taxed on its accumulated net revenue. These penalties were sufficient consequence for an organisation that failed to comply with the provisions of section 30.

The administrative reason offered by the South African Revenue Service (SARS) could be remedied in a way that was less harsh than that proposed in the Bill. Firstly, section 30(9) of the Income Tax Act (ITA) required PBOs to retain books of account, records or other documents that related to any approved PBO for a period of four years.

Secondly, section 17 of the Non-Profit Organisations Act (NPO Act) required that every registered non-profit organisation must, to the standards of generally accepted accounting practice, keep accounting records of its income, expenditure, assets and liabilities, and within six months after the end of its financial year, draw up financial statements.

It must further within two months after drawing up its financial statements, arrange for a written report to be compiled by an accounting officer and submitted to the organisation stating whether or not: the financial statements of the organisation were consistent with its accounting records; the accounting policies of the organisation were appropriate and had been appropriately applied in the preparation of the financial statements; and the organisation had complied with the provisions of the Act and of its constitution which related to financial matters.

The proposed amendment would have dire consequences for an organisation that had accumulated immovable property over the years and because of its non-compliance, would have to pay tax on all its assets. This may force an organisation to sell its assets if there was insufficient cash flow.

Section 30 of the ITA came into operation in 2001 and affected the assets of organisations that were owned prior to 2001. These assets may have been acquired without the organisation having had income tax exemption. It would be an unfair result for the market value of those assets to be deemed taxable income. Although capital assets are excluded from the definition of gross income under the ITA, the proposed amendment to section 30(7) referred to “those assets which have not been transferred”, which would include capital assets.

The NPC did however support the amendment to section 30(3)(g). In addition however, they proposed that such foreign charities should be required to have at least one person who was authorised to accept service on behalf of that charity, to be resident in South Africa. They also supported the amendment to section 30(3)(b)(ii). However they did have a reservation about that this wording may prevent a PBO from investing any portion of its funds in foreign-based shares or unit trusts.

Under the previous “prudent investment” dispensation, as set out in Interpretation Note 32, foreign investments through a financial institution registered in South Africa or through a locally registered foreign unit trust were acceptable.

The NPC also had some proposals beyond the scope of the Bill. With regard to the concept of “Public Benefit,” they proposed that the following clause be inserted into the 9th Schedule to the ITA: “Any other activity that is deemed to support the public benefit,” or “Any other activity that is deemed to be for the public benefit and that is substantially similar to any activity listed in the preceding paragraphs of this Schedule other than the activity listed in paragraph 7(d).”

With regard to exemption from Donations Tax, the question of whether donations tax should be levied in respect of donations that were made to non-profit organisations, that were not registered PBOs should be reviewed. This was of particular concern since this regulation could prejudice donations to small community based organisations that lacked the capacity to register as PBOs.
There was also a need for clarification of the interpretation of a number of terms used in the ITA such as “direct and integrally related” and “unfair competition”. In this respect it would be useful to examine the interpretation given to these terms by the courts in other jurisdictions. The threshold for unrelated activities to be tax exempt should be increased. Mr Wyngaard also said that with regards to tax benefits for donors, the limitation on deductions for private individuals should be raised or done away with entirely.

There should also be a simplified filing procedure for smaller organisations. Voluntary associations, with taxable income below a certain threshold, should be excluded from having to register as tax payers and filing annual tax returns income tax returns, similar to the exclusion for individuals with taxable income below a threshold of R60 000. They recommended that the threshold be set initially at R250 000. While the introduction of a filing threshold would reduce the recurring administrative burden on both SARS and small PBOs with limited risk of loss to the fiscus, it would however not assist small PBOs to enter the tax system in the first place. They further proposed that a simplified set of registration requirements be designed for smaller organisations that wanted to register as PBOs.

There was a great need for an awareness drive to make small non-profit organisations aware of the simplified registration requirement. Registration as a PBO could currently take up to 18 months because of the delays and backlogs at the tax exemption unit. The administration of the unit needed to be improved. Because so many organisations were not aware that they were required to register or were avoiding registration because they were afraid of attracting penalties, the possibility of a tax amnesty for non-profit organisations, such as the amnesty for small businesses, should be investigated.

Discussion
Dr Van Dyk (DA) asked how seriously suggestions such as those as the NPC were taken by SARS and the Treasury. Was there regular communication between them?

Mr Wyngaard replied that SARS and Treasury were committed to meet with people and groups from society on a regular basis and in fact their next meeting was set for the 26th of October. The NPC did feel as though their suggestions were taken into account, albeit belatedly sometimes.

Mr I Davidson (DA) said that the NPC made a good presentation for not increasing the tax rate and was less convinced by SARS’ proposal.

South African Institute of Chartered Accountants (SAICA) submission
Ms Jackie Arendse, the Tax Project Director, began by saying that there was not enough time to go through the legislation, provide comment and allow for feedback. She said that draft legislation should be released earlier to provide more time. With reference to clause 3 of the Estate Duty Act, the insertion of section 12A and section 12B and the arising power to appoint agents did not include the collection of penalties via the agent. Was this intended to be excluded or was it an oversight?

They suggested that the Commissioner should be required to inform the taxpayer immediately after an agent was appointed. A similar provision should also be inserted in the agency provisions that already existed in other Acts administered by the Commissioner. Such a provision would reduce the administrative burden on SARS as it often happened that the taxpayer was unaware of how much they owed SARS at the time that an agent was appointed.

Mr N Nalliah, the Chairman of the National Tax Committee, said that the problems encountered with the existing definition of “connected person” in clause 4 of the ITA had been raised previously in writing and in meetings with both Treasury and SARS and also at presentations to the Committee. However, the current amendment did not address the problem that they had highlighted on many occasions.

The issue could arise where a new shareholder, which may be a BEE partner or any other new shareholder, wished to acquire a share in a company. The prospective shareholder may not wish to purchase shares in the existing company for various reasons. It may not be willing to take on an exposure to the historical risk of the company where there may be unknown liabilities.

They understand the historical need for this anti-avoidance measure prior to the introduction of capital gains tax (CGT) but given the introduction of CGT and the better enforcement capability of SARS, they were of the view that there were more than sufficient measures in place to counteract any possible tax-avoidance in this area. There was no need for this “connected person” anti-avoidance provision, which had at its source the “connected persons” definition.

The amendment to section 3(4) did not include section 80S that dealt with reportable arrangements. As there was a discretion here also, this section should also be subject to objection and appeal, especially given the penalty of R1 million per alleged transgression.

Section 9D contained provisions that were meant to curb tax avoidance. Unfortunately, these anti-avoidance provisions also hampered South African companies from conducting genuine business activities which were not aimed at avoiding tax.

In terms of section 9D(9)(b)(ii)(cc), a controlled foreign company (CFC) which carried on business activities in its country of residence in suitably equipped premises would not be entitled to the business establishment exemption in respect of any income received for services rendered to a connected person that was a South African resident. The loss of the exemption did not depend on whether the CFC supplied the services to the resident connected person at a market-related price. Such income would be imputed to the South African resident shareholder if the exemption did not apply.

The exclusion from the participation exemption in section 9D(9)(b)(ii)(cc) favoured a CFC providing goods as opposed to services. If the provision of services related to the creation of intangibles, the income received from such services was immediately tainted. This was despite the fact that there may be sound business reasons for having a CFC provide such services to a South African resident that was connected to the CFC.

The concession in the section also only applied where the company that provided the on-site managerial and operational employees formed part of the same group of companies as the controlled foreign company. This was rather restrictive and they suggested that the concession apply to companies in the same group of companies where the reference to shareholding was more than 50% as opposed to at least 70% as was currently envisaged in the proposed definition of connected person in section 1 of the Act.

Paragraph (e) required that the vessel must be used “solely outside the Republic” for the purposes of transportation and so on. It did happen, particularly in relation to aircraft and vessels operating in and around Africa, for purely practical reasons, that those aircraft or vessels were returned to South Africa for maintenance and repairs (there were very few places elsewhere in Africa where this can be done). It can be argued that if they were returned here for maintenance or repairs, it would not prejudice the existence of the business establishment, because this would not constitute use in South Africa for purposes of transportation or fishing or prospecting and so forth. Nevertheless, it would be welcome if it were made clear that occasional trips to South Africa for maintenance, repairs and refurbishment would be acceptable.

Ms Arendse then said that the proposed section 10(1)(cO) was unnecessarily punitive. Sub-paragraph (iv) allowed a general exemption of R20 000 per year, which would have to be applied to investment income as well as other income such as hiring out facilities to non-members. The exemption of R20 000 was too low and would result in many recreational clubs facing substantial tax liabilities that could be the cause of their demise as these clubs were self-funding and were heavily reliant on alternative sources of income. These clubs performed a vital function in making sports facilities available to individuals that would otherwise not have any access to such facilities, which also ensured the future ongoing development of sport in South Africa.

SAICA could understand the motivation for keeping the salary level fairly low so that only lower-income employees could benefit from this exemption, but they recommended that the amounts be increased as these monetary limits had not been amended since 2002. There was hardly a tertiary-level course that would qualify using the limit of R2 000. In light of the need to encourage education in South Africa and to build South Africa’s skills-base in terms of Government’s AsgiSA objectives, employers should be encouraged to provide bursaries and scholarships to children of their employees, which should be supported by allowing a beneficial exemption.

Section 11D(1)(a) required that expenditure be incurred directly on research, which seemed to unfairly exclude any general costs incurred in running a research establishment such as the costs of employing a receptionist; a secretary; a senior researcher; research building maintenance and administration. They suggested that expenditure should qualify if it was incurred exclusively in support of the research effort, even if it was not directly productive of research, as the support functions were fundamental and essential to the research process.

Also, the proviso to subsection 2 required an apportionment based on the use of the building but it was not clear as to how this use was to be determined. For example, was it based on the area used or on a time basis? This aspect had to be clarified.

The concept of “beneficial ownership” was unknown in South African law and especially in tax law. Consequently, the reference to beneficial ownership in subsection 5 had to be removed. Alternatively, a definition of beneficial ownership should be inserted for purposes of section 11D or into section 1 of the Act as this concept was used elsewhere in the Bill.


Sections 11B and 11D did not allow any deductions or capital allowances for research and development conducted outside the Republic. This seemed wrong as royalties from both South African and foreign sources were taxed here. In addition export sales of goods developed offshore and for the export market were included in taxable income. This could lead to South African companies allowing foreign companies to further develop and own South African inventions on the basis that the foreign company paid for all further research and that the income stream such as royalties were then shared.

In the long run, a foreign company then owned the improved invention to the detriment of the South African originator. They suggested that foreign research and development expenditure should qualify for deduction, even if only at the normal rate and not the accelerated rate. If
research and development projects conducted offshore gave rise to taxable income, the same incentives for research and development should apply as for local research and development.

In the amendment of section 12E, the change in wording in clause 17(d) from
“at least four” to “three or more” did not achieve any change in the meaning of the provision. The requirement to have three or more employees was extremely punitive for small start-up companies that were denied any benefit from the tax concessions of section 12E until they had the requisite number of employees, which could take several years. These companies were denied tax relief in exactly the period that they most need it in order to survive and grow. This requirement should be amended to “at least one full-time employee that is not a connected person in relation to the shareholder of the company”.

In clause 20, it remained anomalous that payments of remuneration and pension fund contributions were now allowed in terms of section 23(k), but not fringe benefits under the Seventh Schedule, which were just a different form of remuneration.

Ms Arendse said that it was a pity that no clarification had been made that the disallowance of the deduction applied only to the labour broker/personal service company/personal service trust business. Currently, on a literal interpretation, it was required that all the expenses (other than those enumerated) would be disallowed. The Explanatory Memorandum made it clear at paragraph C on page 13 that the rules prohibited deductions “much like an actual employee” who was similarly eligible for only a limited number of expenses.

SAICA did not disagree with this proposal but if an employee also happened to run a business in addition to being an employee (for example, he or she might own a shop managed by his or her spouse or child), no-one would contend that the ordinary trading expenses attributable to that shop should be disallowed merely because it was owned by a person who was also an employee of someone else, and therefore whose expenses were restricted. Only the expenditure related to employment should be disallowed, not expenditure related to the other business, that is, the shop.

SAICA viewed the revised proposals in clause 37 as a huge improvement on the original ones but the overriding criticism of the revised legislation was that it was still too far-reaching. This would result in too many legitimate business transactions being unjustly subject to an attack by SARS in terms of the General Anti-Avoidance Rule (GAAR) unless extreme caution was exercised in the course of carrying out such measures to avoid the effect that such legislation may have on legitimate business transactions.

They were extremely concerned about the powers that may be imparted to the Commissioner through the provisions of section 80B, notably the ability of the Commissioner to “re-characterise” steps or parts of an “impermissible avoidance arrangement”. In effect, this empowered the Commissioner to change any transaction from its existing components or format into some other component or format.

Thus, it was conceivable that, for example, dividend-bearing shares may be re-characterised as interest-bearing debt. There was concern that the Commissioner could use such a powerful tool in a manner abusive of the taxpayer’s right to set up a transaction in good faith in one way, only to have the Commissioner re-characterise such a transaction according to his view. This may be the case even though there may be legal grounds for the taxpayer’s view of the transaction and its components.

While the use of the word “combining” in section 80B(1)(b) could be given some meaning, they had difficulty with the use of that word in section 80B(1)(b) and in section 80F(b). It was difficult to conceive how two different parties could be combined. Better wording might be to say that they would be treated as one and the same person.

Sub-sections 80B(1)(d) and (d) also placed very powerful weapons in the Commissioner’s hands. The ability to re-characterise and reallocate amounts could conceivably lead to abuse. A taxpayer that had genuinely received a capital receipt may find it being taxed as a trading receipt, should the Commissioner choose to “r-characterise” the amount.

Section 80B(2) stated that “the Commissioner “may” make appropriate compensating adjustments … to ensure the consistent treatment of all parties …”. They suggested that the word “may” be amended to read “must” to ensure that the Commissioner was not given a choice as to whether he wished to make such compensating adjustments or not. The Commissioner should be obligated to make the necessary adjustments provided these adjustments were motivated to the satisfaction of the Commissioner by the relevant parties to the arrangement.

Section 80C(1) used some colloquial and vague terms which had to be defined or used with greater precision. For example, what was meant by “substantial effect”? Reference was made to “business or commercial risks”. Was there a difference between the two? What did “net cash flows” mean? This was a very loose accounting term that could have different meanings in different circumstances. What was intended by the use of the expression “beneficial ownership”? This did have a technical legal meaning and clarification had to be provided as to what constituted a “significant effect.”

Section 80C(2)(a) to (c) referred to characteristics of an avoidance arrangement which were indicative of a lack of commercial substance but stated that whilst including these, it was not limited to these characteristics. Again, the taxpayer was left to imagine an unlimited list of potential triggers for the GAAR. The introductory commentary stated that the original abnormality factors were reduced from eleven to five, focusing on those indicative of a lack of commercial substance, as, inter alia, commentators had pointed out that the number of factors was a source of additional complexity. Now, the number of factors has been reduced, but the replacement provision brought with it the uncertainty that the current list was by no means exhaustive. This led to uncertainty for the taxpayer.

Section 80C(2)(b) referred to the presence of “round-trip financing” which was the inclusion of an accommodating or tax-indifferent party or offsetting elements as indicative of a lack of commercial substance. Again, this cast a very wide net that may taint perfectly legitimate transactions as impermissible avoidance arrangements.

The last indicative factor set out in section 80C(2)(c) dealt with where there was an “inconsistent characterisation of the avoidance arrangement for tax purposes by the parties.” In the tax system, there was no symmetry in that if an amount was treated as capital expenditure in the hands of the taxpayer outlaying such amount, the receipt by the other taxpayer was not automatically of a capital nature. The circumstances and facts that related to each taxpayer determined the nature of the deduction or receipt or accrual to such taxpayer.

Neither the discussion document nor the Bill specified the date from which section 103(1) would no longer apply and the new Part IIA would come into force. The way the provisions were drafted in the draft Bill indicated that the new provisions applied from the commencement of years of assessment ending on or after 1 January 2007, which would make them retroactive.

The requirement that a tax benefit could be “assumed to be delivered” in section 80M(1)(a) had absurd implications. Even if no tax benefit was ever derived, an arrangement could still be a reportable arrangement, with the result that all arrangements would be reported “just in case” and due to the high volume would prescribe long before SARS had a chance to look at them.

The proposed amendment to section 88(1), providing that payment was not suspended by an objection, was extremely prejudicial and inequitable to the taxpayer having regard to the way our tax system was administered. While it was accepted that the “pay now argue later” rule was part of our law, extending the rule in this manner ignored the prejudice that could be caused to taxpayers by the lack of resources in SARS.

Treasury Reaction
Prof E Liptek from Treasury said that engagements with civil society took place and many of the proposals to do with PBOs came from those engagements. They raised some issues but SARS and Treasury would only take on a few, and there were some that were simply rejected out of hand.


Club Management Association (CMASA) submission
Mr C Wolfsohn began by saying that Membership of CMASA was voluntary for clubs and no individuals were members. A club could be defined as: “A voluntary association of persons privately constituted and managed in terms of its own rules by and for the benefit of members, with an established clubhouse at which members and invited guests meet on a regular or recurrent basis to further a specified social, sporting, recreational, cultural or other common interest, or a combination of such interests, and which precludes the active pursuit and division of profits but encourages recreation and social conviviality.”

Clubs were governed by a constitution, which limited the activities of the particular club to its core objectives. The guiding principle in the various constitutions was that clubs are formed on a “not-for-profit” basis. This distinguished them from other profitable organisations and businesses. The objectives of a club’s constitution stipulated the activities in which it may partake for the benefit of its members. Similarly, member guest and visitor access to the club’s facilities were governed by the constitution.

Clubs derived their income from members’ subscriptions, facility fees, investment income and other income derived from hiring out facilities or other services. Members’ subscriptions took various forms, that is, annual, seasonal, monthly or occasional, each with a different monetary value. Member facility fees comprised items such as playing fees (for example green fees), charges for on-site food and beverage products, the sale of club-branded products, proceeds from the sale of items used for the playing of the sport, water usage fees and mooring (specific to water sports).

A club’s constitution prohibited a club from distributing any profits to the members. Instead, any surplus income had to be reinvested in the club (on maintenance, infrastructure or capital projects for instance) to ensure sustainability. Approximately 2% of clubs in South Africa owned their own land and the others lease their property or utilised facilities owned by government or local authorities. Many existed on short-term leases, with no security of tenure.

It was a well-researched premise that citizens need to partake in recreational activities in order to function as contributing individuals to both the country’s fiscus and social fabric of society. In a country with a population of approximately 47 million people and a widespread interest in sport, there were relatively few state-funded sports facilities available for use by the general public, even on a “pay-by-use” basis.

The vast majority of sport and recreation clubs in South Africa currently operated within severe financial constraints. Should the proposed amendments be implemented, many clubs would be forced to close their doors, thereby reducing further the already short supply of recreational resources. South African society would lose many of the benefits provided by these sports clubs, both in terms of the provision of sports facilities and in terms of the “green belts” that these clubs provided in many built-up areas. Furthermore, the closure of clubs would inevitably result in the loss of jobs with massive effect on the extended families of the employees concerned especially in the rural areas.

Countries such as the United States, the United Kingdom and Ireland provided a tax exemption for recreation clubs. Some countries provided a partial exemption that applied to income derived from the provision of services to members or in terms of the core objectives of the club. For example, the United States allowed a club to derive 15% of its gross receipts from the non-member use of its facilities.

Countries with a much larger club sector than South Africa had realised the importance of the establishment of clubs to provide recreation facilities for their citizens without additional economic burdens being placed on the government or the clubs as providers of the facilities. The Bill proposed a partial taxation of sport and recreation clubs, which had previously been totally exempt from normal tax in terms of section 10(1)(d) of the ITA. To qualify for this exemption, clubs had to submit a copy of their constitution to SARS by no later than 31 March 2011 and meet certain prerequisites that must be contained in the constitution.

The exemptions in sub-paragraphs (i) – (iii) in section 10(1)(cO) for income derived from members and occasional fundraising activities were welcomed. However, the taxation of all other income subject to a de minimus exemption of R20 000 per year (in terms of sub-paragraph (iv)) was extremely harsh and would have severe negative financial implications for many clubs.

The de minimus exemption would have to be applied to both investment income and income derived by a club from any dealings it had with non-members and the low threshold of R20 000 would only provide real relief for the very smallest of clubs, while giving rise to substantial additional costs for the vast majority of clubs and for the fiscus (as SARS would have to administer and enforce the legislation).

Investment income was a typical feature in many clubs as, due to their “not-for-profit” nature, they were required to accumulate funds to finance capital projects which fell outside the scope of operating expenditure. The constitution of a club governed where and how these funds could be invested (usually, only in approved securities). The constitution also laid down the conditions for withdrawals from investments. Marginal clubs that struggled to break even, typically utilised investment income to assist with meeting annual operational costs. The imposition of a tax on investment income would prejudice the ongoing survival of these clubs.

There was a further consideration regarding the determination of income from non-member activities. Apart from the tax cost to the clubs, the imposition of tax on investment income and non-core income would give rise to substantial additional administrative costs as clubs would have to introduce complex costing systems in order to allocate costs between exempt and taxable activities.

Operating expenditure, which was usually determined for the club as a whole, would as a result of the Bill, now have to be allocated between member and non-member income, which would be a complex and costly exercise. For example, visitors unaccompanied by a member required subtle monitoring by the club personnel in order to prevent the club from infringing any laws, such as liquor laws which provided for only members to pay for liquor purchases. The service of these visitors was therefore more cost intensive than the service of members.

Furthermore, due to budget constraints in the sector, qualified accounting and administrative staff were scarce and information systems are relatively simple. The introduction of sophisticated costing systems and specialised reporting would be onerous and cost prohibitive.

The CMASA understood the motivation to tax the income derived from non-core activities or business activities of clubs. However, they suggested that the de minimus amount should be more realistic so as to avoid placing the financial future of clubs at risk. The undue additional administrative burden that would be placed on clubs would not pass a cost-benefit analysis since the additional tax revenue generated for the fiscus would be minimal.

Following the intention of the proposed amendments, that is, to create a level playing field between clubs and PBOs, the approach taken for PBOs should be adapted for clubs. Clubs approved in terms of section 30A should be allowed a tax-free de minimus amount of gross income derived from non-core business activities to the greater of: 15% of the total receipts and accruals derived during the relevant year of assessment or R300 000. A similar approach was followed in the United States and the United Kingdom.

Clause 27(1) defined a “recreational club” as a company, association of persons, “established solely to provide social and recreational amenities or facilities for the members of that company, society or other association.” The word “solely” was not appropriate as this was not a restriction commonly found in the constitution of clubs. In reality, clubs allowed guests to accompany members as visitors to the clubs and this did not detract from the fundamental nature of such clubs. The permission of access to guests was in line with international norms.

Sub-clause (2)(a)(vi) prohibited members from selling “their membership rights or any entitlement thereof”. There are a number of bona fide sports clubs that had issued debentures or shares (albeit in some cases indirectly) to their members as a means of raising funds for capital expenditure. It would be unfair to automatically and immediately exclude such clubs from the section 10(1)(cO) exemption on these grounds alone and so they suggested that this requirement be reconsidered.

Clubs must, within three months of the date of withdrawal of the approval in terms of section 30A, dispose of all their assets to another unconnected recreational club or PBO, failing which the club would be liable for CGT on the market value of all its assets. Again, taking into account the challenges faced in the administration of clubs, a three-month deadline to arrange for the disposal of assets was unrealistic.

This legislation would also create an additional administrative burden for SARS as it was likely that the club, which would face a considerable CGT liability, would not have the cash resources to settle such a liability. Instead they suggested that a more reasonable period for arranging for the disposal of assets would be six to 12 months and the Commissioner should be granted the discretion to allow a longer period if necessary.

The proposed insertion of paragraph 63 of the Eighth Schedule provided PBOs with relief from CGT on disposals of assets not used for trade purposes. Similar relief should be provided for disposals of assets by recreational clubs. Although roll-over relief was proposed with the introduction of paragraph 65B to the Eighth Schedule, the roll-over relief was only available in certain specific circumstances, and without the roll-over relief, clubs would be subject to CGT on all disposals of capital assets, even where the assets were used solely for the provision of services to members. This was surely an unintended consequence of the Bill.

The roll-over provision proposed in paragraph 65B only applied “an asset that was used solely to produce income that was exempt from tax in terms of section 10(1)(cO)”. Many assets used by clubs would have been used to produce income that was not exempt in terms of section 10(1)(cO), particularly if the current low de minimus amount was retained. The roll-over provision would then fall away entirely, which was unfair and would place an onerous tax burden to the disposing club. An apportionment should be provided for where an asset has been used partly for producing exempt income.

In conclusion, they said that the provisions of the Bill that related to clubs should not be implemented until the impact of the proposed amendments had been properly assessed through inter alia, a cost-benefit analysis and an impact analysis of the effect on the underlying balance sheets of clubs. This would give the SARS Tax Exempt Unit time to evaluate the viability of amending the legislation based on registrations and information provided by clubs that had already made applications for exemption in terms of section 10(1)(d) of the ITA and to engage all relevant stakeholders in the sector in developing a suitable and effective tax regime for clubs.

The additional time would also allow for the development of accounting reporting standards for clubs and the provision of education programmes on governance and accountability to improve the administration of clubs in general.

Discussion
Mr B Mnguni (ANC) said that many clubs were inaccessible to many people. How would the taxation adversely affect the clubs in terms of accessibility?

Mr Wolfsohn replied that the wording of the proposals said “solely for its members.” This would exclude members of the public going to swimming clubs for example if they were non-members. This would also affect the hosting of international events as well. Many clubs could not exist financially without letting non-members in who paid to use the facilities.

Banking Association South Africa submission
Mr Prince Maluleke, General Manager, was appreciative of the opportunity to address the Committee but was also concerned about the limited time the whole industry had to respond to SARS’ and Treasury’s proposals. Maybe in the future it would be better to release the more complex provisions first, and then release the less complicated ones later.

Mr N Nalliah said that the overriding concern with the Reportable Arrangements (RAs) proposals was that a number of them would result in a very substantial number of routine transactions becoming RAs, thus making the proposals impractical. Given the material magnitude of the proposed penalty for non-reporting (R1 million per transaction), the financial implications for banks as well as for most other businesses were extremely material.


The absurdity of imposing a R1 million penalty, per unreported transaction, was patently obvious. Even if the massive uncertainties were in some way clarified, this would result in major businesses reporting thousands (and in the case of financial institutions, tens of thousands) of transactions daily, in great detail, with dire penalties for under-reporting.
It is true that the Commissioner was given the power to reduce these penalties, but there were three remaining objections even to this, namely: Was it a good policy to put such vast powers in the hands of a public servant, however well-meaning that person? How would that public servant possibly deal with the vast volumes of inevitable under-reporting and what were the economic implications of the massive diversion of time by the public service and the public sector into this bureaucratic nightmare?

In terms of the revised proposals for the tax avoidance provisions, Mr Nalliah said that it was concerning that they characterised a number of everyday transactions as impermissible tax avoidance, and had the effect of transferring a significant amount of power governing tax law from the Legislature and Judiciary to the Executive. This was of especial concern, as this transfer would take place in the arena that affected a fundamental canon of tax law, namely that such law be as certain as possible.
Once a transaction constituted impermissible avoidance, the Commissioner was entitled to make adjustments to the transaction, including treating it as if it had never been carried out, thus disregarding the treatment otherwise specified by the ITA. Given the potentially wide scope of these powers, the question was whether the application of, and interpretation of tax legislation should be left in the hands of the Executive, effectively relegating the role of the Judiciary by allowing the Executive to interpret the intention of the Legislature in a manner that could not effectively be challenged?

The proposed section 80A contained four tests in total: the sole or main purpose test; the business context test; the “other than business” context test, being an abnormal manner test and the “any context” test. In terms of the “presumption of purpose” provisions of the proposed section 80G, it was specifically provided that the onus that related to the first test that is, of proving that the sole or main purpose of the arrangement was not to obtain a tax benefit, rested with the taxpayer (or with any party that participated in the arrangement.
The presumption thus existed that the onus rested on the Commissioner to prove that the remaining tests above applied. This had to be expressly stated in the proposed legislation, to ensure that this was clearly understood.
Section 80A also contained a “frustrate” test. That is, any arrangement that resulted in a “tax benefit” was automatically an “impermissible avoidance arrangement” if its sole or main purpose was to obtain this tax benefit and the arrangement would “frustrate the purpose of any provision of this Act”. While it was possible to comply fully with the Act’s provisions that conferred a benefit, while “frustrating” a different provision of the Act it was illogical and problematic to assume that this was a situation that required a remedy.

The proposed section 80C contained three conditions, any one of which would be deemed to characterise an arrangement as having a “lack of commercial substance”. These were in contrast with subsection (2), where a further three circumstances were listed, that could be indicative of a “lack of commercial substance”. The subsection seemed to be trying to influence a Court considering alleged tax avoidance, instead of allowing the Court to consider them objectively. They suggested that section 80C be deleted the draft provisions, as it attempted unduly to influence the Court or remove the Court’s ability to decide at all.
The proposed section 80E contained a prescriptive test where a party could be deemed to be accommodating or tax-indifferent if an amount derived was “substantially offset” by expenditure incurred in connection with the arrangement. In many financial trading transactions, margins of 0,5% or less were common. Expenditure of 99,5% or more of the related income would seem to be “substantial”, but it was absurd that routine financial transactions could result in a party to an arrangement being regarded as accommodating or tax-indifferent.
The section should be amended by either deleting the reference to the “substantial offset” test, or by qualifying the term by wording along the lines of the following: “substantially offset to an extent unusual in the context of the transaction in question.”
Discussion
Mr Davidson said he was uneasy about the way in which the tax avoidance and RA provisions were being presented in a compendium piece of legislation. It was almost as if they were “being snuck in there to get away with something.” One of the issues raised by Judge Dennis Davis a while ago was that the provisions seemed to be usurping some of the powers of the Courts. Those concerns still persisted. He did not think that the Committee had adequately debated this issue before beginning to consider these new proposals.

Mr Nalliah agreed entirely with these comments and said that there had been consultation with SARS and Treasury. Many problems had been addressed but many other issues remained; namely the excessive powers being given to the Commissioner.

The Chairperson said that they were keenly awaiting a response from SARS and the Treasury on this issue.

The meeting was adjourned.

 

 

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