Changes to the taxing of Micro businesses
A “micro business” may elect to be taxed under the Sixth Schedule of the Income Tax Act which provides for tax at 10% of total receipts rather than the normal company rate of 28%. Persons qualifying as a “micro business” include natural persons and companies where the total receipts from business activities (excluding capital expenditure and certain exempt items) do not exceed R1 million per tax year. Such businesses pay tax in respect of taxable turnover as opposed to taxable income. Currently, the provisions of The Act limit the relief given to a “micro business” where there is common ownership in more than one company, such as the case of partnerships. The prohibition makes little sense where the ownership is in a liquidating, inactive company. It is proposed that this limitation be removed in the case of liquidating or deregistering companies. It is proposed that the same limitation be removed for “small business corporations” (gross income not to exceed R14 million per tax year) where a similar limitation applies.
In addition to the changes outlined above, certain technical refinements to the taxable turnover tax methodology of taxing “micro businesses” have been proposed. These include refinements to issues faced by businesses on entering the system, coordination with VAT and a refinement to the definition of “professional services”, which are currently excluded from being taxed as a “micro business
In the 2008 budget speech the Minister announced that a new dividend withholding tax would be introduced to replace STC. The effect of the reform would be to switch this tax charge from a company-level tax to a shareholder-level tax charge. The dividend withholding tax would be collected through a withholding by the company paying the dividend.
Key identified features pronounced upon in 2008 were:
· the dividend withholding tax would replace STC in 2009
· no dividend withholding tax would be applied to exempt entities; and
· importantly, that all STC credits would expire when the change was implemented in 2009 (however this issue was reconsidered – see below)
During 2009 draft dividend withholding tax legislation was issued for public comment (Section 64D to 64N in the Income Tax Act). A new dividend definition was enacted, however the legislation did not provide for the levying of withholding tax on deemed dividends. Furthermore, in an about turn from the Ministers speech in 2008, STC credits would still be available under the new tax but for a limited period and in this regard a mechanism was enacted for dealing with STC credits.
In the 2010 budget speech the Minister was indicated that pursuant to public comment there were still a number of issues which needed to be resolved, namely:
· Changes to the dividend definition (this is a lengthly and complex definition under the current STC regime and will be substituted to cater for the new dividends withholding tax). Furthermore it appears that the National Treasury wishes to make certain amendments to the foreign dividends definition to remedy certain defects apparent in the existing definition.
· There are certain transitional issues between the current and proposed regimes.
· There are practical problems relating to inter alia the declaration of in specie dividends.
The Minister gave no indication as to when the outstanding issues will be resolved. We will however keep abreast of the progress and will keep you advised regarding its impact.
Corporate Reorganisations
Default elections involving intra-group rollovers
Taxpayers generally prefer rollover relief when engaged in various reorganisations including intra-group transactions. Hence corporate relief rules contained in section 41 – 47 of the Income Tax Act No. 58 of 1962 (Income Tax Act) apply automatically provided certain conditions are met and parties involved in the relevant transaction do not elect otherwise. However, taxpayers engaged in the intra-group transfers where items are regularly disposed of such as trading stock prefer to fall outside the corporate relief rules due to tracing problems. It is therefore proposed that a different methodology be provided for this class of intra-group transfers to simplify compliance.
Share-for share reorganisations of listed companies
Unlisted and listed share-for -share transactions qualify for tax relief under section 42 of the Income Tax Act provided certain conditions are met. For instance, the acquiring company is required to determine whether the target shareholder holds the target shares as trading stock or as a capital asset. As it is impractical to establish this from a listed share context, it is proposed that conditions of this nature be waived in the case of listed share-for-share transactions; to the extent the waiver does not create opportunities for tax avoidance.
Reorganisations of bad debts
Corporate relief rules are designed so that the acquiring company generally “steps into the shoes” of the party transferring qualifying assets or in other words, the assets are acquired on a tax neutral basis. As a result, creditors cannot claim a bad debt deduction for debts if the creditor claim is acquired in a reorganisation with the default occurring subsequently. It is proposed that corporate relief rules be modified so that bad debt deductions can be claimed in these circumstances, provided this does not give rise to double losses.
SARS budget speech: Possible Thin- Capitalisation loopholes being closed
South Africa has thin capitalisation rules for income tax purposes which apply to certain related parties. South Africa’s thin capitalisation legislation currently applies to non resident entities for South African tax purposes which have granted financial assistance directly or indirectly to a “connected person” which is South African tax resident. Where the Commissioner is satisfied that the financial assistance granted by investor to the resident is excessive in relation to the fixed capital of the resident, any interest relating to the excessive portion of the financial assistance will be disallowed as a deduction in the hands of the resident and deemed to be a dividend subject to secondary tax on companies at 10%. Currently, a debt : equity ratio of 3:1 is permitted.
The Budget Review for 2010 indicates that South Africa’s thin capitalisation legislation is to be extended and will apply to foreign owned South African branches as the current rules appear not to apply to non resident entities with unincorporated South African branch operations. This allows foreign investors to form a foreign company with excessive amounts of debt whilst remaining free from the thin capitalisation rules, even though the main operations of the foreign company are contained within a South African branch. It is considered that interest on this excessive debt may adversely affect the tax base to the same extent as excessive debt in a foreign-owned resident company. This apparent loophole will now be closed.
Closure of sophisticated tax loopholes
In line with the Government’s goal of achieving lower rates by broadening the tax base, the Minister of Finance has announced from the Budget Review that the one area of concern is the use of sophisticated tax avoidance schemes. He mentions that the scale of these schemes often presents substantial loss to the fiscus even when considered in isolation. As a result the following are some of the schemes have been identified for closure:
· Cross-border mismatches
There is a proposal to amend the Income Tax Act in order to clarify the tax treatment of unacceptable schemes associated with tax treaties and inappropriate use of foreign tax credits. No specific detail was provided on which schemes will be regarded as unacceptable.
· “Protected cell” companies
A controlled foreign company (“CFC”) is a foreign company where a more than 50% interest (participation or voting rights) is held directly or indirectly by South African residents. However, some taxpayers bypass this CFC regime through the use of “protected cell” companies. A statutory cell company effectively operates as a multiple limited liability entity, with each cell protected against the other. Investors most often will have full control over the cell, but fail to satisfy the CFC ownership requirements in the foreign entity overall. It is proposed to treat each cell as a deemed separate company with the CFC ownership requirements measured separately.
· Participation preference and guaranteed shares
Certain taxpayers remit funds from South Africa through deductible payments (e.g. interest) and bring back same funds to South Africa tax free through foreign dividends eligible for the participation exemption. It is proposed to deny the participation exemption for preference share dividends, guaranteed dividends and any dividends derived directly or indirectly from South Africa.
· Restricting the cross- border interest exemption
An exemption exists for local interest payments to any foreign legal person, unless the payment is made to a local branch of a foreign legal person. Bar South Africa’s thin capitalisation and transfer pricing provisions, a foreign investor may invest in South Africa via debt with little restriction. There is a proposal to restrict the exemption to contain the leakage. Presumably, an interest withholding tax is contemplated. However, the proposed changes will not affect investment in South African bonds, unit trusts, bank deposits or other financial instruments of a similar nature.
· Transfer pricing
The Minister has proposed to provide a uniform set of transfer pricing rules to deal with artificial pricing or the misallocation of prices within the various components of a single transaction. These rules will align the treatment on both onshore and offshore transaction. The proposed changes will ensure that an arm’s length principle is achieved.
Miscellaneous amendments: Value-Added Tax Act (1991)
· Movable goods supplied to foreign-going ships
Currently the supply of goods by a vendor to a foreign going ship would be subject to the zero rate provided that the foreign going ship is used for commercial purposes. The provision excluded military and privately owned vessels that are not used for commercial purposes. The application of the zero rate would be extended to include all foreign going vessels whether they are used for commercial purposes or not. The main test for the zero rate to apply may be whether the vessel is on a foreign going voyage.
· Inter-group supplies accounted for on a loan account
The legislation prescribes that input VAT should be reversed on a supply where the creditor remains unpaid for a period of 12 months. This rule was introduced to limit avoidance structures implemented by certain vendors and to align the input tax rules with the output tax relief provided for on bad debts written-off. However, the rule negatively impacted on group companies with a central procurement function and group entities operating without using their own bank account. It is proposed that this rule be relaxed and would reduce the cost of compliance for some groups. This rule proved to be too restrictive where groups operate inter-group loan accounts for commercial reasons which are not cleared within 12 months and will be welcomed by selected group companies.
· Double charge on deregistration
It is proposed that a potential double VAT charge be removed in respect of two differing yet interlinked provisions. The potential double charge relates to the input VAT payback provision on creditors that remains unpaid for a period of 12 months and the output VAT payable on assets upon deregistration of a vendor.
· Commercial Accommodation
The supply of commercial accommodation as provided by for example hotels is taxable at the standard rate whilst the supply of residential accommodation is exempt. Due to the technical interpretation of the legislation certain suppliers potentially met the requirements of both commercial and residential accommodation. SARS intend to rectify the anomaly during 2011.
· Pooling arrangements
The legislation currently provides for certain farming and rental activities of multiple parties to be treated as a single vendor for VAT purposes. However, SARS received numerous requests for rulings to allow other types of industries to account for VAT using the pooling concept such as the betting, trucking and shipping industries. In light of the fact that SARS has granted permission to certain of these industries to account for VAT using the pooling concept, it is their intention to formally extend the pooling concept to other industries.
· Documentary proof for claiming a notional input tax deduction
Currently a notional input tax deduction may be made on the acquisition of second hand goods only to the extent that the vendor has paid for the goods. However, the documentary requirements in order to substantiate this notional input tax claim do not formally include proof of payment. SARS will include specific proof of payment requirements in the legislation.
· Payment of VAT in respect of imported services
Registered vendors are required to declare output tax in respect of imported services on form VAT215 within 30 days. Certain vendors obtained permission from SARS to disclose the VAT payable on imported services on their monthly VAT returns. Vendors will be allowed to use any of the two methods without obtaining specific permission. This change is welcomed as it simplifies the compliance process.
· Claiming input tax deductions on invoices not exceeding R50
In terms of the legislation a vendor is not entitled to claim VAT as an input tax deduction unless he is in possession of valid tax invoice. From a tax invoice perspective the VAT Act does not require a supplier to provide a tax invoice if the total consideration for the supply does not exceed R50. The intention of the R50 de minimis rule is to simply administration for the buyer. The legislation does not specify any documentary requirements in such instances and an amendment is proposed to provide for specific alternative documentary proof.
Corporate law reform
Over the past couple of years government has embarked on an overhaul of the Companies Act of 1973. The definition of “Company” refers to any association, company or corporation incorporated under any law in force in the Republic of South Africa. There are a number of sections of the Income Tax Act which rely on the definition of a company including inter alia, the corporate rules, STC (and proposed dividends withholding tax) and the sections in the Act which deal with connected persons. Pending changes to the Companies Act may require changes to the Income Tax Act.
Special Relief measures
Professional sports bodies:
Section 11E was introduced into the Income Tax Act by the 2007 Revenue Laws Amendment Act which allows a special deduction of revenue expenditure incurred on the development and promotion of certain qualifying amateur sport.
Certain National Sporting organisations separated their professional activities and their amateur activities into separate entities so that the amateur sporting entity could register as a tax-exempt Public Benefit Organisation (“PBO”).
Special rules were introduced in the 2007 Revenue Laws Amendments to allow the professional sporting body to transfer its business and all its assets to the amateur sporting body so that the professional and amateur activities can once again be combined, without tax effects arising out of the transfer. The tax effects are merely rolled over from the professional to the amateur company or association. The amateur sporting organisation must be a tax-exempt PBO, but after the transfer of the professional sporting body’s assets to it, the tax-exempt status falls away and the combined body is subject to tax on all its receipts and accruals in the normal way, commencing in the year that the transfer takes place.
In addition to the special rules, there is a special deduction allowed under section 11E to compensate for the fact that the new entity will lose its PBO status. Thus the amalgamation effectively allows deductions for operational expenditure incurred by professional sports organisations to develop their amateur activities.
The amalgamation tax measure was limited to a two-year period that expired on 31 December 2009.
Proposal: given the practical difficulties of undertaking these amalgamations, it is proposed that this window period be extended to 31 December 2012 and that consideration be given to addressing other anomalies that may arise.
Dissolution or winding up of miscellaneous entities (withdrawal of tax exempt status)
Certain entities, such as Chambers of Commerce, Trade Unions and fidelity funds, are exempt from income tax. While the exemption for these entities shares features with other more well-known entity exemptions such as Public Benefit Organisations (“PBO”) and clubs, current law fails to adequately address the dissolution or winding up of such entities.
A PBO which has enjoyed exemption from tax, and has utilised this benefit to carry on approved public benefit activities, may not, on dissolution, distribute its remaining funds to individuals or other tax paying entities tax free. The distributions are taxed as a recoupment.
Proposal: that the dissolution or winding up of other tax-exempt entities should trigger a recoupment so as to mirror the current treatment of terminating PBO’s and clubs.
Extension of deductibility of donations to Peace Parks Foundation
The Peace Parks Foundation is a Public Benefit Organisation (“PBO”) working to realise the transfrontier parks project along South Africa’s border, thereby promoting biodiversity conservation and employment.
Whilst the foundation is fully exempt, deductible donations are limited to donations made by the close of 31 March 2010.
Proposal: The cut-off date is removed so that deductible donations can freely be made in future.
Unlawful” tax evasion and “lawful” tax avoidance
In the Duke of Westminster’s case 1(which was endorsed by the Appellate Division of South Africa) it was held that ‘every man is entitled to order his affairs so that the tax attaching under the appropriate Acts is less than it otherwise would be’.
Thus, in the past it was generally accepted that there was a simple distinction between “unlawful” tax evasion and “lawful” tax avoidance. While ‘tax evasion’ was generally regarded as an illegal and dishonest means to escape tax, ‘tax avoidance’ was viewed as a legitimate and legal way of protecting one’s property from unnecessary erosion by taxation.
It seems, however, that the legal way of protecting one’s property from unnecessary erosion by taxation may become a thing of the past. In the 2011 Budget speech the Finance Minister noted that “Government will take further steps to reduce tax avoidance and tax structuring” and the 2011 Budget documentation include, inter-alia, the following tax proposals in this regard:
· Increasing the deemed monthly tax values placed on the use of company cars;
· Reducing the remaining salary structuring options available to employees that have the effect of reducing their monthly tax liability;
· Tightening the anti-avoidance provisions for executive share incentive schemes;
· Amending the Income Tax Act no 58 of 1962 (“the Act”) to address schemes designed to generate income but that are not subject to South African tax through the inappropriate use of foreign tax credits;
· Amending the Act to address schemes which, through the skilful use of foreign tax treaties, manage to avoid South African tax (i.e. treaty shopping);
· Introducing measures to ensure that “unproductive interest” is not incorrectly claimed as a tax deduction;
· Denying an exemption for preference share dividends, guaranteed dividends and any dividends derived directly or indirectly from South Africa; and
· Providing a uniform set of transfer pricing rules to deal with artificial pricing or the misallocation of prices for both onshore and offshore transactions.
The Finance Minister made it clear in the 2011 Budget speech that given the current instability of the economic environment, it plans to make up the apparent revenue shortfall by tightening its belt and ensuring that the use of tax avoidance schemes are kept to a minimum.
1. IRC v Duke of Westminster [1936] AC
During the last years budget speech a three-year window period allowing residential property entities to liquidate without triggering additional tax was introduced.
Prior to 2001, many persons utilised companies to hold domestic residences as a way of avoiding transfer duty. With the introduction of capital gains tax in 2001 a potential dual level charge was created.
In addition a Companies Act annual fee was required to be paid by all companies in order to reduce the number of inactive and dormant companies. This further contributed to the tax ineffectiveness of these residential property entities.
The tax relief under the Eighth Schedule of the Income Tax Act was proposed as a CGT rollover event where in effect all CGT gains and losses will be deferred until the residence becomes subject to a subsequent disposal by a natural person. The distribution of the residential property is to be exempt from STC and transfer duty.
Based on further review of these provisions government has decided that this window period initially set of three years is insufficient. A new, more flexible window period has been proposed so that these residential property entities can be liquidated or dissolved with limited compliance and enforcement effort.
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