“Bulking” Progress Report; Double Taxation Treaty with Saudi Arabia

FINANCE PORTFOLIO COMMITTEE
06 March 2007
“BULKING” PROGRESS REPORT; DOUBLE TAXATION TREATY WITH SAUDI ARABIA

Chairperson: Mr N Nene (ANC)

Documents handed out:
Financial Services Presentation on "bulking"
Treasury Presentation on Double Taxation Agreement with Saudi Arabia

Other Relevant document:
FSB Sunday Times Report

SUMMARY
The Committee was briefed on the double taxation agreement between South Africa and Saudi Arabia. The purpose of the tax treaty was to promote economic growth by providing certainty to cross border investments. It would prevent double taxation of the same income through certainty of tax treatment and assignment of taxing rights between the two countries.
It would reduce the withholding tax rate and reduce fiscal evasion. There would be assistance in the collection of taxes.

The Committee received a progress report on bulking by the Financial Services Board. There were approximately 200 pension fund administrators approved in terms of section 13B of the Pension Funds Act, No. 24 of 1956 (the Pension Funds Act). The majority of these administrators only administered one fund and the practice of bulking different clients' funds was therefore not available to them. An agent was not allowed to make any profit from its agency relationship except for the agreed remuneration with its principal. Any profit derived from the relationship belonged to the principal. Accordingly, the benefit that an administrator had derived from the retention of a portion of any enhanced interest earned on bulked accounts amounted to a secret profit. It was only permissible for the administrator to retain a portion of such profit with the prior free consent of its principal following upon a full disclosure by the agent of its practice and the benefits resulting there from. 11 administrators reported that they did bulk their clients' funds but that the full credit of the enhanced interest rate was passed on to their clients or that the prior approval of trustees were obtained for any benefit accruing to the administrator from the practice of bulking funds.

Members asked many questions which included:
- Did the FSB have the necessary capacity to handle the work given the seriousness of the matter and amounts involved. There was an outcry about crime in the country.
- To what extent did the FSB refer matters to the National Prosecuting Authority (NPA) because these were criminal matters.
- What was the role of the Financial Intelligence Centre in relation to bulking?
- How many licences had been withdrawn?
- How much or what percentage of money earned as a result of "bulking" would flow back to beneficiaries
- Was the FSB considering legislative amendments to ensure that it could intervene and force administrators to pay the secret profits to beneficiaries.
- What were the aims and objectives of the FSB Consumer Education Trust and who were the trustees? Who were the beneficiaries and who decided what the trust should do?
- On what basis were companies asked to make donations? Was there a formula that took into account the perceived harm done? How was the figure determined? Was it a trade off against referral to the NPA or withdrawal of approval?

MINUTES
Briefing by Treasury on Double Taxation Treaty with Saudi Arabia
Ms Yanga Mputa (Treasury Director: Tax Policy) and Mr R van der Merwe (SARS: Chief Negotiator) attended the meeting. Ms Mputa made the presentation (see document attached). Mr van der Merwe took the Committee through the technical aspects of the Treaty (see document attached). The purpose of the tax treaty was to promote economic growth by providing certainty to cross border investments. It would prevent double taxation of the same income through certainty of tax treatment and assignment of taxing rights between the two countries. The treaty would promote foreign relations with Saudi Arabia in line with the policy of the Department of Foreign Affairs. South Africa was engaged in negotiations on other bilateral agreements with Saudi Arabia. South African exports to Saudi Arabia were R2, 1 billion in 2006. The main commodities exported were prepared foodstuffs, vegetable products and base metals. The imports from Saudi Arabia were 24, 5 billion in 2006. The main commodities imported were oil and chemical products.

Mr van der Merwe said that the treaty would remove barriers to cross border trade by eliminating double taxation. It would reduce the withholding tax rate and reduce fiscal evasion. There would be assistance in the collection of taxes. It closely followed the OECD model convention. Some of the provisions were different from the normal South African approach. Article 4(1)(b) clarified the residence status of exempt bodies. It made it clear the bodies listed therein qualified for the benefits as residence of the contracting States. This was more relevant to Saudi Arabia and had to do with the difference between liable to tax and subject to tax. The South African approach was that one was liable to and the exempted from paying tax. Liability existed up front. This was not the case in Saudi Arabia.

He said that Article 5 dealt with "permanent establishment". A certain threshold had to be crossed before a business of one State could be liable to pay tax in the other State. Article 7(4) provided that business profits derived by an enterprise of a Contracting State from the export of merchandise to the other Contracting State should not be taxed in that other Contracting State. The intention was not to tax business with a country but business in a country. However, the other Contracting State could tax the activities if the contracts for the export of merchandise included other activities carried on through a permanent establishment of the enterprise in the other Contracting State. Article 10 dealt with the taxing of dividends and there was a split between the Contracting States. Article 21 dealt with teachers and researchers and was not found in some of the South African treaties with other countries.

Discussion
The Chairperson asked if Article 27 was the only provision that dealt with exemption from taxation by the host State.

Mr van der Merwe replied that it was not the only one. The government would normally bring the provision into the treaty because it was in any case already part of domestic law. Saudi Arabia had requested its incorporation and SA had no problems including it.

Mr K Moloto (ANC) said that double taxation agreements were quite standard. Most aspect of the conventions had already been explained to the Committee in previous meeting of double taxation agreements. He asked what were new issues in the agreement besides Article 21.

Mr van der Merwe replied that it was a relatively standard treaty. The teachers and researchers provision was probably included in nearly half of the existing treaties.

Briefing by the Financial Services Board on "Bulking"
The Chair said that the Committee had requested the Financial Service Board (FSB) to provide an update on "bulking". The matter was discussed in the Committee last year. Bulking was a cause for concern in the financial markets. It was indicated in last year's meetings that the meetings on "bulking" were not trials but held in order to protect the integrity of the industry. The Committee also had to play its oversight role and assist wherever possible. Mr Tshidi had last year indicated that the FSB would from time to time come back to the Committee to seek assistance on how to tighten problematic areas. Mr Jonathan Dixon (Treasury Chief Director: Financial Sector Policy) Mr Rob Barrow (FSB: CEO), Mr Jurgen Boyd (FSB: Deputy Chief Executive- Pension Funds) and Mr Dude Tshidi (Deputy Executive Officer: Investment Institutions) and Mr Fannie Rossouw (Senior Legal Advisor) attended the meeting. Mr Boyd made the presentation. (See document attached). He said that On 24 March 2006 the Registrar of Pension Funds issued a general circular requiring all pension fund administrators to disclose voluntarily all bulking and other practices whereby secret profits were made at the expense of the pension funds whose assets they administered. Responses were received from 66 pension fund administrators, which included all the major pension fund administrators. There were approximately 200 pension fund administrators approved in terms of section 13B of the Pension Funds Act, No. 24 of 1956 (the Pension Funds Act). The majority of these administrators only administered one fund and the practice of bulking different clients' funds was therefore not available to them. Having considered the responses the Registrar was satisfied that all the major administrators co-operated and responded to the general circular.

He said that the practice of bulking client funds was not per se unlawful or objectionable. On the contrary, it was expected of administrators in fulfilling their fiduciary duties towards pension funds, to achieve the best possible return on investment for the funds. The relationship between a pension fund and its administrator was one of agency, which encapsulated the principles of trust, confidence and good faith. An agent was not allowed to make any profit from its agency relationship except for the agreed remuneration with its principal. Any profit derived from the relationship belonged to the principal. Accordingly, the benefit which an administrator had derived from the retention of a portion of any enhanced interest earned on bulked accounts, amounted to a secret profit. It was only permissible for the administrator to retain a portion of such profit with the prior free consent of its principal following upon a full disclosure by the agent of its practice and the benefits resulting therefrom.

Of the 66 responses alluded to above, 36 administrators reported that they did not bulk their clients' funds; did not make secret profits and had "nothing to declare" following the invitation in the Registrar's general circular. The FSB had no reason to doubt the veracity of these reports. However, the continued surveillance of pension funds and their administrators by way of on-site visits by the Pensions Department's Compliance Division would endeavour to verify these reports. Eleven administrators reported that they did bulk their clients' funds but that the full credit of the enhanced interest rate was passed on to their clients or that the prior approval of trustees were obtained for any benefit accruing to the administrator from the practice of bulking funds.

Discussion
The Chairperson said that there was a lot of work to be done. He asked if the FSB had the necessary capacity to handle the work especially given the seriousness of the matter and the amounts involved. There was an outcry about crime in the country. To what extent did the FSB referred matters to the National Prosecuting Authority (NPA) because these were criminal matters.

Mr Boyd replied that the FSB currently regulated over 13 000 pension funds. It had finite amount of resources to deploy as best as possible in the regulation and supervision of the pension funds. It was introducing a regulatory methodology called "risk-based supervision". The methodology had been increasingly applied internationally in regulatory circles. It would lead to much more efficient use of internal resources. The FSB was comfortable that the resources it had allowed for effective regulation. The issue of secret profits and "bulking" was a special project. The FSB was mindful of white-collar crime and was aware that the amounts involved were significant. It was engaged in a joint venture with Business Against Crime to provide funding for the prosecution of some matters. There was engagement with the NPA in these matters.

Mr S Asiya (ANC) asked what was the role of the Financial Intelligence Centre (FIC) should the matter be referred to the NPA. FIC could play a big role in this matter. The FSB was relying on fund administrators to make voluntary disclosures and only 66 of them did so. He asked what was happening in relation to the others that did not disclose. The legal framework was an impediment to the FSB. The FSB was thinking of coming with legislation towards the end of the year. This would allow people to continue with their activities without hindrance. There should be urgency so that the industry could be regulated and become accountable.

Mr Boyd replied that the FSB had not engaged the FIC because the funds concerned and monies earned in "bulking" was money that the fund administrators had not passed to the pension funds concerned. It was not really an FIC matter. Pension funds were in any event exempted from the Financial Intelligence Centre Act. There was just over 200 pension fund administrators and 80% of them were single pension fund administrators. Their main business was not to act as third party service providers but to service just one specific fund. There were instances where a fund could decide to set its own administration company and transfer their administrative tasks to that company. The 66 funds that responded were those that were engaged pension fund administration as a business imperative.

Mr Y Bhamjee (ANC) said that the presentation had indicated that the practice of bulking client funds was not per se unlawful or objectionable. He asked for a clear definition of "bulking"

Mr Boyd replied that a pension fund administrator had a number of pension funds for which it provided administrative services. All of the pension funds had banking accounts. It made sense to approach a bank and negotiate an enhance interest rate for all pension funds as opposed to the normal rate. The FSB would respect pension fund administrators to do this because enhancing the returns of the assets of the fund was part of their fiduciary duties.

Mr B Mnguni (ANC) asked for the name of the administrator that had indicated its unwillingness to repay any amount to any of the pension funds whose assets it administered. Paragraph 11.2.4(d) of the document presented referred to such unwillingness. He referred to paragraph 11.3 and asked how many of the administrators involved in "bulking" were part of Fidentia? Which fund was directly implicated? The FSB had the power to withdraw licences. He asked how many licences had been withdrawn?

Mr Boyd humbly requested not to disclose the name of the administrator referred to in paragraph 11.2.4(d). The FSB was engaged in discussions with the administrator. It would look at the remedies available to it. He also requested not to name the administrator referred to in paragraph 11.3. The issue was that the administrator had agreed to provide a certain amount of service with regard to the disposition of death benefits. There were 16 pension funds involved and the largest was the Mine Workers Pension Fund. 80% of the death benefits concerned came from the Mine Workers Pension Fund. The fund had advised that it had negotiated with the umbrella trust to provide certain services to the trust and a commission was arranged for this.

The Chairperson said that there was no reason for the FSB not to disclose the names unless matters were before the courts.

Mr Boyd replied that the matters were not before the court. The administrators referred to in paragraphs 11.2.4(c) and (d) were Wynne-Jones & Company and NBC respectively. Paragraph 11.3 referred to Lekana Employee Benefit Solutions.

Dr S van Dyk (DA) said that the presentation had referred to some of the funds that would allocate the benefits of "bulking" to beneficiaries. He asked how much or what percentage of money earned as a result of "bulking" would flow back to beneficiaries. Fidentia did not submit any financial statement for the past two years. He asked for a comment on this. The benefits of "bulking" were not exposed in the past to beneficiaries. With the scrapping of the tax on pension funds in this year’s budget, what measures were in place to ensure that benefits would end up in the hands of beneficiaries?

Mr Boyd replied that 100% of the total secret profits from "bulking" would go to the pension funds. Mr Dixon replied that the benefits of the abolition of the tax on retirement pension funds should flow to the individual pension fund members.

Mr A Moloto (ANC) noted that 11 administrators had reported that they did bulk their clients' funds but that the full credit of the enhanced interest rate was passed on to their clients. He asked if there was a mechanism to verify that this indeed happened. He also noted that an administrator had indicated its intention to engage the pension funds whose assets it administered in order to obtain their retrospective ratification of the past practice of making a secret profit from bulking clients' funds. He asked if the FSB was considering legislative amendments to ensure that it could intervene and force them to pay the money to beneficiaries. The presenter had indicated that they could not intervene in certain circumstances. He referred to paragraph 11.3 of the presentation. The name of the administrator referred therein was known as a result of what had transpired in court. The administrator was responsible for administrating a fund in which he was a trustee. He asked if the problem was mainly due to the Fidentia issue. The trustees of the fund on which he served as a trustee had asked if the administrator had bulked funds and kept secret profits. The answer was a clear “no”.

Mr Boyd replied that the FSB would continually engage the pension funds concerned on how they would make restitution. The FSB had two possible remedies: putting in place an enforcement Committee which would afford it the power to administratively penalise wrong doers and an amendment of the Pension Fund Act to widen the powers of the regulator from an enforcement perspective. The FSB was engaging Lekana and there was no secret profit involved. The only thing picked up had to do with the commission from the Living Hands trust.

Mr Barrow wondered if the Committee wanted to open up the meeting to the Fidentia scandal. There was a need for some caution. The curators were busy dealing with the issue and it was due be heard in court on 27 March 2007. Despite various media attempt to justify what Fidentia had done the curators report would dispel any suggestion that the FSB had acted inappropriately. There was no alternative but to place it under curatorship.

Mr I Davidson (DA) said that the FSB could refer a matter to the NPA or withdraw approval to act as a fund administrator. He contrasted this with the question of donations to FSB Consumer Education Trust. What were the aims and objectives of the trust and who were the trustees? Who were the beneficiaries and who decided what the trust should do? The presenter said that Alexander Forbes had "agreed to donate R12 million as penance" to the trust. On what basis were companies asked to make donations? Was there a formula that took into account the perceived harm done? How was the figure determined? Was it a trade off against referral to the NPA or withdrawal of approval? He said that he was not implying anything but what could be implied was that certain people could sit in the FSB offices and say that there would a referral of an issue to the NPA or the withdrawal of approval unless a donations was made. There were all sorts of rumours of corruption in the office. The FSB was a prosecutor and judge at the same time and this was not right.

Mr Asiya said that there was a serious question raised by Mr Davidson. It was pregnant and needed to be delivered but the chairperson should make a ruling on it. The FSB was called in to give some feedback on "bulking" following last year's discussions. Mr Davidson should tell the Committee what he knew in relation to the questions he had just asked.

Mr Moloto agreed with Mr Asiya. It would be proper for the Committee to put its case in relation to this matter. There were newspaper reports on the issue which later on proved to be incorrect. The Committee did not interaction with the FSB as alleged in newspaper reports.

Mr Davidson said that he had no information that led him to believe what he had said. The presentation document exposed a practice in the context of how the FSB dealt with issues. The context was morally and ethically wrong. There was a need for clarity on the role of the FSB Consumer Education Trust. It seemed wrong that the FSB could be both the prosecutor and judge in the same course.

The Chairperson allowed the FSB t respond to the question on the donation made by Alexander Forbes. The Committee had issued a statement to the effect that no meeting had taken place between it and the FSB as reported in some newspapers. The newspaper also confessed that it had not confirmed its story with the Committee.

Mr Bhamjee said that there was a need for clarity. The presenter had used the word "penance" in relation to the donation made. One would believe that there was something to hide should the FSB not respond.

Mr Barrow replied that he had not come prepared on the details of the trust and how it was constituted. He could make the information available at a later stage if so required. The trustees of the education trust were eminent business people and he was also a trustee. It was properly constituted and its objectives were very clear. It was specifically granted section 18A exemption status in this year's budget so that donations to it could be tax-free on the hands of the donors. It sought to promote consumer education in its broader context and facilitate consumer education in the financial services. With regard to the donation by Alexander Forbes, he assured the Committee that there were no trade-offs whatsoever. The company had agreed to restitution. The FSB had said that this was good and well but the question was where to go from there. It was indicated that there was an issue that could be handed over to the NPA. Prosecution would have been complex and long and the likelihood of success was fairly remote. It was suggested to them that it might be considered very favourably under the circumstances if they were seen to be going further than simply paying the money back. It was suggested that a suitable home would be the educational trust. He or the FSB had no control over the trust. The board was certainly not acting as a judge and jury at the same time. There were no kickbacks to him or any of the executives.

Mr Barrow said that the question could perhaps be what the FSB should have done. Should it have stopped at restitution or referral to the NPA? Prosecution was very much on the cards in any event. The likelihood was that the matter would be referred to the NPA once the FSB had looked at the entire spectrum of "bulking". The NPA was entitled to raise the issue on its own and anybody could lay a charge. The process was implemented with caution from the FSB side. The result of the process followed was that there was likely to be benefits to somebody but this was not on condition that there would be no referral to the NPA.

Mr Tshidi reminded the Committee that, with the administrators being present before the Committee, he had made a statement that administrators where "bulking" because they were aware of the lack of knowledge and education on part of trustees. They were taking advantage of that lack of skill on the part of trustees. It was on this note that the FSB had asked how to address the issue of education. The issue could be addressed through the Consumer Education Trust. Mr Dixon replied that repayment of the profits from bulking and donations did not preclude any further legal action. This was not an issue of trade-offs.

Mr Barrow replied that it was correct that the February 2005 financial statements that were due in August 2005 were not submitted. The main issue revealed in the inspection into Fidentia was the non-segregation of Fidentia's own funds from those of investors. There was a compliance report that was required to be submitted by all fund managers. The August 2005 compliance report was submitted but it did not refer to fact that the segregation requirement had not been met. This was a specific requirement to which they had to refer. He suggested that the 2004 financial statements were less than accurate. The situation would not have changed even if the 2005 financial statement had been submitted. The 2006 financial statements would have been due in August 2006. Fidentia changed its financial year-end and moved it forward by six months. There was no late submission. In the meantime the FSB was in the process of conducting its investigations. Fidentia did not submit the 2006 compliance report on the basis that they were waiting for the completion of the inspection and investigation that resulted in curatorship.

Mr Davidson put it on record that he did not find the answer to his question around the Alexander Forbes donation acceptable. He could not believe that anybody in their right mind would have agreed to donate R12 million without any trade off. There trade off might have been some promise not to prosecute. There would be credibility issues should the FSB go ahead and prosecute. He wondered how many other administrators had escaped prosecution by simply making donations. The method used for getting donations could imply trade-offs.

Mr Barrow believed that he had answered the questions. There was nothing that he could do if Mr Davidson was questioning his veracity. There were no trade-offs and there would never be any as long as he was in office.

Mr Bhamjee said that there was a misunderstanding. The document presented opened up for members to ask questions. There was no intention to question anybody's integrity. It was important to ensure that a written document did not come back to haunt anyone. The FSB should be careful when drafting its documents and not create a space for anyone to look at its work negatively.

Mr Mnguni said that there were institutions that were still going to face prosecution. There were indications from some funds that some of the secret profits were distributed to beneficiaries and that administrators had kept some of the money. He asked if there was scope for the FSB to specify what percentage could be retained by the administrators. Administrators that were not engaged in "bulking" were not maximising benefits to their clients as required in terms of their fiduciary duties.

Mr Moloto said that it was important for people to have trust in the financial industry. Trust required a regulator that was effective and powerful. The FSB had done a lot of good work. Any engagement between the Committee and the FSB was to ensure that the institution improved and became even a much more stronger regulator. There was no need to hide behind the sub judice rule because the court had already decided to put Fidentia under curatorship. The curators would have to approach a court before liquidating any of the company's assets. Members were not asking questions about the merits of putting Fidentia under curatorship. The intention was to establish what were the weaknesses in the system, how to improve them and what was the response after the Fidentia scandal? He asked if the Committee would deal with the Fidentia scandal today or call the FSB for a special session on this at a later stage.

The chairperson said that he was not a lawyer and did not know much about the scope of the sub judice rule. He also did not know if placing Fidentia under curatorship concluded the legal process.

Mr Rossouw replied that the curatorship order was provisional at this stage. The return date was 27 March 2007 and the court would decide whether or not to give a final curatorship order on that date. It would be inappropriate for the FSB to comment when the report of the curators had not yet been filed. The court would consider the report.

The Chairperson ruled that the matter was sub judice. It would be in the interest of the FSB to come and clear this matter at a later stage.

Mr Asiya suggested that the Committee should source its own legal advice on whether the matter was sub judice.

Mr Mnguni asked if the estimated benefit of R450 000 over a four-year period was fair.

Mr Boyd replied that the administrator concerned was mCubed and it did not have significant pension funds under administration.

The meeting was adjourned.