National Treasury releases for public comment a draft of the 2011 Taxation Laws Amendment Bills that gives effect to most of the 2011 Budget Review tax proposals, as well as to additional urgent measures. The draft legislation and explanatory memorandum can be found on the National Treasury (www.treasury.gov.za) and (www.sars.gov.za) websites.
To support inclusive growth and development, the TLAB provides for further personal income tax relief, the introduction of a third rebate for aged individuals 75 years and over, transfer duty relief, various monetary threshold adjustments including increases in the capital gains exclusion amounts, measures to enhance the learnership and industrial policy incentive programmes, increase in the turnover tax exemption threshold for micro businesses, measures to build on South Africa's role as a regional gateway regime, and includes new anti-avoidance measures. The TLAB does not include the taxation of gambling winnings and contributions to retirement funds. These outstanding matters from the 2011 Budget will be covered by separate legislation in the form of a second set of bills. For technical constitutional reasons, the TLAB continues to be split into two bills - a money bill (section 77 of the Constitution) covering issues relating to rates and base and an ordinary bill covering administration (section 75 of the Constitution).
The draft 2011 Taxation Laws Amendment Bills (TLAB) are published for public comment before formal introduction in Parliament. The Standing Committee of Finance (SCOF) convenes informal hearings on these draft bills and considers public comments received. Subject to confirmation from the SCOF, the date for the briefing is planned for 15 June 2011, and the dates for the public hearings are set for 21 and 22 June 2011. The National Treasury and SARS consider all the comments received, and thereafter submit a response document to the SCOF in August. The draft Bills are then revised and formally introduced in Parliament by the Minister of Finance (expected to be in early September).
Rates and thresholds: The main purpose of the Bills is to give effect to the changes in rates and thresholds so these items can formally go into effect at the start of the tax year or as provided in the 2011 Budget Review. The full list of rates and threshold changes involving the Income Tax and Value-Added Tax Acts are dealt with at the end of this statement (see Rates and Thresholds Annexure B) for easy reference.
Personal income tax relief through adjustments to the personal income tax brackets and rebates amounting to R8.1 billion.
Introduction of a third rebate of R2000 per year for taxpayers' 75 years and older.
Increase in the transfer duty exemption threshold from R500 000 to R600 000 and introduction of a reduced 3 per cent interval from R600 000 to R1 million.
Adjustments to various thresholds, such as the capital gain annual exclusion increasing from R17 500 to R20 000 annually.
Increase in the tax-free interest-income annual threshold from R22 300 to R22 800 for individuals below 65 years and from R32 000 to R33 000 for individuals aged 65 years and older.
Adjustments to the turnover tax exemption threshold for micro businesses from R100 000 to R150 000 per year.
Extension of the learnership tax incentive for a further five years.
Living annuities: The Bills contain a proposal to open up the provision of living annuities (to be relabelled as Retirement Income Drawdown Accounts) in order to promote competition. Under the new regime, collective investment schemes (CIS) companies, banks using their CIS licences and Government will be allowed to offer these products (in addition to the current dispensation for life insurers).
Medical tax credits: The Bills give effect to the 2011 Budget proposal to convert expenditures associated with medical aid contributions converted into tax credits. In addition, a discussion paper on a more comprehensive conversion into credits for all other current medical deductions will be published next week for public comment and consultation.
Long-term insurance: In 2011, changes were made to the taxation of long-term insurance in order to prevent executives from using key person plans as a means of avoiding fringe benefit tax. These changes, however, highlighted the need to revise the whole system as applied to policyholders and beneficiaries. The basic system focuses on payments versus proceeds. Premiums paid with after-tax contributions generate tax-free proceeds on pay-out; premiums paid with pre-tax contributions result in taxable proceeds.
Anti-avoidance measures: The Bills contain a number of anti-avoidance measures including the hiatus of section 45 and ordinary tax treatment of dividends from third-party backed shares (see Suspension of Intra-Group Rollovers - Annexure A). In addition, these Bills treat dividend cessions as ordinary revenue (as well as dividends in respect of long-held shares when matched by offsetting short positions). Like third-party backed shares, dividends in these cases should not be entitled to tax-free treatment because the holder lacks any meaningful economic interest in the underlying shares giving rise to the dividends. As a consequential measure, the imposition of Securities Transfer Tax on the cession of dividends is withdrawn.
Completion of the dividends tax: As stated in the 2011 Budget Review, the proposed Dividends Tax will be made operational as of 1 April 2012 (via Ministerial notice in the Government Gazette). The Bills accordingly make the final adjustments associated with implementation of the new tax. Most notably, foreign dividends will effectively become subject to the same 10 per cent level of tax. The Value Extraction Tax (i.e. the successor to deemed dividend treatment under the Secondary Tax on Companies) will be dropped in favour of a facts and circumstances approach to deemed dividends.
Incentives: Government is revising a number of pre-existing tax incentives: Firstly, the requirements associated with venture capital company incentive will be greatly eased to encourage pooling of investments for junior mining and small business. Secondly, the industrial policy incentive will be enhanced for projects located within industrial development zones. Thirdly, the research and development incentive will now require a pre-approval system to curtail avoidance while providing enhanced certainty for legitimate projects. Lastly, the film allowance for film owners will be converted into an exemption so as to encourage film profit (as opposed to the current emphasis on costs).
Government Islamic bonds: A tax framework will be enacted that will allow for Government to issue Islamic bonds (i.e. Sikuks). The regime will essentially allow for asset-based financing with the yield giving rise to tax that is equivalent to interest. These bonds will serve as the standard for risk-free Islamic financing within South Africa.
Regional gateway initiatives: The Bills largely expand on the Gateway to Africa initiatives initiated in 2010. The Bills remove the potential for double taxation by South African multinationals operating abroad through a variety of legislative measures, such as the use of a revised source system and through the addition of special tax credits in the case of foreign withholding taxes imposed on South African sourced management fees. The Bills also remove a number of practical anomalies associated with the "headquarter company" regime introduced in 2010.
Controlled foreign company (CFC) revisions: The Bills contain substantial revisions to the taxable versus tax-free nature of the activities associated with a CFC. The revised rules eliminate the current transfer pricing penalty but more explicitly require an arm's length analysis when determining whether income is attributable to exempt active business activities. The anti-avoidance rules have also been revised to better target the tainted activities of concern and eliminate the use of discretionary trusts (and other forms of de facto ownership) employed to undermine the CFC regime.
Offshore cell companies: In recent years, it was announced that cell companies would be the target of anti-avoidance legislation. The Bills achieve this result by treating each cell of an offshore cell company as a separate company for purposes of the CFC regime. The net result of this segregated treatment is to ensure that CFC status is measured on a cell-by-cell basis, thereby triggering a greater likelihood of CFC treatment.
Notional input credits in respect of fixed residential property: The proposed rules eliminate the current Transfer Duty limitation when VAT vendors acquire second-hand fixed property from non-VAT vendors. As a result, VAT vendors acquiring properties from non-VAT vendors will be eligible for input credits based on the full purchase price. This change should assist the cash-flow needs of many developers when acquiring residential property.
Temporary relief for developers engaged in short-term rentals of residential fixed property: Under current law, application of residential property for rental purposes triggers an automatic deemed VAT charge. This deemed VAT charge effectively undercuts attempts by developers to obtain short-term cash-flows when difficult market conditions prevent desired sales. The proposed amendment provides relief by deferring this deemed charge for a period lasting up to three years.
Securities Transfer Tax - Broker-member exemption: The broker-member exemption will be temporarily expanded to provide relief for all broker-members acting in their capacity as principal. This amendment will apply from 1 January 2011 until the close of 31 December 2012. The purpose of this temporary adjustment is to review current commercial practices on the JSE. Upon completion of this review, the broker-exemption will be explicitly revised so as to apply solely to situations where the Securities Transfer Tax would otherwise inhibit JSE liquidity.
Transfer Duty - Company rollovers: Companies (and trusts) will now be subject to the same progressive rate of Transfer Duty as natural persons. As part of this change, taxpayers engaged in asset-for-share rollovers (e.g. upon formation of a company) will now additionally obtain relief from Transfer Duty.
The 2011 Budget Review also contains proposals on the retirement contribution base and the tax treatment of contributions to retirement funds which includes proposed thresholds for tax deductions up to 22.5 per cent and limited to R 200 000 per annum. In addition, statements pertaining to the imposition of the 1/3rd lump sum/ 2/3rd annuity split for provident funds are also made. Given the need for further consultation, these issues will first be addressed in discussion documents for public comment, after which legislation will be considered, either in late 2011 or in 2012. These discussion documents will be published in July 2011.
A discussion document will be issued covering the conversion of medical deductions into medical credits (due out next week). These credits are to promote greater equity in the tax system.
Further details on the taxation of gambling winnings will be published for public comment by the end of July 2011. This will focus on the design and administrative aspects of the tax.
The National Treasury and SARS are scheduled to brief the Parliament's Standing Committee on Finance regarding the draft legislation on 15 June 2011 (subject to confirmation by Parliament). Comments should be submitted to the National Treasury via Nomfanelo Mpotulo at Nomfanelo.mpotulo@treasury.gov.za and to SARS via Adele Collins at acollins@sars.gov.za by 4 July 2011.
Comments should also be submitted to the Parliamentary Standing Committee on Finance with informal hearings currently scheduled for the 21st and 22nd of June 2011 (subject to confirmation by Parliament). For further details about the Parliamentary hearings and submission process, contact Allen Wicomb at Parliament at awicomb@parliament.gov.za or by telephone on 021 403 3759. To assist with the processing of comments in regard to all of the above submissions, comments should be given in the order listed as per the explanatory memorandum.
TLAB: Documents for Public Comment (available on www.treasury.gov.
Explanatory Memorandum on the Draft Taxation Laws Amendment Bill, 2011 2. Draft Taxation Laws Amendment Bill 2011 3.
The purpose of this Media Statement is to highlight the immediate hiatus of section 45 rollover relief (as suspended within the Taxation laws Amendment Bills, 2011). This media statement also highlights concerns about related issues, such as form versus substance issues involving the tax classification of debt versus shares, the significant risk to the corporate tax base posed by excessive debt, and the urgent need for an overall review of these and inter-connected matters.
Debt: Commercially, debt represents a claim on a specified stream of cash flows. This claim is payable despite the financial performance of the debtor. In tax terms, debt payments representing interest are typically deductible by the debtor with the same payments being includible as ordinary revenue by the creditor.
Shares: Commercially, shares represent a contingent claim by the owners in respect of company profits as evidenced by dividends declared (and increased share value). In tax terms, the company payor may not deduct dividends. Under current law, dividends generally carry a 10 per cent charge imposed on the company payor by virtue of the Secondary Tax on Companies. With the advent of the new Dividends Tax, the 10 per cent charge is shifted to the shareholder-level.
Depending on the circumstances, a tax preference may exist for taxpayers to attach a label to a debt or share instrument that differs from the underlying substance. As a result, these instruments are often treated as preference shares for tax purposes with the same instruments treated as debt for accounting purposes. Similarly, an instrument can be treated as debt for tax purposes while being treated as shares for accounting purposes. This tax/accounting arbitrage offers many benefits depending on the circumstances.
The main tax benefit of debt versus shares focuses on the deductibility of payments by the payor. Large deductible interest payments can significantly reduce corporate taxes (unlike non-deductible dividends). The deductible nature of interest payments creates a strong incentive for excessive debt. A common trigger for excessive debt is a leverage buyout acquisition with purchasers using debt to acquire a target business (much of which carries a subordinated or junior ranking) based on the target business as security.
As a theoretical matter, deductible interest should be matched by corresponding ordinary income in the hands of the creditor. Hence, debt should act as mere shift in the tax burden. However, in many aggressive schemes, interest income is earned by exempt parties (or ultimately shifted by taxable creditors to exempt parties). This shift is hard to control and represents a significant threat to the tax base.
Excessive debt also creates commercial problems, thereby raising concerns that a tax preference in this direction should not be supported. A company with excessive debt becomes extremely vulnerable to economic conditions, lacking economic reserves during downturns. An economy full of companies with excessive debt can create a "domino effect" of insolvencies that threatens the economy as a whole. Time-and-again history has shown that excessively indebted parties are at the centre of serious economic downturns.
While most taxpayers seeking finance prefer deductible interest in tax terms, some taxpayers seeking finance have no ready tax use for these deductions. These taxpayers may already be in a significant loss position or may be acting as start-up operations that lack significant income at the initial stages. In these circumstances, share-finance offers the benefit of lower charges for the financier (i.e. a 10 per cent or even a zero per cent charge). This lower charge for the financier is then shared with the debtor in the form of lower interest rates.
The seeming freedom of taxpayers to characterise finance instruments as debt or as shares for tax purposes means that taxpayers can choose the best of both worlds depending on the finance deal involved. Moreover, the freedom to lean in favour of one form or another in a single deal can only destabilise the tax base still further.
A prime example of this concern involves "funnel schemes" identified several years ago. In these schemes, an intra-group debt is outsourced to seemingly independent third parties, thereby triggering excessive deductions for the financed party. The funds at issue are then indirectly employed to acquire tax-free preference shares that have the commercial features of debt. The net result is a round-tripping of funds to the detriment of the tax base.
Section 45 intra-group rollover relief was primarily intended to facilitate transfers amongst member companies historically operating together in a single group. When the capital gains tax was being formulated, it was alleged that relief was required to facilitate recurring asset transfers between group companies funded by intra-group loan accounts. The goal of section 45 was to ensure that the tax system did not pose a barrier to intra-group transfers, regardless of whether the transfer occurs in exchange for shares, debt or cash or as a dividend. It should further be noted that intra-group relief is a common feature of most advanced tax systems.
Unfortunately, the history of section 45 has taken a vastly different course. Section 45 has instead become a key acquisition tool. A common use of section 45 involves debt push-down structures. In structures of this nature, section 45 allows for the tax-free movement of target company assets so that these assets can be freely placed in a location where substantial interest deductions can be applied against operating target company income. In essence, section 45 becomes the trigger for connecting excessive debt. Still worse, in the case of funnel schemes, section 45 allows for debt proceeds to be indirectly linked to tax-free preference share dividends. While debt/share concerns exist outside the context of section 45, section 45 greatly facilitates the use of excessive debt schemes.
As stated at the outset, section 45 rollover relief will be wholly suspended for a period of approximately 18 months. During this period, the continued need for this relief will be re-evaluated along with concerns relating to excessive debt. The proposed amendment will apply in respect of any asset disposed of on or after 2 June 2011 but before the close of 31 December 2012.
As a secondary measure, dividends in respect of shares backed by third parties will be treated as ordinary revenue. This ordinary revenue treatment will cover various forms of third-party backing, all of which will apply without regard to any three year or other timing requirements. These anti-avoidance measures are intended to become a permanent feature of the tax landscape with a narrow escape hatch for commercial circumstances that do not pose a potential risk for the tax base.
As illustrated above, section 45 cannot be viewed in isolation. The issues relating to Section 45 are part of a larger set of problems.
The need to allow for interest deductions stemming from leveraged buyouts, regardless of the form of that acquisition.
These rules will become the object of urgent investigation for legislation starting in 2012.
Between R1.0 million and R1.
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