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FINANCE PORTFOLIO & SELECT & JOINT BUDGET COMMITTEES
20 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
South African Council of Churches submission
Business Unity South Africa / South African Chamber of Business submission
The South African Council of Churches said that they agreed that trusts should not bear a disproportionate tax burden but they failed to see why domestic Public Benefit Organisations should be treated like branches of foreign companies.
The real motivation for selecting the 34% tax rate was twofold. One reason was that it was another manifestation of revenue officials’ overzealous attempts to ensure that Public Benefit Organisations did not enjoy any “unfair” advantage in trading over profit-making enterprises. The South African Council of Churches urged Parliament to consider amending the legislation to give Public Benefit Organisations a two-year grace period in which to dispose of property that ceased to be used primarily for public benefit activities. The period should also be calculated to the date of sale, rather than the date of transfer.
Section 26 would also delete Section 30(3)(g) of the Income Tax Act, which required a Public Benefit Organisation to be registered with the Non-Profit Organisations Directorate of the Department of Social Development within a period specified by the Commissioner. This was welcomed.
Business Unity South Africa said that an inflationary element was missing from the provision that dealt with the employee bursary exemption. It would be better to raise the figure to about R5 000. A fiscal “martial law environment” was being created where extreme powers were being given to the Commissioner. While they had a number of recommendations, they proposed that the legislation be put on hold for at least a year. The existing section on General Anti-avoidance Rules and section 103 were manageable.
PricewaterhouseCoopers said that with regard to active royalties, the lack of any amendment to section 9D(9)(b) was disappointing especially given the numerous discussions they had had with Treasury and Revenue on the matter since 12 October 2004. With regard to the anti-avoidance provisions, a major problem was that there was not enough time to analyse all of the presentations.
There were aspects such as section 80C that were excessively prescriptive. Once the law became this prescriptive without consideration of context, the possibility of judicial review was removed which was wrong.
With regard to Reportable Transactions, it would take Revenue and the taxpayers at least another 12 months to understand all of the provisions but here were provisions that compelled reporting with a significant penalty for non-compliance for a concept that was just being introduced. They also agreed with Business Unity South Africa that the bursary limit of R2 000 was far too low given the cost of courses at tertiary institutions.
South African Council of Churches (SACC) submission
Rev Keith Vermeulen, the Director of the SACC’s Parliamentary Office, said that the key areas of concern were that the proposed revenue laws contained clauses that affected aspects of tax law relevant to Public Benefit Organisations (PBOs). They would: alter the tax rates for PBO trading activities; effect technical amendments to Eighth Schedule provisions governing Capital Gains Tax (CGT); add new public benefit activities to Parts I and II of the Ninth Schedule of the Income Tax Act (ITA); extend PBO treatment to most local branches of foreign charities; relax the rules for permissible PBO investments; abolish the NPO registration requirement for PBOs; and regulate the duty payable on goods imported for the 2010 FIFA World Cup and subsequently donated to a PBO.
When the new tax system for PBOs was introduced in 2001, PBOs were only allowed to engage in a very limited range of trading activities without jeopardising their exempt status. PBOs with substantial trading activities were advised to place these under the control of a separate, taxable entity.
Upon reflection, revenue officials agreed with the sector’s objections that these limits were too restrictive and the penalties for breaching them too harsh. As a result, subsequent revenue law amendments relaxed the limits slightly and, more importantly, allowed PBOs to retain trading activities without putting their exempt status at risk. The trade-off was that PBOs would be required to pay taxes on most of the income received from trading that was not otherwise exempt. The rate imposed on income from trading depended on the PBO’s organisational form. Section 21 companies and associations of persons attracted the company tax rate of 29%, while trusts attracted the higher trusts rate of 40%.
Revenue officials now argued that this differential rate imposes an unfair burden on trusts and proposed to equalise the tax rate at 34%. The justification of this rate was on the grounds that it was aligned with the branch profits rate of foreign companies, which combined income tax and Secondary Tax on Companies. They agreed that trusts should not bear a disproportionate tax burden but they failed to see why domestic PBOs should be treated like branches of foreign companies.
They suspected that the real motivation for selecting the 34% tax rate was twofold. First, it represented an attempt to prevent a potential loss to the fiscus as a result of lowering the rate of tax on trusts. Secondly, it was another manifestation of revenue officials’ overzealous attempts to ensure that PBOs did not enjoy any “unfair” advantage in trading over profit-making enterprises.
The majority of PBO trading activities did not directly compete with those of profit-making enterprises. Even where they did, there was little evidence that they undersold or otherwise crowded out for-profit trade. More importantly, the whole point of developing a separate tax regime for PBOs was to encourage them and their activities by giving them a privileged position relative to for-profit enterprises. Efforts to “level the playing field” with for-profits therefore undermined the public policy objectives that gave rise to the PBO tax system in the first place. Consequently, they believed that Section 140 should be changed to make the rate of tax on all PBOs and recreational clubs 2%, rather than 34%.
With reference to CGT, sections 55 and 56 of the proposals reorganised provisions inserted in the Eighth Schedule of the Income Tax Act (ITA) at the end of 2005. They clarified amendments that did not significantly alter the impact of these clauses. However, rereading these sections in conjunction with Draft Interpretation Note 24 (Issue 2), released by SARS in July 2006, highlighted several concerns about the potential impact of these provisions.
If CGT was assessed on all assets not directly deployed in connection with public benefit activities, PBOs would effectively be penalised for investing surplus funds in securities or any financial instrument. This would be a particular problem for PBOs engaged in the provision of funds and resources to other PBOs. Presumably their activities would be supported by a significant endowment which is likely to be invested in shares and other assets. Taxing the returns on this investment would undermine their capacity to finance public benefit activities and frustrate the very objectives that the PBO tax regime was established to promote.
Even if the assessment of CGT was limited to real assets, there would still be practical problems with the assessment of CGT on assets that had a hybrid use or that underwent a change of use. With respect to hybrid use, the Eighth Schedule of the ITA currently required “substantially the whole of the use” of an asset to be for public benefit activities if it was to be exempt from CGT on its disposal. Draft Interpretation Note No. 24 explained that SARS interpreted “substantially the whole” to mean 85% or more. This “all or nothing” approach was problematic.
The SACC urged Parliament to consider amending the legislation to give PBOs a two-year grace period in which to dispose of property that ceased to be used primarily for public benefit activities. The period should also be calculated to the date of sale, rather than the date of transfer.
Section 62 expanded the range of housing activities eligible for PBO status in terms of Part I of the Ninth Schedule, while sections 63 and 63 added these and additional conservation, environmental and animal welfare activities to list of donor deductible activities in Part II of the Ninth Schedule. These changes were unlikely to have significant impact on faith-based organisations, but they support them in principle.
Section 26 amended section 30 of the ITA to include local agencies or branches of foreign charities in the definition of PBO, provided that the parent organisation had the equivalent of PBO status in the country in which it was based. This change necessitated consequent changes to other sections of the ITA. In addition, the local branches of foreign PBOs would only be expected, on dissolution, to transfer their local assets (as opposed to all of their assets) to a similar organisation with in the Republic.
The SACC supported these changes but section 19 would amend section 18A of the ITA to limit 18A (donor deductibility) benefits to domestic PBOs. While it was understandable that SARS wanted to deny domestic tax credit for donations deployed outside of the Republic, it was likely that most donations to local branches of foreign charities would be used within the Republic. It would make more sense to make the 18A status of any given donation conditional on the end use of that donation rather than on the national home of the mediating agency.
Section 26 also abolished most of the restrictions on permissible PBO investments. The only remaining prohibitions would be on foreign investment and on the direct or indirect distribution of proceeds to any person. They supported these changes and the additional flexibility they afford to PBOs.
Section 26 would also delete Section 30(3)(g) of the ITA, which required a PBO to be registered with the Non-Profit Organisations (NPO) Directorate of the Department of Social Development within a period specified by the Commissioner. This was welcomed. They hoped that the Ministry of Finance would now urge government departments and agencies to use PBO status, rather than NPO status, as a criterion for assessment of eligibility to access public funds.
Section 11 of the amended Schedule 1 of the Value-Added Tax Act, 1991, to give effect to Government Guarantee 3 made to FIFA. It regulated the duty payable on goods imported duty free for use or sale during the 2010 World Cup, but then donated to a PBO. They had no objection to the principle that reasonable duties should be paid on such items.
Mr Y Bhamjee (ANC) asked if they had discussed their issues and concerns with SARS. If not, why not?
Rev Vermeulen replied that that they had been in consultations with SARS and the views they expressed here had been formulated over the last six years. However, the SACC had not received responses for some of their concerns and this presentation was part of the ongoing process in revenue reform.
Business Unity South Africa (BUSA) / South African Chamber of Business (SACOB) submission
Mr Bill Lacey, an Economic Consultant with the South African Chamber of Business, said that there seemed to be an omission in section 10(1)(q) of the Act. An inflationary element was missing from the provision that dealt with the employee bursary exemption. It would be better to raise the figure to about R5 000.
SARS and Treasury seemed to think that tax avoidance was rampant. This was an incorrect perception. For example, in the last budget, company tax exceeded R100 billion, a 30% increase from last year. A culture of tax compliance was developing. From the performance of SARS in the recent past, no one could argue that the system was not working. Whether the system was understood was debatable and BUSA had been, and remained, concerned over the introduction of new provisions that posed complexities for tax compliance.
With regards to ‘impermissible avoidance arrangements’, section 80A(c)(ii) broadly declared such an arrangement to be one whose sole/main purpose ‘in any context’ would ‘frustrate the purpose of any of the provisions of this Act’. BUSA said that this ‘catch all’ provision extended the power and related determinations of the tax authority beyond any recourse from the tax payer and the whole system was becoming more complex. A fiscal “martial law environment” was being created where extreme powers were being given to the Commissioner.
The perceived avoidance associated with ‘round-tripping’ of money constituted a serious concern for business. Many commercial transactions required what would now be deemed to be ‘round-tripping’ and certain transactions within the group relief provisions actually necessitated this practice. Furthermore, the use of this sophisticated cash management system by many corporate taxpayers would probably be disallowed as it may be considered to fall within the ambit of this provision.
With reference to ‘accommodating tax indifferent parties,’ a number of commercial transactions required tax indifferent parties for pure commercial reasons. Its adoption would undoubtedly create uncertainty which was unhealthy to the business environment. This indicator should preferably form part of a comprehensive interpretation note. It would ensure that taxpayers were aware of how SARS viewed this element without legislating on the subject.
The introduction of section 80F enabled SARS to treat connected persons as one entity and they could disregard tax indifferent parties and accommodating parties. To the extent that BUSA believed that the issue of group taxation was an area still to be developed, it believed that it would be inadvisable to introduce a concept that had a bearing on group taxation into the (General Anti-avoidance Rules) GAAR. More uncertainty would be created.
While BUSA had a number of recommendations, they proposed that the legislation be put on hold for at least a year. The existing GAAR and section 103 were manageable. The problems lay in getting SARS to take their issues to the Court for them to be tested, rather than introducing legislation that allocated abnormal powers to the Commissioner. Some elements of the legislation could also be dealt with in Interpretation Notes.
Mr B Mnguni (ANC) asked how BUSA wanted the provisions relating to impermissible tax avoidance couched so that they did not give too much power to the Commissioner.
Mr Lacy said that SARS proposals had actually changed things for the worse. Many of the proposals gave too much power to the Commissioner. They wanted people to be ruled by laws that were understood by everybody. Many of the phrases used created uncertainty and were very difficult to interpret in a legal sense.
PricewaterhouseCoopers (PwC) submission
Mr David Lermer, the PwC Tax Director, said that section 9D(1) was the codification of a practice SARS had been allowing in practice. The insertion of subsection (a)(i) to the definition of “foreign business establishment” (FBE) permitting one controlled foreign company (CFC) to access the employees of another in justifying its own business, was welcomed.
However, they were concerned that the requirement for those employees to render services on a fulltime basis could be implied to mean on a fulltime basis to the CFC that sought to establish its FBE. Often where group services companies were used, their employees may render their services to a different number of group companies in that territory and could not be said to do so to any one company on a fulltime basis. Accordingly, they suggested that this requirement be relaxed to be the rendering of services on a fulltime basis for that business or the business of other group companies.
With regard to active royalties, the lack of any amendment to section 9D(9)(b) was disappointing especially given the numerous discussions they had had with Treasury and SARS on the matter since the 12th of October 2004. They were also concerned that the calculation in section 9D(10)(a)(i) was overly harsh in determining the foreign tax after use of assessed loss, credit or rebate. To deny the availability of the Commissioner’s discretion in these cases was inappropriate.
Clarity was needed about the term “contiguous countries” in section 9D(10)(a)(ii) meant. Would this encompass the UK or Ireland for example, separated as they were by the Irish Sea? They recommended that this discretion be available in respect of companies that operated as regional hubs, in respect of that region and in line with the manner in which many multi-national groups operated.
With regard to the anti-avoidance provisions, they echoed the concerns of the South African Institute of Chartered Accountants. A major problem was that there was not enough time to analyse all of the presentations.
There were aspects such as section 80C that were excessively prescriptive. Once the law became this prescriptive without consideration of context, the possibility of judicial review was removed which was wrong. The “frustrate” concept in section 88C(2) could be applied without the “abnormality” requirement. This was wrong as there had to be some sort of ‘abnormality’ for the transaction to not have commercial substance. Also, what did “frustrate” really mean anyway?
The first set of factors in section 88C were prescriptive but the second set were only indicative. PwC said that they should all be indicative. There were also deadlines for taxpayers to respond to SARS within 30 days but the provisions were silent about how long SARS had to reply.
With regard to Reportable Transactions (RAs), Mr Lerner said that there were a number of similar indicators to the anti-avoidance provisions that the taxpayer had not read yet or was aware of. It would take SARS and the taxpayers at least another 12 months to understand all of the provisions but here were provisions that compelled reporting with a significant penalty for non-compliance for a concept that was just being introduced. Once the law was settled this could be instituted, but it was too soon.
Another concern was that the number of transactions that were reportable was too many. This would impose an added burden on taxpayers and may lead to a deluge of reporting that would overwhelm SARS as well. The penalty itself (R1 million), was harsh for new legislation. They suggested that it be changed to: the lower of twice the tax or R1 million.
Mr J Aitchison, the Senior Tax Manager, then said that paragraph 61 exempted capital gains and losses of a Collective Investment Scheme (CIS) by requiring those gains to be disregarded. However, where the gain related to an asset which was acquired in terms of one of the corporate rollover relief mechanisms in Part III and then disposed of within 18 months, by reason of the over-ride stipulated in section 41(2), the ring-fencing provisions of sections 42(7) or 45(5) would apply in priority over paragraph 61 with the result that the gain would be included as a taxable gain of the CIS. They recommended that the wording in paragraph 61 be amended to refer not to the disregarding of any capital gain or loss of a CIS, but rather to the disregarding of any disposal by a CIS.
The foreign financial instrument holding company and the domestic financial instrument holding company tests in section 41 were very complex, costly and time-consuming. A more simplified version was needed. Also, the amounts due to a company as per subsections (a) to (c) may fall into the provisos in (i)(bb) or (cc). They suggested that it be inappropriate for financial instruments which were treated as “good” in terms of the former paragraphs to be then excluded because of the proviso.
They agreed with BUSA that the bursary limit of R2 000 was far too low given the cost of courses at tertiary institutions. Also, the distributions of capital of foreign trusts to a South African beneficiary were an issue. If the funds were put into a trust by the foreigner, section 25B(2)(a) said that if the money had been subject to tax if it was of a South African resident, then it becomes taxable in the hands of the South African resident. This was fine where the money was put into the trust by a South African, but where it was put in by a foreigner for a South African beneficiary with no direct link between them; this was anti-avoidance “gone too far.”
Donations to Government for certain activities, for example for the construction of a hospital, allowed the donor to receive a deduction. PwC wanted this category extended, for example to those donors who donated towards infrastructure development such as roads.
Mr Mnguni asked if increasing the bursary amount would benefit companies in any way. PwC said that the RA penalty should be relaxed for a while since people would understand the whole Bill. After how long should it become applicable in full?
Mr Lerner replied that the reason for the RA provisions was because people were not reporting. They preferred the penalty to match the crime, such as imposing twice the tax, along with the exercise of some discretion. Education was an area that had to be enhanced as a matter of course. The incentive was meant for people who earned less than R60 000 per year so the R2 000 limit was not enough for them to get a proper education.
The meeting was adjourned.
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