REVENUE LAWS AMENDMENT BILL
COMMENTS BY DELOITTE & TOUCHE
Clause 5(1)(m) (amendment of the dividend definition)
The meaning of “value” is not specified in clause 5(1)(m). Is the reference to market value, or to par value (issued share capital plus premium); this should be clarified in the legislation. If market value is meant, this will be administratively onerous if taxpayers are forced to seek market valuations of private companies in order to be able to apply the provisions of the section.
As no distinction is made between different classes of shares, the application of the provision could result in inequities for taxpayers where there is no tax avoidance purpose.
To illustrate the iniquitous results, assume a company issues non participating redeemable preference shares with a par value of 1 cent at a premium of 99 cents. The preference shares are to be redeemed after five years for an amount equal to the subscription proceeds. The share premium created on the issue of the preference shares will be applied towards their redemption.
Assuming the coupon on the preference shares to be market related, the shares’ market value should remain constant. However, the market value of the ordinary shares in the company might have increased substantially over the term of the preference share investment. When the preference shares are redeemed after five years, their value could be insignificant in relation to the value of the ordinary shares. As a result, the application of the share premium (that was created on the issue of the preference shares) to redeem the preference shares could give rise to a significant dividend distribution by the company.
We therefore propose that clause 5(1)(m) be amended such that the test whether a dividend is distributed on a reduction in share premium be applied separately in relation to each class of shares. If our suggestion is accepted, the allocation could be done on the basis of the number of shares held to total issued shares of that class as they would all have the same value.
It could then be made clear that share premium created on the issue of one class of shares will give rise to a dividend distribution if applied towards the reduction of share capital "belonging" to a different class of shares.
Clause 5(1)(c) and Clause 63 (amendment of dividend definition and of paragraph 19 of the Eighth Schedule)
The amendment to the period with respect to the time of disposal as opposed to the time of acquisition of the shares will have the effect of affecting innocent transactions especially in light of the rate of return of 15% over 2 years (i.e. 7.5% per annum) specified in the definition of “extraordinary dividends” in paragraph 19. This rate is very low when compared to current rates obtainable on preference shares in the market.
For example: a person buys a preference share for R100 with a coupon of 10%. She earns dividends of R20 over the following two years and then sells the share for R100. These dividends are extraordinary dividends as they exceed 15% of the proceeds. The effect is as follows:
Add: extraordinary dividends
Less: base cost
The taxpayer therefore pays CGT on the extraordinary dividends received (which in truth are not that extraordinary!), and the company pays STC on the same dividends declared. This results in double taxation.
Double taxation could also result in the following scenario. A taxpayer incorporates a company with a share capital of R10. Ten years later the company is liquidated at which time reserves of R90 are distributed to the shareholder. The R90 (less STC) is a dividend which is subject to STC. It also constitutes an excessive dividend for purposes of paragraph 19. The effect is as follows:
Add: excessive dividends up to original cost
The R10 gain is effectively subjected to tax twice: first to STC and then to CGT. The Act should aim at taxing distributions of profits either by way of STC or by way of CGT, but not by both.
It is proposed that paragraph 19 be amended such that the amount of the extraordinary dividends will be added to proceeds equal in the aggregate to the taxpayer's base cost in the shares, irrespective of the identity of the shareholder. The taxpayer will therefore be prevented from making a capital loss in any circumstances where the payment out within the previous two years of extraordinary dividends would otherwise have caused this to happen. This will result in the taxpayer being denied a capital loss where, for example, he engages in dividend stripping, but it will also prevent the same amount from being taxed twice. Any excess of extraordinary dividend over the amount needed to bring proceeds plus extraordinary dividends up to the base cost amount would be ignored for tax. The current wording could result in penal taxes, which should not be the purpose of tax legislation.
Alternatively, the definition of “extraordinary dividends” should stipulate a higher rate than the current 15%, possibly 25%.
Finally, to avoid retrospective application i.e. turning dividends already paid into “extraordinary dividends” as defined, the amendment should be introduced with regard to dividends declared on or after 1 October 2007, as opposed to disposals of shares occurring on or after 1 October 2007.
GROUP OF COMPANIES
Clause 48(1)(c) (amendment to definition of “group of companies” in section 41)
It is unclear why section 21 companies are excluded from the definition of “group of companies”. Many section 21 companies pay tax, so there is no reason why they should not be entitled to avail themselves of the corporate rules.
We propose that only companies that are exempt from tax be excluded from the definition of “group of companies” as opposed to all section 21 companies.
Clause 48(1)(c) (amendment to definition of “group of companies” in section 41 for the purposes of Part III of the Act)
It is proposed that any company
which is not incorporated in
There appears to be no valid reason for excluding non-resident companies from a group of companies for purposes of the corporate rules. The rules are drafted such that the tax benefits for the most part can only be accessed if the tax “rolled over” remains within the South African tax net, i.e. the rules already sufficiently protect the South African tax base. The exclusion of non-resident group companies therefore unnecessarily restricts the operation of the corporate reliefs for no apparent reason.
For example, in the following type of transactions there is absolutely no risk to the SA tax base:-
the sale of assets by a branch of foreign
(provided that it is subject to South African tax) to a resident South African group company. There is no reason why a gain made on this type of transaction should not be rolled over into the South African resident company.
(ii) The sale of assets by a controlled foreign company to a resident South African group company.
In terms of the proposed amendments to the definition of group of companies, both of the above types of transaction would trigger a South African tax liability despite the fact that the assets remain within the South African tax net and within the same group of companies as the seller. This seems to be unduly harsh (and in our view clearly discriminatory). towards the non-resident companies in these circumstances and seems to contradict the rationale for the intra-group relief.
The proposed legislation is clearly discriminatory because it appears that a company incorporated in South Africa, no matter where it may be tax resident, may continue to be part of a group of companies for purposes of the corporate rules, while a foreign incorporated company will be excluded automatically unless it is tax resident in South Africa.
Retrospectivity – relief required
The proposed amendment will have retrospective effect in respect of past transactions that were concluded in terms of section 45, as a result of the operation of the de-grouping rules contained in section 45. We have many clients where a foreign parent company has sold assets or shares to a South African resident company over the last few years, making legitimate use of the election in section 45. Gains deferred remain in the South African tax net.
If the transferor now ceases to form part of the same group of companies as the transferee, which will be the case from 1 July 2008 if the proposed amendment is enacted, a degrouping tax charge will be triggered in the transferee (assuming it still has the assets transferred to it on hand) and without the companies themselves undertaking any transaction, significant tax liabilities will suddenly be due.
raising this concern with Treasury, an initial response received was that the
clients should restructure prior to July 2008 to prevent the de-grouping charge
arising. It seems very unreasonable to expect companies to incur costs and
administrative burdens to protect themselves against the impact of
retrospective legislation, but they would probably nonetheless consider it if
it were possible, which is not the case. Where the selling company is
We see no justification for such a retrospective application of the legislation and its disturbance of vested rights must be open to constitutional challenge.
Clause 55(1)(d) (amendment to definition of “group of companies” for STC purposes: effect on section 64C(4)(k))
Groups with non-resident shareholders are no longer included in the definition of “group of companies” for STC purposes. This proposal may have adverse consequences for a group consisting of South African subsidiaries with a non-resident shareholder.
For example, if two South African residents have a non-resident parent, and subsidiary 1 grants an interest free loan to subsidiary 2, the relief in section 64C(4)(k) would no longer apply, because the parent no longer forms part of the same group of companies as subsidiary 1 which is deemed to have declared the dividend. The interest free loan would constitute a deemed dividend which would be subject to STC. However, if an interest-free loan is granted by subsidiary 1 to subsidiary 2 where the parent company is a South African resident, then section 64C(4)(k) protection from STC would be available. We see no justification for denying STC relief solely because the parent is a non-resident.
Clause 53(1)(a) (amendment of section 46)
It appears as if the Explanatory Memorandum and the tax amendments under section 53(1)(a) are inconsistent, and that the amendment should read as follows:
“(a) where that unbundling company is a listed company or will be listed and the shares of the unbundled company are listed within 12 months ….”
Clause 55 (amendment of section 64B(5)(f))
It is conceivable that a number of major deals are in the pipeline which have been structured on the basis that this exemption applies.
Most deals have a very long lead time between negotiating a deal and final implementation. The negotiation includes the negotiation of the appropriate funding, which assumed that no STC would be payable.
An unexpected major STC exposure may result in the acquisition being no longer viable, insufficient funding or substantially higher level of funding with higher funding costs or a cancellation of the acquisition with significant breakage costs for, most probably, the purchaser.
We suggest that SARS should reconsider the effective date of the change for the reasons set out above, e.g. 1 January 2008 would seem to be a more reasonable effective date.
Clause 34 (insertion of section 23I)
Paragraph (a) of the definition of “affected intellectual property” places an onerous responsibility on a taxpayer seeking to deduct a royalty payment to establish whether “any resident” has in the current of any preceding year owned the relevant intellectual property.
We submit that paragraph (a) should refer to any “resident who was a connected person, as defined in section 31, in relation to the taxpayer, when it owned the intellectual property”.
One third of the royalty payment may be claimed by the taxpayer if the person to whom the amount accrues is subject to withholding tax in terms of section 35.
It is unclear if the taxpayer is still entitled to the above deduction if the withholding tax rate is less than 12% in terms of a Double Tax Treaty, e.g. 10% or 0%.
It seems that “premiums” payable to non-residents in respect of foreign IP are no longer tax deductible by virtue of the proviso (dd) of section 11(f). Should such premiums not also be subject to a one third tax deduction on the same basis as in section 23I(3)?
Clause 7 (amendment to section 6quat)
In terms of a proposed amendment to section 6quat a deduction will be allowed from income in respect of foreign taxes paid in lieu of claiming a foreign tax credit. The proposed subsection (1D) however limits the deduction so that it shall not exceed the total taxable income which is attributable to the income which is subject to tax as contemplated in subsection (1C).
The effect of this appears to be that no deduction will be allowed where the taxpayer has no taxable income as a result of being in a loss position. In addition, the amendments do not allow for the carry forward of the foreign tax amount, for deduction in future years.
This may be illustrated as follows:
Mr A, a South African tax resident, receives R10 000 income for services rendered in Foreign Country. Mr A has deductible expenses relating to the income of R12 000. Foreign Country has levied withholding tax of R1 500 on the R10 000 of income. In terms of the proposed amendment Mr A’s taxable income (before claiming the 6quat deduction) will be as follows:
Gross Income R10 000
Less: Exempt Income R 0
Income R10 000
Less: Deductible Expenses R 12 000
Taxable loss before the s6quat deduction (R 2 000)
As the deduction may not exceed the total taxable income attributable to the income on which the foreign tax is paid, and as there is no such taxable income but only a loss, it appears that the deduction of the foreign taxes (which in terms of the Explanatory Memorandum is being treated as a deductible expense, “just like any other expense incurred in the production of income”) may not be utilised to further increase the loss nor may it be carried forward to a future year of assessment.
This creates an anomaly in terms of the treatment of this deductible expenditure and other expenses which are deductible because they are incurred in the production of income.
Clause 10: Section 8C
In our view, the proposed amendment to the definition of equity instrument (i.e. including a financial instrument which “derives its value with reference to such a share”) is far too wide. For example, in terms of the proposed wording, rights held by an employee under a cash bonus scheme (such as a so-called “phantom share scheme”), the quantum of which is calculated by taking into account a share price, would fall into the new definition of equity instrument. In our view, such schemes should not be subject to tax in terms of section 8C but rather in terms of general gross income principles.
In addition, and as a general comment on section 8C, in our experience, most share schemes are implemented to incentivise staff, but also to encourage staff to invest in shares of the employer as part of an investment portfolio and to encourage a form of savings. As a result of the taxing provisions in section 8C, in many instances, when the shares vest, the participants in the scheme are forced to sell a portion of the shares in order to pay the tax. In the context of a rising share market, they would not have ordinarily sold these shares, but are forced to do so to raise the tax which becomes due on the vesting of the shares. Often, the cost of obtaining finance from a bank is too high for participants to borrow to pay the tax. In other words, the current law often forces participants to sell shares when they would not have otherwise done so. In our view, thought should be given to legislating a deferral of the tax similar to that which used to be available in terms of section 8A(1)(c). The deferral would not reduce the amount of tax to be paid (since this would be determined on the vesting of the shares) but would allow a taxpayer to postpone the payment of the tax until the shares are sold. This would encourage the long term holding of shares by employees.
Clause 12 – (amendment of section 9C)
The existing section 9B(5) exclusion for section 24A shares only applies in respect of any share purchased on or after 24 November 1999. Section 9B has been in place since 1990. Section 24A ceased to be of application with effect from 1 October 2001. So the carve out in terms of section 9B only applies to shares purchased between 24 November 1999 and 1 October 2001. Shares purchased prior to these dates in terms of section 24A are still currently protected under section 9B. Under the new section 9C, this will be changed with retrospective effect, as the new provisions are intended to apply to any share sold after 1 October 2007, as opposed to any share purchased after this date.
The new section 9C is therefore a widening of the situation that currently exists under section 9B. This is yet another example of the introduction of a change detrimental to the taxpayer which is retrospective in its intended application.
Clause 13 (amendment to section 9D)
We welcome the amendment in terms of which participation rights held by an insurer in a long term policy fund in terms of a linked policy or market related policy do not have the effect of requiring that insurer to impute income earned by the CFC into its own income for SA tax purposes. However, by making the change one where the insurer is still regarded as having participation rights (even though the insurer itself will suffer no SA tax consequences as a result) other SA taxpayers which are connected persons in relation to the insurer may find themselves negatively impacted, which is inequitable.
For example, assume that a South African company holds 51% of the SA life company’s shares and also holds directly 5% of the shares in a foreign collective investment company. The life company invests funds derived from linked policies into the same foreign collective investment entity, which is a CFC, and as a result has an 11% stake in it.
Unless an amendment to or clarification of the law is provided, it is assumed that the SA company will have to impute income earned by the CFC into its own income for SA tax purposes because it’s own 5% stake, measured together with the 11% stake of the life company in regard to which it is connected, causes it to exceed the ten per cent threshold referred to in proviso A to section 9D(2)(b). This is illogical, and we recommend that it be clarified that in calculating the ten per cent threshold, any participation rights held by an insurer referred to in proviso (C) of subsection 9D(2)(b) can be ignored.
We believe that the change to section 9D(9)(fA) to address the fundamental problem of a mismatch in the tax treatment of exchange gains or losses on loans between group companies which are CFCs, and the tax treatment of contracts entered into to hedge those loans, should be effective no later than the date of the February 2007 Budget and preferably, should be made effective at the option of the taxpayer to any open tax year prior to that date. The mismatch concerned was brought to SARS and Treasury’s attention in 2006, and was expressly mentioned as a problem requiring action in the February 2007 Budget. The mismatch in the law was not intentional, is not found in any other country’s tax laws of which we are aware, and creates a tax liability in respect of a “profit” which simply does not exist in reality (since any gain on the hedge serves as an offset against a los on the underlying loan, and simply restores the company to economic neutrality). Hence SA companies are being taxed on fictional and not real income for which no foreign tax credit will ever be available.
We believe this to be the type of situation in which retrospective legislation is justifiable, provided no vested rights of taxpayers are negatively affected. By making the change mandatorily effective from the 2007 Budget when it was announced, and applicable at the option of the taxpayer to periods prior to that if taxpayers have not yet filed their returns for such periods (or those returns have not as yet been assessed) we believe that equity will prevail.
Clause 14(d) (amendment to section 10(1)(gB)
Clause 14(d) proposes to amend section 10(1)(gB) of the Income Tax Act
We fail to see why this exemption is necessary in light of SARS’ practice, as stated in the SARS Income Tax Practice Manual, to view such a compensation payment as falling outside of the “gross income” definition. The SARS Income Tax Practice Manual states at paragraph A:121 (Insurance premiums and proceeds) (subparagraph 9) that:
“Where the proceeds of an accident or stated benefits policy, received by an employer as a result of an accident occurring to an employee, are paid over to the employee concerned or to his estate, widow or dependants the recipient is not subject to tax thereon. Such payments would be made in respect of injury or death suffered by the employee, and, being unconnected with services rendered, are not taxable.”
This view is supported by Silke on South African Income Tax (“Silke”) at page 4-183 where the following is stated in relation to a death benefit paid to the dependants of an employee:
“A voluntary payment made by an employer to the dependants of a deceased employee… would not be taxable under paragraph (c) since the payment to the dependants would be made only because of the death of the employee, that is, in respect of the employee’s death and not his services.”
In our view the above passage would also apply where the death benefit is paid directly by the insurance fund to the recipient.
Furthermore, the payments referred to in paragraph (d) of the “gross income” definition are distinguishable from compensation paid in respect of the death of an employee. The reason for this is that any amount paid in these circumstances is not paid in respect of the employee’s termination of employment, but instead is paid in respect of the employee’s death. In other words, it is not the loss of the employee’s employment that is the direct cause or causa causans for the payment of the lump sum amount, but rather the death of the employee. The payment is made on death, and on death only. This is supported by the fact that the employee would not have any entitlement to any benefits (for example, to the proceeds of a group life policy) upon termination of his/her employment i.e. should he resign before he dies.
Our proposal is accordingly that this exemption should not be included, and that Treasury/SARS should adhere to the current policy of not taxing compensation payments made upon death. The current proposal places a cap on the “exempt” amount, whereas we consider that the amount does not fall into “gross income” in the first place.
Clause 24 –section 12F
It would appear that the extension
of section 12f is earmarked for declared ports i.e. Transnet assets. However it
is not clear whether so called “port assets” constructed by Marine and Coastal
Management (DEAT) would also be entitled to this deduction for any capital
works done on the fishing harbours (e.g.
In our view, in order to fulfil the intention of building up the efficiency of he transportation network and to allow for the depreciation of permanent structures to be available for all trades as appears to be the purpose of a number of the amendments, the section should be drafted so as to cover State owned fishing harbours and private marinas (Club Mykonos, V&A Waterfront, St Francis etc) to the extent that these commercial undertakings are not based on the provision of residential accommodation.
Clause 26 (Section 13quin – Deduction in respect of commercial buildings)
The section proposes to introduce depreciation allowances for commercial buildings used by taxpayers in the production of income, to the extent that those buildings fall outside other available depreciation regimes.
2. Rationale for implementation of section 13quin
During his State of the Nation Address in February 2001, President Mbeki announced an Urban Renewal Programme with the aim “to conduct a sustained campaign against rural and urban poverty and underdevelopment…” One of the focus areas of the programme is urban regeneration. This theme has continued as an important Government policy objective.
Minster of Finance Trevor Manuel, in his budget review of 21 February 2007, proposed that tax depreciation allowances for the economic wear-and-tear of newly constructed commercial buildings (and upgrades) be implemented at the rate of 5% per year.
The Explanatory Memorandum states that depreciation allowances are generally granted on moveable assets to taxpayers in specific trades. With regard to buildings, the specific trade or business activities for which the structures are used determine whether there is a capital allowance claimable. Taxpayers not operating in one of these specific trades are not entitled to any depreciation allowance on their buildings and permanent structures.
In the Explanatory Memorandum it is recognised that buildings and permanent structures depreciate in value due to their limited useful life, regardless of the business for which the building is used. This is reflected in accounting practice. The Explanatory Memorandum goes on to state that no reason or rationale exists for the exclusion of commercial buildings from the potential write-offs of depreciation.
The proposed amendment seeks to level the playing fields, to permit a depreciation allowance for all commercial buildings used by taxpayers in the production of income to the extent that those buildings fall outside the scope of any other depreciation provisions.
3. Scope of the section
Subsection 1 provides that for the section to apply, certain requirements must be met:
a. The building must be used wholly or mainly in the production of income; and b. Only new and unused buildings will be depreciable under the provision.
The Explanatory Memorandum states that buildings that have been used by a taxpayer prior to the effective date of the draft section would not fall within the ambit of the section. In addition, buildings purchased by a taxpayer from a seller who used the building prior to the sale would also not be able to be depreciated. This seems to contradict what the Minister of Finance stated in this regard in his budget speech on 21 February 2007. In this speech, it was stated that the allowance would also apply to “upgraded” commercial buildings as well as new buildings.
It is submitted that the draft section fails to achieve the goal of levelling the playing fields in removing the distinctions between the tax treatment of commercial and industrial buildings.
4. Arguments in support of widening the scope of the section
4.1 Government’s focus on urban redevelopment
As noted above, Government has on various occasions stated the need for urban redevelopment and renewal. It has encouraged the refurbishment and construction of both commercial and residential buildings in designated decaying inner city areas within certain selected municipalities. It was hoped that such investment within these inner city areas will return them to their former glory as vibrant city centres attracting more people to live, work and be entertained in these areas. It was hoped that this would also result in broader growth enhancing effects.
Redevelopment and renewal outside of the designated areas are also encouraged. Investments in old run-down buildings lead to a number of positive results, ranging from generally uplifting an area, improving the infrastructure, and promoting other economic activities due to an increased number of people living and working in an area. In essence such improvements to existing buildings have a ripple effect by providing an incentive for other private investment in an area.
By indirectly discouraging the improvement and refurbishment of old and used buildings through excluding these buildings from an allowance for depreciation, Government creates a disincentive to investors (taxpayers) to invest in the renewal of older buildings.
The draft section encourages the building of new buildings (despite the known scarcity of land in urban areas), leading to scores of buildings (and effectively investment opportunities) not being considered for refurbishment, leading to even further decay of these buildings. In our view this would exacerbate the general degrading of the areas where these buildings are situated, thereby accelerating a self-enforcing cycle of decay by creating disincentives to private investment and blocking sales.
By including used buildings in the draft section, these problems could be eliminated and Government’s stated goal of urban renewal and redevelopment promoted.
4.2 Draft section is not in line with the stated intention
One of the problems identified with the current exclusion of commercial buildings from any allowance for depreciation is the failure of the regime to reduce the cost of doing business. The draft section does little to contribute toward the alleviation of this problem. In fact, a large number of businesses (taxpayers) are excluded from the attempt to reduce the cost of doing business and thereby expanding economic activities by the limiting of the proposed allowance for depreciation to new and unused buildings only.
The section as currently drafted does not recognise normal commercial movements of businesses (taxpayers), who outgrow business premises and then decide to invest in an existing building, improving it to suit the needs of the business. It excludes those businesses (taxpayers) who invest and upgrade an existing building from benefiting from the allowance for depreciation, even though they are contributing to urban renewal.
In addition, the intention to bring the tax treatment of commercial buildings in line with accounting treatment is also not satisfied in the section’s current form as it denies both an allowance on the purchase of a commercial building and on any improvements made to that commercial building in the event that it had been used previously.
The stated intention is wide enough to accommodate in the draft section the inclusion of an allowance for (at least) improvements to existing buildings. The inclusion will satisfy the intention of reducing the cost of doing business, and to some extent the levelling of the playing fields between commercial and industrial buildings.
4.3 Comparison of the draft section with other capital allowances or depreciation regimes
The other sections dealing with allowances for industrial buildings and improvements thereto, with the exception of section 13bis, allow a deduction of an allowance in respect of improvements made. These improvements need not have been made to a building constructed by the taxpayer. The building could have been purchased by the taxpayer and therefore used previously.
It seems as if (as stated in the explanatory memorandum) no meaningful policy rationale exists for treating commercial buildings on a substantially less favourable basis than industrial buildings.
In fact, the draft section does little to level the playing fields in comparison to industrial buildings and to a large extent simply perpetuates the unequal treatment of commercial buildings without any meaningful policy rationale.
It is proposed that the draft section be amended to provide for the qualification for an allowance on improvements and refurbishments not only of new and unused buildings, but also of existing buildings.
Further, the allowance should also be available to subsequent purchasers of an improved and refurbished building.
In view of the fact that many taxpayers may have already commenced with the construction of new commercial buildings (or upgrades to existing buildings) in the expectation that they will qualify for the allowance on the strength of what was stated in the budget speech, we are of the view that the allowance should be available in respect of any such buildings where the construction commenced on or after the date of the budget speech. Similarly, the allowance should be available for renovations or improvements to existing buildings where the renovations or improvements were commenced on or after the same date.
Clause 44 (introduction section 37B)
Clause 44 introduces section 37B into the Income Tax Act.
The proposed new section 37B introduces depreciation allowances for environmental manufacturing fixed assets, split into environmental production assets and environmental post-production assets.
Our concern in relation to an “environmental post-production asset” (as defined in the proposed new section 37B(1)) is that it is defined as, inter alia, “ancillary to any process of manufacture in the course of the taxpayer’s trade” (our emphasis). Surely this definition by its very wording negates the fact that one is dealing with a post-production asset, as it presupposes the continuance of a trade. Nothing in the current draft wording implies that the trade may have taken place in the past, and has now ceased.
Our proposal, in order to give effect to the relief which the amendment (as set out in the Explanatory Memorandum) seeks to afford, is that it be made clear that the allowance in respect of post-production assets can be claimed even though the trade has ceased. We do not consider that the phrase contained in sub-section (2), namely “notwithstanding that such post-production asset is not used for purposes of the taxpayer’s trade” is sufficient to address this, because of the wording of the definition. We are of the view that the proposed definition of “environmental post-production asset” should be amended by rewording paragraph (b) to read: “is or was ancillary to any process of manufacture in the course of the taxpayer’s trade, whether or not such trade still continues, …”) to make it clear that cessation of the trade does not deny the deduction.
Clause 52: Section 45 of the Act.
The amendment to section 45(4)(b) to provide that the de-grouping provisions will only be triggered if the transfer company de-groups within six years of the acquisition, is to be welcomed as a positive development, in line with best practice in other countries. However, this change should be brought in with immediate effect, with the trigger date being the de-grouping and not the date of conclusion of the transaction. In other words, instead of the relief applying only to transactions entered into on or after 1 January 2008, the relief should apply to any de-grouping which takes place on or after 1 January 2008 (or even after 1 October 2007) irrespective of when the actual transaction was concluded.
2. In our view, the reference to Section 45(4) (b) (iii) on page 73 should rather read Section 45 (4) (b) (ii) (cc).
Clause 55 – amendment to section 64B(5)(f)
It is proposed that the section 64B(5)(f) exemption (group companies’ STC exemption) be limited to situations in which the dividend paid “is included in the profits available for distribution” of the recipient shareholder company. Consequently, if, for example, the dividend is not taken to the income statement but simply serves to reduce the cost of an investment in the parent’s books, that dividend will not qualify for the STC relief. Treasury is aiming to link the exemption from STC in the hands of the paying company, to how the (pre-acquisition) dividend may be treated by the recipient for financial reporting purposes in the hands of the recipient company.
Unfortunately it is not appropriate to link qualification for the section 64B(5)(f) exemption from STC, to accounting treatment. Accounting treatment is not an exact science and flexibility in this area will cause illogical results with regard to the STC relief.
For example, many groups adopt the policy of “fair value accounting”. Under this route, all balance sheet items are marked to market at year end. This means that in the context of any group which follows this accounting treatment, it is unlikely that any dividend received will ever be taken to the income statement. Because the investment in the subsidiary is carried at market value and not at historic cost, it is likely that dividends received will always simply reduce the carrying cost of the investment. It is unfair to deny STC relief simply because of the accounting policy chosen (such accounting policy, once chosen must be followed so companies cannot suddenly change it for tax reasons).
Another example relates to parent companies which are insolvent i.e. which have negative retained earnings. In these cases, the dividend received will simply help reduce the negative retained earnings and will not become “profits available for distribution”. There seems no good reason to deny STC relief in these circumstances.
Another example would be if, for example, a shareholder in a South African company buys out its BEE partner in the subsidiary at current market value. The SA parent’s cost of the subsidiary is therefore adjusted upwards in its books. If the subsidiary pays out a dividend shortly afterwards, it may well be the case that the dividend simply serves to reduce the adjusted cost of the investment rather than creating profits available for distribution at the shareholder level.
We have had discussions with our internal accounting specialists on this issue and are concerned that taxpayers will be unfairly penalised if this link to accounting treatment is maintained, and also that scope will exist for manipulation of the test in certain instances, to the detriment of SARS. We would be happy to provide further examples of this to Treasury.
Clause 59: Paragraph 11A of the Fourth Schedule
In terms of the current proposal, the associated institution which granted the right is deemed to have paid remuneration equal to the amount of the gain when the equity instrument is provided to the employee. In other words, the associated institution, rather than the employer is deemed to have paid remuneration. It is then proposed that if that associated institution is unable to withhold PAYE (as the PAYE exceeds the cash amount paid to the employee), then the associated institution and the employer are jointly and severally liable for the employees’ tax. This does not seem to be the correct approach because the associated institution does not in reality pay sufficient remuneration from which it can withhold the tax. It therefore makes little sense to impose the obligation on the associated institution which, by definition, cannot withhold any amount. Additionally, many associated institutions that provide the shares will be non-resident companies and, arguably, the provisions of the Income Tax Act should not apply to such companies in these circumstances.
In our view, it would be more practical, in these circumstances, for the sole obligation to withhold the tax should fall on the actual employer. Accordingly, we suggest that where remuneration in the form of shares is paid by an associated institution, the responsibility to withhold tax on the amount of the gain should rest on the employer only.
Clause 71 –paragraph 76A of Eighth Schedule
It is totally unacceptable that any share premium distributions effected at any date after 1 October 2001 will, as at July 2008 suddenly trigger tax consequences for the shareholders which have received those distributions. It is a cornerstone of any reputable tax system that taxpayers be able to plan their affairs with certainty as to the tax consequences of steps taken.
Share premium distributions effected after 1 October 2001 will be assumed to have reduced the base cost of the shares in the companies distributing them. To alter this, to the taxpayers detriment, with no advance warning must be unconstitutional.
We suggest that this amendment should only apply to distributions on or after the date of publication of the draft bill.