9 October 2000

The Chairperson
Portfolio Committee on Finance
National Assembly

Public Hearings on Tax Reform – Residence Based Tax

I attach for your consideration, a copy of a submission in respect of certain proposed tax reform measures, which include the proposed change from a source to a residence based tax system. This latter is the subject of the Revenue Laws Amendment Bill presently before the Portfolio Committee on Finance. The thrust of the document is towards the potential economic consequences that could flow from the adoption of the proposal.

This memorandum will form the basis of an oral presentation to be made by a SACOB delegation on Tuesday 10th October.

Economic Consultant

Memorandum of comment by the South African Chamber of Business (SACOB) on certain Tax Reform measures proposed by Government.

(Capital Gains and Residence Based Tax)

‘Stable, consistent and predictable policies as well as a dynamic economy should create a climate conducive to foreign investment’ - RDP policy framework

  1. Introduction

SACOB represents some 40000 businesses, large and small, located throughout the entire country. It is largely this constituency that makes decisions on investment that in turn determines whether or not sustainable employment is to result. The focus of this memorandum is on the likely economic consequences of the proposed new tax measures announced earlier in the year

The tax measures announced by the Minister of Finance during the February Budget (2000-2001 Fiscal Year) included the proposal to introduce two major tax reforms, namely a Capital Gains Tax, and a move from a Source to a Residence Based Tax. Given the contrary recommendations of the Katz Commission on these issues, the fact that tax revenues exceeded budget forecasts, and the lower deficit before borrowing; the announcement was unexpected. The impact on investment plans of this unforeseen announcement has been negative and has introduced a further element of uncertainty for future investment. Representations by SACOB in respect of the Capital Gains Tax were made to the Parliamentary Select Committee on the Budget earlier in the year and draft legislation is awaited. With regard to the Residence Based Tax, a draft Bill (September 22 version) has been tabled for comment. Although the time allowed for comment has been constrained, the efforts of the South African Revenue Services (SARS) in drafting such complex legislation under very tight deadlines must be acknowledged.

The purpose of this memorandum is to:

1.1 Urge that the implementation of the residence amendments be delayed until an appropriate assessment is made of the economic consequences it will have on the country’s competitiveness and its ability to attract foreign investment capital; and

    1. Emphasise the need for broader consultation and discussion. Whilst SACOB acknowledges the opportunity allowed it to participate in the SARS "residence" task group, confidentiality requirements precluded wider consultation with its broader membership.
    2. Urge consideration of the possible adverse loss of credibility should SARS find its lack of capacity an impediment to the effective implementation of very complex tax legislation.

Considerable emphasis has been and continues to be given to the highly skewed distribution of income in South Africa. The government is rightly committed to reducing that inequality and continues to receive SACOB’s full support in striving for equity in the tax system. However it must be emphasised that this should be done in the context of the country’s economic realities, namely, a lack of foreign direct investment, the emigration of skills and the need to adapt to global competitiveness. The Minister of Finance recently when reporting on the performance of government’s macro-economic policies confirmed this reality. He is reported to have said (Business Day, October 2) "Our low growth is as a result of low savings in this economy. There also (have) been low investments and a loss of skills". SACOB submits that the proposed tax amendments will exacerbate the situation.

2. The Competition for Capital

2.1 Access to sufficient and appropriately priced capital from foreign investors depends primarily on South Africa adopting and maintaining investor-friendly policies. Capital flows into a country are seen to represent an endorsement of that country’s domestic economic policy by analysts and investors who are in a position to make such judgments. At the time of its tabling in 1996, the government’s macroeconomic strategy (Gear) was well received by business which believed that it showed the new government’s commitment to market- driven realism. Major economic reforms that have taken place, a reduction in the budget deficit from over 5% of Gross Domestic Product in 1996 to 2,3% in 2000, a relaxation in exchange controls, a reduction (albeit minor) in the economic role of the state (privatisation), the liberalization of the internal and external trade regimes, and a transformation of the public service, however the anticipated level of foreign direct investment has not materialised.

2.2 SACOB submits that it is manifest that tax is one of the primary cost factors in considering an investment decision. SACOB is concerned that insufficient research has been conducted to appreciate the effect that recent tax reforms including the taxation of ‘foreign dividends’ received by South African residents; the introduction of a Capital Gains Tax (CGT), and a change from a Source to a Residence Based Tax system (RBT) will have on foreign direct investment, which is already under pressure. These measures must inevitably add to the overall tax burden, which is already deemed to be excessive and which SACOB fears will adversely affect investment decisions. The apparent inconsistency in government policy has to be seen in the context of the considerable energy that has been, and continues to be, expended on efforts to attract foreign investment. To be sure, the economic reforms introduced have helped to make an increase in private finance feasible and, from an investor’s point of view, more attractive. But the fact remains that South Africa is not alone in introducing economic reform measures. South Africa therefore has to offer more, not less, in order to attract investment.

2.3 The ‘best practice’ arguments that have been advanced in support of South Africa’s need to conform to the tax jurisdictions of the developed world are unsound. South Africa remains very much part of the developing world and indeed recognizes itself as becoming a leader in the so-called ‘emerging’ economies. Conforming to the tax regimes adopted by capital-rich countries will do little to enhance South Africa’s attractiveness as an investment destination. It matters more so than before if the country wishes to compete with other emerging markets for investment capital. The high mobility of capital between countries is abundantly evident. In such a highly sensitive and responsive environment, issues such as tax regimes are no longer regarded as fine print issues by investors. They are issues that are emerging into ever- bolder relief.

3. Offshore Returns

The rationale for any person to consider investing outside his own particular domestic jurisdiction is risk diversification and the expectation of securing a higher return. It is difficult to make international comparisons of the taxes paid by firms because few companies pay tax at the standard nominal rate. Instead the measure of comparison used is the ‘effective tax rate’. This compares the extra rate of return that a company must make, before tax, in order to offer investors the same rate of return that they can earn on government bonds. The higher the ‘effective rate’, the more it distorts the investment choices. The point is that tax codes can and do affect investment decisions and more importantly can constitute a big barrier to cross-border investment.

4. Specific Tax Proposals

4.1 Capital Gains Tax (CGT)

4.1.1 SACOB recognizes the wide disparity in incomes that exists in South Africa, and agrees that a need exists to find an appropriate balance between the taxation of income and the taxation of other gains. At the same time SACOB submits that measures that reduce the already poor attractiveness of the country as an investment destination will have adverse consequences, namely a continued deferment of investment and the associated arresting of job creation.

4.1.2 The contention that CGT brings South Africa into line with the ‘best practice’ tax regimes of developed countries (whatever that may mean) must be challenged. CGT would seem to be a discredited tax system in many countries and is arguably not the norm. The fact is that South Africa is not in the same league as countries categorized as the ‘developed’ world. In order to attain such a status the country must attract FDI to make good its own inadequate savings capacity. The adoption of CGT merely fuels the deteriorating domestic savings culture and sends a negative message to foreigners considering investment in this country.

      1. It is a misconception that CGT will bear most heavily on the rich. This is not so, for the application of the tax is triggered only when wealth is realized in the form of capital gains. The rich can afford to have their wealth work for them without having to realize gains. Those less wealthy are not in such a position, and in order to access their capital have no option but to realize assets thereby becoming subject to CGT. The equity objective is accordingly suspect. By the same token the effect of the tax is to discourage asset realization and thereby lock-in capital to the disadvantage to the economy, while at the same time bringing no benefit to the Fiscus. It must be pointed out that the cause of equity will be discredited if, in the calculation of capital gains tax liability, no allowance is to be made for inflation. Failure to provide such an allowance merely imposes a tax on capital as distinct from capital gains.
      2. CGT is not an efficient tax instrument-a feature that has been acknowledged by government. Even if it can be shown to have a positive yield, it would not take into account the administrative onus placed on business to comply. Business, and in particular small business, is ill equipped to engage in additional compliance costs. These are very real issues, which should be considered by the legislators in enacting, not only this proposed measure but, all laws having compliance obligations.
      3. The prospect of double taxation is an equally harmful outcome from the application of this measure. Along with CGT, estate duty, transfer duty and donations tax and even marketable securities tax, all constitute a tax on capital and it will be necessary to ensure that double tax does not occur.

4.2 Source to Residence Based Tax (RBT)

      1. Some of the arguments set out in 4.1 above have an application in respect of the possible adoption of this tax measure. The rationale for the adoption of this measure may well be related again to ‘best practice’ objectives. It may also be the intention to protect the revenue base. Whatever the rationale, there will be adverse consequences for inwards investment flows, the competitiveness of South African businesses operating externally and efforts to encourage international companies to locate their headquarters in South Africa. Furthermore at a time when a number of arms of government are actively encouraging South African businesses to engage as investors in the SADC region it appears odd that another arm of government is proposing measures that will clearly discourage such engagement.
      2. The amendment to section 1 introduces sundry definitions for a resident. According to that definition, certain persons spending more than 91 days in South Africa will on their fourth year become liable for tax on income derived from external sources, though provision is made for the granting of tax credits in respect of any foreign taxes paid. As a new taxation instrument, its intended introduction has created further uncertainty. Affected persons must consider the advantages of living in South Africa for more than 91 days a year against the new tax obligation. The affect of the legislation could well encourage such persons to relocate to a more favourable tax environment. Arguments have been advanced to suggest that so-called ‘high net-worth’ individuals should be encouraged rather than discouraged to locate in South Africa, as they generate wealth in the form of investment and employment, inside the country. The fact that there is a retrospective element to the tax gives further cause for investors to hear alarm bells.
      3. The amendments to section 10 introduce the prospect of reducing the competitiveness of South African businesses operating offshore and who employ South African residents who are absent from country for less than 183 days. Consider that in order to retain their continued commitment to the company, the net loss to such employees (that will come about from the new measures) will have to be made up by the company. Only by increasing their costs and thereby undermining their competitiveness in offshore ventures can that be done. The alternative is to refuse to make up the required tax deduction and thereby run the risk that the employee will resign and work for another non-South African firm, or that he/she will locate to a more favourable tax jurisdiction or non residents will be employed. Any one of these options will have a less than optimal outcome for South Africa. A loss of expertise is encouraged and there will be no benefit to the Revenue Service.

4.2.4 The issue for tax policy-makers to consider is not whether South Africa’s tax regime conforms to the rigours of the dispensations current in the developed world, but whether South Africa can offer more to the potential investor than those jurisdictions. Thus the introduction of RBT must surely serve as a deterrent to international companies using, or considering South Africa as a location for their headquarters. Such companies will now be subject to South African tax on their entire offshore operations. South Africa must endeavour to do more than verbalise welcome messages to the international investment community. This measure is definitely not indicative of any such welcome.


Consideration has been given to the Government’s tax reform measures concerning the introduction of a Capital Gains Tax and a move from a Source to a Residence Based system. Although there may be social arguments advanced for these reform measures, there will be adverse economic affects which conflicts with other important objectives of Government policy.

SACOB accordingly urges greater consultation and broader debate before the introduction of such reforms.

9 October 2000