Tax Implications of a Public Private Partnership (PPP)

1. PUBLIC PRIVATE PARTNERSHIPS (PPP)A few tax implication Presented by JOHAN KOTZE

2. YOUR OWN ATTEMPT …

3. YOUR CLIENT’S SCENARIO Your client is Egoli Health Services (Pty) Ltd It is party to a PPP And queries the tax implications of the money it is receiving pursuant to its obligation in terms of the PPP

4. YOUR CLIENT’S SCENARIO Department of Health required an psychiatric unit Tender terms: • ‘Design, construction, maintenance, operation and finance’ of an institution / facility for psychiatric patients • Private party should design and construct the facility • Private party should finance the facility • Private party should then maintain and operate the facility

5. YOUR CLIENT’S SCENARIO - Continue Tender terms continue: • Facility is to be provided on government land • Maintenance and operating period 25 years • Facility should accommodate 400 patients • Tender consideration: • would be a fixed amount for the design and construction of the facility and • a variable amount for the maintenance and operation

6. YOUR CLIENT’S SCENARIO - Continue Egoli Patient Services (Pty) Ltd was awarded the tender Fixed portion for the design and construction: R120 million, payable over 10 years in equal installments Variable portion for the maintenance and operation: R50 per patient per day, indexed annually Facility was brought into use on 1 March 2009 Financial year 1 March 2009 – 28 February 2010: Fixed portion – R12 million Variable portion – R7,3 million

7. YOUR CLIENT’S SCENARIO - Continue Tax advice required by Egoli Patient Services (Pty) Ltd How should • the fixed portion (R12 million) and • the variable portion (R7,3 million) be treated for income tax purposes. No other information provided and no advice pertaining CGT, VAT etc. required

8. WHAT IS A PPP ? Defined in section 1 ‘a Public Private Partnership as defined in Regulation16 of the Treasury Regulations issued in terms of section 76 of the Public Finance Management Act, 1999 (Act No.1 of 1999) Loosely: • An arrangement between the Public Sector and Private Sector • Public Sector represented by a specific Department of Government • Private Sector normally represented by Special Purpose Company, on behalf of shareholders, financiers and other stakeholders • Could be for use of public assets or to perform institutional function

9. INCOME TAX ACT APPLICATION A PPP is a normal taxpayer, but has TWO provisions in the Income Tax which specifically deals with it: • Section 10(1)(zI): Exemption • Section 11(g): Leasehold improvements All other provisions equally important Because the query is about income, the exemption is the only specific provision to be dealt with herein

10. LET’S START AT THE BEGINNING:BASIC FORMULA FOR TAX CALCULATION

11. ARE THE AMOUNTS GROSS INCOME? The first question about any amount which a taxpayer receives is whether the amount constitutes gross income? Therefore does Egoli’s fixed portion of R12 million, in respect of design and construction, constitutes gross income? And, does the variable portion R7,3 million, in respect of maintenance and operation, constitutes gross income?

12. GROSS INCOME - DEFINED Section 1 – Definition: “gross income” in relation to any year or period of assessment, means – • in the case of any resident, the total amount, in cash or otherwise, received by or accrued to or in favour of such resident; or • [in the case of any non-resident] during such year or period of assessment, excluding receipts and accruals of a capital nature …

13. GROSS INCOME – PER FORMULA

14. GROSS INCOME – AMOUNT RECEIVED Is the fixed portion of R12 million, in respect of design and construction, an amount? YES Is the fixed portion of R12 million, in respect of design and construction, received? YES Is the variable portion of R7,3 million, in respect of maintenance and operation, anamount? YES Is the variable portion of R7,3 million, in respect of maintenance and operation, received? YES

15. GROSS INCOME – PER FORMULA - APPLICATION

16. IS IT A RECEIPT OF A CAPITAL NATURE? No definition of the phrase ‘of a capital nature’ In the normal course there is no difficulty to determine whether a receipt or accrual is income or capital in nature Popular distinction is that capital is the income-producing machine, and the product is income Capital = Tree; Income = apples Position is not always so simple or clear, and the reported cases have introduced a wealth of subtle distinctions

17. IS IT A RECEIPT OF A CAPITAL NATURE? - Continue It is necessary to consider the nature of the fixed portion of R12 million, in respect of the design and construction It is also necessary to consider the nature of the variable portion of R7,3 million, in respect of the maintenance and operation Are they grants or subsidies in nature?

18. IS IT A RECEIPT OF A CAPITAL NATURE? - Continue What is a grant or subsidy? No definition in Income Tax Act of ‘grant’ or ‘subsidy’ Can be described as: • A sum of money given by a government or public body for a particular purpose • A sum of money granted from public funds to help an industry or business, or to keep the price of a commodity or service low • To advance policy decision

19. IS IT A RECEIPT OF A CAPITAL NATURE? - Continue ‘Government grant’ defined as: ‘an appropriation, grant in aid, subsidy or contribution, in cash or kind, paid by a department listed in Schedule 1 to the Public Service Act, 1994 (Proclamation No. 103 of 1994), (other than a provincial administration), but does not include any amount paid in respect of the supply of any goods or any services to that department’ But only in relation to section 10(1)(y) – not relevant for this discussion

20. IS IT A RECEIPT OF A CAPITAL NATURE? - Continue Two tax cases dealt with grants / subsidies: • Moolman v CIR (19 SATC 127) • ITC 1633

21. IS IT A RECEIPT OF A CAPITAL NATURE? - Continue Moolman v CIR Moolman was a wool-farmer In 1940 the UK and SA had an arrangement and via this arrangement Moolman had to sell his wool to the UK After the war in 1945 the UK had large stock of wool, sold in Australia Profits were remitted to SA and Moolman received pro-rata share - agterskot Was it capital or revenue in nature?

22. IS IT A RECEIPT OF A CAPITAL NATURE? - Continue Moolman v CIR Centlivres CJ said that: ’[it] is therefore clear that the amount was paid to the appellant in respect of wool sold by him in the course of his occupation as a wool-producer and was a profit made by him as a result of his operations as a wool-producer, and must be regarded as an addition to the purchase price which he obtained from the wool which he sold … This being so that amount cannot be regarded as a receipt of a capital nature’

23. IS IT A RECEIPT OF A CAPITAL NATURE? - Continue ITC 1633 The taxpayer was a manufacturer of motor vehicles and enjoyed certain excise duty rebates Two main categories were taken into account - the foreign exchange saved by the use of local components and the foreign exchange earned by exports The taxpayer contended inter alia that the rebates were capital in nature

24. IS IT A RECEIPT OF A CAPITAL NATURE? - Continue ITC 1633 Wunsh J: The excise duties were normal deductible expenses and if an amount received has the effect of recouping expenditure, the recoupment is gross income and not capital in nature There was no foundation to claim that if the ‘payment’ was intended ‘as an incentive to achieve certain economic, socio-economic, or political aims of the State, such payment would … constitute a capital accrual’

25. IS IT A RECEIPT OF A CAPITAL NATURE? - Continue ITC 1633 Wunsh J: The rebate was not granted to finance the costs of capital items such as building and plant There was no evidence that by opting to subscribe to the local content programme the taxpayer restricted its freedom to trade as it deemed fit The taxpayer did not surrender any rights

26. IS IT A RECEIPT OF A CAPITAL NATURE? - Continue ITC 1633 Wunsh J: The taxpayer was not contractually or in any way restricted from its right to trade The taxpayer participated in the scheme in order to enable it to receive the rebates and so increased its profits There was no substance in any of the arguments for the proposition that the rebates were of a capital nature

27. IS IT A RECEIPT OF A CAPITAL NATURE? - Continue Therefore: Subsidies may be receipts or accrual of a capital or income nature depending upon the purpose for which they are granted If, for example, it is granted to establish an industry, it will be of a capital nature, since the subsidy goes towards the: • fixed capital or • income earning machine

28. IS IT A RECEIPT OF A CAPITAL NATURE? - Continue But: If the grant or subsidy is granted in respect of the taxpayer’s trading as such, for example: • to manufacturers or producers to encourage production • to encourage export • to compensate a taxpayer for keeping prices low the grant or subsidy is income in nature

29. IS IT A RECEIPT OF A CAPITAL NATURE? - Continue Is the fixed portion of R12 million, in respect of the design and construction, a receipt of a capital nature? YES / NO YES Is the variable portion of R7,3 million, in respect of the maintenance and operation, of a capital nature? YES / NO NO

30. GROSS INCOME – PER FORMULA - APPLICATION

31. LET’S START AT THE BEGINNING:BASIC FORMULA FOR TAX CALCULATION

32. IS THE AMOUNT EXEMPT FROM TAX Section 10(1)(zI) – Exemption provides the following 10. There shall be exempt from normal tax- (zI) any amount received by or accrued to or in favour of any person from the Government, where- • the amount is granted for the performance by that person of its obligations pursuant to a Public Private Partnership; and • that person is required in terms of that Public Private Partnership to expend an amount at least equal to that amount in respect of any improvements on land or to buildings owned by any sphere of government …

33. ANALYSIS OF SECTION 10(1)(zI) Did Egoli receive any amount from Government? Yes

34. ANALYSIS OF SECTION 10(1)(zI) - Continue Is Egoli in a PPP, as defined? Yes

35. ANALYSIS OF SECTION 10(1)(zI) - Continue Was such amount granted to Egoli for the performance of its obligations pursuant to the PPP? Yes

36. ANALYSIS OF SECTION 10(1)(zI) - Continue How much was granted to Egoli for the performance of its obligations pursuant to the PPP? A total of R19,3 million, i.e.: R12 mllion in respect of the design and construction, and R7,3 million in respect of the maintenance and operation

37. ANALYSIS OF SECTION 10(1)(zI) - Continue Did the PPP require Egoli to expend an amount in respect of improvements on Government land? YES It was required to construct a psychiatric unit on Government land

38. ANALYSIS OF SECTION 10(1)(zI) - Continue How much was expend on the psychiatric unit constructed on Government land? Egoli advised that it spent R60 million on the psychiatric unit

39. ANALYSIS OF SECTION 10(1)(zI) - Continue THEREFORE: The amount Egoli was granted pursuant to its obligations R19,3 million The amount Egoli expended on the improvements R60 million The requirement in par. (ii) is that Egoli has to expend an amount at least equal to the amount it receives pursuant to the obligations Did Egoli expend an amount at least equal to the amount received? No, therefore the full amount falls wihin the requirement Is it fair to say that Egoli could have an exemption up to R60 million on an annual basis?

40. TAX CALCULATION

41. INCOME Section 1 – Definition: “income” means the amount remaining of the gross income of any person for any year or period of assessment after deducting therefrom any amounts exempt from normal tax under Part I of Chapter II How much would therefore remain from Egoli’s gross income after deducting the exempt PPP amount?

42. ANSWER TO EGOLI

43. REALITY CHECK Are you sure this is correct? You have just given Egoli a double deduction? 1.By deducting the capital receipt in respect of the design and construction? 2. By deducting it as exempt as well? You have also given Egoli an exemption for its operating income

44. CORRECT APPROACH • No magic to the term, contractor • Egoli was contracted to design and provide a psychiatric unit • The fixed portion of R12 million, in respect of the design and construction, is therefore a receipt for services rendered and revenue in nature • The exemption is still applicable • Cost of psychiatric unit should be considered in terms of section 11(a) & 23(f) • The key is that thepsychiatric unit is ‘trading stock’ as defined

45. THANK YOU