Revenue Laws Amendment Bills 2008

Revenue Laws Amendment Bills 2008 Portfolio Committee on Finance 19 August 2008

Taxation Laws Versus Revenue Laws Amendment Bills • Taxation Laws: • The Taxation Laws Amendment Bills cover rates, thresholds, urgent and quick matters • This year’s Bills were introduced in March and tabled in May • Key changes were made to individual marginal rates, corporate rates were reduced to 28%, and priority corporate avoidance schemes were addressed • Revenue Laws: • The Revenue Laws Amendment Bills deal with the more complex and substantive announcements made in the 2008 Budget Review • Due to their complexity, this set of Bills comes later in the year and requires more public debate

Overview of Key Issues: Individuals and Employment • Ongoing Retirement Reform: • New simplified system for pre-retirement withdrawals • Defaults switched upon job changes to preserve retirement savings • Employers and Employees: • Enhanced broad-based share incentives (amount shifted from R9 000 to R50 000 over 3 years) • Closure of executive share schemes that seek to avoid full tax on salary bonuses • Employers can deduct PBO donations from payroll to encourage monthly donations

Overview of Key Issues:Small Business • Presumptive Tax: • Businesses (sole proprietors and companies) with a turnover up to R1 million may elect into a simplified turnover tax • VAT is now elective up to R1 million (from the previous R300 000); but taxpayers using the presumptive tax may not utilise VAT • Venture Capital Companies: • Taxpayers (individuals and listed groups) receive a special deduction for investing in Venture Capital Companies • Venture Capital Companies are basically portfolio management vehicles designed to invest in small businesses (and junior mining) • This vehicle gives small businesses access to equity finance

Overview of Key Issues:Business Incentives • Industrial Policy Projects: • R20 billion allocated to DTI/NT approved industrial projects • Additional allowances for investments in upgraded plant and machinery • Housing: • Urban Development Zone incentives renewed for 5 years and enhanced rate of depreciation for new buildings • Simplified 5% depreciation regime for residential housing units • Accelerated 10% depreciation regime for low cost housing (R200 000 housing/R250 000 apartments) • 10% allowance for low-cost housing provided by emloyers to employees on loan account

Overview of Key Issues: STC Conversion to a Shareholder Tax • The new 10% dividend tax applies at a shareholder-level • Dividends paid to pension funds, PBOs and domestic companies will be exempt • Treaty relief will now exist for foreign shareholders (5%) • STC transitional credits for a 3-year period • New dividend tax base that relies solely on tax concepts • The new dividend tax will have a withholding mechanism for the tax to be paid by the company payor or an intermediary • The new dividend tax is to be effective upon completion of joint ratification of nine revised treaties (target date: latter half of 2009)

Overview of Key Issues: Indirect Taxes • VAT: • Zero rating for land reform acquisitions • Estate Duty: • Exemption for insurance and pension payouts • 5-year time limit cut-off • Electricity Levy (Law and Regulation): • 2 cents /kWh charge for electricity produced from non-renewable sources • Exemption for electricity from renewable sources

Importance of Public Consultation Process • Time for Public Comment: • Taxpayers have 1 month to comment on the Bill • Bill published on 31 July • Comments due on 29 August/5 September • 20 and 22 August: Taxpayer Hearings • Further Tentative Dates: • 09 September: NT/SARS Response • 16 September: Tabling

Income Tax Retirement Employers and Employees Individuals Small Business Business Incentives Corporate and Commercial Other Taxes Estate Duty Environmental Levy Value-added Tax Repeal of Stamp Duties Customs Tax Administration Outline of Key Amendments

RETIREMENT ISSUES Taxation of withdrawals Divorce settlements Default withdrawals Transfers from pension to provident funds

Pre-Retirement Withdrawals: Background • Pre-retirement withdrawals are taxed at the taxpayer’s highest average tax rate for the current or previous year • A small amount is tax-free (R1,800, which has not been adjusted for many years) • Formula difficult to calculate and understand

Pre-Retirement Withdrawals: Proposal(section 1 (clause 6(n), section 6 (clause 8), paragraph 7 of 2nd schedule (clause 60)) • Tax-free amount tied to 50% of the primary rebate (increased to R23,000) • Taxable amount calculated in terms of stand-alone tax table • Tax table applies to aggregate of withdrawal benefits received over the tax-payer’s life-time • Stand-alone tax table linked to individual tax tables and adjusted annually

Retirement – Divorce Settlements (paragraphs 2, 2B, 4, 6 of 2nd schedule, clauses 54, 55, 57, 59) • Background • Spousal payments from retirement funds stemming from divorce orders are taxed in hands of member • Member has right of recovery of tax from non-member spouse • System is difficult to understand, administer and execute effectively • Proposal • The non-member will pay the tax on amounts awarded to him/her from member’s retirement fund

Retirement – Default Withdrawals (paragraph 4 of 2nd schedule, clause 57) • Generally, an automatic tax event when members of occupational retirement funds’ employer terminates • This does not encourage members to preserve retirement savings until retirement • Proposed amendment will only trigger tax when member elects to receive the retirement fund interest, in cash

Retirement – Pension to Provident Fund Transfers (paragraph 2 of 2nd schedule, clause 54) • Background • A Transfer from a pension to a provident fund is a taxable event • Employee contributions to pension funds are tax-deductible but not for provident fund contributions • Reason: Pension funds must pay an annuity (2/3rds) upon retirement • Court decision treats some transfers from pension to provident funds as tax-free • Proposal • Proposed amendment aims to trigger tax on all pension to provident fund transfers

EMPLOYERS AND EMPLOYEES Repayable employee benefits Personal use of business cell-phones and computers Consolidation of deemed employee regimes Payroll giving Deductions in respect of learnerships

Repayable Employee Benefits (section 23 and par 2 of 4th schedule, clauses 31 and 62) • Background: • Employee receives taxable conditional payments (e.g. maternity payments) • Employee fails to meet conditions, amount received is repaid to employer but no tax relief for employee • Proposal: • Repaid benefit will be allowed as tax deduction for employee by way of: • PAYE refunded by employer; or • Tax deduction on tax return

Personal Use of Business Cell-Phones and Computers • Background: • Employees often receive cell-phones and laptops from employers for business use, but invariably some private use exists • At issue is how to tax the private use • Proposal: • As a matter of simplicity, cell-phone, laptops and related items are not subject to fringe benefit tax if the employer provides the equipment mainly for business use

Consolidation of Deemed Employee Regimes(sections 11, 23, paragraphs 1, 2, 11 of 4th schedule, clauses 16, 31, 61, 62, 64) • Background: • Three deemed employee regimes exist, including: Personal services companies, Personal services trusts and Labour brokers • These entities effectively perform the same type of function (artificial independent relationship treated as an employment relationship) • Proposal: • All three anti-avoidance regimes to be combined (to be called Personal Service Provider) • Should assist legitimate small businesses by reducing practice of “defensive” withholding

Donations via Payroll (section 18A & par 12 of the 4th Schedule; clauses 28 & 62) • Background: • Taxpayers can obtain a year-end deductions for PBO donations • No reduction of PAYE calculation • Proposal: • Employers can deduct donations when calculating monthly PAYE • Reduces employee income tax without waiting to year-end • Automatic procedure should facilitate PBO donations

Learnership Additional Allowances: Background • Employers receive additional allowances (i.e. deductions) for utilising learnership programs to enhance employee skills • These additional allowances are upon initiation of the learnership and successful completion • At issue are multi-year learnerships, which receive less tax benefits than a series of 1-year learnerships

Learnership Additional Allowances: Proposal (section 12H; clause 19) • To correct the current disparity in the tax allowances (deductions) for learnerships (annual contracts) vs. apprenticeships (three to five years contracts). • For longer-term (both time based and competency based modular training) apprenticeships a cumulative allowance will be paid at the end of the contract, upon successful completion. • For example annual learnership contracts qualify for a R30 000 deduction (allowance upon entering into a contract) and an additional deduction of R30 000 upon the successful completion of the learnership, i.e. R60 000 per annum, and R180 000 over three years. • Longer term apprenticeship (e.g. three years): able to deduct from taxable income R30 000 upon entering into a contract and an additional R30 000 x 5 = R150 000, at the end of the three years. • Currently such longer term contracts only qualify for deductions amounting to R30 000 at the beginning and R30 000 at the end, i.e. R60 000 instead of R180 000. • It should be noted that the total tax benefit in this example is equal to 28% x R180 000 = R50 400 in the case of incorporated businesses.

INDIVIDUALS Disability expenses Broad-based employee share schemes Executive share schemes

Disability Expenses: Background • Taxpayers with a handicap or a handicapped dependant receive deductions for all medically-related expenses (without regard to the 7.5% floor) • The term ‘handicapped person’ outdated • In addition, there is uncertainty as to the type of expenses that will be viewed as medically related

Disability Expenses: Proposal(section 18, clause 27) • Replace definition of ‘handicapped person’ with def. of ‘disabled person’ • Definition as approved by Cabinet • In addition, the condition must last longer than one year and should continue after maximum correction or control of the impairment • Assessment by duly registered medical practitioner • Types of deductible expenses listed • List to be drafted by SARS in consultation with representative bodies • List to be reviewed annually

Broad-Based Employee Share Schemes (section 8B, clause 10) • Background: • Employer grants shares to employees: • Tax-deduction for employer upon grant • No taxable fringe benefit in hands of employee • Qualifying requirements too stringent, preventing full utilisation of incentive • Proposal: • Tax-free ceiling raised to R50 000 over 5 years (previously R9 000 over 3 years) • Employee participation lowered from 90% to 80% • Permissible restrictions relaxed – employer may now re-acquire shares during restriction period at initial market value if the employee is subsequently engaged in misconduct/poor performance

Executive Share Schemes(section 8C; clause 11) • Background • Legislation exists to ensure that executive share schemes are taxed as ordinary revenue upon cash-out (like any other deferred executive bonus) • Tightened several years ago but new schemes have emerged • Proposal • Various derivatives (e.g. cash amounts determined in reference to share values held in trust) are now added • Schemes designed to indirectly acquire shares are now added (e.g. Cash bonus must be used for acquisition of shares with security required over other executive assets) • Capital distributions on share schemes will now be treated as ordinary revenue when the restricted instruments vest

SMALL BUSINESS Small business presumptive tax Venture capital company regime

Presumptive Turnover Tax (PTT): General Objectives • Policy response to alleviate the tax compliance costs for very small businesses; • Not necessarily to reduce the tax liability; • Designed as an elective turnover based tax regime, targeted at very small businesses with an annual turnover of up to R1 million per annum; • Both incorporated and unincorporated enterprises (sole proprietors) can elect into the proposed regime.

Presumptive Turnover Tax: Basic Rules (6th schedule; clause 66) • The introduction of the regime also comes with an increase in the compulsory VAT registration threshold from R300 000 to R1 million; • Businesses opting to register for the simplified PTT regime will not be allowed to register for VAT; • Qualifying businesses are exempt from STC/dividend withholding tax if dividends do not exceed R200 000; • Shareholding in multiple businesses will disqualify a person/business from registering for the PTT regime. • Upon joining the system, businesses will be required to remain in the system for at least 3 years; and • Where businesses opt out of the regime, they can’t migrate back into it for a period of 3 years.

Presumptive Turnover Tax: Rates (6th schedule; clause 66) • The proposed rates try to mirror the tax burden imposed under the standard income tax system; • Based on Stats SA data, net profit ratios of between 15 – 20 percent were used; • The rates are steep towards the higher turnover end (R750 000 - R1.0 million) in order to encourage businesses to graduate into the standard income tax system; • Implementation date: March 2009. Turnover Tax liability & Marginal Rates R0 - R100 000 0% R100 001 - R300 000 1% of each R1 above R100 000 R300 001 - R500 000 R2 000 + 3% of the amount above R300 000 R500 001 - R750 000 R8 000 + 5% of the amount above R500 000 R750 001 - R1 000 000 R20 500 + 7% of the amount above R750 000

Venture Capital Companies (VCC): Conceptual Background (section 12J; clause 21) • Objective: • A tax incentive to help address the equity financing gap faced by SMEs; • International examples, e.g. UK VCT model; • Also replaces the flow through share model proposed in Budget 2007 for junior mining exploration companies. • Venture Capital Company Requirements: • Intermediary company which pools retail investments from investors; • Will be approved by SARS; • Must comply with the provisions of the Financial Intermediaries and Advisory Services Act. • Investee enterprises: • Qualifying high growth potential companies with annual gross assets not exceeding R10 million immediately after the investment; • For junior mining exploration companies gross assets not exceeding R100 million immediately after the investment. • Investor profile: • Individual investors; and • Listed corporate investors.

Venture Capital Companies: Detailed Requirements (section 12J; clause 21) • 100% upfront deduction for investments in VCC ordinary shares: • Capped at R750 000 for individuals per annum, with a 3x (R2.25 million) life time limit (to be added to the draft legislation). Tax benefit equals 40% of R750 000 = R300 000; • No limit for listed corporations; • To protect the limit for individuals, unlisted corporations are excluded from the regime. • Minimum gross assets to qualify as a VCC: • R50 million for investments in non-mining qualifying enterprises; • R250 million for investments into qualifying junior mining exploration enterprises. • VCC qualifying investments: • At least 10% in enterprises with up to R5 million gross assets, after the investment; • At least 70% in enterprises with up to R10 million gross assets, after the investment; and • In the case of junior mining exploration companies R100 million gross assets after the investment. • SARS to consider and approve applications for VCC status. • New VCCs will be given 36 months to qualify for full VCC approval. • Over the medium term, special financial regulations for VCCs considered • Consider a sunset clause; 12 year period with compulsory review after 10 years.

Venture Capital Companies: Diagram VCC (FAIS Compliant) 100% deduction Investor: Indiv / Listed Qualifying SME 10% - R5 million Gross assets Individual – R750K deduction limit pa Listed – No limit, subject to a 10% Shareholding limit in the VCC 70% - R10 million Gross assets 20% - any asset class

Venture Capital Companies: Excluded Investee Activities (section 12J; clause 21) • List of excluded activities: • Dealing in land, property development including refurbishment, rentals, redevelopment of property and deriving profits from the disposal of land when developed; • Financial service activities such as banking, insurance, money lending, hire-purchase financing and any other financial service activities; • Provision of professional services such as legal, tax advisory, broking, management consulting, auditing, accounting and other related activities; • Operating casinos or other gambling related activities including any other games of chance; • Manufacturing, buying or selling liquor, tobacco products or arms/munitions; and • Franchising. • Rationale for excluded activities: • The aim of the intervention is to alleviate the equity gap for high risk enterprises; • The exclusion serves to better target the tax incentive; reduce deadweight loss and compliment/not replicate current government access to finance interventions; • The higher the enterprise risk, the lower the chances of obtaining venture capital and the longer the lead time for development; • The so-called lifestyle, personal services and other listed activities are of a much lower risk profile and are not suitable for venture capital funding.

BUSINESS INCENTIVES Depreciation for Residential Units Urban Development Zones Employer Sales of Low Cost Housing Amortisation of Government Business Licences Additional Allowances for Industrial Policy Projects Donations to Multi-Lateral Humanitarian Organisations Promotion of Biodiversity

Depreciation for Residential Units (sections 13sex; clauses 22, 24 & 25) • Background: • In addition to pre-existing grants, the tax system will be used to stimulate increased supply of low cost housing stock by the private sector • Current regime is fragmented and overly complicated • Proposals: • Depreciation of all new residential housing 5% per annum; low cost housing will have a 10% rate (regime replaces former 12% initial/2% regime and other select employer regimes) • Low cost housing is defined as having a cost up to R200 000 in the case of free standing houses and R250 000 in the case of apartments • The depreciation applies to all rental housing and employer-provided housing • To be depreciable, at least 5 units must be owned (to distinguish a real trade from vacation/personal arrangements)

Urban Development Zones: Accelerated Depreciation (section 13quat; clause 23) • Background: • This pre-existing incentive is designed to rejuvenate key inner cities • The incentive is set to expire in 2009 • Proposal: • The incentive will be extended by 5 years • Existing municipalities are invited to apply for possible extended areas • More enhanced depreciation allowances: • All new buildings: 20%(first year) & 8% p.a. (next 10 yrs) [existing system allows 20% (first year) & 5% p.a. (16 years)] • Low cost housing in UDZ: • New buildings: 25% (first year), 13% (next 5 yrs) 10% (7th year) • Improvements to existing buildings: 25% p.a. (in lieu of current 20% p.a.)

Employer Sales of Low Cost Housing (section 13sept; clause 25) • Background: • Some employers would prefer to sell housing to employees rather than rent • Current incentives exist only for rental • Proposal: • Employers are entitled to a special write-off when selling low cost housing to employees at no more than employer cost • A 10% yearly write off exists for employer-loan portion of the sale • Recoupment exists when principal is repaid • Applies to all parts of the economy (not just to specific sectors like the mining)

Amortisation of Government Business Licenses (new section 37D) • Background: • Businesses often require Government licenses in order to conduct certain activities (e.g. mining, casinos, telecoms etc) • Acquisition of these licenses may require an upfront cash outlay, annual fees or cash outlays towards social expenditure • The expenditure for these licenses are often not deductible under section 11(a) • Proposal: • Initial outlay to acquire a Government license will be depreciation over the life of the license • Annual fees to maintain a license will be fully deductible, even if funds a not paid directly to Government (i.e. even if used for required social expenditure)

Industrial Policy Projects: Background • The incentive seeks to support the Government’s Industrial Policy Action plan (promoted by the Department of Trade and Industry) • The focus is the manufacturing sector (with some exclusions), which has not kept pace with global trends • The proposal targets greenfield investments as well as brownfield expansions and upgrades • R20.0 billion allowable deductions over 5 years (an estimated R5.6 billion tax revenue forgone) • This incentive replaces the prior Strategic Industrial Project regime but focuses both on capital investment as well as training

Industrial Policy Projects: Minimum Requirements (section 12I; clause 20) • Greenfield projects: Investment of R200 million in new industrial assets • Upgrades and expansions / brownfields: Investments of least 25% of value of existing industrial assets subject to a minimum of R30 million. • Energy efficiency: 10% reduction in usage • Spend more than 2% of wage bill on training • Training: Detailed skills development programme

Industrial Policy Projects: Scoring Criteria (section 12I; clause 20) • Minimum of 5 points for qualifying status • Minimum of 8 points for preferred status • A sub-minimum of 2 points must be attained in the labour component (employment creation + training)

Industrial Policy Projects: Additional Allowances (section 12I; clause 20) Projects with qualifying status (5 to 7 points) • 35% investment tax allowance / deduction • maximum of R550 million per project for greenfield; • maximum of R350 million per project for upgrades or expansions / brownfield) • Actual training expenses as a tax allowance / deduction up to a maximum • R36,000 per employee, and • an overall maximum of R20 million per entity over 4 years. Projects with preferred status (8 to 10 points) • 55% investment tax allowance / deduction • maximum of R900 million per project for greenfield projects; • maximum of R550 million per project for upgrades and expansions / brownfields). • Actual training expenses as a tax allowance / deduction up to a maximum • R36,000 per employee, and • an overall maximum of R30 million per entity over 4 years.

Donations to Multilateral Humanitarian Organisations (section 18A; clause 28) • Background: • Donations to PBO are potentially deductible (especially for humanitarian causes) but only if the PBO is South African registered • Donations made by taxpayers to multilateral humanitarian organisations such as the United Nations Agencies are accordingly not tax deductible • While foreign PBOs can often obtain deductible donation status via the use of South African registered affiliates, UN agencies cannot form a South African affiliate by virtue of the UN’s unique status • Proposal: • The legislation accordingly allows UN Agencies (that enjoy diplomatic immunity status in South Africa) to qualify for tax deductible donation status

Promotion of Biodiversity: Background Background - Environmental Regulation: • The DEAT has established a regulatory framework to encourage the conservation and protection of biodiversity and priority areas by private landowners to support sustainable economic development. • The key pieces of legislation that enables this process are: National Environmental Management • Biodiversity Management Act (No 10 of 2004) (Biodiversity Areas) • Priority Areas Act (No 57 of 2003) (National Parks and Reserves) • Private landowners may enter into agreements and management plans in terms of above legislation: • Private owners surrender some level of use in the land (and improvements thereon) • Private owners are often required to make operating and capital expenditure to maintain the land Background – Tax: • Even though operating expenses may be required under these agreements, these items provide no tax relief unless part and parcel of a trade • Capital expenditures under these agreements cannot be depreciated (nor can the cost of land be deducted)

Promotion of Biodiversity: Proposal (section 37C; clause 36) • Two issues arise: • Landowners incur conservation and maintenance expenses for the greater good. • Landowner restricted from using the land for other purposes except as stipulated in the agreement. • Amendments: • Biodiversity Agreements – Conservation maintenance and rehabilitation expenses incurred by landowners within the geographical vicinity of a trade and farming will be allowed as deduction against trading of farming income (Biodiversity Agreements) • National Parks and Reserves – Loss of right to use land (outside the vicinity of a trade/farm): • Conservation maintenance and rehabilitation expenses incurred by landowners subject to 30 year declaration will qualify for a tax deductible section 18A donation • Amount of cost to landowner to acquire land plus capital expenditure incurred by landowner in respect of the land declared as a national park or nature reserve subject to a 99 year period of declaration will qualify for a tax deductible section 18A donation

CORPORATE AND COMMERCIAL STC Reforms: Conversion from STC to Dividend Tax Revised dividend definition Dividend tax withholding regime Passive Holding Companies Company Reorganisations De-grouping charge Elections and reorganisations Share Issue Anomalies Intellectual Property Arbitrage

STC Reforms: Background Current Law: • Liability falls on company distributing the dividend (as opposed to shareholder receiving the dividend) • The charge is 10% Problem Statement: • Internationally, dividends are generally taxed at shareholder (as opposed to company) level. Therefore: • SA companies are at a disadvantage to international counterparts (because profits are reduced by dividend tax) • STC generally not catered for by tax treaties (premised on a tax at shareholder level) • Unfamiliarity with STC of foreign investors • Raises costs of equity financing • February 2007: Minister of Finance announced that STC would be replaced with a new shareholder dividend tax

New Shareholder Dividend Tax(sections 64E and 64F; clause 48) • The new tax applies at the shareholder level (by the beneficial shareholder) • Applies only to dividends declared by SA resident companies • Rate: 10% • Beneficial owner will be exempt from the dividend tax if: • A South African resident company; • Any sphere of the South African government (i.e. national, provincial and local); • an exempt parastatal; • a pension or benefit fund; • an approved PBO; or • an environmental rehabilitation trust • Note: The SA resident company exemption means that dividends passed through a chain of SA companies are only taxed at end of chain (versus current regime of taxing initial company with STC credit relief)

Revenue Laws Amendment Bills 2008