Revenue Laws Amendment Bills; Adjustment Appropriation Bill: briefing and finalisation

FINANCE SELECT COMMITTEE
13 November 2006
REVENUE LAWS AMENDMENT BILLS; ADJUSTMENT APPROPRIATION BILL: BRIEFING AND FINALISATION

Chairperson: Mr T Ralane ((ANC) (Free State)

Document handed out:
Revenue Laws Second Amendment Bill [B34-2006]
Revenue Laws Amendment Bill [B33-2006]
Adjustments Appropriation Bill [B32-2006]
South African Revenue Service (SARS) presentation on Revenue Laws Amendment Bill
Treasury presentation on the 2006 Adjustments Budget
 
SUMMARY
The South African Revenue Service took the Committee through the Revenue Laws Amendment Bills. The first proposal dealt with research and development. South Africa’s spending on research and development was very low so the incentive in the Bill was meant to encourage spending in line with broader Government objectives. The incentive allowed an increase in the deductible expenditure from 100% to 150%. A key challenge South Africa faced was the mismatch between employer needs and employee skills. In this regard, employees could receive tax-free training bursaries under certain conditions.

South Africa had maintained a special fiscal incentive/stability regime for oil and gas exploration and production known as OP26 for over 30 years. Government intended to formalise key aspects of OP26 into explicit law (within the 10^th Schedule to the Income Tax Act as opposed to agreements outside the tax code), thereby creating transparency and certainty for oil and gas exploration/production.

With regard to Public Benefit Organisations, a flat rate of 29% for excess trading activities would be applied regardless of the form of the Public Benefit Organisation. Excess funds could be freely invested in any form of passive investment.

Recreational clubs currently received complete exemption from Income Tax with few restrictions. This exemption was questionable in an environment with a high degree of disparity between rich and poor. The proposal here was for the clubs to become subject to a system of partial taxation.

Restructuring of the electricity distribution sector would involve the transfer of assets from Municipalities and Eskom to the Regional Electricity Distributors (REDs). REDs would be exempt from Income Tax up to 2014, at which time a review would be undertaken and they were allowed to account for VAT on a payment basis.    

As countries bidding to host the 2010 World Cup had been required to sign a number of guarantees ranging from visa requirements to safety and security. There were also two guarantees required in terms of taxation. Following South Africa’s successful bid, Treasury, FIFA and the South African Revenue Service came up with a Memorandum of Understanding that contained the provisions of the tax-related guarantees.

With regards to the Adjustment Appropriation Bill, Treasury said that they had received requests for unforeseeable and unavoidable expenditure that amounted to R7.3 billion but the Treasury Committee had approved only R1.7 billion of this. There were declared savings (the amount by which Departments wanted their budgets reduced because they could not spend it all) of R2.1 billion for 2006/07 compared with only R5 million in 2005/06. Land Affairs and Correctional Services had the highest amounts at R1.122 billion and R603 million respectively. The Committee agreed to the Bill.
 
MINUTES
Consideration of Revenue Laws Amendment Bill
Mr Mark Price, Director: Legislation at SARS, took the Committee through some of the amendments. The first was in research and development (R & D). The benefits of R & D expenditure spilled over to other parties and it was difficult to exclude others from using the outcomes of the research as once a patent had expired it became public goods. R & D activities were risky, costly and the outcomes were uncertain. On the other hand, they contributed to productivity, competitiveness, economic growth and skills development.

South Africa’s spending on R & D was very low so the incentive in the Bill was meant to encourage spending in line with broader Government objectives. The national R & D strategy was adopted in 2002 with a target of R & D spending of 1% of GDP and increasing it to 2%.

How the incentive would work would be the increase in the deductible expenditure from 100% to 150%. This would apply only to R & D activities undertaken in South Africa and they must be of scientific or technological nature for the purpose of new discoveries and inventions. The depreciation allowance related to capital expenditure was changed from the current four year write-off period (40: 20: 20: 20) to a three year period (50: 30: 30). A full deduction would be given for expenses incurred in obtaining or renewing a patent and the registration or extension of any design.

However, expenses for exploration or prospecting; management or internal business processes; trademarks; social sciences or humanities; market research or marketing promotion would not be deductible. For monitoring purposes, taxpayers would be required to report additional information to the Department of Science and Technology (DST) (the type of information, form and location of this reporting was to be determined by the DST). The DST would be required to report to Parliament stating the benefits that accrued to qualifying R & D activities and those activities that contributed to innovation, competitiveness and economic growth. 

A key challenge South Africa faced was the mismatch between employer needs and employee skills. In this regard, employees could receive tax-free training bursaries under certain conditions. Their proposal was to give tax-free employee bursaries if those bursaries were part of a salary sacrifice. Employers could fully deduct bursaries even if viewed as a salary sacrifice. This proposal eliminated any potential uncertainty. It was also subject to an agreement that the employee would repay the money if they were unsuccessful due to ill health or death.

A special withholding tax regime was introduced in 2000 to discourage employers from artificially providing services through corporate entities (Personal Service Entities [PSE]) in order to reduce their tax liabilities. This special regime penalised these PSEs by accelerated tax payments and increasing effective tax rates. After consultation with various stakeholders, it was established that this regime negatively affected legitimate small businesses.

Companies/trusts were subject to employee monthly withholding if they qualified as a PSE. The PSE status no longer existed merely because the client controlled and supervised the manner of the SME’s work (unless the work must be mainly performed at the client’s premises). Safe harbour from PSE status now existed if that PSE had a minimum of three employees (as opposed to the four-employee minimum). (The employee minimum for the SME business relief was similarly reduced).

Clients of SMEs could be relieved of any withholding tax responsibility by good faith reliance on an affidavit by the SME that the SME was not a PSE. PSEs could also deduct more than the salary. They could deduct items such as business premise expenses, pensions and medical scheme contributions. The standard 34% withholding rate for PSEs could be reduced to a more realistic final tax liability level upon receipt of a South African Revenue Service (SARS) directive.

With regard to co-operatives, in 2005 the Department of Trade and Industry enacted the new Co-operatives Act to facilitate the operation of co-operatives. However, the Income Tax Act needed to be updated in line with this Act and there was a need to incentivise co-operatives in line with international practice.

Mr Frans Tomasek, Assistant General Manager of Legislative Policy at SARS, said that South Africa currently obtained its transport energy needs from the following sources: imported crude; coal-to-liquids; gas-to-liquids and local offshore crude. Local offshore oil and gas deposits that were being currently exploited were nearing the end of their lives. South Africa had maintained a special fiscal incentive/stability regime for oil and gas exploration and production known as OP26 for over 30 years.

The purpose of OP26 was to create incentives and certainty for potential investors to encourage exploration given the limited known oil and gas deposits on and offshore. OP26 was meant to expire in June 2007 and this was impending expiry was delaying key exploration activities off South Africa’s South and west and south coasts. Government intended to formalise key aspects of OP26 into explicit thereby creating transparency and certainty for oil and gas exploration/production.

The incentive applied to any company that either holds or leases oil and gas “new order” rights; or engaged in oil and gas exploration/production or gas refining, but the company could not engage in any other trade. The incentive applied to both domestic and foreign companies.

In terms of the maximum corporate tax rates, rates for domestic gas and oil companies could not exceed 29% and those for foreign companies could not exceed 32.38%. the current tax on secondary companies could not generally exceed 5% and the pre-existing OP26 rights holders generally received the benefit of a 0% limitation. Exploration capital expenditure (capex) received an immediate 200% write-off and production capex received a 150% write-off.

Capex and operating expenditure (opex) could be freely deducted during the start-up phase and any other associated finance charges could be similarly deducted. Capex and opex losses generally could only be used against oil and gas production income or gas refining income. However, 10% of any unused excess above the ‘ring-fencing’ could be freely deducted (against investment income). All unused losses could be carried forward.

mining companies had to make long-term financial provision for environmental rehabilitation on closure in terms of the Mineral and Petroleum Resources Development Act (2002). Methods of financial provision included setting reserves aside in a rehabilitation fund. Contributions to these funds were currently tax deductible and the growth accumulated was tax-free. These incentives for set aside reserves operated as an incentive for environmental rehabilitation.

The list of parties who could make deductible contributions to rehabilitation funds was expanded to include holders of mineral rights, parties engaged in mining/prospecting without mineral rights and other subjects subject to the Commissioner’s approval. All contributions to valid funds were deductible and as quid-pro-quo for the above relief, the rules that prevented impermissible withdrawals were tightened.

Individual Retirement Annuity Funds could not be withdrawn before the age of 55 to ensure retirement savings. However, administrative fees could eliminate any growth (or the funds themselves) if the funds were small. The Minister would be given the power to regulate all de minimis withdrawals with the level set by way of Gazette Notice.

For post-retirement employer benefits, in 2001, Government agreed minimum benefits (out of employer contributions). Among other impacts, this guarantee required the surplus to be apportioned to ex-fund members. Ex-fund members now had a choice when receiving these post-retirement benefits. They could withdraw the benefits and be subject to tax or rollover those benefits into another retirement fund free of tax.

With regard to Public Benefit Organisations (PBOs), since 2001 the Government had amended the provisions that related to the Income Tax status of PBOs. The proposed amendments addressed some of the anomalies by creating financial sustainability for PBOs, encouraging foreign charitable donor support into South Africa and easing any undue administrative burdens on the PBOs.

A new provision would apply a flat rate of 29% for excess trading activities regardless of the form of the PBO. The system would be neutral as to whether the PBO conducted the activity directly or through a separately controlled company or trust. It would be administratively easier to track trading activities in a separate vehicle.

The second provison was that foreign PBOs could receive Income Tax exemption (as well as a possible VAT zero rating) like domestic PBOs. They had to prove their PBO status existed in the foreign home country and only South African located assets had to be transferred to South African PBOs if the foreign one liquidated (not the foreign PBO’s worldwide assets). Donations to foreign PBOs however, would not be deductible.

Recreational clubs currently received complete exemption from Income Tax with few restrictions. This exemption was questionable in an environment with a high degree of disparity between rich and poor. The proposal here was for the clubs to be become subject to a system of partial taxation. They would only qualify for exemption to the extent that their activities merely represented a sharing of expenses by members through membership fees. Operating and investment revenues generated from outside sources would now be generally taxable at a rate of 29%.

Restructuring of the electricity distribution sector would involve the transfer of assets from Municipalities and Eskom to the Regional Electricity Distributors (REDs). REDs would be exempt from Income Tax up to 2014, at which a review would be undertaken and they were allowed to account for VAT on a payment basis.    

Traditional communities would be explicitly exempt until a date was determined by the Minister. Government payments for assets were generally taxable under current law. The proposal was to that Government payment for assets solely for destruction and scrapping of diseased animals would be exempt by Government notice.

All the countries that had placed a bid to host the 2010 World Cup were required to sign a number of guarantees ranging from visa requirements to safety and security. There were also two guarantees required in terms of taxation. Following South Africa’s successful bid, Treasury, FIFA and SARS came up with a Memorandum of Understanding that contained the provisions of the tax-related guarantees.

FIFA and its subsidiaries; FIFA national associations; FIFA affiliated partners, operators and media associations amongst others were allowed to import World Cup goods free of import taxes. Also free from import taxes (Schedule 1, part VI and Schedule 2) were trading stock for resale or re-exportation; samples of trading stock not for resale, distributed at a site or re-exported; capital goods and promotional material and household effects of a person seconded to the country for the World Cup among others.

Other tax aspects of the guarantees involved the exemption (and partial exemption) from tax of certain persons. FIFA, its subsidiaries and its national associations (except SAFA) were wholly exempt. FIFA’s commercial affiliates; licensees; merchandising partners; providers; concession operators and flagship store operators (among others) were partially exempt.

The wholly exempt entities would be treated in a similar manner to diplomatic missions for VAT refunds in respect of goods directly connected to the Cup. There were some specific exclusions however: embedded taxes such as fuel levies and excise duties, where match tickets, accommodation or off-site hospitality was sold by any of the wholly exempt entities, VAT had to be levied and FIFA was to withhold UIF and the Skills Development Levy from its employees.

The partially exempt entities were essentially FIFA sponsors and the exemption operated in limited areas and periods of time (a “tax-free bubble”). Gods and services sold within designated sites would be free of Income Tax and VAT. However, expenses related to such sales would not be allowed as deductions for Income Tax purposes.

The “tax-free bubble” concept was limited to the stadia, one week before the Cup until the closing ceremony for both the Confederations and World Cups; training sites on official FIFA sanctioned training days; official host city public viewing venues, on Championship days only and the FIFA flagship store, six months before the 2009 Confederations Cup until one month after the closing ceremony of the 2010 showpiece.

Income derived from non-residents in connection with staging the championship would not be subject to Income Tax. These included the FIFA delegation; referees; all commercial affiliate staff; all merchandising partner staff and designated service providers’ staff among others. However, team members; directors and personnel of SAFA and directors of the Local Organising Committee would be subject to Income Tax on income derived in connection with the Cup.

Tickets and hospitality services (including hotel accommodation) would be subject to VAT at the standard rate (14%). Some of the VAT revenue collected from the sale of tickets would be made available via the budget of the Department of Sports to subsidise the ticket prices for some of the local supporters.

Discussion
Mr D Botha (ANC) (Limpopo) asked why Government notice was needed for the destruction and scrapping of diseased animals. Would this not lead to major delays, especially where the farmers needed payments.

Mr Price replied that the system was not one where each farmer would have to get an exemption. The process envisaged in the Bill, was that if any program or scheme was approved by the Minister, any payments made in furtherance of that scheme were exempt.

Mr B Mkhaliphi (ANC) (Mpumalanga) asked why there was inequality in the reporting requirements of taxpayers and SARS. Taxpayers had 60 days to respond to SARS requests but SARS had 180 days to respond.

Mr Tomasek replied that SARS were the people trying to figure out what was going on but the taxpayers knew what was going on. When SARS asked for information from the taxpayers, in some cases they received incomplete information so the 60-day period was reasonable. Taxpayers could also apply for extensions of this period as well.

Consideration of Adjustment Appropriation Bill
Mr Neil Cole the Treasury's Director of Budget Reform, said that R230.4 billion had been made available for spending in 2005/06. Of this, 2.4% or R5.6 billion had been unspent. Approximately R1 billion of the unspent amount was due to savings being made, that is, there were some managerial interventions that led to the savings. R800 million had not been transferred to the Provinces due to non-compliance with the Division of Revenue Act. The March 'spike' in expenditure was still a concern.

On aggregate, Departments should be at an expenditure level of 40% of their budgets. Last year, 48.1% of the total budget had been spent at this point, and it was too early to assess if the March 'spike' would recur.

Section 30(2) of the Provincial Financial Management Act (PFMA) said that adjustment budgets could provide for significant and unforeseeable economic and financial events affecting fiscal targets; any expenditure in terms of section 16 of the PFMA; money to be appropriated for expenditure already announced my the Minister during tabling of the annual budget; roll-over of spent funds from preceding financial years and the shifting of funds between and within votes.

Unforeseeable and unavoidable expenditure was that that was unforeseen at the time of the tabling of the budget and was now deemed to be unavoidable. However, expenditure that, although known when finalising the estimates of expenditure, could not be accommodated within locations, tariff adjustments and price increases and extensions of existing services and the creation of new services that was not unforeseeable and unavoidable, could not be considered as unforeseeable and unavoidable expenditure.

The Treasury had received requests for unforeseeable and unavoidable expenditure that amounted to R7.3 billion but the Treasury Committee had only approved R1.7 billion of this (R900 million was flood related, R662 for changes to VAT and R138 for others).

In terms of section 16 of the PFMA, expenditure of an exceptional nature which was currently not provided for and which could not, without serious prejudice to the public interest, be postponed to a future appropriation could be included in an adjustment budget. In this regard, emergency funding of R110.546 million was approved by the Minister for disaster relief for the floods in Taung in the North West.

The budget made provision for World Cup stadiums but this was not allocated to a specific vote. R600 million had been given to the Department of Sport and Recreation. It was also announced in the budget that a contingency reserve could be used for the recapitalisation of State Owned Enterprises. Some of these were the Pebble Bed Reactor (R462 million); Denel (R567 million); InfraCo (R627 million); Alexkor (R80 million) and the South African Rail Commuter Corporation (R620 million).

There were declared savings (the amount by which Departments wanted their budgets reduced because they could not spend it all) of R2.1 billion for 2006/07 compared with only R5 million in 2005/06. Land Affairs and Correctional Services had the highest amounts at R1.122 billion and R603 million respectively. Projected under-expenditure for the current year was R2.1 billion compared with a projection of R2.5 billion in 2005/06. Declared savings and projected under-expenditure for 2006/07 totalled R4.2 billion.

The Fund Appropriation Bill showed funds appropriated per programme. The format was based on standardised classification aligned to international reporting requirements. The total adjustment from National Departments amounted to R8.2 billion. Adjustments were offset against the contingency reserve; unallocated amounts; declared savings and projected under-expenditure. The adjustments resulted in an increase in expenditure from R472.7 billion to R474.2 billion.

Voting on Bills
The Committee agreed to adopt both the Revenue Laws Amendment Bills and the Adjustment Appropriation Bill.

The meeting was adjourned.