Arbitrage agony and windfall taxation

Last year, a number of commentators (including myself) expressed the thought that the top rates of individual and company tax are now sufficiently out of line to start creating opportunities for arbitrage - that is to run one's business in a manner that takes advantage of that differential.  Tax theorists stress the principle that, as far as possible, there should be no tax penalty attached to the manner in which one does business and this, certainly, has been accepted by Government in the past so that generally, the top marginal rate of individual tax and the combined corporate taxes are not too far different.  Last year, however, government did not react to those concerns.  But any incorporated private business should by now be looking very carefully at whether to give salary increases to its directors/shareholders or, rather, to declare larger dividends which ultimately will result in a lowering of the combined company/shareholder tax bill.  A decision taken on those grounds would probably be viewed by SARS as inappropriate but it is extremely unlikely that the law as it stands could be made to interfere with that lowered tax charge.  How much better, therefore, to remove the problem entirely by dropping the top personal rate to a level where the temptation does not arise!

Synfuel sins
In last year's Budget Speech, and out of the blue to most of us, came the Minister of Finances announcement of a possible "windfall" tax to be imposed on certain synfuel producers.  Since then, a committee has been established to consider the rights, wrongs and technicalities of such a tax, the interested parties have made representations, the report has been delivered to the Minister and up to now, we remain in the dark as to the contents of that report and the Minister's thoughts.  It seems a likely bet, however, that this Budget Speech will provide clarity as to the future.  What is the windfall tax and why is it being considered?  Simply put, the South African petroleum industry has for years refined crude oil which it has purchased at market rates but set its pump price at a rate controlled by Government and based, essentially, upon an international benchmark cost of production.

But the so-called "synfuel" producers the State oil company - do not use crude oil, but coal and natural gas respectively, as the feedstock for their refineries.  Since the input cost of these feedstocks is quite different to crude, the profit (or loss) realised by these entities is quite different to that envisaged in the setting of the pump price.  Prior to the last Budget, according to Government, this resulted in a windfall profit for these entities and the suggestion was made that this profit should be shared with the taxpayers of South Africa.  Of course, it is already shared with the taxpayers of South Africa since it is subject to the normal corporate tax rate of 29%.  But the thought is that a greater contribution is appropriate, not least because both entities at some time in the past (it is suggested) were subsidised by taxpayers when both were Government owned.

Of course, a special tax like this is something of a two-edged sword - in particular Government must carefully ask itself the question "what do we do if crude prices (and the pump price) drop substantially, such that these companies are disadvantaged compared to their crude oil fellows?"  These and other thoughts which I will not go into here, suggest to me that this tax may very well find itself placed on the back burner while the international crude oil price decides which way it is trending and, generally, to further consider the economic and political implications of such a tax.  On that score there is the  issue of what to do with the true "synfuel" producers who will  make ethanol out of agricultural crops in the next few years and whose product will somehow or other have to be incorporated into the pricing mix for petrol and petrol replacements - if we are to encourage 'biodiesel' production can we do so while (possibly) subjecting its producers to a windfall tax if they are successful?  

David Clegg, National Technical Director, Ernst & Young Tax Advisory Services