Draft Taxation Laws Amendment Bill [B13-2008] & Second Amendment Bill [B14-2008]: public hearings

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Finance Standing Committee

05 March 2008
Chairperson: Mr N Nene (ANC)
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Meeting Summary

Bravura Equity Services, PricewaterhouseCoopers, Institute of Chartered Accountants, Deloitte and Webber Wentzel Bowens made public submissions on the draft Taxation Laws Amendment Bill. All raised concerns about the short time allowed for public comment, although it was appreciated that they would have a chance to meet with National Treasury to discuss the issues. Other mutual concerns related to the proposed changes to Section 45. All felt that the changes were too wide, and that the attempts to tighten the anti-avoidance would hit legitimate deals, many of which would be cancelled. It was noted that there was a need to move to a group-based system of taxation that would give weight to inter-group transactions. The changes were criticised as going beyond the principles of the existing section. It was considered that the purchases funded on loan accounts would end up by being double-taxed, without any mitigation. It was felt that the effects of the transaction went against what had been said in the media statement. Of particular worry was the fact that black economic empowerment transactions would be affected.

Securitisation and leverage transactions also were being affected.  It was suggested that perhaps the general anti avoidance rule should be used to greater affect. There was further a suggestion that tax should be examined at the exit rather than entry point in respect of foreign entities. The tax relief for expatriate accommodation should be applied over a four or five year period, to facilitate better skills transfer. The new Section 23K provisions were proposing to limit expenditure for share purposes and it was suggested that this should be narrowed down. Concerns were raised that the new VAT threshold should apply not from January 2009 but immediately. Concerns were also expressed with the backdating of certain provisions, which did not support certainty. Other concerns were raised in relation to definitions of “gross income”, and exclusion of passive income to reduction of debt under clause 8. . No explanation had been given for amendment of Section 64B (clause 29)  nor for the proviso to section 44(3)(d) in relation to VAT.

Members raised queries around the practical effects of some of the changes, repatriation of dividends, the negative impacts of Section 45 on corporate finance, whether the market would be able to adapt, and whether any specific anti-avoidance schemes had been identified, and solutions proposed by the practitioners. Further details were requested on debt push-down and how the base cost would be calculated on disposal of unbundled shares within an eighteen month period, as proposed.

National Treasury indicated that there was no case law around the General Anti Avoidance Rule, and that rules had been used in an abusive manner. Similarly there had been only one test case on dividends being taken out to foreign holding companies, and this would be a slow process. National Treasury would give full responses the following week.

Meeting report

Bravura Submission
Mr James Aitchison, Dealmaker, Bravura Equity Services, noted that Bravura was a group consisting of a number of business lines, including Black Economic Empowerment (BEE) consulting, commodities and resources, property and corporate actions. He would highlight only a few main points of their written submission.

Bravura submitted that the proposed changes to the Section 45 inter-group tax relief went far beyond the stated intention and would impact negatively on legitimate business transactions.

The existing relief was roll over relief for transfer of assets within a group of companies. The inter-group transfer would have the tax deferred, and only when the recipient company disposed of the asset outside the group, would it be taxed. There was some anti-avoidance identified in the media statement, and Bravura supported the closing of the loophole. However, he submitted that where sales were settled in cash, this would attract taxation This went against the principle of the existing section 45. Given that it was a well-used method, he did not believe this made sense. The second situation would be purchases funded on loan accounts. The loan would also take on the rolled-over base cost. He believed this would result in double taxation, as when repaying the loan the original transferor would also be taxed. That was not uncommon in the general rollover relief, but the other sections of the legislation contained mitigatory features, whereas this did not.

Mr Aitchison noted the impact on transactions. Under the current section, there would be allowance for rollover, with tax on disposal. Under the proposed changes, where cash was being used, the first subsidiary would pay tax on the gain, although there had been no cash out. The media statement had suggested that there were alternative forms of relief, or the possibility of using a transfer for no consideration. However, where there were minorities in either subsidiary, that would prejudice creditors and the minority shareholders. If there were minorities in subsidiary 2 this would have prejudiced the entire group. It was in theory possible to use Section 42 relief - transfer against shares - but this was messy, and existing minorities would either be diluted or given undue advantage. In general, the effect of accelerating tax went against the underlying principle.

Mr Aitchison then gave an example of the cascading effect of capital gains tax (CGT). He used an example of a holding company (holdco), a middle company (midco) and a subsidiary (sub).  In a structure where midco sold sub, the funds would be used to pay a dividend and it would be sold at the lesser value. The group would have been taxed once on the gain. He said that there were a number of ways to achieve this effect. However, the proposed change to section 45 would give a cascade effect with no means of mitigating the effect. If sub1 were to sell to sub2, and use a loan account, then sub2, when selling on, would pay tax, but sub1 would also be taxed when sub2 repaid the loan account. Once again, the media statement had suggested that there were other methods of restructuring this, including a sale under value (at the tax base cost). However, minorities would be prejudiced by sales under value, and so would creditors. It was necessary to ensure that solvency requirements must be met.

Classes of transactions affected would include BEE transactions, both internally and externally funded. Securitisation transactions, whereby companies looked to raise cheaper financing, were also affected. Leverage transactions, preclusion of case and debt instruments would also be prejudiced. He explained that broad based black economic empowerment typically involved people with no money. The operating business to be empowered would be transferred to a new company, with a nominal share capital, with a minority shareholding being held by the BBBEE company. No personal liability would attach and the vendor group was giving guarantees. However, if the sale was being funded by external funders, no exemption would apply. The cost would therefore have to be recovered by bringing an additional interest charge to the BEE business. A loan note would also require tax, which would be adjusted by an interest payment. This would not allow for access at a cheap level.

Securitisations had a similar concept, in that assets would be dropped down into a new company, against debt. Where an existing operating company had other loans, they might be able to borrow from the bank at a certain rate. To give the bank additional security, and make it the sole creditor, the assets would be transferred down to a new company, and the bank would lend to that new company. If the assets were transferred for cash, or on loan account, there was no relief.

He noted that leverage transactions would be addressed by Webber Wentzel.

Mr Aitchison raised the issue of timing. The media statements were only released on 21 February, the Bill with the detailed wording was available on 22 February and there were only 5 working days to comment. He was aware of at least one other party who sought, but could not obtain, an audience. He stressed that not all views would therefore be represented. The Bill was quite straightforward, but the extent of impact of the change in one section was significant. The anti-avoidance measures were much wider in scope, and he submitted that the consultation period was too short.

PricewaterhouseCoopers (PWC) Submission
Mr David Lermer, Director: International Tax, PricewaterhouseCoopers, stated that his submission would support the written document. He agreed with Bravura that there was a very short consultation period. The proposed amendments required substantial consultation, and since the changes affected the broadest aspects of the industry, five days was simply too little. He did note however, that the issues had been brought very quickly to the fore and the meeting planned for that afternoon would be useful. Although the Mr tax system and administration were improving every year, the pressure on stakeholders was worsening and he wondered if this was appropriate. Between today and the printing of the final version, there was no chance for anyone to reply to the comments from S A Revenue Services (SARS) or National Treasury (NT) or to comment on the policy, and this was perceived as a flaw in the process.

Prof Osman Mollagee, Director: Tax Services, PWC, noted that there was a query as to why the general anti-avoidance rule (GAAR) should not be used, as this was quite sophisticated. This Rule had resulted from long consultation, and he wondered why it was now necessary to resort to specific anti-avoidance measures. Whilst those might be warranted in some cases, it was difficult to get them right. Sometimes, they were far too broad. He agreed that it would have been useful to hold further consultation.

Mr Lermer noted that there was a provision seeking to tax non-residents when they entered the country as Controlled Foreign Companies (CFC) in a South African group. At the moment, they would be charged tax on any inherent accrued gain in their assets. That not only seemed wrong, but it was unique to South Africa. There was originally allowance for re-basing, with exemption from taxing gains that accrued before coming to South Africa. Now there was instant taxation. He suggested that there should be incentives for groups coming to South Africa, instead of penalising them. This was aimed at anti-avoidance, but he thought that NT should rather focus on exits. The participation exemption might also be considered no longer necessary. The objective of the exemption seemed to be to ease repatriation of funds to South Africa. It was correct that it was expanded to allow dividends to come back to South Africa. However, when introduced in 2001, it was a provision in the CFC legislation because of international competitiveness - for instance United Kingdom did not have CGT on CFCs. Canada was considering participation exemption similar to South Africa’s current situation. He feared that amending these provisions would be taking away the competitive edge.

Prof Mollagee was also concerned about the Section 45 intra group transfers. The objective was to facilitate transfer of assets. However, cash transactions and asset swaps no longer qualified for deferral relief. That forced companies to issue a debt instrument, and the new section was “manufacturing” a capital gain on that instrument. He tabled a hypothetical transaction, comparing the tax under the current section and the new section (see detailed presentation, slide 6), to illustrate that there would be duplication of tax. This, he said,  turned Section 45 from a relief to a penal position.

Mr Lermer applauded the exemption on accommodation for expatriates, but he believed it should be consistent with tax residence rules and Department of Home Affairs, and be extended to four or five years. Home Affairs’ research indicated that five years were needed for skills transfer, and he suggested that this would support an economic need.

Prof Mollagee noted that the restriction on share exemption under the new Section 23K proposed to limit expenditure for share purchases, when previously held by connected persons. He agreed that there was a need to attack the avoidance. However, he warned that collateral damage could be caused. The media statement had referred to a non-resident parent company, but this provision as worded would apply to everyone. It was salvageable, and he asked that it be narrowed down after further consultation.

Finally, PWC noted that the effective date for the new VAT threshold from R300 000 to R1 million was welcomed, but the effective date was 1 January 2009. A business starting today would need to register today, but would then have to deregister at the end of the year. It was suggested the new threshold should become effective immediately, to achieve the objective of keeping small businesses out of the compliance network.

South African Institute of Chartered Accountants (SAICA) submission
Mr Wessel Smit, Tax Consultant, SAICA, also raised concerns about the time limit. This submission was a summary of all comments received from all its members. He noted that five working days had been inadequate, and many of the comments from members could not be incorporated. He was concerned that practical problems might slip through the net and require correction at a later stage.

SAICA was also concerned with back-dating of some amendments, including the definition on "distribution" in Section 47(1) and the definition of "refining”. As a general principle, backdating created uncertainty. In sub-clause 2(1)(k), the definition of "gross income" had been changed to include lump sums. However, the old exemption, referring to section 9(1)(g), for services rendered outside South Africa had not been incorporated in the new definition. On the other hand, the portions of a pension relating to foreign services were exempted. To achieve consistency, SAICA thought that the reference for 9(1)(g) should be reinstated in the definition.

In respect of clause 8, the extension of the exclusion of passive income to reduction of debt was welcomed. However, the new paragraph did not provide for the election of taxpayer that the exclusion not apply.

Mr Smit noted that in respect of clause 23, SAICA was grateful for NT having looked at the de-groupings and giving some relief. However, looking at the group definitions in Section 41, he pointed out that concerns around the exclusion of foreign companies were expressed.

He then commented on the proposed amendment of Section 45. SAICA supported the previous submissions, and the substance of its concerns was similar. The fact that cash transactions were now being excluded meant that many legitimate business transactions would now fall outside the scope and he felt that these would include BEE transactions, securitisations and leverage transactions. The tax now levied would make many transactions now unworkable. SAICA was also concerned about potential double taxation when the loan was being settled.

Clause 29 was amending 64B(5)(f). It sought to exclude exemptions for certain dividends. SAICA did not understand why this was being done as it was not explained in the Memorandum.

In respect of the second draft Taxation Laws Amendment Bill, there were concerns around the introduction of a new penalty for employers who submitted their reconciliation late. It was to be calculated at 10% of the total employee tax deducted and withheld during the year. This could be a huge penalty, and SAICA felt it was out of proportion to the offence. There was an additional amendment that disallowed an employee his PAYE deduction until the employer had returned the IRP, effectively denying the employee a credit for amounts already deducted. Although SAICA could see the logic of putting pressure on the employers, it did not consider it was correct to punish the innocent employee. Members of SAICA had raised concerns on the constitutionality.

The proviso to Section 44(3)(d), dealing with VAT, was once again not explained by NT. Mr Smit explained that foreign companies might have branches that would have to register as VAT-vendors in South Africa. They might not have a physical presence. Previously they were permitted to use the bank account of a representative tax payer. This was being removed. He pointed out that if such branches were not allowed to use another account, then they probably would not meet the requirements of the Financial Intelligence Centre, and could not register as a VAT vendor. In addition, companies within a group may traditionally have used one account, to control cash flow and reduce the costs of doing business. The deletion of this provision suggested that all companies would be forced to open their own accounts, which would increase the costs of doing business

SAICA recommended its immediate introduction of the increase of the VAT threshold. Other points in the written submission were not tabled, but must be taken into account.

The Chairperson noted that the issue of timing had been problematic for the Committee as well.

Mr K Moloto (ANC) shared the concerns around the possibility of double taxation. He asked how exactly this would arise.

Mr Aitchison said that in the proper context, a group should ideally be regarded as a single entity. He cited the example of the parent company with sub1 and sub2. If the market account was sold for R100, but the tax base was R20, it would be taxed on R80. One company would be taxed on R80 from the sale, and the other would be taxed again on R80 when repaying the loan.

Mr Lermer added that the problem was that the loan was given a lower base, which created a new additional gain that did not exist before.

Mr Moloto said that the view was expressed that interest on share deductions should not be allowed, but that there should be focus on active business, not shareholding. He asked for comment.

Mr Aitchison said that currently there was no interest deduction on loans taken out to fund the purchase of shares. In order to get a deduction it would have to generate income; typically when it bought the shares and would receive dividends that were exempt. He said that Webber Wentzel would be dealing with this in more detail.

Mr Lermer said that this required a policy decision on national tax policy. Many competitors did give deductions for interest. South African tenders were often uncompetitive because they did not get the interest deduction.

Mr Moloto asked about repatriation of dividends. He noted the concern about tax on a company coming into South Africa. However, the view had been expressed that consideration should be given to shares held by the Headquarter Company (here he was referring back to a slide by NT on the previous day). He asked what the view was on that.

Mr Lermer said that the current law provided that dividends repatriated to South Africa would not attract further tax cost, provided there was a 20% equity stake in the company paying the dividends. The amendment had tightened it by providing that there must also be 20% of the voting rights. This was close to many of the European participation exemption schemes. In Europe it was possible to sell shares to another European domestic company and gain exemption. The key difference lay between active business and active investment. If active business was supported, and investment income alone was taxed, that was in line with global trends.

Prof Mollagee gave the example of non-residents coming into South Africa. If a non resident individual wished to migrate to South Africa, he would not be taxed on the gains on his assets that had accrued before coming to South Africa.

Mr Lermer said that the concern around Level 1 was that it was acceptable to allow people and assets in to the tax system, but there was a risk that they could also leave tax-free. That was why he had said there was a need to focus on the exit, but not on the entrance. He was not sure that the problems identified were being dealt with in the right way.

Dr D George (ANC) asked Bravura about the negative influence of Section 45 on corporate finance. He asked if the market would not adapt.

Mr S Marais (DA) said that the budget speech had indicated relaxation of requirements, the cost of doing business and attempts to boost direct foreign investment. He wondered if the competitive edge would be lost and if there would be negative impacts on the cost of doing business.

Mr Singh asked for comments on BEE transactions and the effect that these amendments would have on BEE transactions.

Mr Aitchison replied that Bravura had tried to identify a numbers of classes that were negatively affected. He said that, where a group moved its assets around, the market could adapt. However, the point was whether it could adapt in a way to give better growth. In BEE, a cost triggered under Section 45 would have to be borne by the BEE partners, by lenders or the existing group. From a securitisation point of view, this upfront cost being put in would add to the cost of funding. Whether passing the cost down the chain would ameliorate the position was debatable. If something was transferred within the group, without cash, the intention was clearly to have the business more efficient. If there was an upfront cost, the market would adapt but the cost would be passed on to the end consumer. Markets could adapt, but they should not be forced to do so.

Mr Lermer agreed that the effect of the amendments would increase the cost of doing business, and would reduce the competitive edge. He agreed also that the group, as an economic unit, should ideally be taxed as a group, although this was not happening yet. These provisions ran against the group concept. He hoped that the profession and NT would reach a compromise.

Mr Smit said that several SAICA members had noted that some transactions could not bear the additional costs and the planned transactions could fall through.

Dr George asked PWC if it had identified specific anti-avoidance schemes and made proposals around the situation that had necessitated the anti-avoidance.

Mr B Mnguni (ANC) asked what would be considered a reasonable time for comment on the Bill.

Mr Smit said that it would depend on the volume of change. He suggested that a minimum of 10 to 15 working days would have been reasonable. The revenue laws amendment would probably need 15 to 21 working days for comment. Other criteria would impact as well.

Mr Mnguni noted that there were attempts to curb tax avoidance, and for the tax to be easily administered. He asked what would be the proper way to avoid tax when financing BEE companies.

Mr N Singh (DA) asked for further elaboration on the comment that section 45 was being turned from a relief to a penal provision.

Prof Mollagee said that NT were not using the general anti-avoidance rule. The specific anti-avoidance rules were attempting to narrowly describe the abusive schemes. The general rule would place the issue before a panel of humans with the ability to judge it on a case-by-case basis. The general rule said that if the intention looked bad, it would be judged. He suggested that consideration should be given to looking at the general provisions. He noted that today’s consultations were a direct result of the comments to NT.

Mr Lermer noted that there had been a practice note giving a safe harbour. It had been reckoned that a debt to equity ration of 3: 1 would be reasonable. Care should be taken to ensure that every transaction was not being regarded as a disguised transaction. There was a need to look at the commercial impact of what the companies were trying to achieve.

Comment by National Treasury
Prof Keith Engel said that he would not address all the issues. NT understood that there were very tight schedules, particularly this year. From a personal point of view he would have preferred more time. NT had however acted in good faith. When this was released after the budget speech, it was also published on the website, and a media statement was issues to highlight the major issues, which were those raised today.

Prof Engel said that the avoidance transactions were quite important and involved large amounts. Section 45 had taken on a different flavour from what was originally intended, so the rules had been changed. Those submitting comments had been invited to a meeting to try to deal with the issues.

The Chairperson noted that that meeting would deal in detail with the matters. There was no necessity to respond to those now.

Mr Franz Tomasek. General Manager, Legislative Policy, NT, would concur that some transactions were vulnerable to the application for GAAR.

Prof Mollagee clarified that each new amendment bill was coming with more specific anti-avoidance provisions but he was not seeing that the general anti-avoidance Rule was being applied. He thought that a normal application of this Rule might catch many of the transactions. He had been part of the process that set up the GAAR, and was concerned that it did not seem to be used. He agreed that specific anti-avoidance rules might be warranted, but he would like them to be more precise and target exactly what they should.

Mr Lermer said that a sole or main purpose had to be avoidance attacks. If the purpose was commercial then it was not possible to use GAAR. There were grey areas and planners would consider if the main purpose of the schemes was commercial or tax avoidance. There was an 80:20 principle. The Court would tend to look at the presumption around the main purposes of the scheme. The new GAAR allowed a person to look at each step and question whether it had passed the sole or main avoidance motive.

Deloitte Submission
Mr le Roux Roelofse, Director, Deloitte and Touche, noted that the themes running through submissions. The relief provisions in the Act were introduced as a concession, but were clearly being used in an abusive manner to avoid tax.  Practitioners agreed that examples highlighted in the media statement were abusive, but felt that the measures being introduced were going too far. There was a need then to look at alternative measures, and GAAR should be used in the short term. Any legislation with specific anti avoidance rules must be clear as to how far they must go.

Mr Roelofse noted that the system of tax in SA was entity based, not group based. A holding company with 2 subsidiaries would not be allowed to offset a loss in one subsidiary against the gain of another, despite the fact that the holding company may hold all the shares. That was not favourable for business. There needed to be recognition that a group was one economic entity, transfers within the group should be facilitated and it should be allowed to do business consistent with economic growth. Purchase of shares should not attract interest deduction.

Mr Roelofse summarised that concessions were allowed to facilitate the running of business. NT had identified some abusive transactions. Taxpayers would always try to reduce the cost of tax to the business. There was nothing immoral in this; but they must act within the confines of the tax system. The transactions identified in the media statement were examples of abuses. Selling of assets to a third party (not part of the group) by using section 45 to avoid paying tax was a problem. However, the proposals in the new section 45 (and other provisions) were not appropriate. He supported the call for detailed consultation to avoid catching unintended and bona fide transactions. The transactions were being attacked piecemeal and in the process of trying to fix the legislation, the taxpayer morality was being undermined. Deloitte believed that SARS had made significant moves to increase morality, but taxpayers would adopt the right attitude only where the laws were clear and certain.

The new GAAR stated that a transaction devoid of commercial substance, or done with the sole purpose of avoiding tax, was to be attacked. Since 2001 the tax system had moved from source-based to residence-based, and CGT had been introduced. South Africa had a world class and well recognised system. However, there was little case law to assist with interpretation. Deloitte would like SARS to take cases to court and try to develop a body of case law. The time for speculative, pure tax-avoidance structuring, was over. Tax consultants were trying to get a system that worked, but it was in human nature that some would still try to abuse the system. He pleaded for greater consultation in the processes.

Mr Roelofse said that he would not go through the written document in detail, but highlighted the comments on Section 45.

In relation to the new provision of section 23K, he submitted this ran contrary to the CFC rules, the non-residence rules of step-up to market value. Although he understood that it was created to stop a perceived abuse, it went too wide.

Mr Roelofse commented that the section 41 definition of "a group" was clearly intended to provide that relief would be provided to companies acting on the same tax plain within a group. The same rules should not apply to non-residents as to residents, for instance on asset transfer. He agreed that there was a need to focus on exit. A company that was owned more than 50% by non residents was a controlled foreign company. They were within the tax net as their income should be taxed in the hands of SA shareholders, yet they were excluded from the group. Deloitte did not see any justification for this.

Mr Roelofse referred Members to the additional comments, but did not present them (see page 6 of submission).

Webber Wentzel Bowens (WWB) submission
Mr Ed Liptak, Director: Corporate Tax, WWB, commented that the draft Bill had certainly got the attention of the profession, but he thanked NT and SARS for going out of their way to work with the profession in an honest and no-holds-barred way. He was optimistic that the process would produce a good result.

There were a number of topics to be covered. He would like to see a situation where the industry would not keep trying to find loopholes, and the legislation be constantly changed to plug the gaps.

He thought that Section 45 was radically over-broad and was "an invitation to steal". It was fundamentally flawed legislation and had to be addressed. The GAAR alone would not cover it. Some amendments last year had helped to narrow the abuses. The problem was that it was worded too broadly. Practitioners would try to keep aggressive schemes off the radar of SARS. He agreed that it was vital to find a solution to allow legitimate transactions with economic substance to get through.

He also cautioned that BEE was often being used to make millions, at the expense of the fiscus. Often there would be a viable BEE transaction, but various schemes would result in a massive tax saving, which would be split between the partners to the deal. He would estimate that there had been R5 to 10 billion company tax lost through these deals. He would therefore fully support Prof Engel's description of the huge problems encountered.

The issue of retrospectivity was important. In the business context these transactions would take months to put in place. He noted that several transactions that had already been negotiated up to "firm intent stage" and the introduction of these rules would unravel the entire transaction. There would be huge gaps in their loan agreements as a result of immediate tax liability. He pleaded that those taxpayers relying on the rules as written should be given relief for transactions that had reached the firm intent stage.

Mr Liptak said that section 45 was used, in practice, for inter group matters, for mergers and acquisitions, and in anti-avoidance ways. He said that a number of subsidiaries doing the same thing could be consolidated with no tax consequences, or assets shifted. That had worked with no problem. They probably accounted for less than half of the section 45 transactions, and were fairly routine. Merger arrangements would involve the “push-down” debt. He would estimate that 30% to 45% of section 45 transactions fell into this category, and where money was borrowed to buy the target company, a Section 45 arrangement would be used. The third category involved abusive transactions, and there were probably two major categories. A disguised sale could be used to try to get rid of the tax for ever. Alternatively, more complex transactions could be used that involved turning groups of companies into empty conduits to flow funds through with no tax consequences.

Mr Liptak said that the tax system did not deal with modern tax and economic realities. That was recognised during the GAAR debate, when there had been recognition of the need to move towards group taxation. The non-deductibility of interest expense incurred in acquiring shareholding did not make sense. The push-down effect of section 45 had allowed people to get to the international position, but it was merely a stop-gap. Until the interest expense issue was resolved explicitly, he suggested that Section 45 should be modified to ensure that the safety valve remained open. Part of the problem was that NT was being asked to do far too much with far too few resources.

Mr Mnguni asked about the comments that the amendments were resulting in NT and practitioners chasing their tails. He asked how it was proposed that this situation be halted.

Mr Mnguni referred to the BEE transactions and asked what should be put in place for practitioners and companies to prevent the avoidance.

Dr George asked Deloitte to comment on the statement that clients would have placed transactions on hold. He asked if they would find another way to achieve their aims, and if not, what would be the consequences.

Dr George asked whether which was the lesser evil - avoidance or the impact on mergers and acquisitions.

Mr Moloto asked WWB to comment on the issue of deduction of interest incurred in connection with the acquisition of shares. He had read an article to the effect that interest deductions were eroding the tax base. He asked for clarity on the comment that group taxation would solve some of these problems.

Mr Moloto referred to debt push-down within a group, and asked for further clarity what the concerns were. He had understood from NT that it was necessary to move away from the situation where a company was pushing down relief to other subsidiaries.

Mr Moloto asked Deloitte about its proposal that if an unbundled share was disposed of within eighteen months outside the group, then the base costs should be calculated on the base cost. He asked for comment how this would solve the problem.

Mr Roelofse said that the 18-month rule was very technical. Essentially Deloitte had proposed that corporate rules allow re-structures, but that the benefits of the tax relief would be unwound if there were further disposals within an eighteen month period. He had suggested the 18-month period as being consistent with what was contained in other legislation. 

Mr Roelofse noted that many of the other answers would overlap.

In relation to section 45, it was important to bear in mind that there was a principle that a person was allowed to arrange his affairs to pay the least tax possible. Therefore a decision could be made on which option would give a better result. Another principle was that there was no equity about tax. A person would have to look at and try to discern the intention of the legislature and apply the ordinary meaning of the words. However, this could be deviated from if there were a glaring absurdity. In the context of anti avoidance, a purposive approach could be adopted to suppress the mischief. Where there was an ambiguity in the legislation, the taxpayer could take the approach most favourable to him or her. These principles would be applied to each transaction.

Therefore, in the context of section 45, a tax practitioner would consider all the options, the opportunities for structuring, and would apply the principles as set out. However, if there was no commercial substance, or if the transaction had a main or sole purpose to avoid tax, then it would be hit by GAAR. Practitioners had to be intellectually honest.

The explanatory memorandum of NT would help to understand what the legislation was about. However, where it differed from the Act, SARS was asked for clarity. Amending legislation would then include technical corrections. By the same token, however, where there were glaring loopholes, or where the legislation was not clear, tax practitioners would exploit the loophole, provided that the transaction would not be struck down under GAAR. SARS could then introduce an anti-avoidance provision. It was not possible to legislate against taxpayer behaviour. Deloitte was therefore stressing that there must be clear legislation to enhance taxpayer morality, and that there should be no room for argument. There would always be honest advisors and more aggressive ones. He suggested that the clearly abusive transactions should be stopped, but in a manner that did not impinge on the genuine transactions.

Mr Liptak noted that the goal should be to modify the proposed amendments to section 45 to stop the abusive transactions, but permit the BEE transactions to go forward on a commercially sound basis. This raised a broader question of whether there should be specific incentives for BEE. There was no general policy to this effect, although NT had removed unintended tax hurdles for BEE transactions. No new rules should be created that did have unintended hurdles for legitimate transactions. The avoidance schemes resulted in little money reaching the BEE partner. The financiers, the company setting up the scheme, financial advisors and lawyers would be receiving the largest portion of the benefit. In most transactions the shares given on day one had no economic value, and it was not until considerably later that they acquired any value.

Mr Liptak commented that if the proposals were enacted in their current form, this would have a devastating impact on deal transaction. He thought it would take 6 to 12 months for the deals to work themselves out. A number of deals were on hold. If there could be deduction solely for the economic interest expense being incurred to buy the business then this could be acceptable. In the long term there would be repricing of the market. However, the short-term effect would be to add an additional upfront tax burden of about 10 to 15% per transaction. Share prices could drop from R30 to R25 per share. Deferral of tax was intended to encourage genuine economic business activity. Putting tax burdens in up front would make the deals not feasible.

Mr Liptak commented that on debt push-down and interest there was no easy answer. Other countries had found that because the transactions were business-based, the interest expense should be deductible. However, there should be reasonable limits on how much should be deducted. Highly risky bonds used in the 1980s had led to recessions. The current transactions were not like this. Most transactions were probably involving 50:50 debt to equity ratios or less. Under previous schemes, the company would be taken over, cut up, the workforce downsized to pay off debt and then sold on. In the current schemes the deals were set up for the long term. They tended to be growth models, and investments were being made to make the companies grow. There was not excessive interest expense. These kinds of transactions had performed better than traditional listed companies, and they did bring skills in and grow faster. With proper safeguards it would be possible to protect against highly-leveraged deals with too much risk of downsizing. It was a question of balance.

Comment by NT
Prof Engel said that law was an expression of the people's will and he felt that it was indeed about equity. The income tax system was geared to ensure that the richer paid a larger share. The legal climate was not emphasising fairness but literalism. There was a need to move away from this.

Prof Engel said that it was necessary to speak of specific examples. Too often the submissions contained non-specific information. To the extent NT had real facts it could act.

Mr Tomasek said that emphasis had been placed on GAAR. The new GAAR came into effect on 2 November 2006 and would be applied once the returns for that period had been received. There had been many extensions. Application of GAAR would only really commence when the returns were in place.

Insofar as SARS taking on test cases was concerned, Mr Tomasek noted that this would be a long process. In 2004 certain STC structures were permitted to allow dividends to be taken out to foreign holding companies. The Minister had made an announcement. A test case had been started then, but was finally settled only recently, with the taxpayer conceding the matter in full. There were other taxpayers that wished to proceed, and SARS would have to take them to court. It was likely to be 2009 before a final decision was given.

The Chairperson hoped that some of the matters being contested would be clarified at the meeting and the Committee would be able to obtain an informed view next week. He understood that the time frames were difficult, but unavoidable. The Committee would do its best to try to accommodate the issues. Responses from NT would be heard on 12 March.

The meeting was adjourned

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