Revenue Laws Amendments 2007

Portfolio Committee on Finance

18 September 2007

General Overview

3

Origin of Bill: Annual Process

• Budget: Every year, the Minister releases his tax budget proposals in February:– Chapter 4 of the Budget Review contains the main proposals;

and– Annexure C of the Budget Review covers anomalies, technical

corrections and other miscellaneous amendments– Both Chapter 4 and Annexure C serve as the basis for the

annual tax legislation

• Two Sets of Legislative Tax Amendments:– Taxation Laws Amendments (rates and thresholds)

• Released for public comment in February 2007• Formally tabled in Parliament in June 2007

– Revenue Laws Amendments (more complex policy proposals)• Released for public comment in September• To be formally tabled in Parliament in October 2007

4

RLAB Process

• Time for Public Comment:– Bill published on website on 11 September 2007– Comments are due on 8 October 2007

• Informal Hearings:– Opening NT/SARS brief on 18 of September– Taxpayer hearings will probably occur the week of

the 15th of October– The NT/SARS report back on the taxpayer hearings

thereafter

• Tabling:– Scheduled for 30 October 2007

5

April 2007 – Taxation Laws Amendment Bill PIT – adjustments to income tax brackets

RFT - Abolished

Taxation of lump sum benefits on retirement

PBOs (10% deductible donations, R100 000 exemptions of trading income)

Monetary thresholds (Estate duty, donation tax, CGT)

Stamp duties on short term leases

September 2007 – Revenue Laws Amendment Bill Reduction of the STC rate from 12.5% to 10% & base broadening

Disposal of shares – three year rule (CGT)

Depreciation regime for commercial buildings, rail locomotives and environmental expenses

Definition of Customs Duty

Retirement tax & regulatory provisions – streamlined

Taxation of sport bodies (e.g. cricket)

Intellectual property

2007/08 Tax Proposals

6

Main RLAB Proposals: Business Tax Issues

• Reform of the Secondary Tax on Companies:– Reducing the rate from 12,5% down to 10%– Immediate closing of loopholes in the base– Larger reform of the base (work ongoing)– Conversion of the tax from a company-level tax to a shareholder-level

tax planned for 2008 (subject to tax treaty negotiation)• Capital Versus Ordinary Shares:

– Shares held for at least 3 years are generally deemed to be capital– Shares held for less than 3 years continue to rely on case law– Effective date

• Depreciation relief for:– Rolling stock (20% per annum),– Port infrastructure (5% per annum)– Commercial buildings (5% per annum)– Environmental manufacturing structures (40:20:20:20 or 5% per

annum)

7

Main RLAB Proposals: Other Issues

• Work Death Benefits:– Employees currently receive tax exemption for work-related

death and disability benefits provided under the Compensation for Occupational Injuries and Diseases Act

– Employees will be tax exempt for up to another R300 000 of employer-provided work-related death benefits

• Professional Sports Funding of Amateur Sports:– Professional sports bodies can now deduct funding of amateur

sports (within the same entity)– Amateur sports are necessary for the long-term sustainability of

professional sports (in terms of trainees and fans)• Co-operative Banks:

– Co-operative banks will now be eligible for small business tax relief (R43 000 of exempt taxable income, a 10% rate up to a threshold of R300 000 with a 29% rate applying only above the R300 000 threshold)

8

Merger of Indirect Taxes on Shares

• Current Law:– The Uncertificated Securities Tax (“UST”) applies to listed

shares– The Stamp Duty applies to unlisted shares

• Proposal:– The two taxes are to be merged into a new Securities Transfer

Tax, thereby simplifying administration and compliance– The new tax will essentially be the same as the UST with

amendments to cater for unlisted shares

• Not a New Tax; Merely a Merger– The new tax will have the same 0,25% rate and roughly the

same base as both of the old taxes– Most changes merely reflect current unstated practice– Most exemptions are roughly the same

Detailed Clause Review

10

Table of Contents: Main Amendments

Income Tax• Basic STC proposals and related dividend tax Issues (slides 14 - 23)• Capital vs. ordinary Shares (slides 24 -28)• Intellectual property (slides 29 - 31)• Long-term insurers and foreign CISs (slides 32 - 33)• Depreciation relief (slides 34 - 39)• Co-operatives (slides 40 - 41)• Amalgamation of sports bodies (slides 42 – 43)• Top-up of occupational death benefits (slide 44)• Oil and gas fiscal stability (slide 45)• Company reorganisations and related restructuring (slides 46 – 57)

Indirect Tax• Securities tax merger (slides 59 – 64)• Customs and Excise Duties: definitions (slides 65 – 66)• Customs and Excise Duties: control over counterfeit goods (slides 67 – 68)

11

Table of Contents: Lesser Amendments

Income Tax• Directors’ and employees’ equity instruments (slide 70)

• Medical (slides 71 – 72)

• Pension issues (slide 73)

• Research and development (slide 74)

• Foreign tax credits (slide 75)

• Foreign currency hedging (slide 76)

• Transfer pricing (slide 77)

• Employment abroad (slide 78)

• Accommodation and expatriate employees (slide 79)

• Dissolution of branches of foreign PBOs (slide 80)

• Miscellaneous (slides 81 – 82)

12

Table of Contents: Lesser Amendments

Indirect and Other Taxes• Dried maize (slide 84)

• Foreign diplomats (slide 85)

• Horse race winnings (slide 86)

• Rental pools (slide 87)

• ICC Twenty (slide 88)

• Miscellaneous VAT (slide 89)

• Miscellaneous Other (slide 90)

Main Amendments(Chapter 4)

Income Tax

14

Basic STC Proposals: Background

• Rate Reduction:– The proposed amendments decrease the STC rate

from 12,5% to 10% (Clause 55: Section 64B)

– Effective as of 1 October 2007• Conceptual Base Broadening:

– The STC does not apply to all company distributions, only those distributions qualifying as “dividends”

– In order to have dividends, a company must make the distribution out of profits

– Distributions of pure share capital (and share premium) are free from STC

15

Basic STC Proposals: Provisions

• Profits: The proposed amendments broaden the base by expanding the dividend definition to include:

• All unrealised profits; and • All pre-1993 profits/all pre-2001 capital profits

(Clauses 5 and 55; Sections 1 and 64B)

• All Distributions to be Treated the Same: The proposed amendments remove the special rules for all share cancellations and reconstructions so all distribution types are governed by the same provisions

(Clause 5; Section 1)

16

Disguised Sales:Contributions/Distributions

• Shareholders are seeking to avoid the tax on the sale of Target Company shares to independent purchasers by entering into two-step transactions

• Step #1: The Contribution Leg:– The purchaser contributes cash to the Target Company in exchange

for newly issued Target Company shares (no tax)

• Step #2: The Distribution Leg:– The Target Company distributes roughly the same amount to the

selling shareholder– No tax results because the parties ensure capital distribution treatment– The selling shareholders somehow forego their rights in the shares

they continue to hold

Target CompanyRoughly same

cash

(Step #2)

Purchaser

Cash

(Step #1)

Seller

17

Capital Distributions: Current Law

• Current Law:– Capital distributions (i.e. distributions not treated as dividends)

in respect of a share do not trigger tax– Capital distribution proceeds are simply added to CGT

proceeds when the share is sold– Example. Facts: Taxpayer owns Company X shares with a

R100 value and R20 base cost. Company X makes a R45 capital distribution in respect of the share. Result: The distribution is free of STC, and R45 of proceeds is added to a subsequent sale of the shares

• Problem:– The selling taxpayer has effectively cashed out tax-free even

though the taxpayer still holds the shares– The tax-free nature of the capital distribution mechanism is

essential to contribution/distribution avoidance scheme previously described

18

Capital Distributions: Proposal

• Proposal: – Each capital distribution will be treated as a part-

disposal of the share (triggering immediate gain/loss)• Example:

– Facts: Taxpayer has shares with a market value of R150 in Company X, and Taxpayer has a base cost of R75 in the shares. Company X makes a R100 capital distribution in respect of the shares.

– Result: The R100 distribution is viewed as a part disposal. The distribution amounts to 2/3rds the total value (100/150), triggering 2/3rds of the share gain. In this case, the total possible gain is R75 with R50 triggered from the part–disposal.

(Clauses 70 & 71; Paragraphs 76 & 76A of the 8th Schedule)

19

Capital Distributions: Effective Date

• The proposed part-sale rule for capital distributions will be effective as of 1 July 2008

• The main issue will be the “proceeds” outstanding under the old law

• In order to prevent a permanent grandfathering, all “proceeds” outstanding will be deemed distributed as a capital distribution on 1 July 2008 (i.e. all prior capital distributions will trigger a deemed part sale on 1 July 2008)

20

Ceiling on Share Capital Allocations

• Current Law:– It appears that share capital (and share premium) can freely be

allocated to any class of shares on distribution

• Problem:– Taxpayers are using this free allocation so that selling

shareholders can cash-out wholly free of the STC

• Proposal:– Share capital allocated to any share may not exceed the pro

rata value of that share in relation to the total value of the company.

– Example. If share classes A & B are valued at R100 and R50 respectively and the total share capital is R120, only R40 share capital can be allocated to the B shares (R50/R150 x R120 = R40)

(Clause 5; Section 1)

21

Simplifying Intra-Group Relief

• Current Law:– No STC applies for dividends (or deemed dividends) between

companies within the same group (if the parties elect)– STC applies when those same profits leave the group

(essentially the relief amounts to deferral)

• Proposal:– All dividends (and deemed dividends) will be eligible for intra-

group relief even if the dividends relate to pre-group profits (Clause 55; Sections 64B and 64C)

– However, intra-group relief will no longer apply if the company receiving the dividend does not add the dividends to profits (thereby turning deferral into exemption) (Clause 55; Section 64B)

– The group definition will also be narrowed (see slide in “Company Reorganisations: Intra-Group Definition”)

22

Extraordinary Dividend Stripping: Current Remedy

• Facts:– Taxpayer owns shares of Target Company. Target Company

has a value of R100, and Taxpayer has a R75 base cost in Target Company shares.

– The parties plan to generate a loss by having a R60 dividend, followed by a sale of the shares for R40 (R40 proceeds less R75 cost equals a R35 loss; but note that taxpayer has a R25 of economic profit between the combined sale and dividend)

• Current Law:– The tax system may deny the loss in certain limited

circumstances (if the dividend occurred within 2 years after Taxpayer’s purchase and the dividend was not exempt)

Target Company

(Sale of Devalued shares

(Step #2)

Dividend (Step #1)

23

Extraordinary DividendStripping: Proposed Remedy

• The proposal limits the narrow restrictions pertaining to the current anti-dividend stripping rule

• Conditions:– The revised rule applies to all dividends occurring within 2

years before disposal– All dividends will be tainted (i.e. the exclusion for exempt

dividends will be removed)– The dividends must still be extraordinary (exceed 15% of sale

proceeds)

• Impact:– Disposal proceeds will be increased for the dividend– In effect, the new rule increases gain (as well as denying loss)

(Clause 63; Paragraph 19 of the 8th Schedule)

24

Capital vs. Ordinary Shares:Background

• Current law– Ordinary revenue is taxed at higher rates than capital gain– The difference in treatment of proceeds received on disposal is

based on case law focus on intent as to whether the shares are held for sale or investment

– However, a 5-year election allows taxpayers to treat all 5-year listed shares as capital gain (section 9B)

• Problem– Case law is uncertain– Informal practices give certain industries a hidden presumption

in favour of capital

25

Capital vs. Ordinary Shares:General Proposal

• Basic rule:– Automatic capital gain treatment for shares held for

at least 3 years– Effective date: shares sold on or after 1 October

2007– Old 5-year of election (section 9B) no longer applies

• Shares covered: – Listed shares (all domestic and foreign shares on the

JSE)– Unlisted shares (domestic only)– Member’s interests in close corporations – Units in collective investment schemes

(Clause 12; Section 9C)

26

Capital vs. Ordinary Shares:Anti-Avoidance Rule

• Concerns:– Taxpayers will utilise (unlisted) old shelf companies to disguise

the sale of short-term non-share assets– Taxpayer will misuse certain reorganisation rules to do the

same

• Proposal (Clause 12; Section 9C(3)):– No presumption for shares if 50%+ of value of a company is

derived from:• Immovable property purchased within 3-year period• Assets where a 3rd party is receiving lease or license payments (i.e. bare

dominium structures)• Ignore 3-year financial instruments from total calculation

• Test generally applies only to shareholders with 20%+ interest in the company

– No rollover relief for sec. 42 asset-for-share transfers or sec. 46 unbundlings

27

Capital vs. Ordinary Shares:Recoupments

• Concern:– What happens if the taxpayer treats the shares as trading stock

but sells after 3 years?– Issue #1: What to do about claimed interest deductions for

borrowings used to acquire the shares?– Issue #2: What happens when the ordinary classification turns

to capital (the conversion normally triggers a deemed sale as ordinary revenue)?

• Proposal (Clause 12(5)):– Interest deductions on borrowed funds (in respect of former

trading stock shares) must be recouped when sold– The conversion from ordinary to capital will essentially be

neutralised

28

Capital vs. Ordinary Shares:Private Equity Deals

• Potential Concern:– Private equity management is often paid for services through

share schemes– The tax benefit of these schemes allows ordinary income (for

services) to be replaced with capital gain when the “management” shares are sold

• Review:– Potential arbitrage currently investigated– Management carried interests may have to be excluded from

the 3-year rule (at a later date)

29

Intellectual Property Arbitrage: Nature of the Problem

• Taxpayer holds intellectual property in SA.• Taxpayer transfers the property to another

party (usually associated with Taxpayer) located within a low (or no) tax jurisdiction

• Little or no tax arises out of this transfer.• Taxpayer then pays the other party royalties for

the right to use the intellectual property• The royalties paid by Taxpayer are deductible

but the receipts are subject to low (or no) tax.• The royalty receipts are then returned tax-free

to Taxpayer (usually as dividends)

30

Intellectual Property Arbitrage: Proposal

• General Rule: The payor cannot take any deductions when paying for the use of intellectual property if that property—– Was previously owned by a resident; – Was developed by payor or any closely related (i.e.

connected) person; or– The payor or any closely related (i.e. connected)

person claimed a deduction in respect of that property (such as R&D or depreciation).

• Limit: The deduction is denied only to the extent the recipient of the payment is not subject to SA taxes.

(Clause 34; Section 23I)

31

Cross-Border Intellectual Property: Transfer Pricing

• Current Law:– SARS has the power to adjust the price of cross-border royalties if:

• The royalty does not reflect an arm’s length charge: and • The parties are connected persons

• Problem:– South African taxpayers defeat this arm’s length requirement by

entering into transactions with a foreign company with shares that are more than 50% held by another independent party

– However, indirect control is retained through side agreements• Result:

– The proposed connected person threshold will be reduced to 20% (even if independent parties own more than 50% of the foreign taxpayer).

– In terms of the avoidance structures at issue, even the most aggressive South African taxpayers will rarely, if ever, hold less than 20% of the relevant party

(Clause 40; Section 31)

32

Long-Term Insurers and Foreign Collective Investment Schemes (CISs): Background

• Problem:– A clash exists between the long-term insurer “four fund”

approach” and the CFC rules• Four funds approach:

– Long-term insurers are taxed on policyholder funds under the trustee principle (instead of the policyholders)

• CFC rules:– More than 50% control of a foreign company (including a

foreign CIS) trigger CFC status– 10% owners have potential section 9D income from their

ownership (but the participation exemption does not apply to foreign CIS dividends)

• Combination:– Long-term insurer investment into a foreign CIS often triggers

CFC status and section 9D income (because all policyholder fund assets are viewed as technically owned by the insurer)

33

Long-Term Insurers and Foreign Collective Investment Schemes (CISs): Proposal

• The proposal is to ignore long-term insurer legal held in foreign CIS investments that are attributed to investment policies (linked market and smooth bonus)– The CIS is still a CFC (because the tax system views the CIS

as a company, and it is more than 50% South African owned)– However, no section 9D income results from the investments

• Avoidance concerns doubtful:– It is administratively difficult and unlikely that any one

policyholder will have 10% or greater interest in CIS– However, If the new rule is misused to disguise significant

policyholder interests, no relief will apply(Clause 13; Section 9D(1))

34

Rolling Stock Depreciation

• Current Law:– Rolling stock (trains and carriages) are only entitled to a tax

depreciation write-off over 14-15 years• Problem:

– Depreciation write-offs exist for transport such as trucks, aircraft and ships but not for rolling stock (except in limited mining situations)

– South Africa’s transportation infrastructure is key to South Africa’s economic growth (due to the cost productivity impact)

• Proposal:– Rolling stock (and improvements) will receive a tax write-off

over 5 years at a straight-line rate (i.e., 20% per annum)– The rolling stock (and improvements) must be new or unused– Note: Railways are currently depreciable at 5% per annum

over 20 years. The proposal extends this regime to railway refurbishments

(Clause 22; Section 12DA)

35

Port Infrastructure Depreciation• Current Law

– Port infrastructure is not entitled to any tax depreciation

• Problem– Aircraft receive a 20% per annum tax write off, and

airport infrastructure receives a 5% per annum tax write off

– Ships receive a 20% per annum tax write off, but port infrastructure receives no tax write offs

• Proposal– Port infrastructure (new and unused) will be eligible

for a 5% per annum write off (Clause 24: Section 12F)

36

Commercial Building Depreciation

• Current Law– Commercial buildings (e.g. retail, restaurants,

financial) are not entitled to any tax depreciation• Problem

– Depreciation relief exists for manufacturing, mining, hotels and certain residential buildings

– No reason exists to exclude commercial buildings• Proposal:

– Commercial buildings (new and unused) as well as improvements will be eligible for a 5% per annum write off

– This rate is roughly comparable to the rate for other buildings

(Clause 26: Section 13quin)

37

Depreciation of Environmental Manufacturing Fixed Assets: Background

• Current Law:– Unlike manufacturing plant or machinery, environmental

manufacturing fixed assets are sometimes eligible for 40:20:20:20 depreciation only by happenstance

• Problem– Environmental manufacturing fixed assets should be given the

same status as other manufacturing fixed assets– Unfortunately, these assets are often not viewed technically as

part of the plant or directly part of the process of manufacture

• Basic Proposal– Environmental manufacturing fixed assets will be eligible for

the 40:20:20:20 rate or a 5% per annum rate – All of these assets must be new and unused– Improvements receive similar coverage

38

Depreciation of Environmental Manufacturing Fixed Assets: Two Regimes

• Two types of environmental fixed assets:– Environmental production assets– Environmental post-production assets– Note that both sets of assets must be:

• permanent structures• used in a manner that is ancillary to manufacturing• Required to fulfill legal environmental obligations

• Environmental production assets:– These assets are used concurrently with the manufacturing process

(e.g. waste treatment and recycling facilities)– The depreciation rate is 40:20:20:20 (like manufacturing plant)

• Environmental post-production assets:– These assets are used to clean-up the immediate aftermath (e.g.

waste dumps and dams)– The depreciation rate is 5% per annum (like manufacturing buildings)

(Clause 43; Section 37B(1) through (5))

39

Post-Trade Environmental Clean-Up

• Current Law:– After a manufacturing business closes down, the law requires

decommissioning, remediation and restoration to clean-up environmental damage

– However, the Income Tax Act does not generally allow for the deduction of post-trade expenditures

• Problem– The lack of environmental deductions after cessation of a trade

is anomalous because the activity relates to a legal liability stemming from the trade

• Proposal– Environmental decommissioning, remediation and restoration

expenses (and depreciation) will remain deductible as if the former trade continues

(Clause 43; Section 37B(6))

40

Co-operative Banks: Background

• Co-operative banks are community based financial services co-operatives

• These co-operatives come in two forms: – Financial services co-operative based on geographical

membership (i.e. for a specific rural area); and – Savings and Credit co-operatives (Credit Unions) whose

members have a common bond (working for the same employer, belonging to the same labour union, church, social fraternity or living or working in the same community)

• Services are only available to members• Their main objectives are to provide accessible banking facilities or

affordable banking services, not to generate shareholder profit• The Co-operatives Banks Act seeks to formalise and regulate

these banks in order to provide customers with a greater level of confidence

41

Co-operative Banks: Taxation

• Current treatment:– Co-operative banks are taxed at the corporate flat rate of 29% without

relief– They possibly cannot access the small business relief because:

• Of their high investment income percentage (i.e. the bulk of their income stems from interest); and/or

• Their members may own interests in other companies or co-ops• Proposal:

– Co-operative Banks will be eligible for small business relief (i.e. their first R43 000 of income will be exempt and up to R300 000 will be taxable at a 10% rate)

– Their large interest earnings will not prevent small business relief (because interest is an active form of income to a co-operative bank)

– Members may have limited cross-shareholdings(Clause 23; Section 12E)

42

Amalgamation of Sporting Bodies: Background

• Current Law:– Following the tax reform of PBOs in 2000, several sporting

associations split their amateur and professional arms into separate bodies so that the amateur arms could enjoy tax exempt status

• Problem:– A professional body’s sponsorships and other sources of

income are fully taxable– However, that same body cannot claim a tax deduction for the

development and promotion of amateur sport that will serve as its feeder for future fans and professional players

43

Amalgamation of Sporting Bodies: Proposal

• As a first step, the professional and amateur sports arms can be recombined tax-free (like any other amalgamation) (Clause 139)

• The unified body will be taxable, but the proposal creates a special deduction to make it clear that the unified body may deduct from its income:

• Expenditure not of a capital nature• on the development and promotion of qualifying amateur sport• directly incurred by it• in respect of amateur sport under the same code of sport as its

professional sport(Clause 18; section 11E)

– Payments to other entities do not qualify for the special deduction

44

Exemption of “Top-Up” Occupational Death Benefits

• Current Law:– “Compensation for Occupational Injury and Death Act”

(COIDA) payments are tax-exempt – However, additional “top-up” benefits based on the same event

are taxable• Problem:

– Taxation of the “top-up” benefits is seemingly unfair because the families receiving these benefits are never made whole (not even in terms of future salary streams)

• Proposal:– Up to R300 000 of “top-up” benefits will be exempt –

• if the benefit is due to occupational death; and- If the benefit is over and above COIDA (Clause 14; Section 10(1)(gB))

45

Oil and Gas Fiscal Stability• Current Law:

– The 10th Schedule (enacted in 2006) renews tax incentives for oil and gas in order to encourage exploration and extraction

– The 10th Schedule provides the Minister of Finance with the power to offer a fiscal guarantee that the regime will remain in effect for most of life cycle of the investment

• Problem:– Oil and gas companies will not invest unless they obtain the fiscal guarantee– Certain technical details in the negotiation process reveal that minor changes

are required for the guarantee • Proposal:

– Minister can now enter into a conditional agreement in anticipation of an exploration or production right

– In terms of exploration rights, taxpayers can freely assign fiscal stability benefits

– In terms of production rights, taxpayer can freely assign fiscal stability benefits to members of the same group, and these benefits will remain in effect even if taxpayer’s proportional interest in a right changes

– The new regime contains a remedy clause for breach(Clause 74; Paragraph 8 of the Tenth Schedule)

46

Company Reorganisations:Repeal of Financial Instrument Limits

• Current Law:– Prohibits reorganisations that mainly rely on financial

instruments or financial instrument companies– This prohibition ensures only active companies are given relief

• Problem:– Taxpayers view compliance with this prohibition as overly

burdensome– The prohibition erves little benefit in deterring tax avoidance

• Proposal:– Repeal all financial instrument limits from all domestic

reorganisation provisions (Part III)– Retain for foreign-related tax rules

(Clauses 47 - 54; Sections 41 - 47)

47

Company Reorganisations:Repeal of Share-for-Share Relief

• Current Law– Non-share assets transferred for acquiring company shares

receive rollover benefits (under section 42)– Share transfers of active target companies for acquiring

company shares receive rollover benefits (under section 43) • Problem

– Both regimes achieve the same benefits– The main reason for section 43 (versus section 42) was to

prevent financial instrument company transfers• Proposal

– Repeal section 43– Section 42 rollovers include all asset transfers (including share

transfers)– [Probable effective date – years of assessment ending on or

after date of tabling, 2007; to be added](Clause 50; Section 43)

48

Company Reorganisations:Intra-Group Definition

• Current Law:– All (section 1) companies can be part of a group– 70% of shares must be group held– Group relief allows for greater freedom from tax when moving

assets or funds among group members• Problem:

– Not all companies are subject to a 29% rate on all worldwide income

– Some shares in the group are not held for long-term investment• Proposal:

– Only domestic companies and corporations fully subject to tax are part of a group

– Trading stock shares (or shares subject to a right of acquisition by outsiders) don’t count towards 70% ownership

(Clause 52; Section 45)

49

Company Reorganisations:De-Grouping Charge

• Current Law:– The de-grouping charge applies if:

• Group company members previously received the benefit of intra-group rollover relief when transferring assets to one another; and

• One of the company members later leaves the group

• Problem:– The de-grouping charge has no time limit– The de-grouping charge often triggers double tax

• Proposal:– The de-grouping charge will apply only if the de-grouping

occurs within 6-years of the intra-group rollover (similar to the U.K. rule)

– The double tax elements of the charge will be removed (see “connected person depreciable sales”)

(Clause 52; Section 45(4))

50

Company Reorganisations: Intra-Group Effective Date

• The new intra-group rules will be effective as of 1 July 2008

• The main issue is the “deemed de-grouping charge” triggered on that date for group separations caused by the new “narrower” group definition

• The rule prevents permanent grandfathering, but the members have some time to reconfigure along the narrowed group definition (thereby retaining their group status)

51

Company Reorganisations:Collective Investment Schemes (CISs)

• Current Law:– A CIS receives rollover relief only for amalgamations

• Problem:– While amalgamations represent the dominant form

of CIS reorganisation, other forms of CIS reorganisations are used

• Proposal:– Taxpayers will receive section 42 rollover relief when

transferring assets/shares to a newly formed (or old) CIS

– Multiple funds of a CIS can unbundle from one another

(Clauses 49 & 53; Sections 42 & 46)

52

Company Reorganisations:No Transfers to Exempt Transferees

• Current Law:– Reorganisation relief is premised on rollover deferral (i.e. gains

will eventually be taxed at a later date)– Therefore, relief can be denied if the transferee company is

partially or wholly exempt• Problem

– The prohibition applies only to some reorganisations (section 44 amalgamations and 45 intra-group)

– No prohibition exists for transfers to untaxed policy holder funds (one of the insurance four funds)

• Proposal– The prohibition will be added to section 42 asset-for-share

transfers and section 47 liquidations– Untaxed policy holder funds will be added to the prohibited list

of exempt transferees (Clauses 49 & 54; Sections 42 & 47)

53

Share Cross Issues:BEE Self-Financing Structure

• Parent Company owns 70% of Operating Sub• BEE Company issues redeemable preference

shares to Operating Sub• In exchange, Operating Sub issues ordinary (or

convertible preference) shares to BEE Company

Operating

Sub

BEE

Company70%

ParentBEE Pref

Redeemable Shares

Sub

Ordinary

Shares

54

Share Cross-Issues:Gain Relief for Operating Company

• Current Law:– Shares received in a (direct or indirect) cross-issue have a zero

tax cost– Rationale: No real cost is incurred, and no tax is triggered on

the cross-issue• Problem:

– Operating Company will be taxed when BEE Company redeems the preference shares

– In reality, Operating Company is merely receiving repayment of its self-financing

• Proposal:– Operating Company will be free from gain to the extent the

preference shares are redeemed at initial value– However, Operating Company cannot generate a loss from the

preference shares(Clause 36; Section 24B(2))

55

Forced Listed Share Buybacks

• Current Law:– Taxpayers selling shares at a loss cannot claim a tax loss if shares of

the same kind or quality are repurchased within 90 days– However, taxpayers selling shares at a gain are fully taxed even if

shares of the same kind or quality are repurchased• Problem:

– Taxpayers may be forced to sell shares via court order only to repurchase shares of the same kind or quality from remaining shareholders

• Proposal– If a taxpayer is forced to sell shares at a gain via a Companies Act

section 311 court order, that gain will be disregarded if shares of the same kind or quality are repurchased within 90 days

– However, the disregarded gain is added to the subsequent sale of the repurchased shares

(Clause 66; Para. 42A of the 8th Schedule)

56

Connected Person Property Transfers: Rule

• Current Law– Anti-avoidance rules limit the depreciable tax cost of certain

assets if purchased from a connected seller– This depreciation tax cost is limited to the lesser of the

connected seller’s cost or the selling market value

• Problem– The rule applies only to selective depreciable assets– The rule creates potential double taxation (especially if the

connected seller has capital gain on the sale)

• Proposal– The new rule applies to all depreciable assets– The connected purchaser’s depreciable cost equals the seller’s

tax cost plus ordinary revenue on sale (plus partial inclusion for capital gains)

(Clause 35; Section 23J)

57

Connected Person Property Transfer: Example

• Facts:– Company X purchases intangible assets for R100 and

depreciates the assets by R30 (i.e down to R70)– Company X sells the asset for 120 to Company Y (a connected

sibling company)

• Current Law Result:– Company Y has a depreciable tax cost of R100 (lesser of R100

or R120)

• Proposed Result:– Company Y has a depreciable tax cost of R110 (R70 adjusted

cost plus R30 recoupment plus ½ of the R20 capital gain)

Main Amendments(Chapter 4)

Indirect Tax

59

Overview of Securities Tax Merger

• The Uncertificated Securities Tax (“UST”) Act caters for listed securities, and the Stamp Duties Act caters for unlisted securities (and leases).

• The dual application of these Acts creates unintended distortions

• It is proposed that the two Acts be merged insofar as marketable securities are concerned into a new tax called the Securities Transfer Tax (“STT”)– The rates and tax base will be essentially the same– Some definitional issues will be clarified– Some exemptions will be modernised for existing practice

• The UST acts as the starting point for the new regime

60

Definition of “Security”

• The security definition essentially acts as the base for the new STT• The securities definition will cover:

– all shares in a company (not just equity share capital), – all members’ interests in a close corporation and – depository receipts

• Other items included in the STT net:– Partial rights in shares (to the extent those rights represent a right to

receive dividends or the right to cause a conversion and a redemption or other rights attaching to a share (or a member’s interest));

– A cession of dividend rights (as opposed to manufactured dividends);– Only the share portion (i.e. the non-debt portion) of linked units; and

• Exclusions from STT net:– Interests in collective investment schemes in the form of unit trusts (a

unit trust interest is not a share); and– The right to vote (separate taxation is not readily quantifiable)

(Section 1 (“Securities” Definition))

61

Imposition of STT

• The new STT applies to listed and unlisted securities

• In terms of listed securities, the charge applies to:– All South African companies listed on any exchange;

and– Foreign companies listed on an exchange in the

Republic (i.e. JSE)

• In terms of unlisted securities, the charge applies to all South African companies

(Section 2)

62

Change in Beneficial Ownership

• A change in beneficial ownership (purchases, etc…) acts as the trigger for STT

• Beneficial ownership relates to economic ownership, as opposed to mere registration

• A change in beneficial ownership generally includes all changes, even cancellations and redemptions, but excludes:– Share issues– Liquidations

• The exclusion for share issues encourages company formations and equity financing

• No exemptions exist for close corporations per se, but the issue and liquidation exemptions probably constitute the majority of transactions in which close corporations are involved

(Section 1 (“Change” in Beneficial Ownership Definition)

63

Exemptions

• Most of the exemptions will be roughly the same as those already contained in the UST (or within the Stamp Duty)

• However, two wholly new exemptions have been added to the STT:– Acquisition by a spouse in community of property

and– Acquisition by surviving or divorced spouse– These exemptions are in line with the Transfer Duty

Act exemptions

(Section 8)

64

Payment and Recovery of Unlisted Security Liabilities

• The main goal of the new STT is to tax unlisted securities (previously covered by the Stamp Duty)

• The liability falls on the company, but the company may recover the tax from the purchaser

• Tax:– Company X has issued 100 shares. Purchaser buys 20 of

the shares from another shareholder. Company X is liable for the new STT.

• Recovery:– However, Company X may recover the STT liability from

Purchaser(Section 7)

65

Definitions of Customs and Excise Duties

• Customs duties/import duties are imposed on the import of some goods

• The main objective of import duties is to protect local industries under appropriate circumstances, and a secondary objective is to raise revenue for the fiscus.

• Excise duties are imposed on both domestic produced goods and imported goods.

• Some of the main objectives of excise duties are:– To raise revenue for the fiscus; and– To internalise negative externalities and to influence behaviour (e.g.

discourage smoking)• The current definition of customs duties include excise duties on

imported goods, but the definition of excise duties is restricted to locally manufactured goods. The proposal clarifies that excise duties are also imposed on imported goods.

(Clause 75)

66

Definitions ofCustoms and Excise Duties

• If tax on imported goods applies under the same law to that of comparable domestically produced goods, the revenue derived therefrom should be classified as arising from excise duties rather than from import/customs duties.

• This proposal is consistent with the international classification of tax revenues

• This proposal also enhances the revenue estimation process

67

Improved Control Over Counterfeit Goods

• Current Law:– Section 15 of the Counterfeit Goods Act empowers Customs officials

to seize and detain counterfeit goods entering the Republic– Section 113A of the Customs and Excise Act currently supplements

these powers• Problem:

– A need exists to provide legal certainty and address confusion relating to conflicting provisions in the Counterfeit Goods and Customs and Excise Acts

• Proposal:– It is proposed that section 113A be deleted and a new Chapter XB be

inserted to provide for the following:• SARS will now act as a filter for all possible counterfeit goods only while

goods are under Customs control• All provisions relating to the exercise of any power relating to counterfeit

goods by Customs officers will be contained in the Customs and Excise Act in order to provide certainty regarding which legislation governs the actions of a Customs officer in connection with counterfeit goods

68

Improved Control OverCounterfeit Goods (Continued)

– The actions of a Customs officer are therefore limited to the detention of goods; the officer can no longer seize goods

– Goods are handed over for safe-keeping to the Counterfeit Goods Depot Operator as contemplated in the Counterfeit Goods Act

– The right-holder will have to obtain a court order as to whether or not the detained goods are counterfeit

– Steps must be taken by the right-holder to ensure that the goods are not subsequently released into home consumption

– The proposed amendments are in line with the World Customs Organization’s (WCO) model provisions; one of the primary considerations of the WCO in drafting the model legislation is that the holders of intellectual property rights have the primary responsibility to take measures to protect their rights

(Clauses 91 & 99; Part XB & section 113A)

Lesser Amendments(Annexure C)

Income Tax

70

Directors’ and Employees’ Equity Instruments

• Current Law:– Since 2004, a revised set of comprehensive rules have existed to

properly deal with the taxation of share options and their equivalents (in order to ensure that this form of disguised salary is taxed as ordinary revenue)

• Problem:– Despite the above, continued attempts exist to circumvent the rules;

sometimes using extremely strained interpretations of the law• Proposal:

– A vesting date is introduced for disposals of equity instruments at less than market value in terms of a restriction imposed by an employer

– The definition of “consideration” for equity instruments disposed of by taxpayer (or granted by an employer to third parties) is clarified

– The definition of “equity instrument” is changed to counter avoidance transactions that seek to circumvent the provisions of the section

– An amendment is made that intends to further extend the section’s ordinary revenue inclusion of deferred delivery schemes

(Clause 10; Section 8C)

71

Medical Deductions

• Current Law:– Medical expenses for immediate family members are

deductible to the extent these expenses exceed 7,5%

• Problem:– Family membership is difficult for SARS to verify– While medical schemes provide certificates indicating all

expenses not covered by the medical scheme (which is administratively easy to verify), their certificates cover all medical scheme beneficiaries (not only immediate family)

• Proposal:– The proposal allows deductible medical expenses for all

medical scheme beneficiaries (even those outside the immediate family)

(Clause 28; Section 18)

72

Employer-Required Medical Procedures

• Current law:– A limited number of employer-paid medical benefits

are tax-free for employees

• Problem:– However, compulsory medical procedures (e.g.

medical fitness certificates for mineworkers) imposed on employers by law do not qualify

• Proposal:– It is proposed that these procedures also be tax-free

for employees(Clause 62; Paragraph 12B of the 7th Schedule)

73

Pension Issues• The Pension Funds Amendment Act allows certain payments from

retirement funds before a member exits the fund• However, the Income Tax Act only recognises benefits payable

upon membership exiting• It is proposed that these benefits be recognised (i.e. be a formal

tax trigger) for the member when these payments are made• These benefits include payments in respect of:

– divorce orders; – maintenance orders; and– for housing guarantee defaults

• Note: Further amendments may be added to this legislation in respect of divorce payments (under a clean-break principal to be effective later next year)

(Clause 57; Paragraph 2 of the 2nd Schedule)

74

Research and Development (“R&D”)

• In 2006, Government created a 150% deduction for R&D, including the funding of R&D performed by another party (but this inclusion was deleted for connected person funding in the 2007 Taxation Laws Amendment Bill)

• The proposed amendment fully reinstates the deduction for all funding: – again allowing the funder to claim the 150% deduction (even if a

connected person is involved), but– But the deduction is subject to section 23H, meaning that the

deduction will be spread as the R&D services are provided (i.e. taxpayers cannot accelerate deductions via prepayments)

• Note: The dividing line between R&D and other expenses is being revisited (mostly through administrative interpretation, but further amendments may be added in the revised version of this Bill)

(Clause 17; section 12D)

75

Foreign Tax Credits

• Current Law:– Taxpayers can obtain tax credits (i.e. section 6quat rebates) for foreign

taxes paid– However, these credits apply only if the foreign tax relates to foreign

sourced income (i.e. the activity arises abroad)• Problem:

– Taxpayers are wrongly subject to foreign tax by certain countries on South African sourced income (as if the activity occurred abroad)

– No South African tax relief exists, but South Africa should not yield primary jurisdiction over South African sourced income

– Taxpayers are subject to double tax (by two countries on the same income without any offsets)

• Proposal:– While no credit relief will be afforded, South Africans should at least be

eligible for business deductions to the extent the tax relates to business activities

– However, these deductions for foreign taxes are limited to the underlying income giving rise to these taxes

(Clause 7; Section 6quat)

76

Foreign Currency Hedging

• Current Law:– Passive income of a CFC generally triggers tax, but financial

instrument transactions between two CFCs within the same group of companies are exempt

– This same exemption applies to currency transactions• Problem:

– Two group CFCs may enter into a debt transaction but hedge that transaction via an independent third party

• Proposal– The third party hedging will be exempt just like the underlying– This principle already exists for certain foreign currency

transactions (i.e. a hedge is exempt if the underlying currency transaction of taxpayer is exempt), but will also be extended to cross-border connected person transactions

– [Probable effective date: years of assessment ending on or after 1 January 2007; to be added]

(Clauses 13 & 37; Sections 9D and 24I)

77

Transfer Pricing

• Current Law:– An international agreement must be entered into between a

resident and a non-resident (or similarly for resident and non-resident branches) for the transfer pricing rules to apply

• Problem:– The question arises as to what happens if both parties are

resident or non-resident when the agreement is entered into but one later changes residence status

• Proposal:– In order to ensure that the transfer rules apply in this case, the

concept of an international agreement is done away with and the focus is instead placed on the cross-border supply of goods or services

(Clause 40; section 31)

78

Employment Abroad

• Current Law:– Employees working abroad for more than 183 days in 12 months (at

least 60 days continuously) are exempt on their foreign remuneration• Problem:

– The exemption does not apply if the remuneration accrues after the person has returned to the Republic (e.g. a bonus)

• Proposal:– Remuneration earned during any 12 month period where the 183 day

and 60 day test are met will qualify for the exemption irrespective of when it accrues

– Remuneration must accrue in respect of services rendered outside the Republic (e.g. remuneration accruing for loss of office (para (d) of the definition of “gross income”) does not qualify)

– In order to cater for remuneration that accrues over periods longer than 12 months (e.g. share options), it is proposed that the remuneration be deemed to accrue evenly over the period that the services are rendered

(Clause 14; Section 10(1)(o))

79

Accommodation andExpatriate Employees

• Current Law:– Expatriate employees, who are not “ordinarily resident” in South Africa,

are only taxed on their South African source income until they have met the physical presence test over a five year period

– As a general principle, fringe benefits, including accommodation, provided to expatriate employees are taxable with the exception for short-term stays away from home

• Problem:– SARS’s position that a short-term stay for a non-resident could not

exceed one year is overturned by Tax Court in 2006– However Waglay J noted that; “I acknowledge that there may be a

need to restrict the period of time for when the benefit applies but this cannot be randomly determined by the respondent. I would suggest that this may require Legislative intervention.”

• Proposal:– The proposed limit of 183 days is aligned with the threshold for taxing

non-resident employees of foreign employers, as set in Article 15 of OECD and UN Model Conventions

(Clause 60; Paragraph 9 of the 7th Schedule)

80

Dissolution of Branchesof Foreign PBOs

• Current Law:– PBO rules have been extended to cover South African

branches of foreign PBOs– However, the dissolution rules were complicated by the fact

that a branch is not a separate legal entity from the parent PBO• Problem:

– The current system allows repatriation to a parent PBO but relies on tracing of origin of funds, which is difficult to interpret and administer in practice

• Proposal:– The proposal switches to a simpler system where branch

accepts rules applicable to local PBOs (i.e. local transfer of termination proceeds) if more than 15% of receipts and accruals are from the Republic in the three years before dissolution

(Clause 39; Section 30)

81

Miscellaneous #1• Starting and ending CFC status:

– Income of a foreign company becoming or ceasing to be a CFC will be calculated with reference to the date before the key event (not the date of the event (Clause 13; Section 9D)

– This change in dates is consistent with the dates for deemed sales upon entering or exiting CFC status for capital gains tax purposes

• Connected person scrapping losses:– Scrapping losses will be denied for connected person transfers (Clause 15;

Section 11)• Reduction of assessed losses:

– As a general principle, a taxpayer’s assessed loss is reduced if that taxpayer benefits from a compromise:

• with the taxpayer’s creditors; and• that provides for the reduction or extinction of any of that taxpayer’s liabilities that

arose in the ordinary course of her or his trade– The proposed amendments make it clear that this rule will apply if:

• a compromise has been made with one or more of the taxpayer’s creditors; and• the liability to which it relates is linked to an expense or an asset in respect of which a

deduction was allowed to that taxpayer (Clause 29; Section 20)

• Short-term insurers:– The law will be changed to reflect (and make explicit) current practice when

taxing short-term insurers (Clause 38; Section 28)

82

Miscellaneous #2• Intellectual property withholding:

– The exemption for intellectual property will be updated for current trends (i.e. the exemption will apply only if the payments is to a South African permanent establishment of a foreign resident) (Clause 41; Section 35)

• Required reorganisation rulings:– The Minister’s power to require SARS advance rulings as a pre-condition for

reorganisation relief will be dropped (as this power has never been used) (Clause 48; Section 41)

• Listing requirements for unbundlings:– To be a tax-free rollover, the proposal clarifies that the shares of the unbundled

subsidiary must already be listed or listed within 12 months after the unbundling disposal (Clause 53; Section 46)

• First STC dividend cycle for long term insurers:– An STC anomaly exists with respect to certain newly formed insurers, so it is

proposed that the first dividend cycle commence the later of 1 July 1993 or when an insurer is incorporated thereafter (Clause 55; section 64B)

• Translation of CGT gains/losses on assets acquired in foreign currency:– The rules clarify the interaction between the capital gains tax rules and

translation of foreign currency amounts (Clause 67; Paragraph 43 of the 8th Schedule)

Lesser Amendments(Annexure C)

Indirect and Other Taxes

84

Dried Maize

• Current Law: – The local supply of dried maize for human

consumption and animal feed is zero-rated

• Problem:– The VAT treatment is dependent on how the dried

maize will ultimately be consumed, but suppliers lack this information

• Proposal:– To zero rate the supply of all dried maize locally

(regardless of end consumption)

Clause 121 and 122: Schedule 1 & 2

85

Foreign Diplomats

• Current Law:– Vehicles imported into the Republic by a foreign diplomat/consular

mission are exempt from VAT– However, if the vehicle is disposed of within two years, the

diplomat/consular mission must pay VAT– In respect of locally purchased vehicles, the diplomat/consular mission

claims a refund for any VAT paid• Problem:

– If a diplomat/consular mission sells a locally purchased vehicle, a double benefit results

– Second-hand goods sold by the diplomatic/consular mission to vendors wrongfully result in a notional input tax for that vendor even though the diplomat/consular mission was entitled to a VAT refund (i.e. ultimately paid no VAT)

• Proposal:– Vendors purchasing a second-hand vehicle from a diplomatic/consular

mission will not be eligible for notional input tax(Clause 110: Section 1)

86

Horse Race Winnings

• Current Law:– The winnings paid by racing operators to horse owners are

zero-rated – The identity of the other partners (i.e. horse owners) in a

syndicate is usually unknown or not all of them are registered for VAT

– This is an issue when the syndicate is required to charge VAT on supplies made

• Problem:– The zero-rating exists by virtue of a section 72 ruling instead of

legislation• Proposal:

– To encapsulate the Section 72 ruling into legislation; and– Clarify that the zero-rating does not extend to the portion of

winnings paid to trainers and jockeys on behalf of the owners(Clause 114; Section 11(2))

87

Rental Pools

• Current Law: – Management companies must treat the supply of units to

individual purchasers as a single going concern and zero rate the supply

– In effect, the management company becomes the registered vendor on behalf of the individual unit holders

• Problem:– At issue is when units are sold by unit holders– In particular, the supply of a unit by one sectional title unit

owner to another in the same scheme, is a non-supply and not taxable for VAT purposes (but is subject to Transfer Duty).

• Proposal:– To provide an exemption from Transfer Duty on property sold

for intra-rental pool transfers because all parties to the pool arrangement are treated as one and the same

(Clause 2: Section 9)

88

ICC Twenty 20

• Current Law:– The PBO hosting the ICC Twenty 20 World Championship is

subject to VAT on amounts received for staging the event

• Proposal:– A special zero-rating is proposed for the consideration paid by

the International Cricket Council to the PBO staging the ICC’s 2007 Twenty 20 World Championship

– Consideration from other sources for the staging of the Championship will be subject to VAT at the standard rate (e.g. ticket sales, parking and hospitality)

– [Probable application of the concession will be for the period from 1 November 2006 to 31 December 2007; to be added]

(Clause 139)

89

Miscellaneous VAT

• Foreign donor funding:– Clarify the definition of a “foreign donor funded project”– Remove reference to the Minister’s approval under sections 11

and 17 of the VAT Act and incorporate it under the definition (Clauses 110, 114 and 116)

• Documentary proof for claims:– Provide the Commissioner with power to prescribe acceptable

documentary proof that a vendor must obtain and retain before claiming deductions (Clause 115)

• Late claims:– Limit the subsequent deduction of input tax to six months if the

input tax was not claimed as a result of a “practice generally prevailing” - Aligned to section 44(3)(a) (Clause 115)

• eFiling, electronic transfers and debit orders:– Provide clarity on submission and payment dates for vendors

paying taxes by debit orders (Clause 117)

90

Miscellaneous Other

• Transfer Duty:– Amendments are proposed to clarify that the Commissioner may

provide for electronic payments and declarations (Clauses 1 and 3)• Customs

– Further amendments to underpin one stop border (Clauses 77 and 97)– Minor changes following on from introduction of new dispute resolution

process earlier this year (Clauses 82, 86, 87, etc.)• Air Passenger Tax:

– The proposal clarifies that the operator of an aircraft (or agent of the operator) is a withholding agent and accordingly liable for the payment of air passenger tax that has not been collected from passengers (Clause 83)

• PBOs and SDL:– The exemption of a limited set of PBOs from skills development levy

for historical reasons is deleted so that these PBOs are put on the same footing as other PBOs and businesses for skills development (Clause 124)