THE BANKINC ASSOCIATION


13 Qctober 2005


From: Henry Shaw(Consultant Banking Association0


To: Ms Christell Brodrick ( South African Revenue Services) and

Ms Pearl Malumane (National Treasury)


Draft Revenue Laws Amendment Bill


Thank you for the opportunity to comment on the Draft Revenue Laws Amendment Bill, recently made available for public comment. We trust that you will find the observations and recommendations that follow constructive to your further deliberations. We appreciate that our comments on previous batches have been considered and amendments made to the current draft. The comments that follow are those where The Banking Association South Africa has residual concerns


In order to provide a broad overview of the principles underpinning our comments and suggestions, we summarise the detail as follows:


Summary of Principle Issues:


Equity: Taxation allowances are expanded in the Bill as an incentive to encourage social and economic development. Accelerated depreciation allowances, broad-based share ownership schemes, film production, and Public Benefit Organisations are the main items introduced, or enhanced. Our concern is that the use of tax concessions often facilitates arbitrage, where unintended parties benefit from the allowances, or the allowances are abused.


Consistency: Where it is deemed appropriate to introduce or enhance allowances as suggested above, it becomes imperative that such incentives actually work and are not negated by other restrictive provisions of the Act. This is illustrated by existing restrictions on leasing allowances limiting the ability of small businesses to access the benefits of allowances intended. The taxation of share incentive schemes is another example of differential tax treatment.


Simplicity: There is no doubt that taxation is an extremely complex subject, with substantial resources devoted to its collection and administration. Foreign jurisdictions, particularly the UK and USA have moved towards greater convergence between accounting treatment and taxation treatment. This process has greatly reduced arbitrage opportunities, which could favour shareholders over the fiscus.


Certainty: Absolute certainty in application and interpretation is probably impossible to achieve, but we believe that there are areas that can assist in this direction. The clarification of Reportable Arrangement requirements and Advance Ruling implementation are but two illustrations.


Our comment follows the Clause headings of the Draft Bill:


Clause 4


Estate Duty: Amendment of section 1 of the Estate Duty Act, 1955.


We understand that the replacement of the Land Bank Act with the Land and Agricultural development Bank Act of 2002, gave rise to administrative difficulty in the formalisation of property values relating to farming operations. However, the proposals in the draft bill appear to have the effect that, in respect of bona fide farming operations, the executor will be required to base valuations on the determination of a price between a willing buyer and a willing seller, reduced by 30%. On the other hand, other properties will be valued at fair market value.


Other than the statement that Land Bank values were lower than fair market values, there appears to be no motivation for the reduction of 30% in determining farm values. Land bank values may well have been influenced by the Land bank's role as a provider of credit, and valuation for security purposes, but for the purposes of Estate Duty, there does not appear to be justification for the 30% valuation reduction for farming operations.


Productive value is assumed to be market value less 30%. However productive value will be one of the determinants of market value, as will be alternative use, zoning, subdivision and many other variables.


Clause 8


Income Tax: Amendment of section 1 of the Income Tax Act, 1962. Sub-clause (b):


The inclusion of a person with a "contingent" interest in a trust as a beneficiary could have the effect that such beneficiary may be taxed in certain circumstances (Refer Section 25B). This seems to be inequitable, as a "contingent" beneficiary will only become a beneficiary upon the contingent events having occurred. It therefore seems that the narrow definition of a beneficiary for purposes of taxing the receipts and accruals of a trust is more appropriate. It does appear that, within the context of individual provisions of the Act the narrow definition will apply, but the introduction of "contingent beneficiaries" seems to serve no purpose.


Sub-clause (e):


The introduction of tax exemption for specific activities identified by the Minister as in the furtherance of government policy may well have the effect of directing expenditure into specified areas. We would like to ask your consideration of a number of concerns:

· The use of this enabling clause may well bypass established organisations with similar objectives, but which are required to conform to other stringent requirements. (Section 21 companies, Registered Non Profit Organisations and those compliant with the requirements of section 30). This may well require additional controls to ensure that the grant has been expended solely for the purposes intended.

· There may be instances where the targeted activities overlap with those of other taxpayers who are undertaking similar activities with profit making intentions. This could result in unfair competition and inefficient allocation of resources.

· The need to align VAT practices with Income Tax practices in respect of government grants is questioned, particularly as VAT is a transaction tax and Income Tax is a tax on income less expenditure.


Clause 9


Income Tax: Amendments to section 6 of the Income Tax Act, 1962

The draft bill proposes to allow Public Benefit Organisations a rebate of R10 800 in respect of their tax payable in respect of those activities subject to tax. It is accepted that a system of partial taxation will assist these organisations not to breach the conditions of their exempt status. However, where such an organisation does produce taxable income, the introduction of a rebate equivalent to that granted to individuals of 65 years and older seems to unnecessarily complicate the affairs of the public benefit organisation. It is the Banking Association recommendation that such organisations, where exceeding their permissible trading rules, be subject to tax at the normal corporate rate on such excesses, without the application of rebates.


This recommendation is consistent with the proposed amendment to section 10 where income tax exemption is viewed in the context of the profitability, competitive impact and potential level of economic distortion likely to be caused by such activities.


Clause 14


Income Tax: Amendments to section 8C of the Income Tax Act, 1962


The valuation, timing and taxation proved problematical for some time. views held by commerce and industry of employee share incentive schemes has At the heart of the matter are the divergent on the one hand and SARS on the other.


Commerce and industry argue that the acquisition of a capital asset by employees in the form of shares and the subsequent benefits of share value escalation should not subject them to tax and they should be treated no differently to other shareholders. The capital nature of the acquisition argument is further re-enforced by the fact that the cost of these schemes is usually disallowed by SARS.


SARS argue that the benefits of an employee share incentive scheme arise from employment and should therefore be taxed. Furthermore, as the issue of shares does not normally result in costs being actually incurred by the employer company, SARS are constrained from allowing a deduction of these costs.


International Accounting Standards and tax authorities in other jurisdictions have recognised, and applied the principle of "substance over form" and record these transactions to reflect the economic reality of share incentives. From January 2005, the economic effect is recognised in the accounts of reporting institutions. This accounting and valuation process is not voluntary and becomes compulsory under the requirements of the Companies Act and Generally Accepted Accounting Practice.


It is suggested, in the interests of simplification, international best practice and equitable tax treatment, as well as seeking further convergence between accounting and taxation treatment of share incentives, that National Treasury and SARS set up a task group to seek resolution to this impasse.


Clause 18


Income Tax: Amendments to section 10 of the Income Tax Act, 1962 Sub-clause (h)


This amendment provides for the identification of certain activities of Public Benefit Organisations approved in terms of the national annual budget process to be identified by the Minister to receive government grants, which would not be taxable. While these are listed and the minister may approve other activities that will not taint their tax exempt status, there needs to be a mechanism to ensure that the grants are indeed spent on approved projects. Furthermore, we express concern that the vulnerabilities identified in Clause 8 above will still need to be addressed.


Clause 20


Income Tax: Amendment of section 11 of the Income Tax Act, 1962 Sub-clause (c)


Clarification of the legislation relating to the claiming of bad and doubtful debts is welcomed and should create more certainty in the tax treatment of these expenses. The proposed amendment to paragraph (1) has the effect of continuing the Commissioner's discretion in allowing a provision for doubtful debts. However, the proviso is that, had those debts become bad, they would have been allowed under any other provisions of the Act.


In the banking and lending industry, loans which are irrecoverable are claimed under either Section 11(a) and/or 11(i).


We therefore confirm our support for the clarification brought about by the proposed amendments.


We share your concern that some taxpayers may have interpreted the previous section as a cumulative allowance, and suggest that clarification can be enhanced by the issue of an appropriate practice note.


Sub-clause (d)


While the recognition of employee costs in broad-based share incentive schemes in the concession that the employers are entitled to deduct the market value of qualifying equity shares is welcomed, an anomaly for other share incentive schemes still exists.


While employee benefits arising from share incentive schemes are taxed, there is still confusion surrounding the deductability by the employer of the shares issued under such schemes. The argument for denying the deductability of shares is that the cost of the shares is borne by the shareholders and not the company issuing the shares. The principle of issuing shares to acquire assets or pay for expenses seems to be becoming more entrenched, and future reviews of taxation and deductability of share incentive schemes in their entirety, not only "broad based" schemes should seek to establish neutrality in tax treatment. (See also Clause 14 above)


Clause 21


Income Tax: Amendment of section 1 2B of the Income Tax Act, 1962 Sub-clause (d)


The Banking Association supports the introduction of accelerated allowances for machinery to be used in the generation of electricity from bio-sources. However, a point that was previously made by this association is accentuated by the proposed amendment. This point is that incentive allowances for taxpayers to invest in desirable ventures and small businesses will only serve their purpose if accompanied by the relaxation of restrictions of leasing allowances. (Section 23A).


It is particularly true that commercial viability of bio-industry will take some years to achieve. Accelerated allowances will not be able to be availed of by the manufacturer while he/she establishes commercial viability. Where the benefit can be passed on to the entrepreneur, is through bank intermediation under relaxation of the ring-fencing of leasing allowances.


An alternative to the granting of accelerated Income Tax allowances for ventures of this sort is to create direct subsidies payable independently of the SARS processes. There are obvious shortcomings in this alternative, but they could be considered as more effective than the granting of accelerated allowances that cannot be availed of through the start-up phase of production.


Accelerated allowances for assets used by start-up businesses in the process of manufacture, will carry no cash-flow benefits for the business in their early years and, if four or five years is the time to break-even, they will be in no better position compared to other businesses. In fact, they are at a competitive disadvantage to established manufacturers, who have the ability to claim allowances under other sections of the Act, and can utilise such allowances from the first year the asset is brought into production, as well as scrapping allowances, out of their existing taxable income from ongoing operations.


This frustration is further aggravated by the fact that banks have little or no interest in financing these assets. The reason for this is that section 23A effectively limits allowances claimed to the rental income from the leased assets. This ring-fencing process will have little economic impact in times of on low-growth and no-growth on the investment of productive assets. However, in a growth phase that South Africa is currently experiencing, and trying to sustain, there will not be sufficient capacity to absorb new leasing allowances while the rental income limitation remains in place.


As we indicated in previous submissions, it is our belief that most small businesses will choose to acquire productive assets through leasing, firstly as a form of financing and secondly, as a low cost option where the benefits of allowances are passed to the lessor in lower prices. The second option has been severely compromised by the ring-fencing provisions of section 23A


In our view, the only effective way in which these unintended barriers to small business start-up and growth can be overcome is to amend section 12E to allow for leasing, and to amend the ring-fencing section 23A to exclude developmental allowances (e.g. section 12E) from the ring-fencing constraints of section 23A. (See also our general comments at the end of this letter.)


Clause 27


Income Tax: Amendment of section 18 of the Income Tax Act, 1962


The Banking Association has already expressed its support for the more equitable application of allowances relating to medical aid contributions. It is believed that the desired objectives expressed in the previously distributed discussion paper will be achieved. We believe that capping of allowances is the start of a process of creating broader based access to medical services.


Clause 29


Income Tax: Amendment of section 20A of the Income Tax Act, 1962.


The Banking Association welcomes the clarification introduced by the proposed amendment to section 20A but suggests that the condition for ring-fencing part-time income and expenditure should not be determined by the maximum marginal rate for individuals. As is seen in the proposed amendments, the calculations become complex and remain discriminatory against high-income taxpayers.


It is therefore suggested that the income criteria be scrapped and that the provisions of section 20A be applied to all taxpayers.

Clause 30


Income Tax: Amendment of section 23 of the Income Tax Act, 1962.


Sub-clause (e)


The principle of denying deductions for bribes, penalties or fines is understood and accepted. However, having specified certain activities as not qualifying for deductions from income, the question is raised as to whether the list is complete or not? Furthermore, a fine or penalty having been imposed upon a South African taxpayer in a foreign jurisdiction can only be assumed to be unlawful in South Africa, as no court in South Africa has ruled on those specific facts.

The basic test of whether the expenditure is of a capital or revenue nature and whether it is actually incurred in the production of income or not, should cover the contingencies contemplated in the proposed amendments.


While the desired objective is supported, it is suggested that the explicit exclusion of certain expenses may unnecessarily complicate Income Tax law administration.


Clause 34


Income Tax: Amendment of section 24F of the Income Tax Act, 1962.


We concur with the view that special allowances can result in abuse by promoters and investors in films. The use of special allowances to any one category of taxpayer has that inherent danger and, we believe, can result in greater arbitrage opportunities to the detriment of the country as a whole.


If it is deemed necessary to single out a specific industry for special development, it may be more cost effective to consider a system of grants. It is quite evident, from the complexity of the allowance conditions, that compliance costs will be significant.


Clause 41


Income Tax: Amendment of section 41 of the Income Tax act, 1962.


The Banking Association has 2 main concerns relating to the proposed amendments to the definition of a "foreign financial instrument holding company", which are otherwise welcomed.

In the first place, we are concerned that there is a restriction, which requires a foreign company, in order to qualify for favourable treatment, to "mainly conduct business" in "the country of residence of that company" (contained in proviso (b) to the definition of a "foreign financial instrument holding company" on page 66 of the draft Bill). It appears that there is no good reason for this restriction, and it does not take into account the reality that financing companies may conduct business in many jurisdictions. We request that this restriction should be deleted, alternatively expanded to include all countries in which the foreign company has any permanent establishment. Please refer to the Banking Association's letter dated 6 September 2005 (at point 3.1) for further detail in this regard.


In the second place, the timing of the implementation dates of the amendments could lead to anomalies, as (a) the specific amendment to the definition of a "foreign financial instrument holding company" in section 41 comes into operation and applies to any disposal on or after 8 November 2005, and (b) the associated amendments to section 9D apply to foreign tax years which end during any year of assessment ending on or after the date of promulgation of the Act. As the definition of a "foreign financial instrument holding company" has application in section 9D, we suggest that the implementation dates of the amendments to section 41 and 9D be made consistent, by both applying to foreign tax years ending on or after 8 November 2005.


Clause 59


Income Tax: Amendment of section 76A of the Income Tax Act, 1962.


The amendments to Section 76A are consequential to the determinations made by the Minister in the Government Gazette (27209).


The Banking Association South Africa has continuing concerns over the interpretation of the practical requirements of this section. With regard to these interpretations, a number of proposals are before SARS for consideration and discussion. We believe that these issues will be resolved. In the meantime, however, we would ask that, in the light of the ongoing uncertainty, the penalty provisions of Section 76A (4a and 4b) either be suspended or that the Commissioner be empowered to remit additional charges and exercise his discretion as to deeming the transactions to be entered into in the circumstances contemplated in Section 103, provided that there were reasonable grounds for any failure to report.


The Banking Association proposes, under Section 76A, paragraph (bb) of subsection (1 A), that the proviso under this paragraph be changed as follows: "... were it not for a connected arrangement that is entered into for the sole purpose of providing security (and) or no tax benefit is obtained or enhanced by entering into such security arrangement; and.."


This suggestion is in accord with our recommendations previously made and is supported by the assumption that if there is no tax benefit or an enhancement of a tax benefit, there is no need to report.


General Comments.


The proposed amendments to various taxation legislation are generally welcomed by The Banking Association South Africa. It has become evident in reviewing the proposed amendments that there are significant complexities in formulating and applying such legislation. This point relates particularly to "consistency" and "simplicity"


Consistency.


The Taxation Laws Amendment Act passed earlier this year provided for the stimulation of small businesses through accelerated allowances under Section 12E.


Economic and fiscal policy, as evidenced by enhanced allowances, can be made more achievable through facilitating access to the allowances available. Access to productive assets, particularly in the early stages of the life of small businesses, is most economical through leasing. This process allows banks (the lessors) to intermediate allowances and provide the facility to small businesses at a lower cost than other forms of financing. Furthermore, this lower cost will often determine the survival of the businesses as they have the dual problems of cash flow stress and minimal taxable income in their early years.


If there were an alignment of the incentive provisions of the Income Tax Act with the constraints evident under ring-fencing, The Banking Association believes that the policy objectives will be reinforced.


It does appear appropriate that where investment is encouraged by one section of the Income Tax Act, that another section of the Act should be so aligned as not to make the incentive more difficult to achieve. Moreover, by excising such assets from the section 23A limitations, income from these assets will not be sheltering allowances for other conventional assets.


Simplicity.


We would urge National Treasury and SARS to consider selectively adopting Generally Accepted Accounting Practice, now becoming an international norm as a basis for revenue and expenditure recognition. There is already precedent in the Income Tax act for such adoption and sections of the Companies Act are expected to make GAAP mandatory. Wider adoption of GAAP can facilitate greater certainty in tax affairs and reduce regulatory arbitrage in the long run.


We appreciate the opportunity afforded The Banking Association South Africa to participate in the process of legislative reform. We thank SARS and National Treasury for having given our suggestions in earlier drafts due consideration.


Yours sincerely,


Henry Shaw Consultant: The Banking Association