Second Revenue Laws Amendment Bill: hearings

Meeting report

FINANCE PORTFOLIO COMMITTEE
19 October 2001
SECOND REVENUE LAWS AMENDMENT BILL: HEARINGS

Chairperson: Ms Hogan (ANC)

Documents handed out:
South African Institute of Chartered Accountants (SAICA) Submission
Presentation on the method of determining market value of JSE listed financial instruments on 1 October 2001 for capital gains tax purposes.

SUMMARY
SAICA agreed in principle with the amendments proposed but were concerned about various technical issues and raised points that needed clarity. The submission of the JSE was explanatory in nature. The presenter explained why the volume weighted average price is the better method in determining the base cost of shares. This method is the one that is included in the Bill.

MINUTES
SAICA submission
Mr Croome, Chairperson of the SAICA Taxation Committee, noted that a concern of SAICA was that when they had received the draft legislation in batches for comment SARS did not provide an explanatory memorandum or the underlying reasons for the legislation. If SAICA had the objectives of the legislation more meaningful comment could be made. Mr Louw [(Drafting Team) would comment on this later].

The other issues raised by Mr Croome and commented on by Mr Louw are the following:
- The proliferation of tax legislation. He picked up a pile of documents and said that a taxpayer must look at a number of sets of legislation to accurately determine his tax liability. A consolidated act is needed so that a taxpayer does not need to check a number of Acts.
- The rules dealing with the objection and appeal procedures must be in the Bill.
- The amendment dealing with public benefit organisations. All these were commented on by Mr Louw at the end of the submission.

The presenter wanted to raise certain issues not in the written submission. He said currently if a beneficiary of a trust is a SA resident the resident gets taxed at an inclusive rate of 25%. But if the beneficiary of that same trust is a non resident then the trust gets taxed at an inclusive rate of 50%. He submitted that this unequal treatment should not occur.

Another issue is that the Bill adopts a completed year approach as opposed to a part year approach. SAICA therefore has problems with the time apportionment base cost method. The values that are calculated according to the two methods can be radically different. SAICA questions the soundness of this and would like to know the thinking behind this because the explanatory memorandum does not mention this aspect of the amendment.

Hs Hogan asked Mr Louw to respond.

Mr Louw replied that the adoption of the completed year method was because it was simpler. SARS would not have to count all the days. It was a rough justice approach because the calculation variance could go both ways. i.e. it could favour the taxpayer in certain circumstances.

Mr Croome only raised one issue concerning the VAT amendments. The definition of welfare organisation is unclear in that the amendment does not specify if one must look at the Section 30 in the Income Tax Act that lists the public benefit activities or if a new list is going to be drafted. Mr Louw replied that there will be a separate schedule for VAT and that there will be differences to the Income Tax Act list because public benefit activities is much wider than welfare activities. The main focus for VAT is welfare.

Ms Hogan asked Mr Croome why he thinks the 18 month anti-avoidance principle is too long.

Mr Croome replied that he understands the reasons for it and accepts that the provision is a concession but it does appear that the 18 month period is too restrictive. If shares come into a group due to an unbundling then that group must wait 18 months before it can embark on a restructuring. He submitted that this is what was too restrictive.

Ms Hogan asked if Mr Louw had anything to add.

Mr Louw commented on some of the issues raised by Mr Croome.

He said that normally the legislation is completed and then the explanatory memorandum is drafted. What SARS will try and do in the future is attach a short note explaining the main intentions. Anything more will be very difficult considering the short time that is available to prepare the legislation.

On the issue of a consolidated tax act he said that it will take a full time team a year to do this exercise. What can be done is a an informal CGT consolidation that incorporates schedule 8 and all the subsequent amendments. This text could be put up on the SARS website.

The objection and appeal process do not contain the rules in the Bill because flexibility is needed when dealing with court procedure. For this reason the rules of the High Court also takes the form of rules separate from the Act. SARS do undertake to properly consult in the drafting of the rules that will be sent to the Judge Presidents of all the divisions.

On clause 32 that amends section 18A of the Income Tax Act Mr Louw said that SARS has decided to hold back on this clause for a while. This clause is a contentious one and deals with public benefit organisations.

JSE Securities Exchange
Mr Bobby Johnson said that the JSE has two basic problems. The first was with clause 51 that amends section 70B of the Income Tax Act and deals with the JSE having to submit returns to the commissioner. The presenter advised that this was still being discussed between SARS and the JSE and that he was sure an agreement would be reached. This problem would therefore not be discussed now.

The second problem that forms the basis of this submission is the market value established on 1 October 2001.

In the original proposal of SARS the average of the last price quoted per day for the five days preceding 1 October would be used to determine the market value for CGT purposes. The last price is the average of the buying and selling prices quoted at close of business on that day.

To evaluate the proposal it was necessary to look at the types of markets SA has.

There is a quote-driven market, an order-driven market and a hybrid market.

In the quote-driven market the market maker / jobber quotes a double price that represents what he is prepared to pay for the shares and what he is prepared to accept on selling the shares. The difference between the two prices is called the spread. He said that it would be fair to average the bid and the offer for pricing purposes.

On the order driven market a broker places client bids and offers into a central system which then matches these bids and offers to produce matched transactions. There is a problem if there are buyers but no sellers because then an average cannot be established.

The hybrid market is a combination of a quote driven market and an order market.

The presenter submitted that in SA the last quoted price per day cannot be used where the last price is the average of the buying and selling prices.

The alternative is to use the ruling price. This is the last sale price at any time unless there is a subsequent higher bid price or lower offer price. The presenter gave the example of ruling price:

Bid Offer Last Sale Ruling Price
100 102 100 100
100 102 102 102
100 102 99 100
100 102 105 102

The table illustrates that the ruling price is the last sale price. If the last sale price is less that the bid price then the bid price becomes the ruling price. If the last sale price is more than the bid price then the offer becomes the ruling price. The presenter added that the ruling price is published in newspapers.

Another alternative is the ruling price average. For the SAFEX close out a ruling price is established every two minutes for a 2 hour period. The ruling prices are aggregated and divided by the number iterations which is 60 for two hours and 30 for one hour.

The other alternative is the Volume Weighted Average Price (VWAP). The value of each trade is aggregated and that aggregate is divided by the total number of shares which traded.

Example of VWAP:
Time Volume Price Consideration
12:00 1000 100 1 000
14:00 2000 102 2 040
15:00 3000 105 3 150
15:58 100 200 200

Total 6100 R6 390

The ruling price for this day will be 200c. The VWAP will be 6390 divided by 6100 which equals 105c.

The presenter focussed on the volume of 100 with the ruling price of 200 and said that this is an unfair value when considering the volume. The VWAP is a fair price when comparing it to the ruling price.

The JSE is in favour of VWAP over a continuos five day period from 21 September to 28 September 2001. He indicated that it is the same period that SARS has suggested but with a different method.

He said that SARS was worried about the upward manipulation of the base price for CGT purposes but VWAP produces a true price as it requires volumes to push a VWAP up or down. Manipulation is catered for by comparing the VWAP against 105% of the ruling price simple average for the first 14 trading days of September. The 105% is used because to show manipulation a remote period must be used and the more remote the period the higher tolerance level is needed. A VWAP that is 105% above the ruling price should be reviewed.

But then the World Trade Center disaster took place and world markets dropped sharply. The presenter used the all share graph and the ALSI graph to illustrate the downward trend. The steep dive was followed by a steep recovery. The only question that remains is whether it is fair to use this time period. The presenter concluded by saying the method (VWAP) is good, just the timing was wrong because the disaster caused that the majority of counters were below the 100% ruling price average let alone the 105% value.

Discussion
Mr Moloto (ANC) asked the presenter to explain the mechanics of price manipulation.

Mr Johnson said that taxpayers would want a high base cost to reduce tax. So the price gets bid up and if there are no sales then the inflated bid price becomes the ruling price. This is easy in an order-driven illiquid market.

In answer to Ms Hogan asking if manipulation can take place with VWAP, the presenter said that it could but that it would be more difficult.

Ms Hogan asked what the status was of the VWAP proposal.

Mr Louw said that it is incorporated in the Bill.

Mr Johnson confirmed that the JSE was happy with the wording in the Bill.

There were no further questions or comments and the meeting was closed.