2. It is gratifying to note that this version already takes account of certain of the comments made in respect of the previous versions released for public comment as Batches 1 to 4.

3. We thank the Committee, SARS and National Treasury for the ongoing opportunities afforded us to participate in the development of our country's tax legislation.

4. In addition, from an overall perspective, though we have identified various concerns, we would congratulate both SARS and National Treasury on draft legislation which is, on the whole, understandable, justifiable and well considered. The fact that again no changes of the magnitude seen in prior years, in terms of complexity and the introducing of new concepts, is also welcomed.

Clause 8: Amendment of Section 1 of Act 58 of 1962

(h) As regards the reduction in the shareholding requirement from 75% to 70%, this has come about as a result of repeated calls from taxpayers and their advisors over the past few years in order to facilitate BEE transactions through the avoidance of the de-grouping charge in section 45, which occurs when the holding in a company falls beneath the appropriate percentage stated above. It has come to our attention that some taxpayers have inadvertently fallen into the section 45 'trap', having originally formed part of a group, then dropped below the, then, 75% requirement, only now to again form part of a group when the holding requirement drops to 70%.

We request that consideration be given to applying the reduction to 70% with retrospective effect, in order that taxpayers who pursued their BEE initiatives, in pursuance of government objectives, early are not unduly penalised.

Clause 14: Amendment of section 8C of Act 58 of 1962

We refer you to our comments highlighting anomalies between section 8C and the CGT regime, contained in the attached Appendix.

Clause 15: Amendment of section 9 of Act 58 of 1962

(b) We are disappointed to note that despite other changes being proposed to paragraph 2 there appears to be nothing as regards our previous submissions regarding the inclusion of mining rights as immovable property. We would request that, for the purposes of this test only, these rights be attributed to trading stock and so be excluded. Our detailed submissions on this point are included in respect of clause 75 (paragraph 2 of the Eighth Schedule) where the identical wording is imposed.

Clause 16: Amendment of section 9D of Act 58 of 1962

(1)(a) &(e) Definition of controlled foreign company ("CFC')

Concern exists that the revised definition (inclusion of voting rights) may result in certain foreign companies falling within the definition of a CFC when this would take the scope of CFC legislation further than intended and / or result in negative foreign investor perceptions.

In addition, we would highlight that a proviso is required to the definition in the cases where, despite the definition applying, by reason of the de-minimus exception no resident has any amount imputed. It is submitted that, in such circumstances, the foreign company, and its subsidiaries, should not be regarded as CFCs.

Finally, in considering the holdings of "connected persons", in accordance with the changes proposed in Clause 16(1)(p) to subsections 9D(12) and (13), it is submitted that this be limited to residents who are connected persons.

(2) Effective dates generally

It has been stated previously by National Treasury and SARS that legislation will not be effected retrospectively unless this is taxpayer friendly. We would suggest that the effective dates proposed for section 9D be revisited with this in mind.

Clause 41: Amendment of section 41 of Act 58 of 1962

(c)&(d) Definitions of domestic financial instrument holding company ("DEIHO) and foreign financial instrument holding company ("FFIHC')

The relaxations introduced through the references to 'influenced companies' are welcomed.

As regards the exclusion of financial instruments whose market value is equal to their base cost, we understand that these are not considered 'bad' assets as they do not give rise to the loss trafficking concerns which drove the financial instruments and financial instrument holding company exclusions from the reorganisation releifs.

However, on the above understanding there is concern that the wording does not go far enough. The explanation accompanying this change in Batch 3 stated "A further concession is introduced by disregarding any financial instrument the market value of which is equal to its base cost. This would exclude most debts, loans and bank accounts from the calculation". This explanation is conspicuous by its absence from the explanatory memorandum.

Even in the presence of the, now abandoned, wording there was concern that financial instruments which would not give rise to the perceived loss trafficking concern were nevertheless not excluded. Simple examples included fixed rate loans where the market rate has moved since the loan was granted but the base cost remains constant or refunds due from SARS where, due to uncertainties as to when the amounts may be repaid, it is unlikely that the market value could be said to equate to base cost.

It is submitted that the following wording, which we understand to meet the underlying principle, be adopted to provide the relief intended;

"(iii) any financial instrument where repayment of the full principal amount, without any reduction or discharge, would give rise to neither a gain nor loss for tax purposes

(d) Definition of FEIHO banks, financiers etc

The reference to ... bank or financier, insurer, dealer or broker that mainly conducts business in the country of residence of that company and that company

i) regularly accepts deposits or premiums or makes loans, issues letters of credit, provide guarantees or effects similar transactions for the account of clients who are not connected persons in relation to that company; and

ii) derives more than 50% of its income or gains from principal trading activities with those clients (our emphasis)

The reference to "country of residence" does not take into account instances where a controlled foreign company ("CFC") may be resident in more than one country. Even though a wide interpretation may include all locations where there are bona fide activities conducted with clients outside the CFC's country of incorporation/effective management, we are of the opinion that this issue needs to be clarified, especially in relation to permanent establishments of a CFC. In this regard, we note that there are proposed amendments to section 9D(6), which specifically refer to a "permanent establishment of that controlled foreign company", in relation to the calculation of the capital gain on the disposal of an asset of a permanent establishment of a CFC. Therefore, it is apparent that the application of section 9D to CFC's with permanent establishments has clearly been contemplated, which should be borne in mind when considering our recommendations made hereunder.

It is submitted that "(including any permanent establishment thereof in any other country)" be inserted after "country of residence".

In order to ensure that the proviso, which excludes the application of this wording to tax haven jurisdictions, also takes into account all of the jurisdictions where the CFC is operating, it is submitted that the same wording be inserted after "to a foreign company" in the proviso.

(h) Recovery of capital distributions in terms of paragraph 76(1)(b) of the Eighth Schedule

We are concerned that, in the case of intra-group transactions in terms of section 45, the proposed section 41(8)(b)(ii) departs from the accepted principles under which that section operates.

Unlike sections 42, 43 and 44, each of which double up an inherent tax gain, section 45, whilst 'rolling over' the tax history of one leg of a transaction, provides a step-up for the other leg. This was accepted by National Treasury and SARS in their briefing to the Portfolio,Committee at the time section 45 (in its current form) was introduced in 2002.

The proposed inclusions for both transferor and transferee in terms of the proposed section 41(8)(b)(i) and 41(8)(b)(ii) respectively negates this treatment in respect of capital distributions.

Accordingly, whilst we agree that s41(8)(a)(i) cover section 45 transactions (as detailed in subsection (8)(a)) such that any distributions be included in the calculation of a subsequent disposal by the transferee, it is recommended that s41(8)(a)(b)(ii) be restricted to instances other than section 45.

Clause 42: Amendment of section 42 of Act 58 of 1962

(a) We are concerned that the exclusion of personal goodwill from the rollover provisions effectively negates the more positive aspects, effectively permitting the incorporation of professional partnerships, of the changes proposed.

Our discussion with National Treasury and SARS revealed a concern that without this anti-avoidance protection scope would exist for taxpayers to effectively convert otherwise taxable income amounts into capital gains (taxed at lower rates).

Whilst we acknowledge the concern it is our view that this could be addressed in other ways such that legitimate business formations are not negatively impacted.

Clause 45: Amendment of section 45 of Act 58 of 1962

(d) It is submitted that the requirement in s45(6)(a)( iv) for the shares to be in a "controlled group company" in relation to the transferor is no longer appropriate and should be to an "influenced company".

It is now possible to transfer shares in an influenced group company in terms of other of the Part Ill reliefs, e.g. section 47 (e.g. where those shares are the sole asset of a holding company such that the holding company is not a FIHC) or in terms of section 43 (through the transfer of a holding company immediately above the influenced group company, again where the holding company is not a FIHC), or indeed in terms of section 45 via an intermediate holding company.

Accordingly we submit that the prohibition be relaxed to facilitate the direct transfer of such holdings.

In the alternative, if the above is not accepted, we would recommend that the requirement for the shares to be in a controlled group company "in relation to the transferor" be removed as this is currently preventing groups of companies unwinding historical cross-holdings and consolidating holdings within a group.

Clause 46: Amendment of section 46 of Act 58 of 1962

(g) We submit that the time at which the financial instrument holding company ('FlHC") test should be performed in terms of subsection (7) is immediately prior to an unbundling transaction and not afterwards.

Whilst it is appreciated that it could be argued that the unbundling of a non-FIHC which leaves the unbundling company as a FIHC is tantamount to the unbundling of a FIHC itself we would disagree with this viewpoint, considering it to be fatally flawed from a commercial perspective.

Unbundling transactions are undertaken in order to unlock value for their shareholders and realise the undervalue attributable to the unbundled company, i.e. the discount at which the unbundling company is trading compared to the underlying value of its investments.

An unbundling of other assets of the unbundling company (as opposed to the unbundling of a non-FIHC which leaves the unbundling company a FIHC) would not necessarily achieve the same commercially desired results. We submit therefore that the tax rules here should not negatively impact on the commercial objectives and decisions of companies and that the test remain as it currently is, i.e. determined before the unbundling transaction.

Other

Though not addressed in the proposed changes, we would like to determine whether there is any scope for introducing a new category of permissible transaction to the unbundling relief in section 46. Currently section 46 relief can only be obtained in respect of shareholdings over a certain percentage. The original unbundling relief was by reference to the value of the company being unbundled and we consider that the reintroduction of a similar concept (subject of course to the financial instrument holding company restrictions) could well be beneficial to the economy. Currently small transactions are afforded tax relief but transactions involving significant value may not.

Clause 52: Amendment of section 64B of Act 58 of 1962

(h) The proposed insertion of the terminology "directly or indirectly" cannot be supported as for the following reasons;

i) it would appear to give rise to a number of significant administrative difficulties in tracking the original source of profits in instances such as

a) where profits flow up through a chain of companies and are blended with losses in other companies;

b) where groups grow through acquisitions and cash flows up from subsidiaries of acquired sub-groups. Under current legislation, and in line with understood tax policy as regards the exemption applying where profits remain within the group, profits are only earned in a company receiving a dividend when that dividend is received, not when the profits were earned by the company declaring the dividend.

ii) no rules are set forth or guidance given as to what order (e.g. FIFO, LIFO) profits must be treated as being used up.

iii) it has a negative "retrospective" effect on current reserves. Current reserves that were previously exempt will now be subject to STC.

In addition, the move from "earned" as was previously used in section 65B(5)(f)(ii), which the intended proviso (aa) replaces, to arose" has given rise to uncertainty and the explanatory memorandum offers no guidance on this point. In the absence of such guidance, and the underlying reason for the proposed change, we would recommend that the existing use of "earned" be retained.

Clause 75: Amendment of paragraph 2 of Eighth Schedule to Act 58 of 1962

We are disappointed to note that despite other changes being proposed to paragraph 2 there appears to be none addressing the issued raised in our previous submissions regarding the inclusion of mining rights as immovable property for the purposes of determining whether a foreign company is to be subject to SA CGT on the disposal of shares in a SA company.

We would repeat our previous requests that, for the purposes of this test, these rights be attributed to trading stock and so be excluded from the test, notwithstanding that they remain of a capital nature.

Although the point has been raised by SARS and National Treasury that the rationale behind the exclusion of immovable property (or an interest therein) held as trading stock is that its very nature results in a regular turnover of stock and so revenue for the fiscus, the key motivations for the requested change are that the fiscus ultimately benefits from a higher rate of tax on the assets (ore) derived from mining rights as the mining rights are effectively converted to trading stock over their life and that the current definition inhibits international mining groups, which form an important and integral part of the South African economy from restructuring offshore.

We have repeated below the points previously submitted in this respect.

Paragraph 2 subjects to South African income tax capital gains realised by non-residents on the disposal of immovable property in South Africa or interests in such property. Such interests include the holding of shares in a company, where more than 80% of the net asset value of that company is attributable, directly or indirectly, to immovable property in South Africa.

A key exemption from the application of these CGT rules is where the immovable property is held by the relevant company as trading stock, i.e. if any profit arising on the sale of the immovable property would fall to be taxed as revenue income in the hands of the company, as opposed to capital, then the disposal of the shares by a non-resident will not fall within South Africa's CGT net.

It appears clear that the purpose of this exemption is not to levy tax on capital gains of non-residents where the South African fiscus will ultimately benefit from the higher rate of income tax attaching to the disposal of the underlying asset on revenue account.

We are concerned however that an anomaly exists in this regard when considering mining companies. Whilst it may on occasion be that, due to the nature of the mining rights held, which rights very often constitute a large part of a mining company's value, more than 80% of such companies value is indirectly attributable to immovable property in South Africa it is clear that the disposal of the assets eventually derived from the owning of those rights (being the minerals or ore extracted) will be subject to income tax as revenue income. Even though the mining right itself remains a capital asset, such minerals or ore will in due course constitute the trading stock o~ the mining company.

It is hoped that this impact on non-residents is simply an unintended consequence in the legislation due to a peculiarity in the mining industry, whereby a mining company may hold a capital asset related to immovable property (the mining right) at one point in time, but with a view to converting that to a revenue asset (extracted mineral or ore) over time. We consider this to be distinguishable from other industries whereby the capital asset is used to produce the trading stock, as opposed to effectively being converted into the trading stock.

Accordingly we would suggest that subparagraph 2(2) be amended by the addition of the following words at the end of the existing sub-paragraph,

"Provided that, where held by a company or other entity whose main business is the carrying on of mining operations as defined in section 1, the following permits, authorizations, leases, rights or permissions, shall be deemed not to be attributable either directly or indirectly to immovable property

i) any permit, authorization, lease, right or permission described in section 9(1 )(fA)(i), (ii) or (iii);

ii) any old order right as defined in section 1 of Schedule II to the Mineral and Petroleum Resources Development Act, 2002 (Act No.28 of 2002); and

iii) any such similar right."

It is not considered necessary to say that this deeming is for the purposes of this subparagraph only as paragraph 2(2)'s application is already limited to paragraph 2(1)(b)(i) and the inclusion in paragraph 2(2) of the proviso proposed above limits its extent in the same manner.

Sale of the mining right itself by the company in which an interest is held would remain subject to SA CGT.

Clause 78: Amendment of paragraph 12 of Eighth Schedule to Act 58 of 1962

(a)/ other

Paragraph 12(2)(a) provides for a deemed disposal of all assets (with limited exceptions) when a person ceases to be a resident.

From our recent discussions with SAPS! National Treasury, it has recently come to our attention their policy is that this deemed disposal should apply also in the case of a controlled foreign company ("CFC") ceasing to be a CFC (e.g. from a sale of the CFC shares to a nonresident), resulting in the CFC being deemed to dispose of all its assets.

This we consider to be wholly inappropriate and gives rise to significant concerns, including;

1 Apparent conflict with participation exemption

It appears totally incongruous that the legislation should provide for an exemption on the one hand (subject to certain exclusions, paragraph 64B exempts any gain on the disposal of a CFC) whilst on the other applying a section which imposes a potentially punitive tax.

We would suggest that to have such deemed disposals taxable on the residents holding a CFC could severely discourage the sale by residents of such CFCs, notwithstanding the participation exemption in paragraph 64B, thus impacting upon the currency inflows to South Africa from such transactions.

2 Policy not notified

As stated above, our awareness of SAPS! National Treasury's apparent policy in this regard stems only from our recent conversations with them.

We are not aware that any of the documents published by either SAPS or National Treasury has ever even alluded to this effect, with no mention being made in any of the following documents;

· Explanatory memorandum to the draft taxation laws amendment Bill 2001 (introduction of CCT);

• National Treasury's detailed explanation to section 9D of the Income Tax Act.

The most recent '"Draft Comprehensive CGT guide", in respect of the deemed disposal under paragraph 12(2)(a) likewise makes no mention of CFCs, stating only that

"Companies cease to be resident when

· they are not incorporated, established or formed in SA, and

· their place of effective management changes to a country outside SA."

(our emphasis)

This clearly cannot apply in the case of a CFC as its place of effective management is at all times outside of SA.

3 Can result in effective SA taxation in excess of statutory rates

In the case of the disposal to a non-resident of a CFC with multiple tiers of companies beneath it, it is entirely feasible that, due to the deemed disposal at each tier, the total tax suffered by a SA resident (again bearing in mind that an exemption is provided for the gain on the sale of the shares directly held) could well be in excess of the effective statutory rates of 10% (individuals) or 14.5% (companies) and, in some cases could in fact exceed the proceeds.

4 Can lead to double taxation

Unlike imputation of actual capital gains made by a CFC where a SA shareholder can obtain credit for the foreign taxes paid by the CFC in respect of the gain, a deemed disposal for South African purposes will not be a disposal in the foreign jurisdiction and so carries no underlying tax credit. As a result the South African shareholder would face tax now, with the foreign company then only paying tax later on a subsequent real disposal (if this ever happens) which would not be creditable.

5 Internationally uncompetitive

We have detailed below the position in this regard in certain other territories (the territories included are those to which SARSI National Treasury have referred in their explanatory memorandum on other matters).

From the above it would appear that if South Africa does in fact adopt SARSI National Treasury's stated policy that our tax policy will be out of line, and far more draconian, than that of other jurisdictions globally.

6 Interpretative position

There are conflicting views as to whether the legislation in any event achieves SARSI National Treasury's current stated policy thereby undermining one of the key tenets of good taxation, being that of certainty

Conclusion

In light of the above comments, and for purposes of certainty, we submit that a proviso be introduced to paragraph 12(2)(a) (with retrospective effect to 1 October 2001) to ensure that this deemed disposal does not apply in the case of CFCs who cease to be resident by virtue of their disposal to a non-resident.

(c) We are very disappointed to see that the relief measure proposed in the previous draft changes (in Batch 3) has been so severely curtailed through the inclusion of a connected person' test.

The relief offered by paragraph 12(5) could permit many insolvent or dormant companies to liquidate thus reducing administrative burden on taxpayers and SARS alike.

By limiting the relief to waivers of debt between connected parties only a large portion of the benefits otherwise obtainable will be foregone.

The detail in the explanatory memorandum is that published with the draft legislation when it was opened for public comment as Batch 3" However no detail is given for the restriction to current connected party' limitation.

Clause 89: Amendment of paragraph 64B of Eighth Schedule to Act 58 of 1962

(a) It is unclear why the extension of the relief to deemed disposals, as was contemplated in the previous draft, released for public comment as Batch 3, has now been removed. This should be reinstated to cover scenarios such as those envisaged in paragraph 12(2).

We are concerned that the deeming of market value consideration paid by connected parties to be non-market related is taking anti-avoidance measures too far.

ANOMALIES ARISING IN THE INTERACTION BETWEEN SECTION 8C AND CGT

We would like to bring to your attention some problematic aspects of the interaction between section 8C and the Eighth Schedule. The example below illustrates that certain situations, which the legislature ostensibly wishes to relieve from tax, may lead to an unintended (or at least larger than intended) CGT liability. The example concerns a typical employee share incentive scheme where an employee forfeits scheme shares as a result of leaving employment.

Example

A company ("C") issues 10 ordinary shares to a trust ("T") at a subscription price of R1 each (being par value) when the market value of the shares is R5.

Immediately afterwards T vests" the shares (as contemplated in para 11(1)(d)) in C's 10 employees ("the employees"). The employees do not pay any consideration for the shares. The shares are subject to various restrictions and constitute restricted equity instruments" in the hands of the employees for section SC purposes for a period of, say, 10 years.

Two years later one of the employees ("E") resigns from C's employment. The shares are now worth R20 each. The trust deed provides for T to repurchase E's share for R0 (alternatively, E simply forfeits his share).

Analysis

1. You can assume that both C and E will be beneficiaries of T. C, E and T will therefore all be connected persons in relation to each other, so that paragraph 38 may become relevant. The vesting by T of the shares to the employees is a CGT disposal by T - para 11(1)(d). Any gain made by T would be passed on to the employees - para 80(1). However, the exemption contained in para 38(2), in its current format and also its amended version as envisaged in clause 82, would arguably apply to this disposal. The para 11(1)(d) vesting" of the shares should therefore not lead to any CGT exposure for either T or the employees, since T's proceeds will be the actual proceeds of zero, not the market value of the shares (R5).

Section 8C analysis of repurchase

2 The repurchase amount (nil) does not exceed the consideration paid by E (nil) and is also less than the market value at resignation (R20). Section 8C(5)(c) should therefore apply, both as currently worded and as per its suggested amendment by clause 14(1)(f). Under section 8C(2)(a)(i), E would therefore have a section 8C gain of zero (consideration received of zero less consideration paid of zero).

3 The next question is whether the sale of the share to T makes it vest" for section 8C purposes and, if so, when. The exclusion from section 8C(3)(b) literally seems to cover not only cases falling under the main anti-avoidance rule in section 8C(5)(a) or (b), but also cases falling under section 8C(5)(c).

4 It nevertheless appears that the intent was for the section SC "vesting" of a share that is disposed of as contemplated in section SC(5)(c) to be governed by section SC(3)(b)(ii). Assuming this is correct, the share would "vest" in E for section SC purposes immediately before E disposes of the share to T.

CG T analysis of repurchase

5. The sale of the share to T will be a CGT disposal: Para 11(2) (j) could not be relied on, to argue that the sale of the share was not a disposal, since the share would already have vested, i.e. immediately prior to the lime of disposal (see above). In terms of para 38(1), the proceeds in respect of the disposal by E to T would be the market value (R20). Para 35(2)(d) would not apply, particularly given its new wording ... to an employee" (clause 52).

6. E would furthermore apparently not be able to rely on para 20(1)(h) for an uplift in base cost to R20. Where (as in the example) section 8C(5)(c) applies, no market value of the equity instrument would ever have been taken into account in determining E's section 8C gain. E's section 8C gain (zero, in the example) has been determined with reference to consideration received (zero), not the market value at date of "vesting" for section 8C purposes (R20). E as a connected person in relation to T would therefore be subject to CGT on the market value of the share on repurchase (R20).

7. Even if E received not nil but, say, R10 as consideration for the share, E would still incur a CGT liability. E would, in terms of clause 14(1)(f), be taxed on income account on R10 (the repurchase amount of R10 less the consideration given by E, i.e. zero -section 8C(5)(c)). However, para 20(i)(h) would still not provide any uplift in base cost, as E would not have taken the market value of the share into account in determining his section 8C gain. Given the suggested changes to para 20(3) (see clause 79), E would not even be able to claim any original consideration paid for the share (which in the example is zero anyway) as part of base cost. The result is that E would have no base cost. Since E's proceeds are R20 (see above) he would therefore pay CGT on an extra R20. E might be able to argue that included in the proceeds of R20 is an amount of R10 which has already been included in his income under section 8C. However, he would still have to pay CGT on the difference of R10.

Summary of the issue

8 The aim with section 8C(5)(c) was ostensibly to ensure that an employee is not burdened with a tax liability resulting from the repurchase (or forfeiture) of his shares in these circumstances. But the example shows that E would on a strict interpretation incur a CGT liability, immediately after the section 8C vesting of the shares, on the full market value of the shares (R20), without the benefit of any uplift in base cost or indeed any base cost at all.

9 We assume that the legislature did not intend this CGT burden. In the example, E properly escapes income tax under section SC by virtue of falling within section 8C(5)(c). It could presumably not have been the intent that E would nevertheless pay CGT on the full R20 as a result of the very same transaction with T. This is so particularly because E not only never made any economic gain, but in terms of the scheme restrictions actually could also not have done so - i.e. E could not have sold to any third party. In these circumstances any tax at all would mean hardship for E.

Proposed solution

10 We therefore suggest that para 20(1)(h)(i) be amended as follows (although further changes to e.g. paragraph 38(2) might to a degree achieve the same result):

By deleting the reference to the market value that was taken into account' in determining the taxpayer's section SC gain or loss;

By, depending on the intent, providing for an uplift in base cost as follows:

If the legislature intended for E not to pay any CGT in the circumstances (which we think is likely), in the case of (i)a marketable security or an equity instrument, the acquisition or vesting, as the case may be, of which resulted in the determination of any gain or loss to be included in or deducted from any person's income in terms of section SA or SC, the market value of that marketable security or equity instrument at the time of such acquisition or vesting, as the case may be [that was taken into account in determining the amount of that gain or loss] (including where the gain and loss so determined was nil);"; or

If the legislature intended for E to pay CGT only to the extent to which the market value at the time of sale to T exceeds the consideration payable by I to E,

in the case of (i) a marketable security or an equity instrument, the acquisition or vesting, as the case may be, of which resulted in the determination of any gain or loss to be included in or deducted from any person's income in terms of section SA or 8C, the market value of that marketable security or equity instrument (or that gain or loss must be calculated in terms of respectively section 8C(2)(a)(i), or 8C(2)(b)(i) the amount received or accrued in respect of the relevant disposal that was taken into account in determining the amount of that gain or loss (including where the gain and loss so determined was nil);"