Tax Proposals: briefing by Treasury & SARS & Tax Expert's Comment

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Finance Standing Committee

27 February 2007
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Meeting report

FINANCE PORTFOLIO COMMITTEE
28 February 2006
TAX PROPOSALS: BRIEFING BY TREASURY & SARS & TAX EXPERT'S COMMENT

Chairpersons:
Mr N Nene (ANC)

Documents handed out:
National Treasury and SARS Tax proposals: Budget 2007
Mallinicks submission on tax proposals

Relevant documents
Possible reforms to the fiscal regime applicable to windfall profits in South Africa’s liquid fuel energy sector, with particular reference to the synthetic fuel industry
Second Discussion Paper on Social Security and Retirement Fund Reform by Treasury

 

Audio Recording of the Meeting Part 1, Part 2 and Part 3

SUMMARY
The Committee was briefed on the 2007 tax proposals and then heard a submission by Mallinicks on the tax proposals.
The broad underpinnings of the 2007 tax proposals were:
-
Supporting economic growth, investment, job creation, business development and confidence,
- Promoting financial security of households and reducing their vulnerability through retirement reforms that encourage savings; and
- Supporting macroeconomic policy, including monetary policy.

The 2007 Budget would provide net tax relief of R12, 4 billion. The tax proposals included:
- The reduction of the secondary tax on company (STC) rate from 12,5 per cent to 10,0 per cent and the broadening of the base. STC would be replaced by a dividend tax in 2008.
- The abolition of retirement fund tax and streamlining tax and regulatory aspects of retirement funds.
- Increasing the tax-free interest and dividend income monetary thresholds.
- Increasing monetary thresholds for estate duty, capital gains tax on death and donations tax.

Mallinicks welcomed the budget but raised a few concerns.
The long lead-time and sketchy details about phase one of the STC reform gave rise to uncertainty in the business community. STC was unique and only a few countries had it. The abolition of retirement fund tax was welcome. The biggest shareholders were the retirement funds and they would have to pay the dividend tax.

Members raised a number of questions that included the following:

- What elements were taken into consideration when arriving at the effective corporate tax rate?
- Whether Treasury, when moving from STC to taxing the dividends, would also tax other forms of distributions. Some companies deferred the payment of dividends. How would such companies be taxed?
- Whether companies that sponsored amateur sports bodies could have a tax deduction?

MINUTES
The National Treasury and the South African Revenue Services were represented by Mr Cecil Morden (Treasury Chief Director: Tax Policy), Mr Frans Tomasek (SARS General Manager: Legislation) and
Prof Keith Engel (Treasury Director of Legislative Policy). They all presented (see document attached).

The broad underpinnings of the 2007 tax proposals were:

-
Supporting economic growth, investment, job creation, business development and confidence, - - Promoting financial security of households and reducing their vulnerability through retirement reforms that encourage savings; and
- Supporting macroeconomic policy, including monetary policy

The big taxing instruments were personal income tax (PIT), Company Income Tax (CIT) and Value Added Tax (VAT). The total number of registered individual taxpayers was just under five million.
The 2007 Budget would provide net tax relief of R12, 4 billion. The tax proposals included:
- The reduction of secondary tax on company (STC) rate from 12,5 per cent to 10,0 per cent in 2007 and the broadening of the base. STC would be replaced by a dividend tax in 2008.
- The abolition of retirement fund tax and streamlining tax and regulatory aspects of retirement funds.
- Increasing the tax-free interest and dividend income monetary thresholds.
- Increasing monetary thresholds for estate duty, capital gains tax on death and donations tax.

Discussion
Mr K Moloto (ANC) referred to Slide 21 which dealt with a comparison between the Headline Corporate Income Tax (CIT) rate and the Effective Corporate tax rate. He said that one could manipulate statistics until they screamed and gave the kind of information that one wanted. Some people had said that the South African tax on companies was too high compared to other emerging markets. He wondered if people took into account the depreciation allowance when talking about the effective tax rate in South Africa. There should be in-depth discussions on this issue because it was continually raised every year. It had always been said that the government was not incentivising the production side of the economy.

Mr Morden replied that Slide 21 showed that the Headline CIT had been going down in SA and this was also the case in many other countries. There were indeed international comparisons. There were various factors that contributed to the decrease in the rate. What was important was to look at the effective corporate tax rate because the headline rate told just one story. Below the headline rate were deductions and incentives that differed from one country to the other. People who looked only at the headline rate had often missed the point. It was not easy to compare the effective corporate rate across the globe because the necessary information was not readily available. There was the concept called the margin effective tax rate. The World Bank had done a study and South Africa compared favourably with many other countries.

Mr Moloto asked what elements were taken into consideration when arriving at the effective corporate tax rate.

Mr Morden replied that Slide 22 did not refer to gross operating surplus (GOS) which was profit generated by companies. This was published by the Reserve Bank. The total Gross Domestic Product (GDP) was divided between GOS and payments to individuals. GOS surplus as a percentage of the GDP was an important indicator of corporate profitability. It included both incorporated businesses and unincorporated businesses. He referred to Column Five of Slide 22 which reflected CIT as a percentage of gross operating surplus total. It was a lower rate because it also covered unincorporated businesses. Column Six referred to CIT as a percentage of GOS of corporations. This was the estimate of the effective rate just from CIT.

Mr Y Bhamjee (ANC) referred to Slide 22 and said that the percentage dropped a lot between 1991 and 2001. He asked if the drop was for political reasons, as he suspected.

Mr Morden replied that there could be a whole host of reasons and one was the profitability of businesses. There were also compliance issues to deal with. He reminded the Committee that Treasury had made quite an effort to broaden the tax base in the past five years.

Mr Tomasek agreed with Mr Morden. It was difficult to unpack some of the issues. The Slide demonstrated what the SARS Commissioner had been saying about a compliance culture. There were some schemes that were being aggressively marketed in the 1980s and early 90s. One could be seeing the impact of such schemes in Slide 22. Other factors included the impact of over generous incentives, tax planning and compliance.

Mr I Davidson (DA) said that Mr Moloto should compare apples with apples. It was very difficult to make a comparison in terms of the effective tax rate because one did not know what to include and exclude. One could not bring in depreciation allowances in SA and say they lowered the effective corporate tax rate without looking at international effective tax rates and building in depreciation allowances there. One should draw a line at some stage and the question was where should the line be drawn. KPMG and other companies had been trying to draw this line. South Africa had added the STC into the bargain.

The Chairperson said that the problem also lay in identifying the apples themselves before one could start comparing apples to apples.

Mr J Fubbs (ANC) also said that it had been said that the corporate tax rate was high and one also had to add the huge number of regulations and complexities that the country had. It had been said that there were constraints to investment in the country.

Mr Morden replied that the government was working on the issues of the complexities of the system and the compliance burden. There were efforts to simplify matters but tax was by nature not easy. It was hoped that the STC reform would reduce some of the complexities. There were also proposed reforms aimed at small businesses.

Mr Tomasek said that Mr Morden had made very valid points. The tax code tried to deal with the complexities of economic life in a country. One should expect the tax code to respond accordingly as the economic life became more complex. There was a need to manage the complexities and reduce them where possible. Some emerging economies might not have to worry about the taxing of derivatives. This was an issue that SA would have to continue to address. Certain things should be borne in mind when drawing the comparisons.

Mr B Mnguni (ANC) said he operated on the assumption that people who appeared before the Committee made proper comparisons before making presentations. The Africa Commission had said that it did not worry much about the tax rate but about the stability of the country. He asked if Treasury, when moving from STC to taxing the dividends, would also tax other forms of distributions. Some companies deferred the payment of dividends. He asked how such companies would be taxed.

Mr Tomasek made an example of a company that had one asset and the asset had appreciated in value. He assumed that the company had distributed and not sold the asset. There would have been a profit in the company if the asset were sold. Distributing the asset without having sold it meant that the company had an unrealized profit. The question was whether there was profit. There was indeed a profit in the hands of the shareholder that should probably be taxed. The nature of the dividends tax was such that tax was deferred once the dividend was deferred.

Mr K Murray (DA) asked if companies that sponsored amateur sports bodies could have some tax deductions. With regard to personal income tax (PIT), he said that the presentation was silent on relief for disabled dependants.

Mr Morden replied that a sponsorship in the form of an advert would be a fully deductible expense. Normal donations might not be deductible.

Mr Tomasek agreed with Mr Morden. He gave an example of a sponsorship in terms of which the company was expecting some recognition in return for putting company banners where the event was being held. This could be regarded as an advert and therefore deductible. A straight donation would not be deductible. With regard to disabilities, he said that there was very generous relief in relation to medical expenditure for people who suffered from disabilities. The relief covered a whole range of expenditure.

Mr Bhamjee again said that there were political considerations that contributed to the drop he referred to previously when discussing Slide 22.

Mr Davidson asked for clarity on retirement reforms and social security subsidy. There were two types of wage subsidies: one to the employer and the other to the employee. When the announcement about the wage subsidy was made, he got the impression that it was a subsidy to the employee in lieu of social security costs if they were below a certain wage level. Slide 16 presented a different picture. One of t
he objectives of such a subsidy was to reduce the direct costs of employment to help alleviate the high rate of joblessness. This implied a subsidy to the employer. The second objective was to facilitate the proposed social security reform process. This implied a subsidy to the employee. He asked if the new package would provide both subsidies. He was of the view that the intention was to provide a subsidy for employees. The subsidy to employers was an interesting addition.

He also focussed on phase two of the STC reform and the introduction of a dividend tax. STC was 12, 5% at the moment and would be reduced to 10%. Adopting a classical form, the top marginal rate would be 40% if the shareholder were an individual. The dividend would be taxed at 40%. The dividend would be taxed at 29% if the shareholder were a company. The total revenue off take by Treasury would rise remarkably.

Mr Morden replied that the 10% had been floated and there was no final decision on it. It was a ball park figure that the government was looking at. The most important thing was that it would be the final withholding tax.

Mr Tomasek replied that the proposal was a final withholding tax of 10%. It did not come into the taxable income thereafter.

Mr Morden replied that the intention was to provide a subsidy that would do two things: alleviate social security contributions that would be required by all employees and to alleviate the cost of employment. Achieving both objectives would be a tall order. A lot of work still had to be done. Treasury envisaged an employer-based subsidy (even the employee part because it would be a contribution directly made by the employer on behalf of the employee).

Mr Davidson said that the contribution would cover the social security tax and there might need to be a further supplementary wage subsidy to the employer to encourage them to employ more people.

Mr Morden replied that the size of the subsidy would be of such of a nature that it would be more than the contribution required for social security.

Mr Davidson also referred to the windfall tax and said that he had not read the recommendations of the Task Team on this matter. The fiscal recommendations of the Task Team included a
progressive incentive regime for investments in new synthetic fuel and biofuel plants. The Minister had not yet made a decisions and Treasury had not yet formulated its views on the matter. He asked for more clarity on what the Team meant when it referred to a subsidy / tax credit when crude oil prices were below a certain amount and a sliding scale tax when crude oil prices rose above a certain amount. He asked how this would work. Was it tied to the amount of investment made? He could not understand how such tax/credit (attached to the value of a product) would increase investment in the industry.

Mr Morden replied that the Minister had not pronounced on the windfall tax. The understanding was that the subsidy would kick in if the oil price was very low because there would be higher costs in producing it. A tax would be imposed should the price rise above a certain level. The previous regime had something similar but there was a flat rate of 25%.

Mr A Harding (ID) said that SA had a highly developed economy that was complex in some areas. The tax regime would without any doubt reflect the level of development and complexity. He asked if mine rehabilitation programmes would be factored into the environmental depreciation expenses. If so, did Treasury consider the impact this would have on the effective tax rate of mining companies and operations.

Mr Mnguni said that the transport sector had indicated that it was using trucks to transport its goods because rail was slow and expensive to maintain. He asked for the rational for having a depreciation allowance for rail. There was a living document in mines that provided that companies should rehabilitate the environment. He asked if Treasury was saying that mining companies would get a depreciation allowance. How could there be depreciation if there were only dumps and no buildings.

Prof. Engel replied that the most important concern was not mining although there would be some impact on mining. The issue was that environmental rehabilitation required certain things. There might be a need for a waste treatment plants and dams. Such things might not be depreciable.

Mr Tomasek replied that mines had been in a position to create rehabilitation trusts for some time. There was a long dispensation for mines for remedying any environmental impact that they might have created.

Mr Morden added that the mining rehabilitation fund was already a tax-deductible expense. He said that rail was one area in which the country had probably gone wrong. There had be no sufficient investment in the rail network and people had as a result moved to road transport. The intention was to upgrade the current rail infrastructure so that there could be more playing fields and a shift back to rail transport. It should be more cost effective for people to use the rail network.

Ms Fubbs referred to Slide 28 and focused on air pollution from coal mines. She asked if the existing penalties would be factored into the depreciation allowance referred to in the Slide. She also asked how auctioneers were taxed. The customs definition would be changed. She asked what this would mean to Southern African Customs Union members. She was under the impression that tax could be seen or used as a redistributive instrument. She asked for a comment on this.

Mr Morden replied that pollution from coal mines was a new area to look at. A draft report on environmental fiscal reform was published last year. It dealt with environmental taxes and potential incentives. Treasury and the Department of Environmental Affairs and Tourism (DEAT) were looking at how to treat and disincentivise pollution. This would involve some taxes or penalties. Some of the issues could be addressed through the tax system whilst others would have to be addressed by DEAT.

He said that the change in the definition of customs would have some impact. Customs revenue was distributed differently from excise revenue. Most of the customs revenue went to the
Botswana, Lesotho, Namibia and Swaziland (BLNS) countries because it was based on intra imports within the region. Excise revenue was to a large extent based on the GDP figures. The proposal was to take some of the money from the customs pool into the excise pool. This would favour SA and would be open an interesting debate with SACU countries.

Mr Morden said that one of the fundamental principles of tax was to raise revenue. The issue of equity was important. The tax system had historically been and was being used as a redistributive tool. The question was how to strike the balance. PIT was probably one of the most progressive taxes in the country. All other taxing instruments were either proportional or regressive. Indirect taxes like excise on tobacco and the fuel levy tended to be regressive. It was difficult to say if corporate tax was progressive or regressive. The overall tax system was marginally progressive.

Mr Tomasek replied that auctioneers were taxed just like anybody else. There were additional reporting rules for them so that the government could control what took place in their activities.

Mallinicks presentation
Mr H Bester (Mallinicks Tax Director) made the presentation (see document attached). He said that the budget proposal had been well received. It had been said that the PIT top marginal rate was very high. It should be remembered that the PIT was progressive and started from a lower rate and moved up to 40%. It was different from the corporate rate where there was a flat rate. The long lead-time and sketchy details about phase one of the STC reform were leading to uncertainty in the business community. STC was unique and only a few countries had it. The abolition of retirement fund tax was welcome. The biggest shareholders were the retirement funds and they would have to pay the dividend tax.

The Chairperson invited SARS and Treasury to respond to the submission by Mr Bester.

Mr Tomasek said that 23 out of 30 countries in the OECD had a withholding tax on dividends for resident shareholder. Eight out on 14 none OECD countries surveyed had it. On the switch from STC to dividend tax, he said that a company that had R100 would not distribute the whole amount because it still had to pay STC. It would have to keep R11 back to pay the STC. Going into the future it would declare the R100 and deduct a withholding tax of 10%. This means that R90 would go to shareholders. Shareholders would be economically far better off. Dealing with preferent shares, the problem could be that there was a fixed rate for them.

Prof. Engel said that the presentation wanted changes and the government had made them. It seemed like the sky was falling and the presentation assumed worst-case scenarios. There was no intention to destroy everything and burn the fields. Phase one was the lowering of the rate and the broadening of the base. This was where a lot of legal planning was going on. When there was a distribution, a shareholder would get some money and call it a dividend. A lawyer might call such money something else. There were a lot of games to turn profits into share premium or capital in order to re-label the money to be paid as something else. The government was saying that people would get a lower rate and the re-labeling games should stop. When the money comes out, companies would be given the recovery of the share capital. This would be received last.

Mr Morden said that shareholders would not be worse off after the changes. At the moment they paid tax on the dividends. On PIT maximum marginal rates, SA was far better than most OECD countries. The average for the OECD was 42, 6% and the average for the EU was 44, 6%. Australia was at 48,5% and Canada was at 47, 4%.

The meeting was adjourned.

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