South African Federation of Civil Engineering Contractors
Presentation to the Portfolio Committee on Finance
Residence Basis of Taxation
10th October 2000

We would like to thank the Committee for giving us this opportunity to express our concerns regarding the implementation of the Residence Minus Basis of Taxation.

The Federation considers that the change to the Residence Minus Basis of Taxation will in its present form lead to severe problems for South African contractors and believes that certain exemptions are necessary for the industry to maintain international competitiveness and to be able to compete internationally on a level playing field.

Soon after the February 2000 budget speech SAFCEC commissioned Deloitte & Touche to compile a report setting out the basis of taxation of our selected countries. This together with a covering letter was submitted to the South African Revenue Services (SARS) for consideration (Annexure A). We would like to emphasise that the approach we have followed has been to offer constructive suggestions on the wording of the legislation.

In our original representation letter of the 3rd of May 2000 we asked to be given an opportunity to discuss this matter. Unfortunately a proposed meeting was cancelled at the last minute by the SARS.

Following Industry representations on draft legislation it was accepted by both SARS and the Department of Finance that construction workers outside of South Africa warrant a special exemption. This was even incorporated in the penultimate draft issued. But was subsequently reversed due to the adoption of draconian American styled measures. We believe that our industry representations have been totally ignored in the Draft Bill currently before parliament, which will make South African contractors / contract workers uncompetitive outside of South Africa.

Our belief is that South Africa remains very much part of the developing world and that conforming to the tax regimes of highly developed countries, like the USA, does little for the development of both South African and SADC. It is worth noting that many developed first world economies made use of fiscal incentives as an integral part of their evolution. For example, Ireland provided relief in the form of a FED (Foreign Earnings Deduction) to individuals who spent at least 90 qualifying days outside Ireland during a tax year or during a continuous 12-month period. The aim of this was to enhance the skills base of the country, as well as to earn valuable foreign exchange when the workers brought back their earnings to Ireland. This has only recently been restricted to 25 000 Irish Pounds per annum.

The construction industry in South Africa is currently in a very poor state due to the lack of work in recent years. In order to survive most of the major contractors have had to look for work outside of South Africa.

A large part of this work has consisted of foreign aid contracts in SADC and other African countries and would typically include roads, bridges, railways, airports, infrastructure, ports, mine development, agricultural development, etc.

It is important to note that this foreign aid is usually given on condition that the contract is exempt from all taxes in the host country. Clearly the subjection to individual and corporate taxes of wages and profits substantially negates the true objective of aid funds and is detrimental to the development of Africa, for whom the aid is vital. For example, Japan may be prepared to fund a bridge over a river in Mozambique. If the contract is exempt from taxes then it will cost $10m to build. If not tax exempt it will cost $15m. If the effect of the exemption agreed between Japan and Mozambique is not mirrored into South African legislation the benefits of such aid may be lost to the continent and South African business, as these cost will exceed the aid budgets.

The international competition is equally fierce and there is a need for the playing fields to at least be level. It is interesting to note that in countries such as Australia, the government actively supports and assists contractors to work outside of the country. It is also worth noting that South African contractors are tendering in countries with substantially lower individual rates of taxes and thus we will be uncompetitive if we continue to employ South Africans. For example the top marginal rates in other countries are:

•Botswana - 25%

•Mozambique - 20%

•Namibia - 36%

•Tanzania - 30%

•Zambia - 30%

To clarify the impact of the current proposals on our industry we have tabled a theoretical contract tender make up.

The general practice internationally is for salaries to be calculated on an after tax, take home basis. Thus any tax payable is basically an additional cost to the employer. Thus if the proposed legislation was to be implemented the effect would be that the tax on the salaries of South African employees would effectively increase the cost of the contract.

The implication of this to the contractor is that they would become uncompetitive and would in all likelihood not be successful in obtaining the contract. The only sensible option then available to the contractor would be to stop employing South Africans and replace them with other nationalities.

The net effect of the above to the country would be:

* Increased unemployment;

* A reduction in foreign exchange earnings as the vast majority of salaries earned abroad are brought back to South Africa;

* A loss of exports, particularly if non South African contractors are awarded the contracts.

* By its very nature the construction industry is very mobile and operates in various countries with the result that it is subject to various tax jurisdictions.

* Many of our competitors are still on source-based rules or are given exemptions by home governments, for example:

* An individual who works outside the UK for more than 1 complete tax year can be classified as having ceased residence in the UK, in which case the income relating to the overseas work would not be reportable in the UK;

* In the USA there is an exclusion for foreign income earned up to $76 000 per annum;

* Australia provides exemption when certain conditions have been met and where individuals have been outside of the country for a continuous period of more than 91 days.

* Employment of South Africans

* South Africans will become unemployable as the cost to company will increase by approx 60% (i.e. to give same "take home pay")

* Skill enhancement

* New skills acquired internationally ultimately come back to SA and enhance the skills base of the country. We have found that by exposing workers to international work methods they have been able to return to South African and pass this knowledge on to their fellow workers to the benefit of all concerned. This benefit will be lost if South Africans are not employed abroad

* Impact on the SA economy

* The bulk of income earned by South Africans workers outside of the country is remitted back to South Africa in order to support their families.

* In addition to this, we have found that South African contractors would generally tend to purchase goods and services from South African countries, which results in substantial exports for the country.

* South African contractors are currently playing a major role in building infrastructure in SADC & African countries. This role will be lost if we become unaffordable.

* In the current legislation exemptions have been made for seagoing staff due to the fact that South African seaman were previously unemployable by South African shipping companies due to their high cost. As far as we are concerned the argument for seamen is no different to that for contractors.

The exemption applies to "any person in respect of services rendered outside of the Republic for a continuous period of 183 days or longer during the relevant year of Assessment".

* "Continuous period" - this concept of a continuous period of absence is unrealistic. Does this mean that a person employed outside of the country is not able to ever visit friends or family in South Africa? Could he or she not return if a family member was ill or for a funeral? We also believe that this will be extremely difficult to enforce and monitor from an employer perspective and for the SARS. It would make more sense for the period outside of South Africa to be calculated in aggregate or to rather speak about a continuous period of employment outside of South Africa.

* "183 days" - this period is much longer than that given by some competitors and we suggest that a 91 day rule (as is applied in Australia) would not destroy the competivness of South African Contractors who also face competition from China and South Korea.

* "Relevant year of Assessment" - this does not take into account the reality of the situation in that construction contracts do not start and finish in accordance with tax years. A person may be out of the country continuously for 23 months, but this could span tax years and in reality he could then be taxed on up to half of his foreign earnings. The approach followed by countries such as the UK is for the foreign income to be non-taxable from the date of departure until the date of return, provided that the above rules are satisfied.

A good example to illustrate the effect of the proposed legislation is the Mozal aluminum smelter that has recently been constructed in Mozambique at a cost of $ 1 billion. This project was granted tax-free status by the Mozambique government due to the various other benefits that it would bring to the country. In addition a large part of the financing was in the form of CGIC backed loans from South Africa. This resulted in exports of goods and services from South Africa of over $450 million. Also approximately 5 000 South Africans were employed on this contract at a cost of approximately $100 million.

The effect of the proposed legislation on Mozal would be that the cost of employing South African workers would increase by $65 million and the construction price would increase by 6.5%. This should be looked at context of the average contract markup being between 5% and 8%. In all probability, the effect of the new legislation would either make the entire project unviable or exclude South African involvement.

Clearly the benefits of a project such as this proceeding are enormous. Both in the short term, for South African exports and employment, and in the long term, for increased employment opportunities and greater growth and stability within neighboring countries.

* Fringe benefits. The whole question of the taxation of fringe benefits has not been addressed and no relief is contemplated in the current legislation for fringe benefits received while employed outside of South Africa. We believe this to be extremely draconian, as no cognizance has been taken of the cost vs. the benefit received. For example, a person working in Zambia would be provided with accommodation. The cost of renting an average house in Zambia would be approximately $ 3000 per month (R 22 000 per month). To rent a comparable house in South Africa may only cost R 5 000 per month. Thus the cost of the benefit received is grossly disproportionate to the value to the employee and it would be extremely unfair to now tax the employee at 42% on this perceived fringe benefit. The same considerations apply to schooling, local cost of living allowances and air travel to and from their home base.

* Transitional relief. Contracts are currently being undertaken and tenders have been submitted based upon the existing legislation. To now retroactively tax these contracts, and persons employed on them, is inequitable. We would suggest that some type of transitional relief be implemented. As has been proposed in respect of the taxation of foreign pensions we suggest a similar period of three years before the new legislation comes into effect.

* For tax free aid contracts undertaken outside of South Africa provision should be made for these contracts to be exempt from tax in South Africa, i.e. by means of a tax sparing clause be introduced to exempt such income.

* The application of South African tax rules to the calculation of foreign taxable income is completely unreasonable. This places an unnecessary administration burden on the company, as they have to comply with two different tax regimes. For example, they need to keep three asset registers, one for book value, one for the host country tax values and one for South African tax values. This application will lead to serious difficulties when determining the credit for foreign taxes paid by construction companies. Consider the position of an advance payment of $10m. The theoretical profit would be taxed in terms of section 24c in South Africa but NIL in most other jurisdictions as no profit has been earned.

What is needed is a basis of taxation that will level the international playing fields for both South African individuals and corporate's. We would suggest that the following amendments be made to the proposed legislation:

* Foreign income be exempt provided that the person is employed outside of South Africa for a continuous period of more than 91 days in any 12 month period or if the person has been employed outside of South Africa for more than 183 days in aggregate during the relevant year of assessment;

* The exemption should apply to remuneration earned from the date of departure from South Africa until the date of return to South Africa.

* Transitional measures be introduced whereby income earned outside of South Africa will only be taxable during years of assessment starting on or after 1 January 2004, i.e. after three years.

* There should be a suspension of taxation on any fringe benefits until the matter has been properly investigated.