Ref: #173477 v2/WS/MB/MF/DT/CBW/ZM/NK
Call for comment file
10 October 2007
Mr N Nene
Chairman: Portfolio Committee on Finance
DRAFT REVENUE LAWS AMENDMENT BILL 2007 (THE BILL), AND EXPLANATORY MEMORANDUM
Set out below please find the SAICA National Tax Committee’s comments on the above-mentioned documents:
1. General overview
1.1 The press release issued by The South African Revenue Service (SARS) after the Budget Speech indicates that Secondary Tax on Companies (STC) shall be referred to as dividend tax with effect from 1 October 2007. However, it is noted that the amendment Bill has not captured this change. In particular clause 55(1)(e) still refers to this as STC.
1.2 In addition to the above comment, the taxation of pre-2001 capital profits is likely to be costly to companies that have high pre-2001 capital profits. As a result, these companies could be tempted to apply for deregistration or liquidation and this could be costly. The deletion of the exemption for pre-2001 capital profits is a de-incentive to going concern entities which existed prior to 2001 and is also tantamount to retrospective legislation.
2. Clause 5 – section 1
2.1 Clause 5(1)(a) – the definition of dividend (basic principles)
2.2 Clause 5(1)(b) – the dividend definition (redemption and reconstructions)
2.3.1 This specific amendment proposes to regard capital profits as a dividend on the winding up, liquidation, deregistration or termination of the corporate existence of a company. The proposal is to come into effect on 1 January 2009 and is to apply to all distributions on or after that date.
2.3.2 In light of this proposed amendment, there would be no distinction between distributions as discussed above or any other distribution made as a ‘going concern’. Is it then necessary to have a distinction as is currently the case between paragraph (a) and (b) dividends?
2.3.3 It has also been proposed in Clause 55(1)(h) of the Bill that sections 64B(5)(c)(i) and (ii) be repealed with effect from 1 October 2007. The effective date of the repeal of sections 64B(5)(i) and (ii) is, thus, in contradiction to the statement in the Explanatory Memorandum that the effective date of the proposed amendment is 1 January 2009.
2.3.4 It is understood, 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 Bill. In this regard, National Treasury 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.
2.3.8 Other proposed amendments to the definition of “dividend” would impact on share buy-back transactions/redemptions, particularly the allocation of share capital and share premium where different classes of shares are in issue. This is best illustrated by way of an example: A company has ordinary shares and preference shares in issue. It proposes to redeem the preference shares out of share premium arising from the original issue of the preference shares but, at the date of redemption, the preference shares are nominal in value in relation to the value of ordinary shares. A consequence of these proposals is that there is a limitation on how much of the capital and premium may be returned to the preference shareholders, based on the current market value of the preference shares in relation to the current market value of the ordinary shares, even though the premium arose out of the issue of preference shares and should justifiably be returned to preference shareholders. It is submitted that the determination on the basis of current market values is onerous and unfair, particularly in the circumstances illustrated. This basis also distorts the determination of how much may be returned to preference shareholders, given that the value of preference shares generally remains constant, whilst the value of ordinary shares of a company generally fluctuate.
2.4 Clauses 5(1)(f), 5(1)(g) and 5(1)(i) – the definition of dividend (proposed amendments to paragraph (c) of the definition of “dividend”)
2.5.1 This proposal deals with the apportionment of the share premium account amongst the various classes of shares based on the respective shares market value. The Explanatory Memorandum to the Bill indicates that the market value should be determined at the date of the relevant share premium distribution. Consideration should be given to legislate that the market value should be determined at the date of the distribution as the current proposal is silent on the matter.
2.5.2 In addition, because of the nature of certain classes of shares (for example preference shares), it may be impossible for such shares to increase in value over time especially in relation to the equity shares in issue. This may unfairly prejudice the preference shareholders where for example the only share premium in issue relates to the preference shares which premium is now deemed to ‘proportionately vest’ in the equity shareholders.
2.5.3 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.
2.5.6 Presumably this proposal will not override the situation where the shareholders have agreed that the share premium specifically attaches to a particular class of shares in terms of a shareholders agreement or in the articles and memorandum of the relevant company. In other words, the share premium is not regarded as a ‘pool’ which the amendment proposes to address but rather attaches (through agreement) to a specific class of shares by agreement.
2.5.7 According to section 5(1)((m) of the Bill, in the event of the reduction of the share capital or share premium of a company, the share capital or premium that must be apportioned to any share shall be deemed to be an amount which bears to the total shares in the company the same ratio as the value of that share bears to the total value of all shares in the company.
126.96.36.199 This is likely to cause a burden to companies that have unlisted shares as they have to determine the value (which necessitates valuation of shares) of each share every time when there is a reduction of share capital. In addition, it is not clear what forms of valuation will be acceptable to SARS.
188.8.131.52 The fiscus is not worse off as the use of share premium from ordinary shareholders to settle distribution to preference shareholders does not come from profit (where the share premium is not tainted). By introducing this legislation, dividend tax is likely to be imposed on capital rather on profits.
184.108.40.206 The proposed legislation is not clear as how the share premium not recognised is treated in future i.e. does any excess retain its nature as share premium for tax purposes?
2.5.8 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.
2.5.9 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 R5 000 (i.e. R50 000 x R10 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.
2.5.10 The example provided on page 10 of the Explanatory Memorandum is not clear, and it also contains some obvious errors (for example, 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.
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.
2.7.1 Consideration should be given to the utilization of the following wording - “Sub-sections (1)(c) to (e) shall come into operation on 1 January 2009 and shall apply in respect of any distribution made on or after that date” and Sub-sections (1)(b) and (f) to (o) shall be deemed to have come into operation on 1 October 2007 and shall apply in respect of any distribution made on or after that date.”
2.7.2 This wording aligns with the preamble to the dividend definition which deals with ‘any amount distributed by a company’.
3. Clause 7 - section 6quat (deduction in respect of foreign taxes on income)
3.1 The amendments to section 6quat of the Act are welcomed.
4. Clause 10 - section 8C
4.1 Clause 10(1)(e)
The wording is cumbersome and it is not clear how this is to apply in practice.
4.2 Clause 10(1)(f)
4.2.1 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.
4.2.2 The proposed substitution in subsection (7) for paragraph (b) of the definition of “equity instrument”, seems to also include cash bonuses payable to employees in terms of the so-called “phantom share schemes”. In terms of the rules of the majority of the phantom share schemes, the participating employees are only entitled to a cash bonus and the value of the bonus is determined with reference to the value of the employer company or other company shares at a particular time in the future. It is further often the case that the rules of the scheme may, where the employees will only be entitled to the cash bonus after a specific date (therefore making it a restriction instrument if it is a financial instrument based on the proposed revised definition), make provision for the employees to defer the receipt of the cash bonus to an even later date. Should the employees elect to only receive the cash bonus at a later date, the proposed wording would cause the employees to be liable for tax on part of the cash bonus (determined with reference to the market value of the shares at that date) when the restriction on the receipt of the bonus is no longer applicable but before the employee has received any cash
4.3.1 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.
4.3.2 The meaning of the term “date of introduction of the Bill” is not clear and is not commonly used in South African legislation.
4.3.3 It could be construed to mean that the amendments will have effect as from 12 September 2007, when the Bill first became available on the internet. However, on that date, as at present, the Bill 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 Bill was first introduced.
4.3.4 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.
4.3.5 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.
5.1 The introduction of this section is welcomed but it is questioned why this section would not be applicable to shares held by a resident in a non-resident company? It could be argued that paragraph 64B of the Eighth Schedule to the Act already provides relief in this regard but the counter argument to that is that paragraph 64B of the Eighth Schedule only applies in very specific circumstances and then also only if the shares are disposed of to a non-resident.
5.2 Section 9C(3) of the Act deals with the concerns around immovable property. Whilst section 9C(3)(a) is clear that it deals with immovable property, section 9C(3)(b) refers only to property which is of wider application than just immovable property. We therefore suggest the following wording for section 9C(3)(b) “that company acquired any other immovable property during the three year period contemplated in paragraph (a) and amounts were paid or payable during that period to any person other than that company for the use of that immovable property during that period.”
5.3 With regard to the ‘direct or indirect’ attribution to immovable property, would this also include shares held in another company that is ‘land rich’ as is the case for non-residents in terms of the Eighth Schedule to the Act?
5.4 Section 9C(6) of the Act provides that the qualifying shares are deemed to have been disposed of on a FIFO basis. This provision would be in direct conflict with the provisions of paragraph 33 of the Eighth Schedule to the Act dealing with the base cost of identical assets. This is especially so where the taxpayer has elected to utilize the specific identification method. So in other words, the share that is deemed to be sold first under section 9C would not necessarily have the same base cost as that elected under the specific identification methodology. Is this what is intended? If so, this could become rather complicated to administer both from a taxpayer and SARS perspective?
In addition, we assume that this section is prescriptive and not elective and that any losses incurred on qualifying shares would be regarded as capital losses?
5.5 Section 9C is introduced to expand section 9B with view to provide a greater degree of certainty with respect to share transactions on a more generalised basis. It is also stated in the Explanatory Memorandum that continued reliance on case law often leads to unintended differences of application. It is our view that the objective of introducing section 9C as outlined in not adequately achieved for the following reasons:
5.6 Paragraph 3 of this section states that the provisions of this section shall not apply to any qualifying share if at the time of the disposal of that share the taxpayer was a connected person in relation to the company that issued that share and more that 50% of the market value of that company is attributable directly or indirectly to immovable property acquired by that company during the 3 year period refer to in the definition of a qualifying interest. It is not clear from this provision whether the taxpayer must automatically treat the disposal of the qualifying interest as trading stock.
5.7 The section does not deal with preference shares that do not fall within the ambit of section 8E. These shares may not fall within the definition of equity share.
5.8 The introduction of section 9C without amending section 22(8)(b)(v) could cause an undesired effect. The introduction of section 9C could cause an automatic cessation of holding shares as trading stock. In these instances, section 22(8)(b)(v) requires that the cost of acquiring stock be recouped. Paragraphs 5 and 7 do not appear to be dealing with the problem adequately as they both seem to be referring to the treatment on the date of sale.
5.9 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.
5.10 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.
5.11 Section 9C(3) does not clearly state how the market value of the company must be calculated in order to determine the more than 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 asset 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%.
5.12 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.
Please note textual amendment as follows―
“(C) to the extent that―
the participation rights are held by an insurer in any policyholder fund as defined in terms of section 29A, in terms of a linked policy or a market-related policy, as defined in section 1 of the Long-term Insurance Act, 1988 (Act No. 52 of 1998); and”.
6.2 Clause 13(e) - CFCs
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.
7. Clause 14 - section 10
The proposed addition of subparagraph 10(1)(gB)(iii) does not read properly as it starts with the words “so much of any”. The previous subparagraphs are preceded by the word “any”. It is recommended that the proposed subparagraph 10(1)(gB)(iii) should simply start with “compensation …..”.
8.1 Please note textual amendment as follows -
“(i) which qualified for an allowance or deduction in terms of section 11(e), 11B, 11D, 12B, 12C, 12DA, 12E, 14 or 14bis; and”.
8.2 Section 11(o) applies where a taxpayer has made an election for this section to apply. This section has two main requirements for it to apply. The first requirement is that it applies to assets that qualify for allowances mentioned in subparagraph 11(o)(i). The second requirement is that it applies to assets whose useful life is not more than 10 years for tax purposes. There are two main problems associated with this section. The first concern is that this section does not indicate how election should be made. In this regard, we recommend that the words “at an election of the taxpayer” should be deleted. The second concern relates to the fact that not all assets which have less than 10 years of useful life are included in subparagraph 11(o)(i). For example, section 13quat allows the deduction of improvements over a period of 5 years. However, it does not seem the taxpayers would be entitled to a section 11(o) deduction if they dispose of their buildings even on the actual improvements.
8.3 The amended provisions of section 11(o) come into effect on 2 November 2006 and shall apply in respect of any expenditure incurred on or after that date. The application of amendments retrospectively is always difficult to manage by taxpayers who already submitted their tax returns. For example, if a taxpayer (who has 31 March as its year-end) has disposed of its assets to a connected person and claimed section 11(o), which was acceptable to SARS, it needs to resubmit the tax return. It is recommended that the amendments to this section should apply with effect from 1 October 2007 and should apply in respect of any expenditure incurred on or after that date.
8.4 The subsections referred to in respect of the amendments (i.e deletion) to section 11D are not in this section. Is this confused with another section perhaps? In the Explanatory Memorandum it appears this change refers to subsection 1 of section 11D. However, subsection 1 does not have (c).
9. Clause 17 - section 11D
In terms of clause 17(2) of the Bill, only clause 17(1)(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.
10. Clause 18 - insertion of section 11E
It is noted that section 11E(1)(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.
11. Clause 21 - section 12D
It is noted that whilst it is proposed that the definition of “effective date”, as set out 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.
12. Clause 22 - section 12DA
The alignment of the write-off period of rolling stock with that of ships and aircraft is welcomed.
13. Clause 24 - section 12F
The amendments to section 12F do not appear to add the value they should be adding to entities such as Transnet. The reason for this being its effective date. These entities could have already contracted for certain infrastructure expenditure.
14.1 The introduction of this provision is welcomed. However, it is proposed that the ambit of the section be widened to include the scenario where a purchaser acquires the building from a seller that qualified for allowances in terms of section 13quin of the Act. This would align this provision with the other provisions granting allowances to taxpayers on buildings used in a process of manufacture.
14.2 The reduction in respect of improvements incurred on current commercial buildings should also be deductible as soon as section 13quin becomes effective. Otherwise there will be little motivation for the improvements of these buildings.
14.3 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. Clarity is sought 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 (i.e. to buildings constructed before 1 January 2008).
15.1 The proposals made which in many ways serve as confirmation of the practices adopted are welcomed. The proposals currently only refer to deductions allowed in terms of section 11 of the Act. The question may be posed as to what about the other allowance sections such as section 12C etc. It is assumed that all the other deductions and allowances are brought into section 11 by virtue of section 11(x) of the Act. Consideration should be given to clarifying this position.
15.2 The amendment to section 20(2) is not explained. It is believed that the deduction/allowances claimable under sections 11A to section 18A should constitute an assessed loss. It is not in the best interest of the economy to deny the carry forward of losses in respect of the deduction/allowances arsing from sections 11A to section 18A
16. Clause 34 - insertion of section 23I (intellectual property payments)
It is submitted that it may be difficult to apply the
provisions of section 23I, 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
16.2 It is understood that the provisions of section 23I 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 23I only applies to IP transferred after the enactment of the Bill 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.
16.3 The following clause in subsection (2) of the proposed section in the Bill 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 sub-licensor. 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.
16.4 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.
17. Clause 35 - insertion of section 23J
17.1 The proposed new section 23J could be difficult to manage due to other criteria which are not included in the Explanatory Memorandum. The provisions of this section apply where a depreciable asset held by a taxpayer was previously held by any other person who was at the time that other person held depreciable asset, or at the time that the taxpayer claimed section 23J deduction, a connected person in relation to the taxpayer. The problem arises because this section applies even if the taxpayer and the other person are not connected at the time of acquisition of the asset by the taxpayer:
For example A has subsidiary B and subsidiary C. In this example B and C are connected persons. A sells C to third parties. A acquires a depreciable asset from C (who is no longer a connected person) which was acquired by C when C was still a subsidiary of A. In this case A will have limited deduction even though there was not intention to avoid tax in this transaction.
For example on 1 April 2002 A buys an asset while A is connected to company C and claim allowances in 2003 and 2004. A then disposes the asset to company X who is not part of A and its subsidiaries. X then sells the asset to C who is no longer connected to A. The section as it stands limits the allowances that can be claimed by C even though there are no signs of tax avoidance in this transaction.
17.2 It is noted that the provisions of paragraph 38 in the Eighth Schedule have been amended to reflect a consistent treatment between normal tax and CGT for assets acquired from connected persons. This paragraph still regards market value as the amount to recognise in the disposal of assets between connected persons.
17.3 According to paragraph 76(3), the market values are still applied in respect of company distribution. It is not clear whether section 23J would override the provisions of this paragraph in respect of connected persons.
Consideration should be given to expanding on the wording as follows -
“…the expenditure incurred by that company in respect of the acquisition of the preference share is deemed for purposes of this Act to be an amount equal to the market value of the preference share determined on the date of acquisition of the preference share or the amount received or accrued in respect of the redemption of the preference share, whichever is the lesser.”
19.1 The proposals introduce a definition of connected person that is applicable in the case of section 31 of the Act. Section 31(2) deals with the application of transfer pricing whilst section 31(3) deals with what is commonly referred to as thin capitalization provisions.
19.2 In regards to the application of section 31(3) of the Act i.e. the thin capitalization provisions, these provisions apply where the transaction occurs between connected persons or any other person where such other person is entitled to participate in not less than 25% of the dividends, profits or capital of the recipient.
19.3 It is believed that either the proposed connected party definition should be made to only apply to section 31(2) or alternatively section 31(3) should be amended to make reference only to the connected party definition. This should address any anomalies.
19.4 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-
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.
19.5 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
20. Clause 43 - section 37A
It is not clear as to what provisions are amended in section 37A(7). It appears that it is (i) and (ii) in subsection 7, but this needs to be clarified.
21. Clause 44 - section 37B
21.1 In general, the introduction of this section is welcomed.
21.2 However, the requirement that the facility or equipment (the cost / 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.
21.3 Subsection 3 provides a 5% per annum (20 year write off) for post production assets. Noting that these are post production presumably these allowances may be set off against other income (as it is unlikely that significant income is generated post production). If not allowed to be set off against other income this allowance is meaningless.
21.4 According to the proposed section 37B(5), no deduction shall be allowed under this section in respect of any environmental production or post-production asset that has been disposed of by the taxpayer during any previous year of assessment. In line with the comments in section 11(o), we believe that there should be a scrapping allowance in respect of any write-off arising from the scrapping of the environmental production asset. The provision of this allowance will ensure that the tax treatment of the asset governed by this section is in line with the tax treatment of assets governed by section 11(e), section 12C etc.
22.1 National Treasury and SARS are commended for proposing to repeal the domestic financial instrument holding company and foreign financial instrument holding company tests in applying the corporate relief measures.
proposed amendments appear to exclude non-resident companies in the
determination of whether a group of companies exists for the application of the
corporate relief provisions. We do not agree with this proposal and cannot
understand what the loss to the fiscus would be where for example two South
African resident companies that are both wholly-owned by a non-resident parent
company enter into a restructure transaction within
22.3 In addition, companies that have qualified as a group as a result of the non-resident shareholding (prior to the proposed amendments) and have entered into section 45 intra-group transactions will now not be regarded as a group which means the provisions of sections 45(4) and (5) of the Act arguably would become applicable. This would have disastrous consequences (albeit unintended) and would be retrospective in nature.
22.4 It is thus proposed that this proposal be reconsidered for purposes of the application of the corporate relief measures.
22.5 Clause 48(1)(c) – narrowed group definition
22.5.1 Paragraph A – Narrowed Group definition (section 41) on page 22 of the Explanatory Memorandum states that “(A) group of companies eligible for intra-group rollover relief must all operate on the same tax plane (…). Therefore fully or partially exempt companies will now fall outside intra-group relief (…). As a result of these changes, the intra-group relief provisions will be mainly limited to fully taxable companies and close corporations”.
22.5.2 The proposed “group of companies” definition excludes:
220.127.116.11 A co-operative (paragraph (c) of the definition of “company”);
18.104.22.168 Any association formed in the Republic to serve a specific purpose (paragraph (d) of the definition of “company”) (referred to above as a “specific purpose association”);
23.1 The proposal that the de-grouping provisions are to be changed from a ‘forever’ rule to ‘six-year’ rule is welcomed.
23.2 With regard to the proposed amendments to section 45(4) of the Act, it must, at the outset, be stated that from a practical point of view this sub-section has been the most difficult section to consult on given the various anomalies that arise on application and interpretation especially as a result of references and cross-references to various dates. It is therefore hoped that these issues could be addressed and corrected as part of the current process.
23.3 In regards to the proposed amendments to section 45(4)(b)(i) of the Act –
23.3.1 The transferee is deemed (on de-grouping) to have disposed of the asset on the day immediately before the date on which the transferee company ceased to form part of that group of companies;
23.3.2 To a person that was a connected person in relation to the transferee company immediately before the disposal;
23.3.3 For an amount equal to the market value of the asset as at the date of acquisition of that asset by that transferee company as contemplated in paragraph (a) (i.e. the original transaction to which section 45 applied); and
23.3.4 As having immediately reacquiring that asset for an amount equal to the market value of that asset as at that date (i.e. the date of the original section 45 transaction).
23.4 If we apply the requirements to a set of facts―
Company A sells land and buildings to Company B in terms of an intra-group transaction on 1 January 2006 at a time when the market value is R1 million and the base cost is R0.5 million;
Company B effects improvements to the land and buildings after acquisition in the amount of R2 million. Thus the base cost of the land and buildings for Company B amounts to R2.5 million (R0.5 million plus R2 million);
Company B ceases to form part of the same group as Company A on 31 September 2007.
23.5 The consequences are as follows―
Company B is deemed to dispose of the asset on the day immediately prior to ceasing to form part of the same group of companies which would imply that the base cost of R2.5 million would be applicable.
The proceeds are deemed to be equal to the market value of the asset on 1 January 2006 of R1 million. Therefore a capital loss of R1.5 million arises that is restricted as a result of the application of paragraph 39 of the Eighth Schedule.
Company B is also deemed to have reacquired the asset for an amount equal to the market value of the asset as at 1 January 2006 i.e. R1 million.
The problem is clear, any future disposal of the asset in excess of R1.million would attract CGT and company B would effectively be denied a deduction for the improvements effected amounting to R2 million. This could not have been the intention? If all that is intended is to ‘undo’ the roll-over relief, then the provision needs to make provision for the adding of expenditure incurred on the assets subsequent to their acquisition in terms of section 45 of the Act and for the exclusion in base cost of costs incurred on the assets subsequent to their acquisition in terms of section 45 of the Act.
23.6 The problem is that the deemed disposal and reacquisition is deemed to take place on the day immediately prior to the cessation of the group and where costs have been incurred on the assets subsequent to their acquisition, the base cost increases in relation to what it was on acquisition.
23.7 In addition, the Explanatory Memorandum states that the deemed sale and repurchase occurs at market value on the date of group severance. This is certainly not what is stated in the legislation where the disposal takes place on the date of group severance but the proceeds are deemed to equal the market value of the asset at the time of the original section 45 transaction.
23.8 With regard to the proposed amendments to section 45(4)(b)(ii) of the Act, it is understood from the Explanatory Memorandum that further depreciation allowances on allowance assets that have been deemed as disposed and reacquired will be limited as if the deemed repurchase was from a connected person (i.e. is subject to the type of limitations found in section 23J of the Act). If this is what is intended then the proposed wording requires serious amendment.
23.9 This proposition is best explained by way of example.
Company A sells and allowance asset to Company B in terms of an intra-group transaction at a time when the market value of the asset is R110; the cost of the asset was originally R100 and allowances of R30 had been claimed. Company B paid R110 (the market value) for the asset on acquisition from Company A;
Company B claims a further R30 of allowances on the asset acquired and then ceases to form part of the same group of companies as Company A.
23.10 The consequences are as follows -
Company B is deemed to have disposed of the allowance asset on the day immediately prior to ceasing to form part of the same group of companies for proceeds equal to the market value of the asset at the date of the original section 45 transaction. The tax value of the asset on date of deemed disposal is R40 (R100 – R30 – R30) and the proceeds R110. Therefore a recoupment of R60 arises in terms of section 8(4)(a) of the Act and a taxable capital gain of R5 arises (R10 x 50%).
With regard to allowances that may be claimed in the future, the proposals indicate that this should be equal to the sum of―
The cost of that asset to the transferee company as at the date of disposal of that asset as contemplated in paragraph (a) (i.e. the original section 45 transaction), less -
All deductions which have been allowed to the transferee company in respect of that asset in terms of section 11; and
All deductions that are deemed to have been allowed to the transferee company in respect of that asset in terms of sections 11(e)(ix), 12B(4B), 12C(4A), 12D(3A), 12DA(4), 13(1A), 13bis(3A), 13ter(6A) or 13quin(6);
Any amount contemplated in paragraph (n) of the definition of gross income in section 1 that is required to be included in the income of the transferee company which arises as a result of that disposal; and
The applicable percentage in paragraph 10 of the Eighth Schedule, of the capital gain of the transferee company that arises as a result of that disposal.
Total on which allowances can be claimed
This result does not make sense if one has regard to the fact that what one is trying to achieve is to be similar to the result had section 23J of the Act applied. To test this proposition, if one assumed section 23J of the Act applied to the original transaction (i.e. assume that section 45 of the Act was not applicable) then Company B would only be able to claim allowances on an amount not exceeding R105.
The R105 is arrived at by taking the original cost of the asset to Company A of R100 and subtracting from that the allowances claimed of R30, adding the recoupment of R30 (assuming sold at market value of R110) and adding the capital gains element of R5 (assuming sold at market value of R110).
23.11 How do we create parity? The following proposal creates parity―
The cost of that asset to the transferor company as at the date of disposal of that asset as contemplated in paragraph (a) (i.e. the original section 45 transaction), less―
All deductions which have been allowed to the transferor company (prior to the disposal of that asset as contemplated in paragraph (a)) and the transferee company (subsequent to the disposal of the asset as contemplated in paragraph (a)) in respect of that asset in terms of section 11; and
All deductions that are deemed to have been allowed to the transferor company and transferee company in respect of that asset in terms of sections 11(e)(ix), 12B(4B), 12C(4A), 12D(3A), 12DA(4), 13(1A), 13bis(3A), 13ter(6A) or 13quin(6);
Any amount contemplated in paragraph (n) of the definition of gross income in section 1 that is required to be included in the income of the transferee company which arises as a result of that disposal; and
The applicable percentage in paragraph 10 of the Eighth Schedule, of the capital gain of the transferee company that arises as a result of that disposal.
Total on which allowances can be claimed
The methodology above works without loss to the fiscus where the asset is acquired by the transferee from the transferor in terms of the section 45 transaction at its market value.
Where the asset is acquired by the transferee at its original cost to the transferor or less than its original cost, then the allowance should be based on the lower of the determination above or what was paid for the asset. This would treat the transaction on the basis of had section 45 not applied, and the asset was disposed of at less than market value, section 8(4)(k) of the Act would have penalized the transferor and not compensated the transferee.
24.1 Sub-clause (1)(i) proposes that sub-paragraphs (i) and (ii) of section 64B(5)(c) of the Act be deleted. The Explanatory Memorandum indicates that these proposals are to become effective from 1 January 2009. Clause 55(2) however indicates that all of these amendments are effective from 1 October 2007. Clause 55(2) therefore requires amendment in as far as referring to sub-clause 1(i) of clause 55.
24.2 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.
24.3 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”.
24.4 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.
24.5 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.
25. Clause 55(1)(d) – insertion of definition of “group of companies”
25.1 The proposed amendment contained in Clause 55(1)(d), i.e. the insertion of a definition of “group of companies”, which will mean “group of companies as defined in section 41”, will limit the dividends declared which will be exempt from STC in terms of section 64B(5)(f) of the Act. The proposed “group of companies” definition excludes
25.4 Clause 55(1)(i) – deletion of post-31 March 1993 profits and pre-1 October 2001 capital profits exclusion
25.5 Clause 55(1)(k) – group exemption limitation
25.5.1 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”.
25.5.2 This gives rise to a problem of iniquity. A dividend from pre-acquisition profits must be written off against the investment (i.e. 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. In addition, the provisions of section 64B(5)(f) should apply to the extent that the dividend is included in the profits available for distribution.
25.5.3 What is also of concern is that a particular taxpayer may be carrying the investments at fair value and would therefore mark-to-market the investments on an annual basis thus creating a profit on revaluation. When a dividend is subsequently declared, this amount will not be recognised in profit despite the revaluation forming part of the profits available for distribution. How will such scenarios be dealt with i.e. where subsequent to the original acquisition the investment is revalued to above the original cost? Also, what if the recipient company has an accumulated loss? Would the dividend be regarded as forming part of the profits available for distribution despite the recipient company having an accumulated loss? Clarification should be provided in this regard via further amendments to cater for these scenarios.
25.5.4 It is proposed that the section 64B(5)(f) exemption (group companies STC exemption) be no longer limited to profits “earned” whilst the companies were part of the same “group of companies”. This, provided that the dividend is included in the “income” (i.e. income statement) of the shareholder for financial reporting purposes. That is, it is proposed that the section 64B(5)(f) exemption will apply to so-called “pre-acquisition” dividends in circumstances where the dividend is not set-off directly against the cost of the investment for financial reporting purposes but taken to the income statement. It is apparent that National Treasury seeks to link the exemption from STC to the paying company, to how the (pre-acquisition) dividend may be treated by the recipient for financial reporting purposes. We do not believe that it is appropriate to determine the pre-conditions to qualify for the section 64B(5)(f) exemption from STC, with reference to IAS 18 (International Financial Reporting Standards), which statement, it is acknowledged globally is at best, vague. It is foreseen that this link to financial reporting statement IAS 18, will cause companies in a group to manipulate their financial statement disclosure, to secure the STC exemption, given that the treatment for financial reporting purposes is arguable. In addition, globally there is much debate on how one determines so-called “pre-acquisition” and “post-acquisition” profits in a group. In other words, does one look to the immediate holding company of the acquired company, or the ultimate group holding company? Tax legislation is in itself complex and it is submitted that entering the debate on accounting concepts will unnecessarily add to it and should be avoided.
26. Clause 56 - section 64C
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.
27. Clause 57 - paragraph 2 of the Second Schedule
It is not clear what changes are proposed in respect of paragraph 2 of the Second Schedule to the Act. Paragraph 2 does not have subparagraph (a).
28. Clause 59 – paragraph 11A of the Fourth Schedule
Clause 59(1)(c) provides (after subparagraph (ii)) that “that person and that employer must deduct or withhold from the remuneration payable by them to that employee during that year of assessment, an amount equal to the employees' tax payable in respect of the gain …”. The proposed wording suggests that both parties must withhold the total employees’ tax payable in respect of the gain, i.e. if the total gain was say R100, the applicable tax rate was 40% and the employees’ tax was R40, then both parties has to withhold R40 each from any remuneration payable to the employee. A total of R80, i.e. double the actual amount of employees’ tax due will therefore have to be withheld. It is proposed that the wording be amended to clarify the situation.
29. Clause 60 - paragraph 9 of the Seventh Schedule
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.
30. Clause 61 - paragraph 10 of the Seventh Schedule
It is not clear
why this exemption is not also provided to foreign expatriate employees, who
are stationed in
31. Clause 63 - paragraph 19 of the Eighth Schedule
31.1 It is understood 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.
31.2 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 CGT in respect of the same dividend.
It is not clear from the DRLAB what has been amended in sub-clause 1(b) relating to CFC’s? The Explanatory Memorandum also refers to something totally different.
33. Clause 66 - insertion of paragraph 42A of the Eighth Schedule
The provisions of the proposed paragraph 42A to the Eighth Schedule to the Act appear to apply in respect of an arrangement or a compromise as envisaged in section 311 of the Companies Act and are confined to listed companies. It is noted that the problem outlined in the Explanatory Memorandum in respect of shares in listed companies can equally apply to shares held in an unlisted company. It is also noted that the provisions of section 311 of the Companies Act apply to unlisted companies as well. As the provisions of the proposed paragraph 42A of the Eighth Schedule do not seem to apply to unlisted companies, it is recommended that the provisions of this paragraph be extended to unlisted shares as well. It is also recommended that the provisions of this paragraph also apply even in instances where an arrangement is between the company and its creditors as shareholders could be forced to dispose of their shares in these circumstances as well.
34. Clause 68 - paragraph 65 of the Eighth Schedule
This amendment proposes the deletion of the word “capital” in its first appearance in paragraph 65(4) of the Eighth Schedule of the Act, but it is not deleted in its second appearance. It is submitted that the word be consistently deleted throughout paragraph 65(4).
35. Clause 70 and 71 – paragraphs 76 and 76A of the Eighth Schedule
35.1 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.
35.2 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.
35.3 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.
36.1 The proposed amendment that seeks to tax capital distributions that have taken place prior to the tabling of the Bill should be strongly reconsidered in light of the fact that this amounts to retrospective legislation. Numerous taxpayers relied on the provisions of the Act to determine whether to distribute profits or to return capital. To change laws retrospectively is not an acceptable practice and leads to mass uncertainty in regards to legitimate tax planning. Should any of the said transactions be regarded as unacceptable or impermissible avoidance, then the merits of the provisions of section 80A of the Act should be considered.
36.2 It is common that in a group of companies there will be some restructuring in one way or another. The restructuring could entail the distribution of shares to the ultimate holding company and this could give rise to a capital distribution in specie. With the proposed introduction of paragraph 76A to the Eighth Schedule, such a capital distribution in specie could result in cash flow problems as the ultimate holding company may not have cash to settle capital gains tax. In these circumstances, the ultimate holding company could be forced to dispose of some of the shares received in order to settle the tax liability arising from the capital gain. The situation could even be more complex if one considers the provisions of section 9C. In terms of this section, ultimate holding company could be seen to have realised a revenue profit on the disposal of the capital distribution in specie.
37. Extraordinary dividends
37.1 It is proposed that the scope and the application of the provisions relating to extraordinary dividends (paragraph 19 - where a share is acquired and disposed off within two years of its acquisition and a dividend accrued or is received which dividend exceeded 15% of the proceeds on sale of the shares) be widened significantly and should cover all shares (not only shares disposed of within two years of acquisition). In terms of the proposed amendments, it would appear that any extraordinary dividend received must be added to proceeds on disposal of the shares (the add-back of the extraordinary dividend being limited to the cost of acquisition of the shares). At first glance, there is a possibility that there would be a liability for STC (payable by the paying company) and CGT (payable by the recipient), on all extraordinary dividends, which is iniquitous. If this proposed change is enacted in its current form, it will penalise all those long term shareholders who are invested in companies that have followed a strategy of “profit reinvestment” (as opposed to dividend stripping), who happen to receive a dividend after conceivably many years of no dividend payouts, and who soon thereafter happen to dispose of their shares. Clearly the proposed change does not favour a policy of reinvestment of profits and encourages shareholders to invest in companies where dividends are paid out regularly. It is submitted that the consequences of this proposed change be considered more fully, before it is enacted in this form. A more equitable result would be for the add back to proceeds to happen for capital gains tax purposes, only in circumstances where the paying company claimed exemption from STC.
37.2 In terms of the proposed amendments effective 1 July 2008, “capital distributions” (paragraph 74) would be treated as part disposals, triggering CGT earlier than is currently the case for persons using the specific identification or first-in-first-out methods of determining “base cost”. As a ‘transitional measure’, any capital distributions on these shares received pre-1 July 2008, would be treated as a part disposal on 1 July 2008 (to the extent that the tax on it has not been triggered as yet). In respect of shares for which the weighted average method of determining base cost is used, where a ‘negative’ base cost is arrived at on the weighted average method, as a consequence of capital distributions, then the ‘negative’ base cost at 30 June 2008 must be treated as a (taxable) capital gain on 1 July 2008. Section 46 (unbundling transactions) are not impacted by these proposals. It is submitted that given the scope for misapplication in this regard, for the purposes of clarity for particularly those shareholders who are individuals (who could conceivably be close to retirement or in retirement), that SARS issue a media release explaining, by way of illustrative examples, what the effect of this proposal would be.
VALUE-ADDED TAX ACT NO. 89 OF 1991
38. Clause 114 - section 11 (read together with clause 110 – section 1)
38.1 Section 11(1)(a)(i) of the VAT Act
38.1.1 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 VAT export incentive scheme, published as Notice 2761 of 1998, which deals with indirect exports.
38.1.2 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.
38.1.3 It is assumed that this was not the intention of the proposed amendment and the wording of the section should be reconsidered. It is believed that 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.
39. Phase 2 of STC Reform
Thus far, there has been no consultation by National Treasury on the manner in which the switch to a ‘withholding tax on shareholders’ regime will be implemented. Given the significance of the proposed change, it is imperative that extensive consultation be had with the likes of SAICA (SAICA is keen to play a role) so that practical issues are debated and addressed prior to any draft legislation being released for comment.
Please do not hesitate to contact me should you require further information.
M Benetello W J Du T Smit
CHAIR: NATIONAL TAX COMMITTEE ACTING PROJECT DIRECTOR: TAX
The South African Institute of Chartered Accountants