6 March 2006

Mr N Nene
Chairman: Portfolio Committee on Finance
Parliament
P O Box 15
CAPE TOWN
8000

BY E-MAIL: [email protected]

Dear Sir


2006 BUDGET SPEECH


We refer to the Minister of Finance’s 2006 Budget Speech, delivered to the nation on 15 February 2006 and thank you for the opportunity to make this submission to your Committee.

Set out below, please find comments from SAICA on the 2006 Budget Speech.

Introduction

The South African Institute of Chartered Accountants (SAICA) is the pre-eminent accountancy body in South Africa, with more than 23 000 members who are Chartered Accountants. One third of our members are practising accountants in South Africa and 48% are either business-owners or are employed in the business sector, many in key leadership positions. The designation is widely associated with people that have considerable expertise in the theory and practice of accountancy in its broadest context. This submission has been compiled with input from our National Tax Committee, which is made up of 14 of South Africa’s most respected tax experts.

Personal income tax

The revised tax tables will result in tax reductions across all income levels in the 2007 tax year, ranging from R900 to R9 900 for the year.

It should be noted, however that the tax reduction for persons under 65 years of age, particularly at the higher income levels, will be offset by the additional tax payable as a result of –

the new tax regime for medical scheme contributions;
the increase (from 50% to 60%) in the portion of travel allowances that are subject to PAYE and the increase in deemed private mileage from 16 000 to 18 000 kilometers; and
the increase in the taxable value of company cars from 1,8% to 2,5% of determined value.

In some cases the increased tax will be greater as a result of the above than the tax reduction granted through fiscal drag.

Reduction of tax allowances available to employees

The move over the last few years to reduce the number of tax deductions available for employees has contributed to the overruns in revenue collections by SARS. These overruns have in turn been used to reduce the overall tax burden on employees. It is, however concerning that the reduction in taxes has led more to consumption spending than to savings and investment.

In light of the above, consideration should perhaps be given to introducing tax allowances that encourage capital formation and savings. Such allowances could include:

Deductions for interest on mortgage bonds below a certain level (e.g. housing below R300 000) for a first property that will be occupied by the taxpayer as his or her primary residence.
Deductions for the transaction costs for property acquisition (conveyancing fees, mortgage bond registration, legal fees, etc.) up to a certain limit instead of being added to the base cost for CGT purposes. This would assist in lowering the barriers to capital formation and access to housing.
An increase in deductions allowed for contributions to pension and retirement funds.

Company tax

It is believed that the single most important matter affecting companies was the abolition of RSC levies. As a quid pro quo for there not being any corporate or STC tax rate reductions, this relief is most welcome, but it would be seen as an extremely retrogressive step if an alternative tax is to be introduced in future years, as mooted in the recent National Treasury document. We strongly urge that the abolition be made permanent as the abolition of a form of tax would assist in simplifying our taxation system.

Revision of STC

The comment made in the Budget relates to the dividend cycle and penalties for non disclosure. The definitions of a "dividend" and a "dividend cycle" in the Income Tax Act differ greatly from the accounting concepts thereof, particularly with reference to the deeming provisions of section 64C, which is an anti-avoidance provision. To now introduce a penalty in addition to the deeming provisions would be unfair.

Tax on retirement funds

The significant reduction in the tax rate applicable to retirement funds will assist in preserving the retirement capital of individuals. There remains the argument, however that the rate of 9% is still excessive for lower-income earners who, as contributors to these funds, are subject to 9% tax on a portion of their retirement savings in spite of the fact that their earnings fall below the tax threshold.

It is hoped that the long-awaited discussion paper on a new tax regime for the retirement industry will be released soon so that the process of overhauling the current tax system can be expedited.

We look forward to the final abolition of this tax which is clearly a form of double tax and affects mostly those who have no choice but to belong to pension, provident and retirement funds. The more affluent section of the population may choose other forms of retirement savings e.g. equity, property, etc and thereby avoid this form of double tax.

Reduction of transfer duties

The above reduction will provide welcome relief for home buyers. We refer, however to our comment under 2. above regarding costs of home ownership.

Amnesty granted to small businesses

The tax amnesty granted for small business should encourage many small businesses to transition from the informal to the formal economy, with a resultant reduction in the tax gap. We are, however, concerned with the following:

The turnover cut-off is R5million. In our view, this threshold should have been coupled with an asset-based amount as some business are more turnover driven but with very low margins, that is, it is very easy for some business to reach a turnover of R5million but with little profit generation.

The exclusion of businesses that are under investigation by SARS is unnecessary. Perhaps a higher penalty for these businesses would have been more appropriate instead of outright exclusion if the intention is to encourage compliance.

The choice of basing the penalty on the 2005 income should be compared to charging a penalty based on the value of assets accumulated by the business, as was the case with the Exchange Control amnesty. Taking into account only the most recent year’s taxable income could be misleading in relation to the overall performance of the business in the previous years. Consideration must be given to ensuring that any tax losses in prior years are taken into account. Charging penalties where no tax would normally have been payable in prior years due to tax losses, will act as a deterrent. This obviously does not apply to taxes other than income tax.

Another concern that must be addressed in the amnesty legislation is the implications in terms of the Financial Intelligence Centre Act (FICA). Since tax offences are reportable in terms of section 29(1)(b)(iv) of FICA, any client coming forward and disclosing any irregularities in the course of applying for amnesty will have to be reported.  We suggest that a specific exemption from the FICA be granted.

Finally, it should be ensured that sufficient time is allowed from the date when the legislation is finally promulgated, for affected businesses to apply for the amnesty. Care should be taken to avoid the situation that occurred with the Exchange Control Amnesty where the legislation was only finalized some months into the duration of the amnesty.

Self assessment

The move towards a self-assessment system will, in the long-term, facilitate more efficient tax administration. There are, however concerns that few taxpayers are ready for this development and extensive adjustments will have to be made to business systems to facilitate the process. The proposed system of disclosure requirements and penalties would effectively require accountants / tax practitioners to do an "audit" of every client, even where such an audit may not be a statutory requirement (for example a close corporation), which will add to the compliance costs of businesses.

The advance tax ruling system will have to be fully operational before the process of self-assessment commences to ensure that taxpayers have certainty on the tax implications of all their transactions. In this regard the various exclusions for the granting of rulings should be eliminated as soon as possible prior to the introduction of self-assessment as it would be grossly unfair for taxpayers to be penalized without the option of having SARS, as the tax administrator, informing the taxpayer of the interpretation of the law and its practice.

The eFiling of tax returns will greatly assist and should be implemented as soon as possible for all taxpayers. However, we caution that this should not be made mandatory as not every person or business has access to the internet. We also raise some concern on the constitutionality of making eFiling mandatory.

SMME development

One of the key objectives highlighted in the 2006 Budget is the development of the small business sector. The various incentives introduced in recent years, and the enhancements announced in the 2006 Budget, being the raising of the turnover threshold and the revision of the tax tables for small business corporations, are welcomed. It is unfortunate, however that the current legislation prevents many small businesses from accessing the tax relief offered. We are encouraged to see that the definitions of "small business corporation" and "deemed employee" are to be reviewed and we hope that this review will remove the legislative barriers and enable more small businesses to access this relief.

It is important that the review of "deemed employee" considers the current definition of "personal service company" and the definition of "remuneration" in relation to independent contractors and, in particular, SARS’ interpretation of "regular payments" in both contexts, as the present application of this interpretation is leading to absurd results and is a serious impediment to the development of small businesses.

Since job creation is key, the deemed employee definition should look towards including a part-time employee if it is the sole job of that part-time employee.

The requirement in the definition of a "small business corporation" that a shareholder may not hold any other unlisted share, even for one day, should be amended to cater for the circumstance in which a person held a JSE listed share and that company, for whatever reason, delisted. There should be a window period say, 60 days within which to dispose of the share, since in many instances SBC shareholder are not even aware that the shares they held were delisted. The exclusion could, in the alternative, be where such private company was previously listed.

It is noted in the Budget that cooperatives operating like small businesses will be allowed to access the same benefits enjoyed by small business corporations. It is hoped that the necessary amendments will also be made so that sole traders and small partnerships can access these benefits.

Inoperative section of the Income Tax Act (section 37G)

This section was introduced into the Income Tax Act in 1995 to assist natural persons that carry on business as sole proprietors or in partnerships, with a view to simplifying their compliance obligations and granting them some concessions. Whilst section 12E dealing with small businesses operating through corporate entities was introduced in 2001, no concessions have been made to date to assist those persons who are carrying on small business as sole proprietors or in partnerships. If there is no intention to issue regulations in terms of section 37G, we suggest that the section be removed from the statute books.

We are, however strongly of the view that some concessions need to be made for natural persons carrying on business other than through corporate entities.

Small business thresholds

There is a discrepancy between the VAT Act and the Income Tax Act with regard to the threshold for a "small business".

In the VAT Act, category "F" vendors that qualify for four-monthly tax periods are those vendors whose taxable supplies do not exceed R1 million in a 12 month period. However, "small businesses" is defined in the Income Tax Act as those businesses whose turnover does not exceed R6million (to be increased to R14million).

We recommend that SARS address the lack of consistency in the understanding of "small business" in the VAT and Income Tax Acts.

Access to finance

It is generally acknowledged that the main challenge for emerging businesses is raising initial capital. The institutions established by Government to assist with funding e.g. IDC, Khula, Business Partners, etc., cannot on their own raise enough capital to fund all new SMMEs. With lower costs of capital and not being driven by the profit motive, these institutions should be able to afford to fund more SMMEs without the risk of failure. In practice, however the Government institutions appear to be more risk averse than private sector banks.

In order to make more finance available to the SMME market, tax incentives should be considered for the venture capital industry, especially those institutions that invest in high-risk industries with long payback period. These incentives could be recouped in later years when profit are realised. Capital losses incurred could also be offset against future taxable income of the sponsored businesses.

Learnership allowances

We welcome the extension of the learnership allowances for a further period of five years and the generous increase in the monetary value of the allowances. These allowances have proven to be an important stimulus to skills development since their inception five years ago.

The introduction of an additional allowance for the employment of disabled learners will provide an important incentive to increasing skills levels in this area.

Employee housing

It is not clear whether the proposed amendment refers to section 11(t) or 13ter of the Act. In our view, both allowances should be retained to encourage the private sector to assist with the provision of housing. It is unfair to only allow farmers and mines to enjoy this deduction and we recommend that other businesses should not be excluded.

Denial of double deductions

It is hoped that any amendment will only deal with what is highlighted in the Budget. In our view, the current wording of the provision does not cater for the interpretation that is being targeted, that is, that a double deduction can be claimed if the deductions occur in different years of assessment.

Review of revenue vs capital

In the course of reviewing the "safe-haven" provisions in section 9B we request that consideration be given to extending the scope of the provision to both listed and unlisted shares, if not to all assets.

Capital gains tax implementation date issues

We commend the proposed review of problems arising around the 1 October 2001 implementation date for calculating capital gains and losses.

One particular problem that we would like to see addressed, and which we have raised before, is the STC exemption contained in section 64B(5)(c)(ii) of the Income Tax Act, which relies on a CGT valuation at 1 October 2001 ("valuation date") in order for the exemption to apply. When this particular sub-paragraph was amended in 2003, inserting the reference to "…the market value of that asset as contemplated in paragraph 29 of the Eighth Schedule", it was not clarified that a company would lose the STC exemption on pre-1 October 2001 capital profits if it did not obtain a CGT valuation of its assets by 30 September 2004. Many taxpayers did not have their assets valued at 1 October 2001 for CGT purposes as they were under the impression that they had three alternatives for determining the valuation date value of their assets (market value, time apportionment base cost (TABC) or 20% of proceeds) and did not consider the determination of market value to be obligatory. The effect of the 2003 amendment is that it makes the valuation of assets compulsory whereas the legislature did not intend to make the performing of valuations compulsory but optional for taxpayers (refer paragraphs 26 and 27 of the Eighth Schedule).

The lack of clarification that, in fact, a market value determination was essential to access the section 64B(5)(c)(ii) exemption, is causing substantial additional and unforeseen STC liabilities on the liquidation, winding up or deregistration of companies and close corporations. Companies that used TABC to determine the valuation date value of their assets are then subject to STC on the whole capital profit distributed as a liquidation dividend, and not just on the capital profit arising after 1 October 2001. The argument that there is no difference in treatment at the end of the day because shareholders that faced a higher STC liability will be compensated as they can claim a capital loss on liquidation of the company is flawed. In reality many shareholders will not be able to claim the capital loss (due to the provisions of paragraphs 26 and 27, and particularly paragraph 26(3) of the Eighth Schedule) or the taxpayer will have a much lower capital loss as a result of using the time-apportionment method. In very many, if not the vast majority, of cases where this is an issue for private companies, the cost of the shares to the shareholder could be the par value, e.g. a new business or a new property-holding company has been formed. But even if a capital loss is claimable, it might take many years before that loss can be offset against a capital profit, whereas the STC at the company level is payable immediately.

We suggest that the section 64B(5)(c)(ii) exemption should refer to the pre-1 October 2001 capital profit as determined in terms of the Eighth Schedule, whether market value or TABC is used.

Another problem arising from the 1 October 2001 implementation date of CGT is the denial of the use of market value as the valuation date value of an asset where a taxpayer did not submit a formal valuation of assets in the first tax return submitted after 30 September 2004. Paragraph 29(5) of the Eighth Schedule provides that a taxpayer may only adopt the market value as the valuation date value of –

intangible assets with a market value exceeding R1million;
unlisted shares if the market value of all the shares held by that person in a particular company exceed R10million; or
other assets with a market value exceeding R10million

if he/she had furnished proof of valuation of the asset with the first tax returns submitted after 30 September 2004. It transpires that a number of taxpayers that had their assets valued, erroneously or through omission, did not submit those valuations with the first tax returns submitted after 30 September 2004 and they now wish to rectify the situation. Unfortunately, however paragraph 29 does not grant the Commissioner any discretion and these taxpayers are therefore denied the use of market value as the valuation date value of the assets, merely as a result of an administration oversight. We would suggest that paragraph 29 be amended to grant the Commissioner the discretion to allow the use of market value in certain circumstances where the taxpayer can prove that the valuation was completed on or before 30 September 2004.

Incentives granted for land and building ownership

Government’s main response to the frustrations experienced with the land re-distribution process has been to increase allocations for acquisition of land. It is suggested that National Treasury should consider implementing tax incentives for land and buildings acquired for business purposes other than farming or manufacturing process. The practice of providing depreciation allowances only to buildings that are used in the process of manufacture is probably outdated and does not take account of the new "knowledge driven economy" that is not necessarily driven by manufacturing.

Other sectors of the economy which also contribute to employment and growth of our country and which require buildings to carry on their business should not be prejudiced, for example service related businesses which use buildings as workshops, retail business which use building as warehouses, etc.

Research and development

The proposed increases in the allowances for research and development expenditure are welcomed, as is the proposed review of the definition of "research and development" for this purpose as the current definition is unnecessarily restrictive.

Company formations, share-for-share acquisitions and other company restructuring provisions

Although no specific mention is made of BEE transactions in the 2006 Budget, it is noted that various provisions in Part III of the Income Tax Act are to be reviewed. It is important that any amendments should facilitate both conventional restructuring, as well as BEE transactions. Although some improvements have been made, more needs to be done to remove the tax impediments that result in substantial additional costs in BEE transactions. With the recent introduction of Codes of Good Practice for BEE, now would be an opportune moment to complement these codes with a clear package of tax provisions to assist in transforming our economy

Review of bursaries

The intention to review the whole bursaries and scholarships regime is welcomed. It is, however concerning that this review will only be effective from March 2007 and no adjustment to the monetary amount of the exemption is envisaged this year. Consideration should be given to increasing the exemption as the current limit of R2 000 falls far short of the cost of tertiary education.


Contributions for income protection insurance premiums

There is an anomaly in the treatment of contributions by private individuals to income protections plans provided by the private sector. While premiums paid for income protection insurance are allowed as a deduction against taxable income, contributions to the UIF are not. Highly employable personnel and professionals obtain little or no benefit from their contributions to UIF as these individuals are seldom without employment and can be easily re-employed in the event that they lose their jobs. It is perhaps opportune to consider allowing a tax deduction for UIF contributions. We cannot see any need to differentiate UIF from other forms of income protection insurance for the purposes of allowing premiums as a tax deduction.

Furthermore, the requirement for directors of private companies to contribute to UIF should be amended.

Reportable arrangements

It is important, particularly in light of the proposed amendments to section 103 of the Act, that the provisions dealing with reportable arrangements are suitably amended to enable SARS to obtain the information they believe they should obtain from taxpayers. We prefer this section being improved, if necessary, as opposed to an over-reaching section 103.

Proposed amendments to the Value-Added Tax Act ("VAT Act")

Credits for excess consideration

It is mentioned that consideration will be given to clarifying the imposition of VAT on amounts received in excess of invoice value. As VAT is levied on the value of a supply, the conditions and nature of the excess must be examined before VAT can be levied. If VAT is imposed on the recipient of the excess amount, the payer should be entitled to claim an immediate input tax credit. Likewise, when an amount is refunded, the recipient of the refund should be required to raise output tax. Consideration should be given to the unintended consequence that this approach can have which could, in certain circumstances, be tantamount to the imposition of VAT on loan capital.

Documentary evidence for zero rated exports

It is stated that the Commissioner will be allowed to prescribe the documentary proof required for zero-rating to apply. Where the exports are registrable goods a copy of the registration certificate in the foreign country should suffice as proof of export. The power of the commissioner to prescribe documentary proof should be subject to objection and appeal.

Additional assessments

An amendment to allow the raising of more than one additional assessment should not be retrospective. Furthermore, the decision to issue a second or subsequent assessment should be subject to objection and appeal, particularly where there was no change in material facts as per the first additional assessment.

Customs and Excise Act: General duties and powers

Foreign customs administrators should not be allowed to administer any aspect of SARS’ operations. Their assistance should be restricted to information sharing only. The scope of these mutual assistance programmes, once finalised, should be made available to the general public for comment and neither citizen rights nor the sovereignty of the country should be infringed upon.

Monetary limits in the legislation

We attach a list of monetary limits in the Income Tax Act and Value-Added Tax Act. It was announced in the 2006 Budget speech that some of the monetary amounts will be adjusted. As is indicated on the list, however, many of these monetary limits, in addition to those identified for review, have remained unchanged for many years and are in need of updating. We suggest that there should be a legislative obligation on National Treasury to formally review all of the monetary limits on an annual basis, taking into account annual inflation and other relevant economic factors.

Income tax

We would recommend that SARS apply an inflationary rate increase to monetary limits which have not been updated in the last 3 years. In this regard, particular attention would need to be given to limits in respect of retirement tax, as it is recognised that this area of tax has been under review for some time now but the lack of reform to date should not be an excuse for leaving taxpayers with limits which are very old. Some of the limits have not been updated since 1980.

Another limit that should be updated is the SITE limit of R60 000 (in the Fourth Schedule to the Income Tax Act) which brings a large number of salary-only taxpayers into the formal assessment process of SARS. This increases the administrative burden on SARS and also increases the compliance obligation on taxpayers for no additional tax.

It was announced in the 2006 Budget that the following monetary limits in respect of capital gains tax (CGT) would be revised:

The annual capital gain/loss exclusion will increase from R10 000 to R12 500;
The primary residence exclusion will increase from R1million to R1,5million; and
The exclusion on death will increase from R50 000 to R60 000.

Whilst these increases are welcome, consideration should be given to the fact that during the past four years, property prices have increased by more than 100% in some areas. Accordingly, the proposed increases to these monetary limits do not appear adequate.

We suggest that the increases in property prices should be taken into account in updating these limits.

Value-Added Tax

Again, we would recommend that an inflationary rate increase be applied to monetary limits which have not been updated in the last 3 years, with the exception of section 66(b) (the rounding off limit of 1 cent).


We shall be glad to provide further information or assistance in connection with any matter raised above either to yourselves, National Treasury or SARS.

Please do not hesitate to contact us should you require further information.


Yours faithfully


J Arendse N Nalliah
PROJECT DIRECTOR: TAX CHAIRMAN: NATIONAL TAX COMMITTEE
The South African Institute of Chartered Accountants

Encl.

cc. Mr J de la Rey – SARS ([email protected])
Ms P Malumane – National Treasury ([email protected])

APPENDIX 1

MONETARY LIMITS IN FISCAL LEGISLATION

INCOME TAX ACT NO. 58 OF 1962