SOUTH AFRICAN COUNCIL OF CHURCHES
DRAFT REVENUE LAWS AMENDMENT
BILL, 2006 (BATCHES 1 & 2)
16 OCTOBER 2006
1. The
South African Council of Churches (SACC) is the facilitating body for a
fellowship of 23 Christian churches, together with one observer-member and
associated para-church organisations.
Founded in 1968, the SACC includes among its members Protestant,
Catholic, African Independent, and Pentecostal churches with a combined
constituency of roughly 15 million adherents. SACC members are committed to
expressing jointly, through proclamation and programmes, the united witness of
the church in South Africa, especially in matters of national debate.
2. Our
submission is informed by discussions with SACC member denominations and other
faith communities through the Religious Tax Policy Working Group, which the
SACC has convened for the past six years.
In addition, we have benefited from regular interactions with secular
organisations concerned about the legal and tax environment for non-profit
organisations, including the Non-Profit Consortium, the Legal Resources Centre
and the Charities Aid Foundation.
Key Areas of Concern
3. The
draft Revenue Laws Amendment Bill (RLAB) and the supplemental amendments issued
on 12 October propose amendments to the Income Tax Act, 1962 (hereafter the
“ITA”) and related revenue laws contain clauses that affect seven aspects of
tax law relevant to Public Benefit Organisations (PBOs). They would:
·
Alter the tax rates for PBO trading
activities;
·
Effect technical amendments to
Eighth Schedule provisions governing Capital Gains Tax;
·
Add new public benefit activities to
Parts I and II of the Ninth Schedule of the ITA;
·
Extend PBO treatment to most local
branches of foreign charities;
·
Relax the rules for permissible PBO
investments;
·
Abolish the NPO registration
requirement for PBOs; and
·
Regulate the duty payable on goods
imported for the 2010 FIFA World Cup and subsequently donated to a PBO.
Tax rates for PBO trading
4. When
the new tax system for PBOs was introduced in 2001, PBOs were only allowed to
engage in a very limited range of trading activities without jeopardising their
exempt status. PBOs with substantial
trading activities were advised to place these under the control of a separate,
taxable entity.
5. Upon
reflection, revenue officials agreed with the sector’s objections that these
limits were too restrictive and the penalties for breaching them too
harsh. As a result, subsequent revenue
law amendments relaxed the limits slightly and, more importantly, allowed PBOs
to retain trading activities without putting their exempt status at risk. The trade-off was that PBOs would be required
to pay taxes on most of the income received from trading that was not otherwise
exempt. The rate imposed on income from trading depended on the PBO’s
organisational form: Section 21 companies and associations of persons attracted
the company tax rate of 29%, while trusts attracted the higher trusts rate of
40%.
6. Revenue
officials now argue that this differential rate imposes an unfair burden on
trusts. They propose to equalise the tax
rate at 34%. The explanatory memorandum
justifies this rate on the grounds that it is aligned with the branch profits
rate of foreign companies, which combines income tax and Secondary Tax on
Companies. It is also claimed that the
34% rate “puts PBO trading activities on par with operations conducted by PBO
subsidiaries (all of which would be subject to both a combined income tax and
Secondary Tax on Companies)”.
7. Essentially,
revenue officials seem to be trying to reconcile two sets of tax rates. First, they are trying to equalize the tax
rate imposed on all PBO trading income, regardless of the PBO’s legal
form. Secondly, they are trying to
equalize the nominal rate of tax attracted by PBO trading activities with the
effective tax rate on companies.
8. We
support the first of these objectives, but have reservations about the
second. We agree that trusts should not
bear a disproportionate tax burden.
However, we fail to see why domestic PBOs should be treated like
branches of foreign companies, we question the assertion that PBO subsidiaries
would necessarily be liable for secondary tax on companies, and we have grave
doubts about the policy rationale underlying the entire effort to equalize PBO
and corporate taxes.
9. Our
understanding is that unlike income tax, which is payable on all company
profits, secondary tax is payable only on profits distributed to shareholders
in the form of dividends. Thus, the
effective tax rate experienced by companies (income tax + STC) would depend to
some extent on what proportion of profits a company decided to distribute. Even if we accept that 34% is an accurate
average, we do not believe that a PBO subsidiary would necessarily attract STC
if it donated its post-tax profits to its PBO arm, rather than distributing
them as dividends to shareholders.
10. We
suspect that the real motivation for selecting the 34% tax rate is
twofold. First, it represents an attempt
to prevent a potential loss to the fiscus as a result of lowering the rate of
tax on trusts. Secondly, it is yet
another manifestation of revenue officials’ overzealous attempts to ensure that
PBOs do not enjoy any “unfair” advantage in trading over profit-making
enterprises. We continue to believe that
this is a straw man. First, we believe
that the majority of PBO trading activities do not directly compete with those
of profit-making enterprises. Even where
they do, there is little evidence that they undersell or otherwise crowd out
for-profit trade. More importantly, the
whole point of developing a separate tax regime for PBOs is to encourage them
and their activities by giving them a privileged position relative to
for-profit enterprises. Efforts to
“level the playing field” with for-profits therefore undermine the public
policy objectives that gave rise to the PBO tax system in the first place.
11. Consequently,
we believe that Section 140 should be changed to make the rate of tax on all
PBOs and recreational clubs 29 per cent, rather than 34 per cent.
Capital Gains Tax
12. Sections
55 and 56 of the RLAB would reorganise provisions inserted in the Eighth
Schedule of the ITA at the end of 2005.
They are essentially clarifying amendments that do not signifiicantly
alter the impact of these clauses.
However, rereading these sections in conjunction with Draft
Interpretation Note 24 (Issue 2), released by SARS in July 2006, has
highlighted several concerns about the potential impact of these provisions.
13. At
first blush, the principle underlying these provisions – that PBOs should not
be exempt from capital gains tax (CGT) on assets not directly used for public
benefit activities – seems fair and consistent with the logic of the ITA. Indeed, we accepted it as such in our October
2005 submission on last year’s RLAB, but raised concerns about how this would
be applied to assets used for more than one purpose. Further reflection on the practical
applications of these provisions has confirmed and extended our earlier
reservations.
14. First,
if CGT will be assessed on all assets
not directly deployed in connection with public benefit activities, this would
mean that PBOs would effectively be penalised for investing surplus funds in
securities or any financial instrument.
This would be a particular problem for PBOs engaged in the provision of
funds and resources to other PBOs.
Presumably their activities will be supported by a significant endowment
which is likely to be invested in shares and other assets. Taxing the returns on this investment will
undermine their capacity to finance public beneifit activities and tend to
frustrate the very objectives that the PBO tax regime was established to
promote.
15. Even
if the assessment of CGT is limited to real assets (and the law is further
amended to clarify this), there would still be practical problems with the
assessment of CGT on assets that have a hybrid use or that undergo a change of
use.
16. With
respect to hybrid use, the Eighth Schedule of the ITA currently requires
“substantially the whole of the use” of an asset to be for public benefit
activities if it is to be exempt from CGT on its disposal. Draft Interpretation Note No. 24 explains
that SARS interprets “substantially the whole” to mean 85% or more. This “all
or nothing” approach is problematic. Suppose a PBO acquires a structure to
accommodate certain public benefit activities. It later realizes that this
structure can also be a community resource and decides to let others use it
when it is not required for the PBO’s work. It lets out the premises at a
nominal fee to community groups (some of whom pursue PBAs, either as recognized
PBOs or not) and occasionally at slightly higher rates to business
clients. On the whole, its income is
primarily related to cost recovery and its “profits” (which, of course, help to
underwrite its other PBAs) remain sufficiently low that they do not attract
tax, even under the partial taxation provisions. However, it is a popular venue – in part
because of the nominal fees – and so it is used virtually to full capacity,
such that the owning PBO is only using it 50% of the time. In this scenario, the PBO attracts full CGT
on the disposal of the asset. In effect,
they are being penalized for being good stewards of this resource, ensuring
that it is fully utilized and making it available at sub-market rates to
community groups. Had they just let it
stand empty when they were not using it or had they charged higher rates, they
would have been better off. Would it not
be fairer to pro-rate the CGT payable, such that the PBO would only be liable
for 50%? Of course, this would require
the PBO to maintain records of usage to support their claim, but presumably
such evidence would be required to support an 85% claim, anyway.
17. Another
example of hybrid use might be a manse owned by a worshipping congregation. It
owns the property for 35 years. For 7 of
those years, the congregation has a pastor that has her own home and does not
wish to use the manse. The congregation
therefore decides to rent out the manse at market prices and use the bulk of
the income to finance a housing allowance for the pastor. On a straight time calculation, the property
was only used by the church as a manse for 80% of the 35-year period, so it
would attract full CGT on disposal. This
also seems unfair.
18. The
third area of concern involves change of use. Suppose a PBO has an asset that
it has used primarily (85%+) for public benefit activities for four years. It is valued on 1 January 2007. In February 2008, it decides it no longer
needs the property for its work and puts it on the market. Due to characteristics of the property or the
market, they cannot find a buyer until June 2009, and the transfer process is
not finalized until Jan 2010. In an
effort to generate revenue, the PBO rents out the property at market rates from
March 2008 until July 2009. In terms of
the ITA, as amplified by Draft Interpretation Note 24, it appears that this
property would attract CGT.
19. We
would urge Parliament to consider amending the legislation to give PBOs a
two-year grace period in which to dispose of property that ceases to be uses
primarily for public benefit activities. The period should also be calculated
to the date of sale, rather than the date of transfer.
New Public Benefit Activities
20. Sections
62 of the RLAB would expand the range of housing activities eligible for PBO
status in terms of Part I of the Ninth Schedule, while sections 63 and 63 would
add these and additional conservation, environmental and animal welfare
activities to list of donor deductible activities in Part II of the Ninth
Schedule.
21. We
do not believe that these changes are likely to have significant impact on
faith-based organisations, but we support them in principle.
Local branches of foreign charities
22. Section
26 of the RLAB would amend Section 30 of the ITA to include local agencies or
branches of foreign charities in the definition of PBO, provided the parent
organisation has the equivalent of PBO status in the country in which it is
based. This change necessitates
consequent changes to a number of other sections of the ITA.
23. In
addition, the local branches of foreign PBOs would only be expected , on
dissolution, to transfer their local assets (as opposed to all of their assets)
to a similar organisation with in the Republic.
24. We
strongly support these changes.
However, section 19 of the RLAB would amend section 18A of the ITA to
limit 18A (donor deductibility) benefits to domestic PBOs. While it is understandable that SARS would
wish to deny domestic tax credit for donations deployed outside of the
Republic, it is likely that most donations to local branches of foreign
charities would be used within the Republic.
Indeed, it would make more sense to make the 18A status of any given
donation conditional on the end use of that donation (e.g., to activities occurring within the Republic and listed
in Part II of the Ninth Schedule) rather than on the national home of the
mediating agency.
Permissible investments for PBOs
25. Section
26 of the RLAB would also abolish most of the restrictions on permissible PBO
investments. The only remaining
prohibitions would be on foreign investment and on the direct or indirect
distibution of proceeds to any person.
We strongly support these changes and the additional flexibility they
afford to PBOs.
Abolition of NPO registration
requirement
26.
Section 26 would also delete Section 30(3)(g) of the ITA,
which requires a PBO to be registered with the Non-Profit Organisations
Directorate of the Department of Social Development within a period specified
by the Commissioner. We have long
campaigned for the abandonment of this requirement and are pleased that it is
finally taking place. We hope that the
Department of Finance will now urge government departments and agencies to use
PBO status, rather than NPO status, as a criterion for assessment of
eligibility to access public funds.
Duty on goods imported for the 2010 FIFA World Cup
27.
Section 11 of the Second RLAB would amend Schedule 1 of the
Value-Added Tax Act, 1991, to give effect to Government Guarantee 3, made to
FIFA. It regulates the duty payable on goods imported duty free for use or sale
during the 2010 World Cup, but then donated to a PBO. We have no objection to the principle that
reasonable duties should be paid on such items.
Conclusion
28.
The SACC thanks the Portfolio Committee for this opportunity
to comment on the RLAB. We hope that it
will be possible for the Committee to accommodate our concerns.