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.
SOUTH AFRICAN COUNCIL OF CHURCHES
Parliamentary
Office
Tel. (021) 423 4261 ◦ Fax. (021) 423 4262 ◦ E-mail. [email protected]