SUBMISSION BY KPMG
Comment on the Draft Revenue Laws Amendment Act, 2007 ("DRLAB") and the Explanatory Memorandum thereto
This clause proposes several changes to the definition of dividend
Based on the fact that all distributions (whether capital in nature or not) will constitute dividends as defined, after I January 2009, the question arises whether both paragraphs (a) and (b) of the definition of dividend are in fact needed, or whether they can be consolidated into one.
Clause 5(1)(c) proposes that the definition of "dividend" be amended by withdrawing the exclusion of capital profits earned pre-1 October 2001, which was granted to companies who made distributions in the course or in anticipation of the winding up, liquidation, deregistration or final termination of that company. Consequent upon this proposed amendment taking effect, all capital profits will constitute "dividends" for secondary tax on companies ("STC') purposes. This amendment is proposed to take effect on I January 2009. The explanatory memorandum states, in support of the delayed effective date of this proposed amendment, that "the delayed effective date will give taxpayers time to plan accordingly."
It has also, however, been proposed in Clause 55(1)(h) of the DRLAB that sections 64B(5)(c)(i) and (ii) be repealed with effect from 1 October 2007. The effective date of the repeal of section 64B(5)(i) and (ii) is, thus, in contradiction to the statement in the explanatory memorandum, quoted above.
Sections 64B(5)(c)(i) and (ii) of the Act currently exempts capital profits earned before 1 October 2001 and non-capital profits earned before 31 March 1993 from STC. At first glance, it seems that this exemption is superfluous; in view of the exclusion of the same pte2001 capital profits from the dividend definition. However, distributions to shareholders that are not dividends, as defined, could, under section 64C, constitute deemed dividends for purposes of section 64B. In fact, under current legislation it seems that the distribution of a liquid3.tion dividend comprising pre-200 I capital profits would constitute a section 64C deemed dividend. Thus, it is essential that sections 64B(5)(c)(i) and (ii) exist to exempt such deemed (liquidation) dividends to the extent that they are represented by pre-200t capital profits or pre-I 993 profits.
The proposed deletion of these exemptions with effect from 1 October 2007 will effectively negate the delayed amendment of the dividend definition in relation to pre-2001 capital profits. This is because even though pre-2001 capital profits are excluded from the dividend definition, the declaration thereof would constitute a deemed dividend, and without the exemptions in sections 64B(5)(ii), STC would be levied on the deemed dividend, constituted by capital profits.
We understand, however, that National Treasury is also of the opinion that the effective date of the repeal of sections 64B(5)(c)(i) and (ii) is 1 January 2009 and not 1 October 2007 as has been erroneously stated in the DRLAB. In this regard, National Treasury has issued a briefing note on 28 September 2007, in which it advised that the error will be rectified before the final Bill is tabled in Parliament. Based on the above, it is clear that it is important that the rectification is made.
Clause 5(1)(m) proposes that the amount of share capital and share premium that may be distributed to a shareholder be allocated to any share based on the pro rata value of that share in relation to the total value of the company.
The example provided on page 10 of the explanatory memorandum is not clear, and it also contains some obvious errors (e.g. there is a reference to ordinary shares that should refer to preference shares). It is requested that the example be revised in order to clearly demonstrate the application of the law.
Further, the proposal to limit the amount of capital and share premium that can be distributed to shareholders based on the pro-rata value of that share to the total value of the company creates a number of iniquities.
The value of redeemable preference shares does not grow with the value of the company. Thus determining their dividend portion of a distribution based on the relative value of the ordinary shares and preference shares creates an obvious iniquity.
The draft legislation also does not make it clear whether the relative values of the shares at the date of acquisition or the date of distribution should apply. The explanatory memorandum, however, seems to indicate that it is the values as at distribution date that will apply. It is recommended that the DRLAB explicitly state the date at which the shares should be valued in order to determine their pro-rata share of capital and share premium.
It is further submitted that it is impractical to value the shares of a company every time a distribution is made. Uncertainty also exists as to what form of valuation will be acceptable.
Companies are also concerned that share premium may be "lost", where share premium is distributed to certain shareholders, but the allocation of the share premium to such shareholders, for dividend definition purposes, is limited in terms of the amendments proposed in clause 5(1)(m). It is submitted that, where the balance of share premium distributed falls into the definition of dividend, an equal amount of retained income should take on the nature of the share premium distributed, but treated as a dividend.
This is can be illustrated by the following example:
A company has share premium of R50 000. The share premium is distributed to its preference share holders only. The value of its preference shares on distribution date is R10 000 and the value of its ordinary shares is R90 000. By virtue of the application of the proposed amendment, only R50 000 (ie R50 000 x R 10 000/ R100 000) of the share premium distributed will be treated as share premium for purposes of the dividend definition and the balance of R45 000 will be deemed to be a dividend. The company, therefore, no longer has any share premium to distribute. It is, thus, recommended that R45 000 of the retained income of the company take on the nature of the share premium for the purpose of making future distributions .
Clause 5(1)(o) defines "profits" to mean realised and unrealised profits. It is submitted that this reference is circular and that the term "profit" is not defined per se. This may lead to uncertainty, since different taxpayers may interpret "profits" differently. It is suggested that the term be given a defined meaning for purposes of the Act.
The amendments to section 6quat of the Act are welcomed.
The wording of clause 10 (l)(e) is cumbersome and it is not clear how this is to apply in practice.
Clause 10 (1)(f)
This clause proposes that any financial instrument that derives its value with reference to a share in the company or member's interest will constitute an "equity instrument" as defined. The explanatory memorandum states that the purpose of this amendment is to counter schemes where the shares are sold immediately on termination of the period of the option and the proceeds paid to employees It is submitted, however, that this extended definition may be too broad and will apply to options or rights granted to employees in terms of a "phantom share scheme" where the employees have not yet received any compensation in terms of the scheme.
This clause proposes that the amendments to section 8C of the Act will come into effect on the date of introduction of the Bill and will apply in respect of any equity instrument held on or after that date.
The meaning of the term "date of introduction of the Bill" is not clear and is not commonly used in South African legislation.
It could be construed to mean that the amendments will have effect as from 12 September 2007, when the DRLAB first became available on the internet. However, on that date, as at present, the DRLAB is merely draft legislation and has not yet, and may never be, enacted (at least not in its current form). Furthermore, there does not seem to be consensus amongst the general public and tax practitioners regarding the date on which the DRLAB was first introduced..
Secondly, no legal obligation exists on persons to comply with proposed legislation - persons are obliged to comply with legislation once it has been enacted as law by Parliament.
It is submitted that the proposed amendments, be effective as from the date that the bill is enacted or, in the alternative, that the term "date of introduction of the Bill" be clarified and defined.
This clause proposes the introduction of section 9C into the Act.
Although the proposed section 9C deems qualifying shares, which were held for longer than three years, not to be trading stock, it does not deem these shares to be a capital asset. It is therefore possible that the proceeds from these shares can still be regarded as being revenue in nature. It is submitted that the section must contain both these deeming provisions in order to achieve the objective as stated in the explanatory memorandum
The definition of qualifying share is restricted and it, therefore, appears that preference shares have been excluded from the definition. It is not certain as to whether this was the intention of the legislature.
Section 9C(3) does not clearly state how the market value of the company must be calculated in order to determine the more then 50% requirement. In is unclear as to whether the value of each property should be determined separately by using the net asset value calculation and that thereafter the 50% rule should apply or whether the net value calculation must be done as a collective. Consequently, it is requested that this section be clarified. An alternative method could be to refer to paragraph 2 of the Eighth Schedule, but to substitute the 80% requirement with 50%.
Further, in the event of a capitalisation award or a subdivision of a share, section 9B provides that the capitalisation shares and the subdivision shares and the original shares are deemed to be one and the same. However this deeming provision is not included in section 9C. It is unclear as to why capitalisation shares and the subdivision shares should be treated differently from the original shares and, therefore, it is submitted that a deeming provision, similar to that contained in section 9B, be included in the new section 9C.
Clause 13(e) defines the valuation date for offshore companies that become controlled foreign companies ("CFCs") as the day before the company becomes a CFC. However, since this is the day before residents hold more than 50% of the participation rights in that company, it may be impractical to determine the value on that day.
This clause proposes amendments to section 11D.
In terms of clause 17(2) of the DRLAB, only clause 17(I)(c) shall be effective, retrospectively, as from 1 November 2006. However, the wording of the explanatory memorandum seems to indicate that all the amendments proposed by clause 17 shall be effective, retrospectively, as from 1 November 2006. This needs to be clarified.
Clause 18 introduces the new section 11E into the Act.
It is noted that section 1IE(I)(i) only makes reference to companies which are incorporated in terms of section 21 of the Companies Act. It is submitted that the provisions of the new section 11E should also apply to companies, which are incorporated in terms of section 21A of the Companies Act.
It is noted that whilst it is proposed that the definition of "effective date", as setout in section 12D, is to be deleted, the use of this phrase in the definition of "affected asset" is not proposed to be removed. This appears to be an oversight and we request that this be corrected.
This clause introduces section 12DA into the Act.
The alignment of the write-off period of rolling stock with that of ships and aircraft is welcomed.
This clause introduces section 13quin into the Act.
It is unclear whether or not the allowances provided for in section 13quin would only apply to commercial buildings, the construction of which commences on or after 1 January 2008, and to improvements to such buildings. We request clarity as to whether this section will also apply to improvements, which were commenced on or after 1 January 2008, but where the improvements are made to old buildings (ie to buildings constructed before 1 January 2008).
These amendments, which clarify the application of section 20 of the Act, are welcomed.
However, it is not dear why the reference to sections other than section 11 has been removed (eg section 12 capital allowances). Furthermore, it is not clear whether interest on funds used to purchase an asset (which is deductible in terms of section 11 (a)) would be sufficient to be a deduction in respect of such expenditure or asset, even if the expenditure or asset was not itself deductible for tax purposes.
This clause introduces section 231 into the Act.
It is submitted that it may be difficult to apply the provisions of section 231, where the original "affected intellectual property", as defined ("IP"), was developed by a resident and disposed of to a non-resident and the non-resident has, subsequently, improved and further developed the IP outside South Africa. In such instance, it may be very difficult to determine what portion of the royalty or license fee is being paid in respect of1he IP originally developed in South Africa and what portion is attributable to the development of the IP, subsequent to it being transferred abroad. This may, for example, be encountered in respect of a portfolio of trademarks which has evolved over time.
We understand that the provisions of section 231 is to be effective as from the commencement of years of assessment ending on or after 1 January 2008, and will apply in respect of all IP transferred to a non-resident prior to this date. Because of the problems discussed above, it is suggested that section 231 only applies to IP transferred after the enactment of the DRLAB and that a mechanism be prescribed, whereby it will be possible to identify any royalties and license fees attributable to IP originally transferred and distinguish it from royalties and license fees attributable to subsequent developments of the IP outside South Africa.
The following clause in subsection (2) of the proposed section in the RLAB is also not clear:
”if that amount of expenditure does not constitute an amount of income received by or accrued to any other person”. Often royalties or license fees are paid to sub licensors and are only thereafter received by the owner of the IP from the sublicensor. If the IP owner is required to include the amount ultimately received by it in its income from a South African point of view, the section should surely not apply.
Subsection (3) is not clear in that an amount may be subject to tax in terms of section 35 of the Act, but this is reduced by virtue of the application of an agreement for the avoidance of double taxation.
Section 31 is to be amended by the substation for subsection (2) of the following subsection:
"Where any supply of goods or services has been effected
(b) between persons who are connected persons in relation to one another;"
This implies that all connected party transactions, whether local or international, must be implemented at an arm's length price, and simultaneously renders section 31(2)(a) superfluous.
We suggest that section 31 (2) (b) be amended to state:
"the persons are connected persons in relation to each other"
Section 32(2)(a) could be ended with "and" to reinforce this.
Section 31(2)(a) also needs to clarify the position, where the supply is between two permanent establishments of foreign companies, where both permanent establishments are in South Africa.
This clause introduces section 37B into the Act.
In general, the introduction of this section is welcomed.
However, the requirement that the facility or equipment (the cost I value of which the taxpayer would be depreciating under this section) must be "required by any law of the Republic for purposes of complying with measures that protect the environment" seems unnecessarily narrow. The good intentions of a taxpayer, who wishes to control the impact his business has upon the environment, but is not legally obliged to do so, but nevertheless satisfies all the other requirements of section 37B, would cause him prejudice from a taxation viewpoint. There also does not seem to be significant scope for abuse, as the requirements that must be fulfilled before an allowance may be claimed clearly limit the section only to waste treatment, recycling and monitoring equipment. The use of these assets, whether or not in terms of a legal obligation, should be rewarded.
In terms of the amendments to section 64B, "a group of companies", for the purposes of the application of section 64B of the Act, means a "group of companies" as defined in section 41. In terms of this definition, when determining whether a company forms part of a group of companies, an equity share shall be deemed not to be an equity share if "any person has an obligation to sell, is under a contractual obligation to sell, has made a short sale of that share or is the grantor of an option to buy that share".
It is submitted that the above limitation is unduly restrictive. It is common in the case of private companies with multiple shareholders to give a pre-emptive right to the other shareholders to acquire these shares should a shareholder decide to dispose of his shares. Such pre-emptive rights appear to fall foul of the proposed amendment as they will be subject to an instrument for sale and thus fall outside the definition of group of companies.
For example BEECO holds 71 % of the shares of ABC, with Mr X holding the remaining 29%. BEECO's shareholding is subject to a pre-emptive right for Mr X to buy their shares should they decide to dispose of them. The proposed amendment appears to no longer regard BEECO and ABC as being members of the same group of companies due to the existence of the pre-emptive right.
Please refer to our comments on clause 5(l)(c) regarding the effective date of the deletion of sections 64B(5)(c).
Section 64B(5)(f)(i) is amended to include the words:
"and that dividend is included in the profits available for distribution of that shareholder"
This gives rise to a problem of iniquity. A dividend from pre-acquisition profits must be written off against the investment (ie not included in profits available for distribution) and the section 64B(5) exemption is therefore not available. However, if a loan is instead given to the shareholder, since these profits are not reflected as distributable, no STC would be payable.
The official rate of interest is used to exclude the deeming of low interest loans as dividends for STC purposes. However, some institutions are able to enter into agreements with third parties to borrow and lend at rates below the official rate as a matter of course. These entities are prejudiced by the official rate of interest requirement.
It is proposed that paragraph 9(7A) of the Fourth Schedule be included in the Act specifying that there shall be no fringe benefit on residential accommodation provided to an expatriate employee for a period less than or equal to 183 days. This time period is very short, since many secondments tend to be for up to two years.
It is not clear why this exemption is not also provided to foreign expatriate employees, who are stationed in South Africa away from their families for up to six months.
It is our understanding that the purpose of the provisions of paragraph 19 of the Eighth Schedule to the Act is to prevent the generation of capital losses by dividend stripping.
It is submitted that paragraph 19, as now amended, will find too wide an application and will have a punitive effect on certain companies and their shareholders merely because the companies are too prosperous. For example, a company experiencing a boom may distribute an extraordinary dividend, as defined, simply because it is cash flush. However, when a shareholder, within two years of receiving the dividend, disposes of the relevant shares, which have now significantly escalated in value, the shareholder will have to add the dividend to the proceeds realised. This will result in unwarranted economic double taxation in that the company will be subject to STC on the extraordinary dividend declared and the shareholder will be subject to capital gains tax ("CGT') in respect of the same dividend.
This amendment proposes the deletion of the word "capital" in its first appearance in paragraph 65(4) of the Eighth Schedule to the Act, but it is not deleted in its second appearance. It is submitted that the word be consistently deleted throughout paragraph 65(4).
Clause 70 and 71
The amendments to paragraphs 76 and 76A amount to the retrospective taxation of capital distributions made between 1 October 2001 and 30 June 2008. Such capital distributions will now be deemed to be-a part disposal on 1 July 2008-.- This amounts-to retrospective taxation and undermines the concept of certainty which is a fundamental tenet of any tax system.
In addition, the requirement that the tax on past distributions be paid on 1 July 2008 may give rise to significant cash flow implications for holders of shares and a phased payment period should perhaps rather be put in place.
Further, the proposal that each capital distribution will trigger a disposal of shares will be extremely complex to administer. It will be difficult to determine the market value of the shares as at either 1 July 2008 or at the date of distribution, where capital distributions are made after 1 July 2008. This is a particularly onerous obligation in respect of unlisted shares. Using, the example quoted in the explanatory memorandum the shares would be required to be valued at each date of distribution.
Clauses 114 read together with clause 110
These clauses deal with amendments to the Value-Added Tax Act, No 89 of 1991 ("the VAT Act).
Section 11(1)(a)(i) of the VAT Act
It is proposed that the references to paragraphs (a), (b) and (c) of the export definition be deleted. As a result, exports may only be zero rated as contemplated in the regulations. The only regulations currently issued in respect of exports are the V AT export incentive scheme, published as Notice 2761 of 1998, which deals with indirect exports.
Section 11 (1)(a)(i) will as a result only refer to paragraph (d) of the export definition, since no regulations have been issued for direct exports and, therefore, no direct exports will be covered under section 11.
We assume that this was not the intention of the proposed amendment and the wording of the section should be reconsidered. In our view, even if new regulations will be issued in future, which cover both direct and indirect exports, the legislation needs to explicitly authorise exports as defined in paragraphs (a), (b) and (c) of the definition of "exports" and accordingly the amendments to section 11 (1)(a)(i) should not be made.