The Banking Council of South Africa

POSITION PAPER: REPORTABLE TRANSACTIONS
Written submission on the proposed insertion of Part 1A to Chapter III of the Income Tax Act, 1962

1. Introduction
The insertion of Part 1A to chapter III of the Act is intended to give SARS early notice of any transaction in which a financial institution utilizes a tax benefit to reduce the interest rate or cost of finance to a lender, or to increase the viability of a project by reducing a tax obligation. This practice – generally referred to as "structured finance" – is accepted as a component of sophisticated financial transactions throughout the world.

Structured finance has had significant benefits for start-up enterprises, i.e. where the lender does not have sufficient taxable income to claim the tax benefit. Many important projects – including infrastructure developments and numerous black economic empowerment deals – have been viable partly due to structured finance.

From a tax policy perspective, however, some structured finance transactions are "aggressive" in their interpretation of prevailing tax legislation (in other words, they are premised on a dubious interpretation of the law) or, alternatively, exploit unintended consequences of tax legislation at the expense of the fiscus.

2. Background
The Minister first raised concerns over the amount of tax paid by banks in the 21st February 2001 Budget Speech. Subsequently, the banking industry engaged in a co-operative exercise with SARS and Treasury to establish the extent to which various activities contribute to a reduction in the effective rate of tax paid by the industry.

As a result of this exercise, the industry has co-operated with SARS in various attempts to increase the tax liability of banks, but has also emphasized the need to do this in a methodical manner, driven in the treatment of various transactions by clear tax policy objectives, rather than the simple desire to reach target percentages.

3. Objections in principle to the proposed amendment
Since their December 2000 bi-annual meeting with SARS and Treasury, the banks have regularly offered to disclose to SARS the type of information specified in these new provisions, but with a view to facilitating an advanced ruling system.

3.1 The overriding concern of the financial sector is tax certainty. Businesses prosper when they operate in a stable environment with laws operating in an impartial and predictable way.

Revenue laws contribute to this environment and should therefore be clear in their intention, consistent in their application and not subject to frequent changes or amendments.

Advanced rulings would enable the correctness of any assumptions on the tax treatment of a transaction to be established at the outset. This would enable banks to refrain from entering into certain transactions – thus avoiding the economic and other costs that a subsequent adverse tax treatment would have on the viability of the transaction – and to proceed with other transactions with greater confidence. A body of precedent would develop out of such rulings, creating greater certainty and guiding financial institutions in their future dealings.

Conversely, the implementation of a disclosure requirement without a concomitant ruling system – such as now proposed – is likely to result in the proliferation of ad hoc tax amendments. This is the only way under the current draft by which the Revenue Authority can prevent the continuation of structures considered undesirable.

Instead of bringing about greater certainty, the new provisions would thus facilitate an environment wherein the rules change all the more rapidly and "in mid-play".

The situation will be further exacerbated if Parliament allows the Commissioner the added power of notifying additional transactions under item (c) of the proposed definition of "reportable transaction".

Since the ambit of the provision is already very wide, and both the administrative burden of compliance and the consequence of non-compliance are severe, we feel strongly that the Commissioner should not be allowed the discretion to further extend the ambit of these provisions.

There is also a tendency for SARS to draft new provisions very broadly and the Parliamentary process imposes the discipline of having the ambit of some of these provisions more narrowly circumscribed.

3.2 Many of the proposed provisions are altogether unreasonable.
By virtue of the current draft, a mere administrative oversight (not reporting a transaction, or not including an identity number in a tax return) will have serious consequences for the taxpayer and effect the viability of the transaction.

A criminal sanction is imposed – disproportionate in its severity to the other penalties imposed under the Act – without any need to prove malicious intent (as required under section 104(1) of the Act) and without provision for the Commission to waive the penalty (as provided for in section 76).

In addition, the failure to report a transaction will frustrate the taxpayer’s ability to rely on a tax treatment in accordance with prevailing law. The economic consequence of this measure bears no relation to the seriousness of the "offence" committed.

To further exacerbate the position, the taxpayer is required to deliver a great volume of documents and materials in respect of every transaction – and to do so within hours or minutes of the time the transaction is concluded.

SARS would not be happy with an obligation to assess all tax returns within 7 days of receipt, failing which it would lose the right to dispute any aspect of the taxpayer’s liability for that year of assessment?

We would argue that the test for reasonableness – with regard to obligations imposed on the taxpayer – should be the standard of efficiency and severity of penalties which SARS is willing to have imposed upon itself.

3.3 We are concerned that the broad scope of ‘reportable transaction’ and the type and number of documents required for each transaction, diminish the efficiency of the current draft.

Efficiency is the measure of output (product) in relation to input (cost or effort). The greater the output or product, in relation to input, the greater the efficiency.

Every statutory obligation imposed on an enterprise increases the cost and effort required by that enterprise to do its business. (This notwithstanding the regulatory benefit to be derived from compliance.)

The less the effort in relation to the envisaged benefit to be derived from compliance with that obligation, the greater the efficiency of that legislation. The desired policy objective should be achieved without placing an excessive compliance burden on the taxpayer.

We would strongly argue that any provision that proposes to extend the obligations of taxpayers should in future be subjected to a cost / benefit analysis. Even a more rudimentary impact assessment would be helpful.

3.4 Clarity and consistency
The current draft shows signs of incomplete conceptualisation and hasty formulation.

Clarity and consistency with other provisions of the Act contribute to both tax certainty and efficiency.

4. Objections with regard to process
It has become the norm for revenue amendments to be presented haphazardly, with short notice and comment periods.

There has been no prior consultation with the industry on these proposals.

5. Evaluation of specific provisions in light of accepted principles
Some of the detailed provisions of the draft legislation are discussed below, in light of the various principles discussed earlier.

5.1 Relationship between sections 76A(1) and 76B(1)
Section 76A(1) defines ‘reportable transaction’ and section 76B(1) then determines who must report the transaction. The reporting obligation – wisely, in our view – does not rest on every participant in a transaction, but only on the parties deriving the tax benefit or engineering the structure.

The definitive features of a reportable transaction seem to be that there should be (i) an assumption as to tax treatment, and, (ii) as a result of which a tax benefit is obtained.

A provision for a variation of rights and obligations between the parties if the tax treatment does not materialize is merely indicative of the fact that the transaction rests on an assumption (rather than being based on clear precedent).

Where it not for (i) of the definition, every tax reducing transaction – including the purchase of a box of paperclips – would be reportable.

Whereas a confidentiality clause or proprietary claim reveals which of the participants is responsible for engineering a reportable transaction – and is thus included under 76B as triggering a reporting obligation – it is not in our view correct to include this as part of the definition of ‘reportable transaction’. (In other words, we suggest that a transaction should not be reportable unless the ‘assumption’ requirement in (i) of the definition of ‘reportable transaction’ has been met.)

The definition of ‘reportable transaction’ should not rest on a confidentiality clause or proprietary claim, but rather on an assumption as to tax treatment leading to a specific tax benefit.

We thus propose the deletion of (b) from the definition of ‘reportable transaction’ and its more complete inclusion under the reporting obligation imposed by section 76B. This will reduce the number of transactions falling unnecessarily into the definition and thus improve efficiency.

5.2 Item (c) to the definition of ‘reportable transaction’
We propose the deletion of this item – for reasons discussed earlier.

Apart from being an unjustifiable derogation of legislative power, it also enables the Commissioner to extend the scope of a provision which carries a criminal sanction. This may be unconstitutional.

5.3 Time allowed for reporting under 76B(1)(2)
It is unreasonable to expect delivery of all the information required under section 76B(3) on the date of concluding the transaction. The Commissioner is allowed 60 days in terms of section 76D to issue a number. Financial institutions should be granted a period of at least 30 days to comply with a far more onerous obligation.

5.4 Certified copies of signed agreements to be delivered in terms of item (d) of section 76B(3)
In order to lessen the compliance burden on the taxpayer, we propose that the obligation to deliver ‘certified copies of all the signed documents relating to that … transaction’ be omitted from item (d). In our view the balance of the reporting requirements under (a) to (e) of 76B(3) provide the Commissioner with a sufficient basis on which to assess the viability of any assumptions made in respect of the transaction. The Commissioner then has ample powers under section 74A of the Act to request copies of the agreements in respect of transactions that are of specific interest.

5.5 Section 76E
Administrative oversight should not give rise to such far-reaching consequences. As a result of this section, arbitrary and unquantifiable consequences may flow from an administrative oversight.

The tax benefit arises by virtue of the normal application of legislation – not as a special concession – and the general application of law should not be altered for the sake of creating innovative penalty provisions.

Although section 76 is comparable in its effect – imposing a double tax obligation in respect of undisclosed income – this consequence only results where there is an intention to evade tax (section 76(2)(a)). In all other cases the Commissioner may waive the penalty, and in the event that the Commissioner decides ‘not to remit the whole of the additional charge’ the taxpayer has an automatic right to object and appeal.

The proposed 76E has none of these requirements or safeguards.

Moreover, by virtue of the broad definition of ‘tax benefit’ this penalty may go so far as to require that the right to make general deductions, or claim input credits in the calculation of VAT, be forfeited in respect of that transaction.

We propose the deletion of this section.

5.6 Criminal sanction imposed under section 104 (1A)
Under the current draft, the failure to report a transaction will carry a criminal sanction vastly disproportionate to any other imposed by the Act – for a simple administrative oversight, i.e. without the requirement that there be malicious intent.

Ironically, the complete failure to render a tax return for the year of assessment in question carries a maximum penalty of R 2000 or 12 months imprisonment (under section 75 of the Act). The timeous rendition of that return, on that other hand, with only one of numerous reportable transactions omitted, would carry a maximum penalty of 5 years imprisonment.

Conviction for tax evasion (section 104) – for which intent must be proved – carries a maximum penalty of two years imprisonment.

The closest equivalent in the Act to pure administrative oversight is the failure of an officer of SARS to undertake an oath of secrecy – before dealing with confidential information relating to a taxpayer. Such an oversight carries the penalty upon conviction of ‘a fine not exceeding R50’ (section 4(4) of the Act).

We question the need to criminalise administrative oversight, the applicability of hefty penalties without the need to prove culpability or intent, and the disproportionate weight of this penalty in relation to others imposed under the Act. We propose a maximum fine of R 2 000 without the option of a jail sentence.

In respect of the provisions of item (b) of that section, as currently worded, a taxpayer will be penalised for claiming ‘any tax benefit in terms of a reportable transaction where no identification number has been issued’. The issuing of the number is completely within the control of the Commissioner, and the taxpayer should not incur a penalty for any failure of the Commissioner.

6. Proposed modifications to the draft legislation
Annexure 1 sets out possible changes to the draft legislation, aimed at addressing some of the concerns raised earlier in this Submission. In addition, a number of typographical changes have been made with explanations, where necessary, in the footnotes to that annexure.

21 October 2003