TAX UPDATE - Home Page - Fasset · Web viewAnti-avoidance rules will be introduced to prevent taxpayers from transferring new assets into shareholdings held for the three year period

CONTENTS

PART 1 - BUDGET 2007PAGE

2007 BUDGET - TAX PROPOSALSHighlights 1Personal income tax 1

Tax tables 2006/07 1Tax tables 2007/08 1Rebates 2Tax threshold 2Tax saving per annum 2Interest and taxable dividend income exemption 2Monthly monetary caps for tax-free medical scheme contributions 2Annual exclusion for capital gains or losses 2Annual exclusion in year of death for capital gains or losses 2Primary residence exclusion for capital gains or losses 2

Corporate tax rates 3Normal tax (basic rate) 3Tax rates for qualifying small business corporations 3Secondary tax on companies (STC) 3

Other taxes, rates 3Estate duty 3Donations tax 3Capital gains tax 4Transfer duty 4

Savings and retirement reform 5Introduction 5Abolition of retirement fund tax 5Simplifying retirement fund thresholds 5Streamlining the tax regulatory regime for retirement funds 5Foreign collective investment schemes 5Lump sum death benefits 5

Growth business development and job creation 6Reform to the taxation of dividends 6Taxation of gains on long-term equity investments 6Depreciation allowances 7Corporate reorganisation and BEE transactions 7Public Benefit Organisations 8

Implementing the municipal property rates act 8Tax reform measures under review 9

Wage subsidy and social security tax reform 9Small business development 9

Measures to enhance tax administration 9Small business tax amnesty 9Small business amnesty as applied to trusts 10

Miscellaneous amendments - income tax act, 1962 10Residential accommodation fringe benefits 10Exemption for South Africans working abroad 10Streamlining the medical regime 10Incorporation of professional partnerships involving part-time members 10

Budget and Tax Update 2007

i

Permissible use of buildings benefiting from the urban development zone incentive 10Schemes to avoid the reduction of assessed losses upon indirect debt compromises or concessions

11

Foreign companies with South African activities 11Foreign taxpayers receiving passive South African interest and/or royalties 11Loans made in respect of emigrating South African residents 11Changing status of controlled foreign companies 11Deductibility of foreign taxes 11Ambiguous foreign currency cross-references 11National sports organisations 11Simplifying the averaging formula for individual farmers 12General anti-avoidance rule 12Provisional payment system 12Refund payments 12Employee share options 12Reciprocal tax relief for sportspersons 12Employee tax relief for sole proprietors 12

Miscellaneous amendments – value-added tax act, 1991 13E-commerce downloads 13Nominal or passive foreign-controlled local activities 13Dried maize 13Streamlining business reorganisations 13Insurance versus financial services 13Bare dominium financing structures 13Transfer among rental pool members 14Horse-racing industry 14Game-viewing clarification 14Foreign diplomat resale of local purchased vehicles 14Change of use adjustments of fixed property 14Improper use of turnover apportionment method 14Duty-free shops 14Clarifying payment dates 15Documentary evidence for input tax 15Documentary evidence for zero-rated exports 15Electronic storage of cheques, bank deposit slips and other documents 15

Pension funds act, 1956 15Forced early withdrawals from retirement funds 15Defining annuity payments 15Living annuity drawdowns 15

International cooperation for enhanced cross-border enforcement 16Indirect tax proposals 16

Fuel taxes 16Duties on beverages and tobacco products 16

PART 2 - TAX UPDATE

These notes will cover amendments to the legislation promulgated during 2006 and early 2007. You will recognise edited versions of the Explanatory Memoranda which make up the bulk of these notes. We do not intend this to be an exhaustive reference work.

Developments over the last year 17The small business tax amnesty and amendment of taxation laws act 9 of 2006 and second small business tax amnesty and amendment of taxation laws act 10 of 2006

18

Small Business Tax Amnesty 18Persons who may apply for amnesty 18To qualify for amnesty the requirements are that- 19Method and period of application 19Information required in the application 19


ii

Evaluation and approval 19Review of Commissioner’s decision 19Amnesty Levy 20Example of levy calculation 20Payment of tax amnesty levy 20Scope of the tax amnesty relief 20No prosecution 21Exclusion from the tax amnesty relief 21Treatment of deductions and losses going forward 21Circumstances where approval is void 22Reporting by the Commissioner and Minister 22Waiver of additional tax, penalty and interest 22

Draft regulations 22Information required in application 23Approval of application to waive business tax debt 23Circumstance where not appropriate to waive business tax debt 24Amount to be waived 24Amounts that may not be waived 24Agreement setting out the conditions of waiver 24Commissioner not bound to waiver 24Records of tax debt waived 25Reporting 25

Financial Intelligence Centre Act (FICA) 25Auditing Profession Act (APA) 25

Transfer Duty Act 25Section 9B of the Income Tax Act – Sale of listed shares 25Section 12E of the Income Tax Act – Small business corporation 26Section 12H of the Income Tax Act – Learnership allowance 26Section 56 of the Income Tax Act – Donations tax threshold 27Paragraph 1 of the Fourth Schedule to the Income Tax Act – PAYE on motor vehicle allowance

27

Paragraph 9 of the Seventh Schedule to the Income Tax Act – Residential accommodation

27

Paragraph 10 of the Seventh Schedule to the Income Tax Act – Free or cheap services 27Paragraph 12B of the Seventh Schedule to the Income Tax Act – Medical services 28Section 1 of the Stamp Duties Act, 1968 – Definition of stamp 28Item 14 of Schedule 1 of the Stamp Duties Act – Stamp duty on leases 28Section 1 of the Value-Added Tax Act, 1991 – Municipalities 29

Introduction 29The above is achieved through the following amendments: 29Definition of a ‘designated entity’ 29Definition of an ‘enterprise’ 30Definition of a ‘municipality’ 30Definition of ‘municipal rate’ 31Liability of municipalities for tax and limitation of refunds 31Examples 1 and 2 32

Section 11 of the Value-Added Tax Act – Biofeuls 32Section 27 of the Value-Added Tax Act – Small scale farmers and other vendors 32Section 2 of the Tax on Retirement Funds Act – Tax rate 32Section 1 of the Uncertificated Securities Act, 1998 – Change in beneficial ownership of securities

33

Section 5 and 5A of the Uncertificated Securities Act, 1998 – Change in beneficial ownership of securities

33


iii

The revenue laws amendment act 33 of 2006 and second revenue laws amendment act 34 of 2006

34

Section 1 of the Income Tax Act, 1962 – Definitions 34Company 34Co-operative 34Shareholder 34Connected person 34Dividend 34

Section 8 of the Income Tax Act – Subsistence allowance 35Section 8C of the Income Tax Act – Vesting of equity instruments 35Section 9D of the Income Tax Act – Controlled foreign companies (CFC) 36

Country of residence 36Foreign business establishment 36‘foreign financial instrument holding company’ 37‘net income’ 38Diversionary transaction rules provide for situation when the above exclusion does not apply. 38Services performed by CFCs 38CFC sale of foreign intangibles 39Matching of intra-group deductions and interest 39CFC ruling escape hatch 39Business establishment waiver for related CFC group employees, equipment and facilities 40Diversionary transaction waiver for centrally located operations 40Passive income waiver for active royalties 40Diversionary transaction and passive income waiver for high-taxed income 40Financial services comparably-taxed waiver 41Commencement date 41

Section 10 of the Income Tax Act – Foreign donor funding 41Section 10 and 30A of the Income Tax Act and Paragraph 65B of the 8 th Schedule to the Income Tax Act – Partial taxation of recreational clubs

41

Introduction 41The new section 10(1)(cO)) 42Capital gains tax 42

The new paragraph 65B of the Eighth Schedule reads as follows: 42The new section 30A 43

Penalties 44Effective Dates 44

Section 10(1)(h) of the Income Tax Act – Interest earned by non-residents 44Section 10(1)(q) of the Income Tax Act – Scholarships and bursaries 44Section 10(1)(y) and (yA) of the Income Tax Act – Domestic and Foreign Government Grants

45

Domestic 45Foreign 46Reasons for change 46Amendments – Domestic 46

1.Anti-double-dipping rules 462.Government scrapping payments 46

Amendments – Foreign 461.Grants 462.Discounted loans and technical assistance 47

Section 11(gB) of the Income Tax Act – Registration of intellectual property 47Section 11B of the Income Tax Act – Registration of intellectual property 47Section 11D of the Income Tax Act – Scientific or technological research and development

47

Position prior to the amendment 47Reasons for change 48The amendment – New section 11D 48

Basic regime 48Part R&D Expenditure 48


iv

Example: 48Recoupments 49

Examples 49No doubling of the 150% deduction 49

Example 49Government grants 49

Example 50Reporting requirements 50Effective Dates 50Old section 11B 50

Section 12E of the Income Tax Act – Small business corporations 50Introduction 50Small business relief 50Membership in consumer co-operatives and friendly societies 51Investment income 51Personal service 51

Sections 18A, 30 and the 9th Schedule to the Income Tax Act - Public Benefit Organisations (PBOs)

51

Tax rates for PBO trading activities 51Refining the PBO activity list 51

Housing PBOs 51Conservation, environment and animal welfare PBOs 52Foreign established charities 52

Liberalising permissible PBO investments 53Capital gains on disposal of PBO assets 53Definition of PBO - Concept of public benefit 53Administration - Dual registration 54Miscellaneous administration – Provisional tax 54Miscellaneous administration – Withdrawal of approval 54Commencement dates 54

Section 23(k) of the Income Tax Act – Permissible deductions of personal service companies and personal service trusts

55

Section 24I of the Income Tax Act – Foreign currency transactions 55ection 24J of the Income Tax Act – Incurral and accrual of interest 55Section 26B and the Tenth Schedule to the Income Tax Act - Oil and Gas Exploration and Production

55


55

Section 24I of the Income Tax Act – Foreign currency transactions 55Section 24J of the Income Tax Act – Incurral and accrual of interest 55Section 26B and the Tenth Schedule to the Income Tax Act - Oil and Gas Exploration and Production

55

New Tenth Schedule override 56List of Tenth Schedule provisions 56

1. Coverage (paragraph 1) 562. Income tax rates (paragraph 2) 563. Dividend tax rates (paragraph 3) 564. Foreign currency gains or losses (paragraph 4) 575. Oil and gas deductions (paragraph 5) 576. Thin capitalisation (paragraph 6) 587. Disposal of oil and gas rights (paragraph 7) 588. Fiscal stability (paragraph 8) 59Effective date 60

Section 37A of the Income Tax Act – Mining environmental rehabilitation funds 60Introduction 60Eligible contributing parties 60Eligible mining rehabilitation funds 61Penalties 61


v

Effective dates 62Insertion of Part IIA of Chapter III of the Income Tax Act – General anti-avoidance rule 62

The requirements for an impermissible avoidance arrangement summarised 62Section 80L – The definitions 63Section 80A – Impermissible tax avoidance arrangements 63Section 80B – Tax consequences of impermissible tax avoidance 63Section 80C – Lack of commercial substance 64Section 80D – Round trip financing 64Section 80E – Accommodating or tax indifferent parties 65Section 80F – Treatment of connected persons and accommodating or tax indifferent parties 65Section 80G – Presumption of purpose 65Section 80H – Application to steps in or parts of an arrangement 65Section 80I – Use in the alternative 65Section 80J – Notice 65Section 80K – Interest 65Sections 80A to 80L - Commencement date 66

Insertion of Part IIB of Chapter III of the Income Tax Act – Reportable arrangements 66Section 102 of the Income Tax Act – Refunds 67Section 103 of the Income Tax Act – Anti avoidance provisions 67Paragraph 5 of the Second Schedule to the Income Tax Act – Retirement fund withdrawals

67

Amounts payable by Retirement Annuity Funds 67Taxation of withdrawal and retirement benefits – pension and provident funds 68Taxation of withdrawal and retirement benefits 68Effective date 68

Paragraph 1 of the 4th Schedule to the Income Tax Act – Relief for small personal service entities

69

Narrowing the scope of the PSE regime 69Relaxation of client withholding 69Taxation of net profits 69Effective date 70

Paragraph 9 of the 4th Schedule to the Income Tax Act – Withholding tax on lump sums from pensions, provident funds and retirement annuity funds

70

Paragraph 11 of the 8th Schedule to the Income Tax Act – Issue or cancellation of a member’s interest in a close corporation

70

Paragraph 20 of the 8th Schedule to the Income Tax Act – Base cost of assets inherited from a non-resident

70

Paragraph 29(5) of the 8th Schedule to the Income Tax Act – Submission dates of certain valuation date valuations

71

Paragraph 62(e) of the 8th Schedule to the Income Tax Act – Donations and bequests to approved recreational clubs

71

Paragraph 64A(b) of the 8th Schedule to the Income Tax Act – Government scrapping payments

71

Paragraph 67 of the 8th Schedule to the Income Tax Act – Deceased estates and roll over provisions

71

Paragraph 80 of the 8th Schedule to the Income Tax Act – Capital gain attributed to beneficiaries of a trust

72

Section 9 of the Finance and Financial Adjustments Act, 1977 – Tax treatment of different spheres of domestic and foreign government

73

Section 8(27), 10(26) and 16(3)(m) of the Value-Added Tax Act – Excessive consideration 74Section 15(2) of the Value-Added Tax Act – Payment basis of accounting 74Section 16(2) of the Value-Added Tax Act – Time limit to claim input tax 75Section 16(3) of the Value-Added Tax Act – Prize or winnings 75Section 17(2)(a) of the Value-Added Tax Act – Entertainment expenditure 76Section 20(8) of the Value-Added Tax Act – Record keeping for second-hand goods 76Section 22(3) of the Value-Added Tax Act – Deemed output tax on cessation of enterprise 76Section 31(1) of the Value-Added Tax Act – Additional assessment 77Section 41 and 41A of the Value-Added Tax Act – Written decisions by the Commissioner 77


vi

Section 44(1) of the Value-Added Tax Act – Additional assessment 78Schedule 1 of the Value –Added Tax Act – 2010 FIFA World Cup 78Schedules 1 and 2 of the Revenue Laws Amendment Act, 2006 – Special tax measures relating to the 2010 FIFA World Cup

78

Introduction 78Tax-free bubble concept 78FIFA retail outlets 79Associated persons 79Specifics of Guarantee No. 3 (Customs) 79Specifics of Guarantee No. 4 (Other Taxes, Duties and Levies) 79Government Guarantee No. 4 does not include the following taxes– 80Administrative Aspects 82Date of Implementation 82

Section 14 of the Unemployment Insurance Act – State old-age pensions 82


vii

PART 1 - BUDGET 2007

2007 BUDGET TAX PROPOSALS

HIGHLIGHTS• Replacing the secondary tax on companies with a dividend tax, reducing the rate from 12.5%

to 10% and broadening the base• Personal income tax relief for individuals amounting to R8.4 billion• Abolishing the retirement fund tax• Treating the sale of shares held for more than 3 years as capital gains• Interest and dividend income tax-free thresholds increase• No change in VAT, CGT, Donations Tax or Estate Duty rates• Wage subsidy and social security tax reform

The notes that follow draw extensively from the guide published by SARS titled 2007/8 Budget Tax Proposals.

PERSONAL INCOME TAXPersonal income tax relief of R8.4 billion has been proposed.

Tax tables 2006/07Taxable income Rate of tax

R R

0 - 100 000 18%

100 001 - 160 000 18 000 + 25%

160 001 - 220 000 33 000 + 30%

220 001 - 300 000 51 000 + 35%

300 001 - 400 000 79 000 + 38%

400 001 - 117 000 + 40%

Tax tables 2007/08Taxable income Rate of tax

R R

0 - 112 500 18%

112 501 - 180 000 20 250 + 25%

180 001 - 250 000 37 125 + 30%

250 001 - 350 000 58 125 + 35%

350 001 - 450 000 93 125 + 38%

450 001 - 131 125 + 40%


1

Rebates 2006/07 2007/08Primary 7 200 7 740

Secondary 4 500 4 680

Tax thresholdBelow age 65 R40 000 R43 000

Age 65 and over R65 000 R69 000

Tax saving per annum Age below 65 Age above 65Taxable income Tax reduction Tax reduction

R43 000 – R100 000 R540 R720

R120 000 – R150 000 R1 415 R1 595

R200 000 R2 415 R2 595

R250 000 – R300 000 R3 915 R4 095

R400 000 R5 415 R5 595

R500 000 and above R6 415 R6 595

Interest and taxable dividend income exemption2006/07 2007/08

Natural persons below age 65 R16 500 R18 000

Age 65 and over R24 500 R26 000

Of the above, the amount that can be

Applied to foreign interest and dividends R2 500 R3 000

Monthly monetary caps for tax-free medical scheme contributionsFirst two beneficiaries R500 R530

Each additional beneficiary R300 R320

Annual exclusion for capital gains or lossesNatural persons R12 500 R15 000

Annual exclusion in year of death for capital gains or lossesNatural persons R60 000 R120 000

Primary residence exclusion for capital gains or lossesNatural persons R1 500 000 R1 500 000


2

CORPORATE TAX RATES – Years of assessment ending between 1 April 2007 and 31 March 2008Normal tax (basic rate) 2007 2008Non-mining companies 29% 29%

Close Corporations 29% 29%

Employment companies 34% 34%

Other companies 29% 29%

Tax rates for qualifying small business corporations2007 Taxable income Rate of tax

R

0 - 40 000 0%

40 001 - 300 000 10%

300 001 - 29%

2008 Taxable incomeR

0 - 43 000 0%

43 001 - 300 000 10%

300 001 - 29%

Secondary tax on companies (STC)Rate of STC on dividends declarations:

17 March 1993 to 21 June 1994 15%

22 June 1994 to 13 March 1996 25%

14 March 1996 to 30 September 2007 12.5%

On or after 1 October 2007 10%

OTHER TAXES, RATES

Estate dutyRate of estate duty on dutiable value of the estate:

Death prior to 14 March 1996 15%

Death on or after 14 March 1996 but before 1 October 2001 25%

Death on or after 1 October 2001 20%

Primary abatement R3 500 000 (2007: R2 500 000)

Donations taxPayable at a flat rate on taxable value of all property donated in excess of R100 000 (2007: R50 000):

Prior to 14 March 1996 15%

From 14 March 1996 to 30 September 2001 25%

From 1 October 2001 20%


3

Capital gains taxEffective capital gains tax rates remain unchanged as follows:

Taxpayer Inclusion Statutory EffectiveRate (%) Rate (%) Rate (%)

Individuals 25 0 – 40 0 – 10

Trusts Unit - 29 -

Special 25 18 – 40 4.5 – 10

Other 50 40 20

Companies Ordinary 50 29 14.5

Small business corporation 50 0 – 29 0 – 14.5

Permanent establishment 50 34 17

Employment company 50 34 17

Life assurers

Individual policyholders fund 25 30 7.5

Company policyholder fund 50 29 14.5

Untaxed policyholder fund - - -

Corporate fund 50 29 14.5

Transfer dutyTransfer duty rates remain unchanged.

Transfer duty rates for individuals 2007/08

Property value Rate of taxR

0 - 500 000 0%

500 001 - 1 000 000 5%

1 000 001 - R25 000 + 8%

In all other cases the rate is 8% of the consideration.


4

SAVINGS AND RETIREMENT REFORMIntroductionThe proposed reforms to retirement saving are aimed at providing an efficient and equitable framework for individuals to provide for their retirement. Mandatory contributions, compulsory preservation, portability and enhanced regulation together provide the foundation for the retirement funding reforms.

The tax treatment of retirement savings must complement these regulatory and institutional reforms. Details of these reforms will be published by the National Treasury in a separate discussion paper, including reforms to the tax system that seek to maintain sufficient incentive to provide adequately for retirement, while addressing inequities and complexity in the current system.

In keeping with practice in many other countries, the reforms will see a shift to an expenditure model of retirement fund taxation, in which contributions to retirement funds are eligible for full or partial deductibility, investment growth is tax exempt and benefits are taxable. As part of this, a uniform and more equitable tax treatment of contributions to pension, provident and retirement annuity funds will be phased in over time, consisting of three parts

• favourable tax treatment of a basic savings element,

• some tax encouragement of a supplementary component, and

• no special tax treatment above a specified ceiling.

The reforms will improve equity and more effectively encourage long-term savings by lower and middle income individuals.

It is hoped the complete package of reforms will be finalised during the course of 2007, following further consultation in the light of social security reform discussions. However, several elements of the reform package outlined below will be implemented in 2007.

Abolition of retirement fund tax Retirement Fund Tax (RFT) on interest and rental income will be abolished with effect from 1 March 2007. This is consistent with the shift to the retirement savings taxation model outlined above. It will result in improved returns for retirement fund members and should be seen as a counterpart to the proposed limitations on tax deductibility of retirement fund contributions by high-income individuals.

Simplifying retirement fund thresholdsThe tax rules permitting lump sum withdrawals upon retirement are overly complex, resulting in unnecessary compliance costs. To alleviate these difficulties, government will simplify the tax system for lump sum withdrawals. To streamline the tax administration process, withholding taxes on lump sum retirement fund payments to persons with taxable income of less than R43 000 per year (the revised income tax threshold) will be abolished.

Streamlining the tax regulatory regime for retirement fundsRetirement funds have to comply with two sets of regulatory legislation, making for an unnecessarily complex regulatory landscape. A streamlined tax administration environment will reduce the indirect costs incurred by retirement fund members, resulting in improved retirement savings. As a first step, regulatory requirements contained in the Income Tax Act and related regulatory notes will effectively be moved to the Pension Funds Act. This will result in reduced regulatory costs without sacrificing oversight.

Foreign collective investment schemesIt has come to government’s attention that foreign collective investment schemes in the hands of long-term insurers are inadvertently subject to a higher level of tax than schemes held directly by beneficiaries. Changes in policyholders’ portfolio preferences can result in foreign collective investment schemes moving in and out of the controlled foreign company regime. This places a large administrative burden on the scheme’s manager to monitor such movements. Legislative amendments to alleviate the higher tax and compliance burden will be introduced.

Lump sum death benefitsThe Income Tax Act provides for certain lump sums paid in respect of the death caused by an occupational injury to be tax-free. However, payments of a similar kind made outside the Compensation for Occupational


5

Injuries and Diseases Act (1993) framework are as a rule subject to income tax. It is proposed that payments in respect of death while at work be tax-free up to a monetary cap of R300 000.

GROWTH BUSINESS DEVELOPMENT AND JOB CREATION

Reform to the taxation of dividendsWhile dividend taxes are a familiar feature of taxation worldwide, they are typically imposed at a shareholder level, with treaty relief for foreign investors. In South Africa, secondary tax on companies (STC) is provided at the company level as opposed to the shareholder level. Only two other countries, Estonia and India, have a formal dividend tax liability at the company level.

This has meant that international summaries of company tax rates have typically compared the combined company and dividend tax rate in South Africa with the company tax rate in other countries. If compared on a like basis and SA’s combined rate in 2006 is compared with that of the OECD countries, SA would have the 7th lowest rate out of 31.

International investors are also more familiar with a dividend tax at the shareholder level and often enjoy double tax treaty limitations on a dividend tax at this level. That is to say, double tax treaties limit the dividend tax imposed at the shareholder level but not at the company level.

It is widely argued that SA’s STC raises the cost of equity financing to the detriment of economic growth. To help lower the cost of doing business, government proposes to phase out STC and replace it with a dividend tax.

This reform will happen in two phases. The 1st phase takes effect from 1 October 2007 and the 2nd from 2008, depending on the renegotiation of certain double tax treaties. An anti-avoidance measure is also announced with immediate effect.

Anti-avoidance measure

With effect from 21 February 2007 the STC exemption for amalgamation transactions contained in section 44(9) of the Income Tax Act, is withdrawn. This exemption permits a permanent loss of STC, rather than a deferral of tax, which is the intent of the amalgamation provisions.

First phase - 1 October 2007

• STC will be renamed as a dividend tax at company level

• The tax base will be broadened to cover all distributions by companies and not just those from profits, since the determination of what constitutes profits available for distribution can be a complex and uncertain area of SA law. Provision will be made for the tax free return of capital but anti-avoidance provisions will have to address inflated or transitory capital contributions.

• The tax rate will be reduced from the current 12.5% to 10%.

• A more targeted exemption for amalgamation transactions will be introduced, depending on an analysis of the transactions concerned.

Second phase - commencing in 2008

• The formal legal liability for the dividend tax will be moved from the company paying the dividend to the shareholder receiving it.

• The administrative enforcement will be through a withholding tax at company level whereby the company will have to withhold tax of 10% on dividend payments which they must pay to SARS on behalf of the shareholder. The implementation of this phase will depend on the renegotiation of several international tax treaties. The negotiations are aimed at the small number of treaties that provide for a 0% withholding tax rate for substantial shareholders. The negotiations are aimed at ensuring that SA has the right to impose a withholding tax of at least 5% in these cases.

It is envisaged that the withholding tax will be a final withholding tax and that companies paying dividends will have to determine whether a reduced tax rate applies as a result of the application of a double tax treaty.

Taxation of gains on long-term equity investments


6

Profits realised on the sale of shares can be taxed either as ordinary income or capital gains, depending on facts and circumstances. The current legislation has resulted in some large institutions receiving capital gains tax treatment on the sale of shares, and many other players paying ordinary income tax. In order to provide equitable treatment, all shares disposed of after three years will trigger a capital gains tax event. This proposal will not affect the ordinary income tax treatment of executive employee share schemes. Anti-avoidance rules will be introduced to prevent taxpayers from transferring new assets into shareholdings held for the three year period. The above proposal will take effect on 1 October 2007.

Depreciation allowancesThe tax regime related to depreciation of fixed and moveable assets will be reviewed to ensure a greater degree of consistency. The following interim amendments are proposed.

Rail locomotives, wagons and port assets

One way of reducing the cost of doing business in South Africa is to improve the efficiency of transport networks and ports. It is proposed to reduce the tax depreciation periods for new rail locomotives and rail wagons from 14 years to 5 years. It is also proposed that new quay walls and other port facilities qualify for deductions over 20 years. This would match other infrastructure depreciation periods, such as those applying to aircraft runways.

Commercial buildings

The Income Tax Act provides for the depreciation of buildings used for manufacturing and similar processes. However, it does not provide for tax depreciation for certain commercial buildings. It is proposed that tax depreciation allowances for the economic wear-and-tear of newly constructed commercial buildings (and upgrades) be implemented. It is envisaged that the rate will be 5% per year (write-off period 20 years).

Environmental capital expenses

In line with global trends, South African businesses are increasingly subject to environmental regulatory oversight. However, the Income Tax Act has not kept abreast of the importance of expenditure in this regard. Environmental capital structures (such as dams and tanks) are often not depreciable. In addition, environmental clean-up, restoration and decommissioning are often seen as non-deductible capital expenditures. It is proposed that the above capital expenditures qualify for depreciation allowances or immediate deductions, depending on the circumstances.

Corporate reorganisation and BEE transactionsAn important issue for black economic empowerment (BEE) transactions is the ability of BEE partners to raise financing. Amendments to the Income Tax Act are proposed to ensure that BEE and other similar restructurings do not encounter undue additional tax costs that could undermine necessary financing. Discussions with key role players have revealed the following six areas of concern:

• Share cross-issues: Many BEE structures involve the cross-issue of shares. In some structures, the operating company issues ordinary shares to the BEE entity. In return, the BEE entity issues preference shares (which operate as a quasi-loan) to the operating company. If the ordinary shares reach a predetermined value, the BEE entity sells a portion of the ordinary shares for cash and redeems the preference shares. Rules are required to ensure that the ultimate dual dispositions do not give rise to unwarranted gain while simultaneously ensuring that the proposed structure does not trigger artificial losses.

• Share buybacks of listed shares: BEE restructurings of listed shares frequently involve a two-step transaction. Shares are first purchased from the public before transfer to BEE partners pursuant to a forced sale via section 311 of the Companies Act (1973). Many of those parties forced to sell their listed shares (especially management) then repurchase identical listed shares on the market from non-BEE participants. At issue is the tax triggered on the forced sale for those parties who simply use sale proceeds to repurchase identical shares. It is proposed that these parties be free from tax to the extent that timely repurchases leave them in the same economic position as before.

• Anti-avoidance financial instrument company provisions: While the company rollover rules have gradually changed to accommodate ongoing transactions, recurring problems exist in respect of anti-avoidance rules for companies that mainly contain financial instruments. These anti-avoidance rules were designed to ensure that company restructurings were limited to active companies. However, the calculations required are often


7

excessively burdensome and often add little value in preventing real avoidance. It is proposed that the financial instrument rules be deleted to the extent possible and/or be mitigated in favour of a simpler anti-avoidance mechanism.

• Intra-group transfers: The company restructuring rules allow for the tax-free rollover of assets within a single group of companies as if the group were a single entity. However, this rollover treatment comes at the price of the de-grouping charge. The de-grouping charge essentially triggers tax on transferred intra-group assets once companies within the group become separated. While the need for the de-grouping charge is accepted, taxpayers have long sought to obtain time limits on its use. It is accordingly proposed that the de-grouping charge apply only if the group break-up occurs within six years after the intra-group asset transfer (in line with the system in the United Kingdom). This proposal will also require re-evaluation of the general ‘group of companies’ definition because certain transactions are giving rise to avoidance through artificial temporary arrangements. As a final matter, ongoing legislative relief is required for various intra-group anomalies (such as an alleged dual charge on transferred mining assets) and avoidance loopholes.

• Connected person sales of depreciable property: As a practical matter, the majority of BEE transactions involve BEE entities that obtain a 26% to 30% shareholding with the pre-existing company shareholder retaining a 70% to 74% shareholding. These situations largely receive relief through the intra-group rules discussed above. At issue are situations where BEE partners (especially with assistance of outsider investors) obtain ownership levels nearing 50%. In these situations, the transfer of depreciable assets to the BEE entity often becomes subject to certain anti-avoidance rules that prevent the BEE entity from depreciating newly obtained assets at currently existing market values. While the general need for these avoidance rules is accepted, it is proposed that these anti-avoidance rules accommodate situations where avoidance is unlikely to be the driver.

• Broad-based share incentive schemes: In 2004, government introduced a tax incentive to facilitate broad-based share employee ownership. As a result, employees can now receive up to R9 000 worth of shares tax-free over a three year period (with companies eligible for up to R3 000 of deductions per annum). This incentive was partly driven by the need to have more broad-based schemes that would include rank-and-file employees. Unfortunately, usage of the incentive appears to be minimal. This incentive will accordingly be reviewed for possible change.

In addition to the relief discussed above, a number of potential avoidance schemes involving corporate reorganisation rules have been identified. As mentioned above, immediate anti-avoidance provisions relating to STC are to be proposed with effect from 21 February 2007. Other potential concerns involving corporate reorganisation rules have been identified and additional measures may be proposed.

Public Benefit OrganisationsThe Income Tax Act allows individuals and companies to deduct donations made to qualifying public benefit organisations (PBOs) up to a maximum of 5% of their taxable income during the tax year. It is proposed that the threshold for tax-deductible donations be increased to 10% for both individuals and companies. The objective of this proposal is to encourage charitable contributions.

In 2005, government introduced a system of partial taxation for PBOs, accompanied by a tax-free income threshold of 5% of gross income or R50 000, whichever is the greater. This means that PBOs that conduct trading activities may continue to do so without losing their tax-exempt status. They will, however, pay income tax on income from trading activities exceeding the relevant threshold. Given the important role played by many PBOs, it is proposed to increase the R50 000 threshold to R100 000.

The tax treatment of national sporting codes that have separated their professional and amateur sporting arms into separate bodies has resulted in certain anomalies. Amendments are proposed to allow the professional and amateur bodies to merge their legal structures so that qualifying expenses incurred by the professional bodies to develop amateur sports can be deducted.

IMPLEMENTING THE MUNICIPAL PROPERTY RATES ACTThe Local Government Municipal Property Rates Act (2004) regulates municipalities’ powers to impose rates on properties. The act provides for the exclusion of certain properties from rates in the national interest; a transparent and fair system of granting relief measures; fair and equitable valuation methods; and objections and appeals processes. The act enhances certainty, uniformity and simplicity in the valuation and rating of properties.


8

The act took effect on 2 July 2005, and municipalities have four years from this date to fully implement the legislation. However, only a few municipalities are currently implementing a new valuation roll and rating in terms of the act.

Implementation will require all municipalities to properly manage the transition from their old rating practices to the new system. A smooth transition is essential. Municipalities that historically have not rated on the market value of land and buildings combined are expected to reduce the rate charged (percentage or cents per rand) to ensure that there is broad continuity in revenue collected from the expanded tax base.

TAX REFORM MEASURES UNDER REVIEWWage subsidy and social security tax reformIntroduction of a wage subsidy is proposed by 2010. The objectives of such a subsidy are to reduce the direct costs of employment, help alleviate the high rate of joblessness among youth and facilitate the proposed social security reform process. For further discussion of how this aligns with proposed social security reforms, see Chapter 6 of the 2007 Budget Review.

It is envisaged that SARS will administer the social security tax and wage subsidy. As this will be a payroll-based tax and the subsidy will be paid to employers, the PAYE system will, to a large extent, be used as the administrative platform. In addition, SARS will have to gather more specific and regular information about employees, as the tax will require that records be kept to match details of contributing and eligible employees. The challenges that will arise from these large-scale fiscal and institutional arrangements will be taken into account in the SARS modernisation programme.

Small business developmentGovernment policy remains focused on reducing the tax compliance burden for businesses, especially small businesses, to promote entrepreneurship, the formalisation of informal businesses, economic growth and job creation. The National Treasury and SARS have commissioned a small business tax compliance cost study. The results of this study should also support the development of a more simplified tax regime for very small businesses to be introduced in 2008.

MEASURES TO ENHANCE TAX ADMINISTRATIONRecent years have seen a substantial growth in the tax base and, consequently, the volume of work for SARS. At the same time, there is also need for a broader and more integrated tax register to improve the view of potential taxpayers and to simplify registration. SARS has begun modernising its systems and processes, using the benefits of automation and e-business to become more cost effective, to better manage risk and to improve the quality of service. In 2007/08 SARS will place greater emphasis on e-filing, re-engineering of forms, scanning and imaging and greater reliance on third party data to speed up document processing.

SARS has committed to adopting the World Customs Organisation Framework of Standards, resulting in the need to re-engineer business processes and to draft new customs legislation over the medium term. A formal discussion paper on these matters will be released in 2007.

In addition to specific industry focus areas, SARS has identified three cross-industry areas as focal points for 2007/08. These are:

• Trusts, because of their continued use to avoid tax. Initiatives will include greater cooperation with the Master’s office to register trusts and identify risk cases, and the allocation of more specially trained auditors.

• The undervaluation and understatement of stock, which will involve additional audit activity and verification.

• Employees’ tax. Dedicated audit teams have been established and trained to counter abuses in this area.

Small business tax amnesty


9

The 2006 Budget announced a small business tax amnesty to facilitate the entry of marginalised small businesses into the economic mainstream and to help non-compliant small businesses to regularise their tax affairs and thus avoid potential penalties in future.

Amnesty applications may be made until 31 May 2007. By 13 February 2007, the unit had received 47 489 enquiries and 11 301 amnesty applications. The inflow of applications compares favourably with the exchange control amnesty of 2003/04, in which application volumes peaked in the final weeks of the application period. It is anticipated that the pace of applications for the present campaign will gather pace in the coming weeks and as awareness continues to be raised about the benefits of this process for small businesses.

Small business amnesty as applied to trustsSome technical issues have risen regarding the application of the small business tax amnesty in respect of certain types of trusts. These issues may have to be clarified by legislative amendment depending on the facts.

MISCELLANEOUS AMENDMENTS - INCOME TAX ACT, 1962

Residential accommodation fringe benefitsResidential accommodation provided by an employer to an employee is a fringe benefit unless provided to an employee when the employee is away from the employee’s usual place of residence. This ‘place of residence’ test is wrongfully being applied on a basis similar to the concept of ‘country of residence’. As a result, foreign residents are arguing that accommodation provided by employers to foreign residents for their entire stay within South Africa is not a taxable fringe benefit even if those foreign residents regularly work at a single South African location. The law will be amended to eliminate this interpretation.

Exemption for South Africans working abroadSouth African residents working abroad for more than 183 days over a 12-month period are exempt from income tax on remuneration for services rendered while abroad. However, if a person has rendered services during a 12-month period that meets the requirements (i.e. more than 183 days abroad of which 60 days are for a continuous period) but the remuneration for these services accrues or is received in a later year of assessment during which the 12-month period does not commence or end, the remuneration will not be exempt. This mismatch typically arises in the case of share incentive schemes. The current exemption will be amended to correct the above inconsistency.

Streamlining the medical regimeThe tax regime for medical deductions (especially contributions to medical schemes) was fundamentally changed in 2006. One key aspect of this change was a shift from the two-thirds deduction formula to monthly ceilings, thereby enhancing the equity aspects of this concession. While this change was fundamentally sound, administrative and compliance hurdles continue to arise that may require legislative intervention.

Incorporation of professional partnerships involving part-time membersIn order for audit firms to comply with recent regulatory legislation, certain audit firms need to incorporate their consulting and advisory activities. However, it has come to government’s attention that tax may stand as a barrier to some of these incorporations. Under present law, some incorporations may not be eligible for tax-free rollover relief because certain partners will neither hold the requisite 20% shareholding nor participate on a full-time basis in the business of the newly created company. Legislative amendments may be undertaken, depending on the available facts.

Permissible use of buildings benefiting from the urban development zone incentiveIn 2003, government introduced a tax incentive to encourage the development and renovation of selected urban centres. This incentive is available for buildings that are used solely for trade purposes. The question


10

has arisen as to impact of the incentive if an urban development zone building was used for purposes other than trade before renovation occurred. The law will be clarified in this regard.

Schemes to avoid the reduction of assessed losses upon indirect debt compromises or concessionsSpecial provisions exist to reduce company assessed losses to the extent that a company’s debts are relieved via compromises or concessions from the lender. Certain taxpayers argue that this reduction of assessed loss can be avoided through indirect means. The law will accordingly be clarified to eliminate this argument.

Foreign companies with South African activitiesForeign companies are subject to different rates of South African tax, depending on the level of their South African activity. Foreign companies with South African sourced income are subject to the standard 29% tax rate, but a higher tax rate applies (34%) if the foreign company generates the income through a South African branch or agency. This higher rate (acting as a proxy for the STC) should apply regardless of whether the foreign company maintains a local branch or agency.

Foreign taxpayers receiving passive South African interest and/or royaltiesForeign taxpayers with passive South African interest income are exempt from tax while passive South African royalties are subject to a flat 12% withholding charge. However, the two tests for distinguishing passive versus active status differ. It is accordingly proposed that both tests be harmonised.

Loans made in respect of emigrating South African residentsTo protect the South African tax base against erosion through the use of loans to South African residents by foreign residents, the tax system disallows the deduction of interest on excessive loans of this nature. However, this anti-avoidance rule may not apply if a loan is made by a South African resident who becomes a foreign resident immediately after the loan is made. This and similar loopholes will be closed.

Changing status of controlled foreign companiesSpecial rules apply when foreign companies acquire or lose controlled foreign company (CFC) status (such as the deemed disposal treatment for capital gains tax purposes). Technical anomalies continue to arise in this area, especially when a chain of foreign companies gain or lose CFC status simultaneously (thereby creating conflicting deemed sale dates for the different foreign companies in the chain). Clarification in this area is required.

Deductibility of foreign taxesSouth African controlled foreign activities are often subject to foreign tax in addition to South African tax. The South African tax system provides clear guidelines for obtaining foreign tax credits, but the law is less clear whether South Africans can deduct foreign taxes if no credit is available (or if a deduction is preferred). It is proposed to freely allow deductions for foreign taxes in lieu of credits.

Ambiguous foreign currency cross-referencesTwo sets of corresponding rules exist for the taxation of currency gains and losses – one for ordinary gain/loss and the other for capital gain/loss. Upon review, it appears that the technical wording of the capital gain/loss currency rules generates confusion due to reliance on cross-references to the ordinary gain/loss currency provisions. This use of cross-references will be removed in favour of more explicit rules.

National sports organisations


11

National sports organisations typically have a professional arm and an amateur arm. Some organisations have split these two arms into separate entities in order to enjoy public benefit organisation status for the amateur arm. In certain cases, however, this split has proven to be to the organisation’s disadvantage. Measures will be considered to assist with the reintegration of these different arms.

Simplifying the averaging formula for individual farmersThe income-averaging formula for farmers is complex, especially for newly commencing operations. It is proposed to simplify the thresholds within the commencing formula as a first step toward greater simplification.

General anti-avoidance ruleA wholly revised general anti-avoidance rule was approved by Parliament in 2006. Initial indications are that the new rule has already discouraged impermissible tax-avoidance arrangements. However, it would also appear that the new rule is under intense scrutiny by some in an effort to circumvent it. The practical operation of the general anti-avoidance rule will be monitored with appropriate amendments to ensure its effectiveness.

Provisional payment systemThe provisional tax system is problematic in terms of enforcement and compliance ease. Effective provisional tax systems should be simple and require minimal audit intervention. Amendments to the provisional tax system will be considered in order to add certainty, minimise compliance and administrative burdens, and to ensure a coherent penalty/interest structure. Any legislative amendments will become effective only after sufficient time is permitted for taxpayers and SARS computer system changes.

Refund paymentsRefunds of overpaid taxes by cheque result in delays, continue to be subject to fraudulent negotiation and impose significant costs on SARS. In view of the Mzansi initiative to provide bank accounts for low-income earners and the fact that fewer than 2 500 refunds in 2006 were to taxpayers who did not have access to a bank account, consideration will be given to requiring that refunds be made directly into taxpayers’ bank accounts on a similar basis to refunds in terms of the Value-Added Tax Act (1991).

Employee share optionsIn 2004, government substantially revised the tax treatment of share options to prevent executives and other high-income employees from receiving tax preferences for consideration that effectively represents deferred salary. Share-option schemes continue to generate issues that require minor legislative adjustment.

Reciprocal tax relief for sportspersonsFrom July 2006, income earned by foreign visiting entertainers or sportspersons performing within South Africa became subject to South African withholding tax. While this form of taxation is consistent with international norms, some countries provide various forms of reciprocal relief in the case of international tournaments (i.e. involving teams from multiple countries). These countries legislatively elect not to tax foreign visiting sportspersons playing in their countries on condition that the foreign home country provides a similar exemption on the other side. Restated, source taxation is waived in favour of residency country taxation as long as that waiver is reciprocal. Legislation may be considered so that South African sportspersons can benefit from this reciprocity principle.

Employee tax relief for sole proprietorsIn 2006, government acknowledged that the anti-avoidance rules safeguarding employee withholding taxes may have introduced excessive rigidities for small business operators. The 2006 legislative relief involved the


12

removal of the automatic ‘deemed employee’ triggers, such as: (i) client control or supervision over hours of service performance and over the manner in which duties are performed and (ii) regular payments. However, the above sets of relief applied solely to small businesses operating as trusts and companies. Comparable relief was inadvertently omitted for small businesses operating as sole proprietors. This oversight will be corrected.

MISCELLANEOUS AMENDMENTS – VALUE-ADDED TAX ACT, 1991

E-commerce downloadsThe VAT system operates on a destination basis, thereby taxing goods and services consumed within South Africa. This principle theoretically requires South African users of e-commerce downloads to pay VAT and for foreign providers to register for VAT. There is a growing international trend to require foreign e-commerce suppliers of services to register as VAT vendors in countries in which they supply services. The practical implications of requiring these suppliers of services to register within South Africa will be considered with regard to international practice.

Nominal or passive foreign-controlled local activitiesThe VAT Act prescribes that persons must register as vendors if those persons conduct enterprises and make taxable supplies that exceed or are likely to exceed R300 000 in a 12-month period. This prescription applies equally to domestic and foreign persons. That said, VAT registration for nominal or certain wholly passive activities of foreign persons is impractical when the supply is made to domestic VAT vendors. It is therefore proposed that scope be provided to allow relief in order not to discourage foreign investment and trade.

Dried maizeThe supply of dried maize for human consumption, animal feed or as seeds is zero-rated. On the other hand, the supply of dried maize from one vendor to another for resale is standard-rated unless it is a zero-rated supply. The tax treatment by the supplying vendor depends on the ultimate consumption of the recipient, which is often outside the vendor’s control and probable knowledge. In order to simplify matters, it is proposed that all supplies of dried maize be eligible for zero-rating regardless of the recipient’s intended consumption.

Streamlining business reorganisationsThe Income Tax Act provides extensive relief for company reorganisations (mergers, intra-group transfers and liquidations, etc). The VAT rules indirectly provide relief but further clarification is required. It is proposed that the VAT rules be fully examined in relation to all forms of company reorganisations sanctioned by the Income Tax Act, thereby legislatively remedying any inconsistencies between the two tax systems.

Insurance versus financial servicesShort-term insurance products are generally subject to VAT, whereas long-term insurance products are regarded as financial services that are exempt. At issue is the uncertainty in terms of modern financial practices, especially given the fact that many financial services (such as guarantees) are designed to guard against risk much like insurance products. It is proposed that this distinction be legislatively clarified.

Bare dominium financing structuresIt was mentioned in last year’s Budget that certain taxpayers were entering into bare dominium structures designed to disguise actual financial services as rental payments, thereby misusing the statutory exception to the financial services definition. As a result input credits are claimed even though no subsequent taxable supplies are made. The investigation has now been completed and the VAT implications will be clarified by legislative amendment.


13

Transfer among rental pool membersA rental pool administrator acts as a VAT representative for the unit owners and is accordingly conducting an enterprise on their behalf. At issue is the VAT treatment of the transfer of units between rental pool members where the unit remains in the rental pool. Theoretically, these transfers should be regarded as going concerns and hence zero-rated. However, due to the current provisions of the VAT Act, the supply of the unit does not qualify as a going concern. It is proposed that legislation be enacted to this effect.

Horse-racing industryIn the horse-racing industry, a number of persons typically have joint ownership of one horse. The financial affairs of the racehorse owners are managed by an administrator. For the sake of administrative simplicity, consideration will be given to treating racehorse administrators as a VAT representative on behalf of the racehorse owners, much like the situation for rental pooling arrangements. Due to difficulties in establishing the tax status of each racehorse owner, the winnings paid by racing operators to racehorse owners are regarded as a single supply. As such, consideration will also be given to zero-rating such supply.

Game-viewing clarificationIt has always been intended that game-viewing drives should be treated as a taxable supply at the standard rate. However, some practitioners are taking positions that undermine this intent due to possible weakness in the technical language. Legislative clarity will be provided to ensure that the supply of game viewing is fully subject to VAT.

Foreign diplomat resale of local purchased vehiclesForeign diplomats receive VAT refunds in respect of locally purchased vehicles and are exempt from tax on importation of imported vehicles. If the foreign diplomats dispose of these vehicles within two years of purchase or importation, rules exist that require partial or full recoupment of the VAT under certain circumstances. This recoupment ensures that foreign diplomats do not receive unfair benefits. The law will be amended to ensure that the rules for the recoupment of VAT on locally purchased vehicles mirror those for imported vehicles. Rules will also be required to ensure that local VAT vendors do not receive notional input credits on these vehicles to the extent foreign diplomats benefit from unrecouped VAT refunds.

Change of use adjustments of fixed propertyVAT-registered property developers acquiring fixed property for resale claim VAT input credits on purchase and levy VAT on the subsequent sale of the property. On the other hand, residential leasing is an exempt activity and therefore no VAT input credits are allowed for fixed property acquired for residential rental purposes. While this rule is fundamentally sound, problems arise when developers change the use for which the property was originally acquired, i.e. from resale to rental. The change of intent should result in a VAT adjustment.

Improper use of turnover apportionment methodCircumstances often arise when a VAT vendor makes mixed supplies of goods or services (some subject to VAT, others exempt). In these situations, questions often arise as to the nature of input credits for purchases to the extent that those purchases cannot be directly allocated to a specific output (i.e. general overheads). Current law provides for a general written ruling prescribing the turnover-based method as being the default method of apportionment. Vendors may, however, use another method if the turnover method does not give an equitable result. Consideration will be given to similarly allow the Commissioner to prescribe another method of apportionment if the turnover-based method does not give an equitable result.

Duty-free shops


14

Under current administrative practice, South African and foreign travellers benefit from zero-rating when purchasing goods at South African duty-free shops on the basis that these goods are being exported. Although this result is consistent with the destination principle for VAT, legislation is required to support this practice. The VAT Act will be amended accordingly.

Clarifying payment datesVAT requires different payment dates depending on the means of payment (e.g. cash or electronic transfer). However, lack of legislative clarity exists as to the payment dates for the different electronic payments. It is accordingly proposed that the VAT Act be amended to eliminate this confusion.

Documentary evidence for input taxSupporting documentation when claiming input credits is a critical element of a sustainable VAT system. While legislation generally requires this documentation, there are legislative ambiguities in the case of deemed supplies. The VAT Act will be amended to ensure that full documentation requirements exist in terms of deemed supplies (e.g. requiring proof of the claimed amount and the reasons of entitlement) as well as limiting such entitlement to the prescribed five-year period.

Documentary evidence for zero-rated exportsUnder current administrative practice, VAT vendors must provide proper documentation within a three-month period in order to receive zero-rating for exports. Lack of timely documentation results in subsequent standard rating, but VAT vendors may subsequently claim the VAT as input tax if the documentation follows within another nine-month period. Current practice will be clarified in legislation with some possible refinements depending on comments received.

Electronic storage of cheques, bank deposit slips and other documentsModern technology increasingly allows for the effective electronic storage of information. While the tax law generally accounts for this shift, certain relics remain. One relic is the ongoing VAT requirement to maintain paper originals of cheques for a five-year period. This paper requirement is costly for the vendors and inefficient in terms of data searches. It is accordingly proposed to allow for the destruction of paper cheques if digital images (or microfilm) are maintained for the same five-year period (similar to the income tax).

PENSION FUNDS ACT, 1956

Forced early withdrawals from retirement fundsRetirement fund members may be forced to surrender all or part of their retirement fund interests while still being a member of the fund. These forced surrenders may stem from a variety of events, such as housing loan payments and defaults as well as divorce and maintenance orders. Lack of clarity in the law often means that the forced surrender is effectively deferred until a member’s final retirement or withdrawal from the fund. This delayed surrender gives rise to unnecessary tax complications. The Pensions Act will be amended to clarify that the forced withdrawal triggers an immediate severance from the fund (as opposed to a delayed severance upon retirement or withdrawal). Corresponding changes will also be made to the Income Tax Act.

Defining annuity paymentsWhile the term ‘annuity’ has legal meaning in the case law, the term ‘annuity’ lacks precise statutory definition. This definition is critical for determining the tax impact of guaranteed and living annuities, thereby requiring clarification.

Living annuity drawdowns


15

Currently, living annuities allow pensioners to withdraw retirement funds at an accelerated rate. This rate varies between a 5% minimum to a 20% maximum. However, accelerated withdrawals of this nature often leave pensioners with insufficient funds. In order to limit drawdowns in line with market factors, it is proposed that the permissible drawdown range be shifted to a low of 2.5% and a high of 17.5%.

INTERNATIONAL COOPERATION FOR ENHANCED CROSS-BORDER ENFORCEMENTSouth Africa has an extensive network of treaties for the avoidance of double taxation, which include provisions for the exchange of information and assistance in the collection of taxes. In a regional context, the number of South African businesses active in neighbouring jurisdictions (and vice versa) has highlighted the need for improved mechanisms for implementation of these treaty enforcement provisions. SARS will therefore explore memoranda of understanding with neighbouring jurisdictions in order to achieve more efficient outcomes. This increased level of administrative cooperation will assist in countering avoidance and abuse in respect of the region’s tax systems (such as artificial dual residence, transfer pricing and non-declaration of foreign income). This increased level of administrative cooperation will also accelerate resolution of differences in the interpretation and application of tax treaties as they arise.

INDIRECT TAX PROPOSALS

Fuel taxesThe general fuel levy will be increased by 5 cents with effect from 4 April 2007 to 121 cents per litre on petrol and 105 cents per litre for diesel. The Road Accident Fund levy increases by 5 cents per litre from 36.5 cents per litre to 41.5 cents per litre.

Duties on beverages and tobacco productsDuties on alcoholic beverages are increased by between 8% and 10.5% with the exception of traditional beer which enjoys no increase.

Excise duties on tobacco products will be increased by between 5.3% and 10.7% for all categories of tobacco products. This increases the cost of a 340ml can of malt beer by 5 cents and packet of 20 cigarettes by 52 cents.


16

TAX UPDATE

DEVELOPMENTS OVER THE LAST YEAR

The Small Business Tax Amnesty and Amendment of Taxation Laws Act 9 of 2006 and Second Small Business Tax Amnesty and Amendment of Taxation Laws Act 10 of 2006 were both promulgated on 25 July 2006. These Amending Acts introduce the small business tax amnesty and in addition deal mainly with the proposals made in the February 2006 Budget speech.

The Revenue Laws Amendment Act 20 of 2006 was promulgated on 7 February 2007 and deals with amendments to the Income Tax Act, Value-Added Tax Act, Transfer Duty Act, Estate Duty Act, Stamp Duty Act, Uncertificated Securities Tax Act and Unemployment Insurance Fund Act. We will cover what are felt to be the more relevant changes.

The Revenue Laws Second Amendment Act 21 of 2006 was promulgated on 7 February 2007 and deals with further amendments to the same Acts referred to above.

Interpretation notes issued in 2006 and early 2007:30 Jan 2007 38 Application and cost recovery fees for binding private rulings

24 Jan 2007 37 Procedures for requesting binding effect in respect of written statements issued by the Commissioner prior to 1 October 2006

24 Jan 2007 36 Scope and impact of section 76I upon written statements issued by the Commissioner prior to 1 October 2006

7 Mar 2006 35 Employees’ tax: Personal Service Companies, Personal Service Trusts and Labour Brokers

12 Jan 2006 34 Exemption from Income Tax: Remuneration derived by a person as an officer or crew member of a ship

Draft interpretation notes issued in 20066 Dec 2006 Learnership allowances, section 12H

23 Nov 2006 Documentary proof required to substantiate a vendor’s entitlement to apply the zero rate to the supplies of goods or services

25 July 2006 Public Benefit Organisations (PBO’s): Trading rules – Partial taxation of trading receipts

19 July 2006 VAT treatment of the supply of goods and services by a municipality

Income tax brochures released by SARS in 2006 and early 2007

Feb 2007 Guide on the deduction of medical expenses

2006 Advanced tax rulings, detailed guide to binding private rulings

2006 Advanced tax rulings, a quick guide to binding private rulings

Sept 2006 Urban development zones, section 13quat

July 2006 Residence basis of taxation for individuals

July 2006 Tax guide on small business

June 2006 Tax guide for foreigners working in South Africa

May 2006 Draft comprehensive guide to secondary tax on companies


17

http://www.sars.gov.za/it/Draft%20Interpretation%20Notes/Draft%20Interpretation%20Note%20Municipalities%2019%20July%202006.pdf

http://www.sars.gov.za/it/Draft%20Interpretation%20Notes/Interpretation%20Note%2024%20Issue%202%20Trading%20Partial%20Taxation.pdf

http://www.sars.gov.za/it/Interpretation%20Notes/Draft/Interpretation%20note%20Issue%202.pdf

http://www.sars.gov.za/it/Interpretation%20Notes/Draft/Interpretation%20note%20Issue%202.pdf

http://www.sars.gov.za/it/Interpretation%20Notes/Interpretation%20Note%2034%20-%20Exemption%20from%20Income%20Tax%20-%20Crew%20members%20-%2012%20Jnauary%202006.pdf

http://www.sars.gov.za/it/Interpretation%20Notes/Interpretation%20Note%2034%20-%20Exemption%20from%20Income%20Tax%20-%20Crew%20members%20-%2012%20Jnauary%202006.pdf

http://www.sars.gov.za/it/Interpretation%20Notes/Interpretation%20Note%2035.pdf

http://www.sars.gov.za/it/Interpretation%20Notes/Interpretation%20Note%2035.pdf

http://www.sars.gov.za/it/Interpretation%20Notes/Scope%20and%20impact%20of%20section%2076I%20upon%20written%20statements%20issued%20by%20the%20Commissioner%20prior%20to%201%20October%202006.pdf

http://www.sars.gov.za/it/Interpretation%20Notes/Scope%20and%20impact%20of%20section%2076I%20upon%20written%20statements%20issued%20by%20the%20Commissioner%20prior%20to%201%20October%202006.pdf

http://www.sars.gov.za/it/Interpretation%20Notes/2007/Procedures%20for%20requesting%20binding%20effect%20in%20respect%20of%20written%20statements%20issued%20by%20the%20Commissioner%20prior%20to%201%20October%202006.pdf

http://www.sars.gov.za/it/Interpretation%20Notes/2007/Procedures%20for%20requesting%20binding%20effect%20in%20respect%20of%20written%20statements%20issued%20by%20the%20Commissioner%20prior%20to%201%20October%202006.pdf

http://www.sars.gov.za/it/Interpretation%20Notes/2007/Scope%20and%20impact%20of%20section%2076I%20upon%20written%20statements%20issued%20by%20the%20Commissioner%20prior%20to%201%20October%202006.pdf

March 2006 Income tax and the individual

March 2006 Draft transfer duty handbook

Feb 2006 Tax guide for share owners

The interpretation notes and brochures will not be covered in these notes but can be obtained from the SARS website: www.sars.gov.za.

THE SMALL BUSINESS TAX AMNESTY AND AMENDMENT OF TAXATION LAWS ACT 9 OF 2006 AND SECOND SMALL BUSINESS TAX AMNESTY AND AMENDMENT OF TAXATION LAWS ACT 10 OF 2006

The notes that follow draw extensively from the Explanatory Memorandum on the Small Business Tax Amnesty and Amendment of Taxation Laws Bill, 2006.

Small Business Tax Amnesty

Government has recognised that small businesses play an important role in stimulating economic activity, job creation, poverty alleviation and the general improvement of living standards. Many small businesses operate informally, were historically marginalised and were excluded from the economic mainstream, thus remaining outside of the tax system. It is believed that these small businesses are now keen to regularise their tax affairs but an obstacle is their past non-compliance and the resultant potential tax liabilities, penalties and interest.

The Commissioner’s tax-base broadening efforts and ‘walkabouts’ in informal business areas have indicated that numerous small businesses are not on register or have not made full disclosure to the Commissioner and would like the opportunity for regularisation without fear of tax liabilities arising out of past non-compliance. This also includes taxi operators who want to participate in the taxi recapitalisation program.

The purpose and objective of the tax amnesty is, therefore, to:

• broaden the tax base;

• facilitate the normalisation of the tax affairs of small businesses;

• increase and improve the tax compliance culture; and

• facilitate participation in the taxi recapitalisation programme.

A separate unit within SARS, with regional presence, has been established to process all applications on a confidential basis. To this end, the secrecy provisions of section 4 of the Income Tax Act, 1962, are extended to cover applications for tax amnesty. Section 4 now applies to every person ‘employed or engaged’ by the Commissioner in carrying out the amnesty provisions.

Persons who may apply for amnesty

• a natural person (including the deceased or insolvent estate of a natural person);

• an unlisted company (including a close corporation) that was unlisted throughout the qualifying period and all the shares or members’ interests in the company were held directly by natural persons (including the deceased or insolvent estate of a natural person) throughout the 2006 year of assessment.

• a trust (inter vivos and testamentary) and all the beneficiaries (discretionary and vested) of that trust throughout the 2006 year of assessment were natural persons (including the deceased or insolvent estate of a natural person).


18

To qualify for amnesty the requirements are that-

• the person must have carried on a business;

• the gross income of the business (or businesses if the person carried on more than one business) for the 2006 year of assessment was not more than R10 million, but if that person’s financial year was not 12 months the amount of R10 million must be adjusted proportionally, and for this purpose a part of a month must be regarded as a full month.

Method and period of application

An applicant must apply for amnesty with the Commissioner on a form SBA-001 and delivered together with all supporting schedules to any SARS office. Application forms must be submitted at any time during the period 1 August 2006 to 31 May 2007.

Information required in the application

The applicant must, in the application, disclose the taxable income in respect of all amounts received by or accrued to (or deemed to have been received by or accrued to) that applicant from the carrying on of business during the 2006 year of assessment.

The applicant must, together with the application for tax amnesty (or within such later period as the Commissioner may allow) furnish-

• an income tax return for the 2006 year of assessment; and

• a statement of all assets (at cost) and liabilities of that applicant as at the end of the 2006 year of assessment.

If it is not possible for the applicant to provide full particulars of any actual amounts in the application or in any return or statement relating to the application, the applicant may provide reasonable estimates of those amounts and must disclose that the amounts provided are estimates. It is important that any estimate provided is not materially wrong as this is one of the circumstances that could result in an approval being void.

Evaluation and approval

The Commissioner must approve an application only if the applicant-

• is a qualifying person as defined above;

• applies on the correct form to the correct address within the period prescribed above;

• provides all the prescribed information.

An application may not be approved if the Commissioner has, before the submission of the application, formally notified the applicant of an audit, investigation or other enforcement action relating to any failure by that applicant to comply with any Act in respect of which application for tax amnesty is made.

This disqualification falls away if the Commissioner has, before the submission of the application for tax amnesty, formally notified the applicant that-

• the notice of audit, investigation or other enforcement action has been withdrawn; or

• the audit or investigation has been concluded.

The Commissioner must deliver to the applicant a notice of his decision to approve or deny the application for tax amnesty and must set out the reasons for any decision to deny that application.

Review of Commissioner’s decision

An applicant whose application for tax amnesty is denied by the Commissioner may object and appeal against that decision in terms of Part III of Chapter III of the Income Tax Act, including the alternate dispute resolution procedures. In addition the tax court has the jurisdiction to hear any appeal against a decision of the Commissioner.


19

Amnesty Levy

The successful applicants must pay an amnesty levy. The amnesty levy is based on a sliding scale rate and is applied to the taxable income of the applicant for the 2006 year of assessment to the extent that the taxable income is attributable to any amount derived by the applicant from the carrying on of business.

The rates to be applied in the calculating of the tax amnesty levy are-

• 0% of so much of the taxable income as does not exceed R35 000;

• 2% of so much of the taxable income as exceeds R35 000 but does not exceed R100 000;



• 5% of so much of the taxable income as exceeds R500 000.

In determining the tax amnesty levy no regard must be had to the balance of any assessed loss or assessed capital loss carried forward from any year of assessment preceding the 2006 year of assessment.

The 2006 year of assessment means the year of assessment ending during the period 1 April 2005 to 31 March 2006.

Example of levy calculation

Facts: Mr. A is employed by company B and earns employment (salary) income of R200 000 for the 2006 year of assessment. During this period Mr. A also conducted the business of selling household chemicals to clients after hours. He started the business in 2001 and has never disclosed it to SARS. The turnover of this business is R400 000 for the 2006 year of assessment. His expenses in relation to his business amount to R100 000 for that year. At the end of the 2005 year of assessment Mr. A had an assessed loss of R20 000. Mr. A furthermore earned rental income of R5 000 on the use of his holiday cottage for a month by a friend during the 2006 year of assessment.

Calculation of the tax amnesty levy

Taxable income from carrying on business:

R400 000 less R100 000 (expenses) = R300 000

0% up to R35 000 = R0, 2% of amount over R35 000 and up to R100 000 = R1 300, 3% of amount over R100 000 and up to R250 000 = R4 500, 4% of amount over R250 000 and up to R300 000 = R2 000 Total tax amnesty levy = R7 800

• The employment (salary) income of R200 000 will not be taken into account for purposes of calculating the tax amnesty levy.

• The rental income of R5 000 will not be taken into account for purposes of calculating the tax amnesty levy as it is not attributable to the carrying on of business.

• The assessed loss of R20 000 for the 2005 year of assessment will not be set off against Mr. A’s taxable income for the 2006 year of assessment.

Payment of tax amnesty levy

The levy must be paid to the Commissioner within 12 months from the date on which the notice of approval was delivered to the applicant or a longer period as the Commissioner may allow.

Scope of the tax amnesty relief

If an application for tax amnesty is successful, the applicant is granted relief from the payment of-

• income tax in terms of the Income Tax Act, in respect of any amounts received by or accrued to (or deemed to have been received by or accrued to) the applicant in all years of assessment preceding the 2006 year of assessment from the carrying on of a business. For purposes of the amnesty provisions, ‘carrying on of a business’ includes the earning of investment income incidental to the regular carrying on of a business;


20

• employees’ tax in terms of the 4th Schedule to the Income Tax Act, in respect of remuneration as defined in that schedule paid to employees on or before 28 February 2006. Please note the word ‘paid’ does not cover amounts unpaid on 28 February 2006 even though they may be due and payable;

• value-added tax in terms of the Value-Added Tax Act, in respect any supply or importation of goods or services on or before 28 February 2006;

• withholding tax on royalties in terms of the Income Tax Act, in respect of any amount paid to a non-resident on or before 28 February 2006;

• secondary tax on companies in terms of the Income Tax Act, in respect of any dividend declared or deemed to be declared in all years of assessment preceding the 2006 year of assessment. It therefore applies to any dividend cycle which ends in the applicant’s financial year ending prior to 1 April 2005;

• contributions payable in terms of the Unemployment Insurance Contributions Act, in respect of remuneration, as defined in that Act, paid on or before 28 February 2006; and

• levies payable in terms of the Skills Development Levies Act, in respect of any leviable amounts as contemplated in that Act, paid on or before 28 February 2006.

It is important to note the different qualifying periods depending on the type of tax covered by the amnesty.

An applicant whose application has been approved is not liable for the payment of any additional taxes, interest and penalties to the extent that they relate to any amount for which relief has been granted.

The Commissioner may extend the date for submission of any returns to be furnished by an applicant in terms of any Act to which the tax amnesty relates and may waive the penalty for the late submission of that return.

The Commissioner may waive any additional tax, penalties or interest charged to an applicant in terms of any Act to which the tax amnesty relates on any amounts relating to returns due after the qualifying period. The Commissioners decision is subject to objection and appeal.

No prosecution

A successful applicant for amnesty is deemed not to have committed any offence in terms of any Act to which the tax amnesty relates to the extent that relief has been granted to that applicant. It therefore seems that if liability for any tax is waived in terms of the tax amnesty, the successful applicant will not be subject to criminal prosecution as far as that tax is concerned.

The above also applies to a person in so far as that person acted in a representative capacity on behalf of the applicant during the qualifying period.

Exclusion from the tax amnesty relief

The tax amnesty does not apply in respect of any tax, levy, contribution, interest, penalty or additional tax to the extent that it-

• had already been paid before the submission of the application; or

• is payable or becomes payable by the applicant as a result of any return, declaration or information submitted to SARS before the submission of the application; or

• is payable by the applicant in terms of an assessment issued by SARS before the submission of the application; or

• relates to value-added tax not paid as a result of a false declaration of the acquisition, import or export of goods or services that did not actually occur. This means that a false claim of input tax or a false claim of zero-rating of exports will not qualify for tax amnesty.

Treatment of deductions and losses going forward

If tax amnesty is granted to an applicant, that applicant may not-


21

• for purposes of determining that applicant’s liability for income tax after the qualifying period, utilise any assessed loss or assessed capital loss arising during the qualifying period;

• for purposes of calculating that applicant’s liability for secondary tax on companies, set off the excess of dividends which accrued to the applicant during any dividend cycle ending during the qualifying period against any dividends declared by the applicant in any dividend cycle ending after the qualifying period; or

• for purposes of calculating that applicant’s liability for value-added tax after the qualifying period, claim a deduction of any input tax as defined in section 1 of the Value-Added Tax Act, or any other deduction as contemplated in section 16(3) of that Act, which relates to any supply to that applicant during any tax period ending during the qualifying period.

Circumstances where approval is void

Any approval granted by the Commissioner is void if-

a) the applicant fails to pay the full amount of the tax amnesty levy within the prescribed period;

b) the applicant failed to make full disclosure in respect of any of the following-

• the application form;

• the taxable income for the 2006 year of assessment;

• the information required in the 2006 tax return; and

• the statement of assets and liabilities;

c) any estimate made by the applicant in the application for amnesty is materially incorrect.

Reporting by the Commissioner and Minister

The Commissioner must provide the following information relating to the tax amnesty process to the Minister of Finance and the Auditor-General-

• the number of applications received and the number of applications approved and denied;

• the number of new taxpayers registered per tax type as a result of the tax amnesty;

• the total amount of all tax amnesty levies payable by all applicants; and

• the number of new taxpayers registered with the Commissioner per tax type that are classified as active taxpayers on 31 March 2008 and 31 March 2009, respectively.

This information must be provided in a form which does not disclose the identity of any applicant. The information must be submitted at a time as agreed between the Commissioner and the Minister of Finance and Auditor-General. The Minister of Finance must report to Parliament on the above information.

Waiver of additional tax, penalty and interestIn an effort to facilitate the purpose and object of the tax amnesty, the Minister may by regulation prescribe the circumstances upon which the Commissioner may waive in whole or in part any amount of additional tax, penalty or interest payable, imposed on failed applicants.

Draft regulations issued under Section 13 of the Small Business Tax Amnesty and Amendment of Taxation Laws Act, 2006 prescribing the circumstances under which the Commissioner may waive any amount of additional tax, penalty or interest payable by specific persons were issued on 24 January 2007.

Draft regulations

For purposes of these regulations ‘business tax debt’ has been defined and means any additional tax, interest and penalty imposed in respect of any amount of-


22

• income tax, payable in respect of any amount received by or accrued to (or deemed to have been received by or accrued to) the applicant in all years of assessment preceding the 2006 year of assessment from the carrying on of a business;

• employees’ tax, payable in respect of any remuneration paid to employees on or before 28 February 2006 engaged in the carrying on of any business;

• value-added tax, payable in respect of any supply or importation of goods or services on or before 28 February 2006;

• withholding tax on royalties, payable in respect of any amount paid on or before 28 February 2006 to any person that is a not a resident;

• secondary tax on companies, payable in respect of any dividend declared or deemed to have been declared in all years of assessment preceding the 2006 year of assessment;

• contributions, payable in terms of the Unemployment Insurance Contributions Act, in respect of any remuneration paid on or before 28 February 2006 in the course of the carrying on of any business; and

• levies, payable in terms of the Skills Development Levies Act, in respect of any leviable amounts as contemplated in that Act, determined on or before 28 February 2006.

A person who satisfies the requirements discussed under the heading “Persons who may apply for tax amnesty” above, will be prohibited from applying for tax amnesty relief to the extent that any amount of tax, levy, contribution, interest, penalty or additional tax-

• is payable or becomes payable by the applicant in consequence of any information which was furnished to the Commissioner by the applicant or a representative of the applicant in any return or declaration or otherwise before the submission of the application;

• is payable by the applicant in terms of an assessment issued by the Commissioner before the submission of the application.

A person prohibited from applying for tax amnesty relief by virtue of the above reasons may apply for the waiver of a business tax debt. An application must be made to the Commissioner-

• by no later than 31 May 2007; and

• at the address and in the manner and form prescribed by the Commissioner.

Information required in application

The applicant must, in the application for waiver list the category or categories of business tax debt to be waived by the Commissioner.

The applicant must furnish together with the application for waiver or within such period as the Commissioner may allow-

a) a statement of assets (at cost) and liabilities of that applicant as at the end of the 2006 year of assessment;

b) all returns outstanding from that applicant as on 31 December 2006 that have not been furnished before the submission of the application for waiver.

If the applicant has applied for tax amnesty relief and a return would no longer be required were that tax amnesty relief to be granted, the applicant need not furnish that return unless and until that application for tax amnesty relief has been denied.

If it is not possible for the applicant to provide full particulars of any actual amounts in the application or in any return or statement relating to the application, the applicant may provide reasonable estimates of those amounts and must disclose to the Commissioner that the amounts provided are estimates.

Approval of application to waive business tax debt

Subject to the circumstances detailed in the next paragraph, the Commissioner must approve the application for waiver if all the requirements are met.


23

The Commissioner must deliver to the applicant a notice of his decision to approve or deny the application for waiver and must set out the reasons for any decision to deny that application.

Circumstance where not appropriate to waive business tax debt

The Commissioner may not waive a business tax debt if, before the submission of the application for waiver-

a) the Sheriff of the High Court has attached the assets of the applicant in execution of a writ of execution obtained on behalf of the Commissioner in satisfaction of the business tax debt;

b) sequestration or liquidation proceedings have been instituted against the applicant; or

c) the Commissioner has delivered a notice to that applicant or that applicant’s representative informing that applicant of an audit or investigation relating to any failure by that applicant to comply with any Act administered by the Commissioner.

The subparagraph c) above will not apply if the Commissioner has, before the submission of the application for waiver, delivered a notice that-

a) the notice contemplated in that subparagraph has been withdrawn; or

b) the audit or investigation contemplated in that subparagraph has been concluded.

Amount to be waived

Subject to the next paragraph dealing with amounts that may not be waived, the amount of the business tax debt that must be waived by the Commissioner is the amount of the business tax debt that is outstanding at the close of business on 31 July 2006 (day before the amnesty application period opened).

In determining the amount of the business tax debt outstanding at the close of business on 31 July 2006 any credits or refunds due on that date to the applicant in respect of any tax must first be off-set against the business tax debt outstanding on that date.

Amounts that may not be waived

The Commissioner may not waive a business tax debt to the extent that-

a) the business tax debt exceeds an amount of R1 million; or

b) an amount paid after the close of business on 31 July 2006 in respect of business tax debt or other tax debt outstanding on that date exceeds the amount of other tax debt outstanding on that date.

Agreement setting out the conditions of waiver

If the Commissioner approves the application for waiver, the Commissioner and the applicant must sign an agreement which provides-

a) that the balance of the tax debt (if any) together with any interest thereon must be settled by the applicant within 6 months from date of signature of the agreement or such longer period as the Commissioner may determine; and

b) for any other conditions that the Commissioner may require for purposes of the waiver of the business tax debt.

Commissioner not bound to waiver

The Commissioner will not be bound by the waiver if the applicant-

a) failed to make full disclosure in the application for waiver of all information required in the application,

b) supplied any materially incorrect information to which the waiver relates; or

c) fails to comply with any condition contained in the agreement contemplated above.


24

If the Commissioner is not bound by the waiver for any of the above reasons, the Commissioner shall have the right to reinstate the full amount of the business tax debt so waived and calculate interest on that amount as from 1 August 2006 to date of the payment of the business tax debt.

Records of tax debt waived

The Commissioner must maintain a register of all business tax debts waived in terms of these regulations.

The register must contain-

a) details of the applicant, including name, address and tax reference numbers; and

b) the amount of the business tax debt waived and the periods to which that business tax debt relates.

Reporting

At the time the Commissioner provides the Minister and Auditor-General with a report contemplated in section 7 of the Second Small Business Tax Amnesty and Amendment of Taxations Laws Act, the Commissioner must also include, in that report, a summary of all business tax debts waived, in whole or in part, in terms of these regulations during the period covered by the report.

Financial Intelligence Centre Act (FICA)

On 13 October 2006 the Minister of Finance issued an exemption from the reporting obligations under section 29 of the FICA in respect of the Small Business Tax Amnesty and Amendment of Taxation Laws Act No. 9 of 2006. The exemption applies to persons who assist or advise a client who applies for the Small Business Tax Amnesty.

The exemption applies irrespective of whether the client actually applies for amnesty or not and applies for the duration of the amnesty application period (1 August 2006 to 31 May 2007).

Auditing Profession Act (APA)

Section 2A has been added to the Second Small Business Tax Amnesty and Amendment of Taxation Laws Act No. 10 of 2006. It exempts a registered auditor of an entity, who assists or advises that entity in applying for the Small Business Tax Amnesty, from the provisions of section 45 of the APA which would otherwise require the registered auditor to report an irregularity in respect of any law administered by the Commissioner. The exemption applies irrespective of whether an application is in fact made by or one behalf of that entity or not. The registered auditor must possess written proof of an appointment to assist or advise the entity in connection with an application or prospective application for the Small Business Tax Amnesty to qualify for the exemption.

The exemption applies from 1 August 2006.

Transfer Duty ActSection 9 of the Transfer Duty Act was amended. A divorced spouse married out of community of property could not acquire the sole ownership in the whole or any portion of fixed property registered in the name of his or her divorced spouse exempt from transfer duty where that property or portion is transferred to that divorced spouse as a result of the dissolution of their marriage. The amendment ensures that transfer duty will not be payable on the acquisition of property as a result of the death of a spouse or divorce irrespective of whether the marriage was in or out of community of property.

Section 9B of the Income Tax Act, 1962 – Sale of listed sharesSection 9B of the Income Tax Act provides for the circumstances in which amounts received or accrued from the disposal of listed shares are deemed to be of a capital nature. This section applies in respect of all taxpayers, whether natural persons or companies. Section 9B(8), however, only applies in respect of companies. This section provides that amounts included in the income of a company as a result of the


25

application, disposal or distribution of a share in a manner contemplated in section 22(8)(b) (for example as a result of a donation of a share), must be deemed, for purposes of section 9B, to be an amount which accrued to the company as a result of the disposal of the share. There was no rationale for this provision applying only in respect of companies and the amendment extends its application to also apply in respect of natural persons and other entities.

The amendment is effective as from the commencement of years of assessment ending on or after 1 January 2007.

Section 12E of the Income Tax Act – Small business corporationSmall business corporations enjoy certain tax benefits, i.e. a beneficial rate structure, an immediate 100% write off in respect of manufacturing assets and an accelerated write off in respect of other assets. A small business corporation is defined in section 12E of the Income Tax Act, 1962, and one of the criteria is that the gross income for the relevant year of assessment did not exceed R6 million.

The Minister of Finance proposed in the 2006 Budget Review that the turnover limit for small business corporations would be increased from R6 million to R14 million. The amendment gives effect to this proposal and is effective as from the commencement of years of assessment ending on or after 1 January 2007.

Section 12H of the Income Tax Act – Learnership allowance

Government introduced the learnership tax allowance in 2002 to encourage on the job training and to enhance skills development in the Republic. This allowance, which was set to expire in October 2006, has boosted the number of learnerships.

The amendments are as follows:

The expiry date has been extended from October 2006 to October 2011, in line with the extension of the national Skills Development Strategy to 2010.

The maximum allowance upon the entering into a learnership is increased-

• from R17 500 to R20 000 for existing employees; and

• from R25 000 to R30 000 for new employees.

The maximum allowance upon completion of all learnerships is increased from R25 000 to R30 000.

The increased amounts apply to learnership agreements entered into on or after 1 March 2006.

Given the additional expenses associated with employing disabled persons as learners, a more favourable learnership allowance has been introduced and applies to learnership agreements entered on or after 1 July 2006 in respect of disabled learners. The new section 12H(2A) applies where the learner is disabled at the time of entering into the learnership agreement.

For purpose of this section ‘disabled’ means a person who falls within the definition of ‘people with disabilities’ as contained in section 1 of the Employment Equity Act 1998.

Existing disabled employees

The amount of the allowance for a registered learnership agreement entered into by that employer with that learner who at the time of entering into that agreement was already employed by the employer or an associated institution of the employer, is an amount equal to the lesser of-

• in the case of a leanership agreement with a duration of-

a) less than 12 months, 150% of the total amount of the remuneration of that learner for the period of that learnership agreement as stipulated in the employment agreement; or

b) 12 months or more, 150% of the annual equivalent of the remuneration of that learner stipulated in the employment agreement; or

• R40 000.


26

New disabled employees

If the employee was not employed by that employer or any associated institution in relation to that employer, is an amount equal to the lesser of-

• in the case of a learnership agreement with a duration of-



• R50 000.

Completion allowance for disabled employees

In the year of completion of the registered learnership agreement, the allowance is an amount equal to the lesser of-

• in the case of a learnership agreement with a duration of-



• R50 000.

Section 56 of the Income Tax Act – Donations tax thresholdThe annual donations tax exemption for natural persons has been increased from R30 000 to R50 000.

The increase applies to any donation which takes effect on or after 1 March 2006.

Paragraph 1 of the Fourth Schedule to the Income Tax Act – PAYE on motor vehicle allowanceAs mentioned by the Minister of Finance in the 2005 and 2006 Budget Reviews, the provisions relating to the motor vehicle allowances are amended as the allowance in the formula created an unfair bias in the structuring of salary packages with undue benefits accruing especially to higher income earners. Although the amendments to section 8 of the Income Tax Act address these concerns, the full amount of tax payable on the non-business related portion of the travel allowance only becomes payable on assessment. To ensure that the correct amount of income tax is collected through the employees’ tax system during the year, the percentage of the monthly motor vehicle allowance which should be subject to PAYE is increased from 50% to 60%.

The increase applies to any remuneration paid or payable on or after 1 March 2006.

Paragraph 9 of the Seventh Schedule to the Income Tax Act – Residential accommodationEmployees who receive free or discounted residential accommodation are subject to fringe benefit taxation. The amount of the abatement allowed in the formula for the determination of the rental value of residential accommodation in paragraph 9(3)(a)(ii) of the Seventh Schedule has been increased from R20 000 to R40 000 and the amendment gives effect to this proposal.

Paragraph 10 of the Seventh Schedule to the Income Tax Act – Free or cheap servicesCross-border travel benefits up to R500 for transport business employees were not subject to fringe benefit taxation. The R500 monetary cap rule has been deleted from both Para 10(1)(a) and 10(2)(a)(ii).

The amendment to Para 10(1)(a) means that any travel facility granted by an employer who is engaged in conveying passengers for reward by sea or air will be taxed as follows-


27

If the employer enables the employee or the employee’s relative to travel to a destination outside the Republic for private or domestic purposes, the employee will be taxed on the lowest full fare, less the amount of any consideration given by him or his relative for the facility.

The amended Para 10(2)(a)(ii) provides that no value will be placed on a travel facility granted by an employer who is engaged in the business of conveying passengers for reward by land, sea or air to enable an employee or an employee’s spouse or minor child to travel-

• to any destination in the Republic or to travel overland to any destination outside the Republic, or

• to any destination outside the Republic if such flight or voyage was made in the ordinary course of the employer’s business and the employee, spouse or minor child was not permitted to make a firm advance reservation of the seat or berth to be occupied.

Paragraph 12B of the Seventh Schedule to the Income Tax Act – Medical servicesThe cash equivalent of the value of the taxable benefit is the amount incurred by the employer during any month, directly or indirectly, for any medical, dental and similar services, hospital services, nursing services or medicines for that employee, his spouse, child or other relative or dependant.

Before the amendment Paragraph 12B(3)(a)(ii) provided that no value must be placed on any taxable benefit resulting from the provisions of medical treatment listed in any category of the prescribed minimum benefits determined by the Minister of Health in terms of section 67(1)(g) of the Medical Schemes,1998,

• which is provided to the employee or his spouse or children in terms of a scheme or programme of the employer which does not constitute the carrying on of the business of a medical scheme,

• if the treatment provided in terms of the scheme or programme is available only to employees of the employer who are not members of a registered medical scheme, and to the spouses and children of those employees.

Paragraph 12B(3)(a)(ii) has been amended to provide that no value must be placed in terms of paragraph 12B on any taxable benefit resulting from the provision of medical treatment listed in any category of the prescribed minimum benefits determined by the Minister of Health in terms of section 67(1)(g) of the Medical Schemes Act 131 of 1998,

• which is provided to the employee or his spouse or children in terms of a scheme or programme of the employer which does not constitute the carrying on of the business of a medical scheme,

• if the employee and his spouse and children are not beneficiaries of a registered medical aid scheme,

• or are beneficiaries of such medical aid scheme, and the total cost of that treatment is recovered from that medical scheme.


Section 1 of the Stamp Duties Act, 1968 – Definition of stampThe definition of ‘stamp’ has been amended consequential upon the introduction of electronic stamping. Adhesive revenue stamps and impressed stamps (franking machines) will be phased out and these provisions will become obsolete. The amendment will come into operation on a date to be fixed by the President by proclamation in the Gazette.

Item 14 of Schedule 1 of the Stamp Duties Act – Stamp duty on leasesCurrently item 14 of Schedule 1 to the Stamp Duties Act provides that stamp duty is not payable if the duty calculated on a lease or agreement of lease does not in aggregate exceed R200 over the period of the lease. In order to reduce the compliance burden for taxpayers entering into lower-value rental agreements and the administrative burden on the Commissioner, this exemption level has been increased to R500.

The amendment is deemed to have come into operation on 1 March 2006 and applies in respect of any lease agreement executed on or after that date.


28

Section 1 of the Value-Added Tax Act, 1991 – MunicipalitiesIntroduction

Where a local authority (municipality) charges municipal rates, that charge did not form part of the municipality’s taxable activities in terms of paragraph (c) of the definition of ‘enterprise’ in section 1 of the VAT Act. Consequently, municipalities could not claim any input tax on expenses incurred in connection with the services provided to the public at large, which are funded out of rates income. These services include the provision of fire services, street lighting, road infrastructure, public amenities such as parks and gardens, and the maintenance of those facilities. A result of the old dispensation was that it complicated the administration of VAT in a municipality in respect of the apportionment of input tax.

It was therefore announced in the Minister’s Budget speech on 15 February 2006 that municipal property rates will be zero-rated for VAT purposes with effect from 1 July 2006. Municipal property rates were always regarded to be in respect of a supply, however, it never formed part of the municipality’s taxable supplies, except where a flat rate charge in respect of municipal rates and other services was made by certain municipalities. Section 8(6)(a) of the VAT Act, as it read, deemed the supplies in that case to be subject to VAT at the standard rate.

Municipal rates are now brought into the VAT net as a charge for taxable supplies by the municipality, which fall within paragraph (a) of the definition of ‘enterprise’ in section 1 of the VAT Act. The aim of the amendments is primarily to unlock input tax related to non-taxable or ‘out of scope’ supplies which municipalities could not claim prior to 1 July 2006. In addition, it sought to simplify the municipality’s accounting and tax records.

Section 67 of the VAT Act provides that municipalities may increase their contract price for goods or services which were previously exempt or out of scope for VAT purposes. However, as the municipality will now be able to claim input tax which it previously could not, municipalities might not find it necessary to increase their prices. In some cases, the input tax which previously formed a part of the cost of the supply may put the municipality in a position where prices could be decreased. This is also partly because the services provided by municipalities are in any event generally subsidised with the municipal rates.

In order to achieve these aims, a number of amendments to the VAT Act had to be effected. The amendments intend to bring all the activities of the municipality within the scope of the ordinary test for an ‘enterprise’, except for those activities which are specifically exempt in terms of section 12 of the VAT Act (e.g. bus transport and rental of residential housing).

A Regulation for approval by the Minister in terms of either section 74(1) or (2) of the VAT Act, is to set out the arrangement for the purposes of the general administration of the Act and consequential transitional matters arising for municipalities, as a result of the deletion of paragraph (c) of the definition of ‘enterprise’ as defined in section 1 of the Act.

The activities listed in Regulation 2570 dated 21 October 1991, such as caravan parks, hiking trails, nurseries, game farms, etc. were only taxable if the municipality was able to at least break even on the associated costs of making those supplies. The effect of the amendments for the activities listed in Regulation 2570 is that the activities become taxable at the standard rate, as it falls within the enterprise with effect from 1 July 2006 without having to meet any profitability or breakeven requirement.

The above is achieved through the following amendments:

• The deletion of paragraph (c) and the deletion of the specific exclusion of a municipality in paragraph (a) of the definition of ‘enterprise’ in section 1 of the VAT Act. The list of activities contained in Regulation 2570 dated 21 October 1991 will become obsolete;

• The insertion of a definition for municipal rate;

• The insertion of a new zero-rating provision (section 11(2)(w) of the VAT Act) which applies in respect of municipal rate charges; and

• The blocking of all input tax adjustments on assets which were acquired prior to 1 July 2006, which will now be applied in a taxable activity.

Definition of a ‘designated entity’


29

A ‘municipal entity’ as defined in section 1 of the Local Government: Municipal Systems Act, 2000, does not fall within the definition of a ‘municipality’ as defined in section 1 of the VAT Act. The amendment includes a municipal entity in the definition of a ‘designated entity’ in section 1 of the VAT Act. Therefore, a municipal entity will be deemed in terms of section 8(5) of the VAT Act to supply services at the standard rate to the municipality or public authority respectively where that payment is not in respect of an actual supply in terms of section 7(1)(a) of the VAT Act.

Definition of an ‘enterprise’

The proposed amendment is to ensure that, as far as possible, all the activities of the municipality (except for those which are exempt under section 12 of the VAT Act) are brought within the ambit of paragraph (a) of the definition of ‘enterprise’. Since a municipality’s activities are now included in paragraph (a) of the definition with effect from 1 July 2006, there will no longer be a need for specific enterprise rules for municipalities. Paragraph (c) of the definition of ‘enterprise’ has been deleted.

The amendment ensures that the municipality levies VAT at the standard rate on all supplies, which are not otherwise zero-rated under section 11 or exempt under section 12 of the VAT Act. The municipality will, in turn, be entitled to claim the input tax incurred in carrying on those taxable activities under the normal rules for claiming input tax. However, there is an exception, in that no input tax adjustment will be allowed in terms of section 18(4) of the VAT Act where the municipality applies goods and services which it acquired on or before 1 July 2006 for taxable supplies on or after that date. In addition no future adjustments on any change in use of the said goods or services in terms of sections 18(2), (4) and (5) of the VAT Act will be required, as long as those goods or services continue to be used in the municipality’s enterprise.

Where a municipality imposes a penalty or fine, e.g. traffic fines, in respect of an unlawful activity, that charge is not taxable, as it is not in respect of any supply of goods or services by the municipality or provincial authority (as the case may be). Fines are generally levied in terms of provincial or national laws, or municipal bylaws, where the administration thereof is assigned to municipalities.

The collection of license fees in terms of the Road Traffic Act will not be in the course or furtherance of the municipality’s enterprise, as the actual charging/levying of the license fee is not in respect of the supply of any goods or services made by the municipality, but rather in terms of the authority of the Province (a public authority). However, where the municipality is paid/refunded a certain percentage of the licence fee collected on behalf of the Province, the municipality is liable to account for VAT at the standard rate on that amount, as it is in respect of the collection service which the municipality renders to the Province.

Where the municipality has the authority to levy fees for licenses, permits, or similar charges for access to facilities for its own account, that charge will be taxed at the standard rate of 14%.

Furthermore, where the Minister is satisfied that an activity of a municipal entity is of a regulatory nature and the Commissioner, in pursuance of a decision of the Minister, has notified that ‘municipal entity’ accordingly, the supply of goods or services in respect of that activity by that municipal entity will not be in the course or furtherance of an enterprise, and therefore not subject to VAT.

The definition of ‘local authority’ is replaced by ‘municipality’. The amendment is due to the term ‘local authority’ becoming redundant as various Acts applicable to the local sphere of Government, now refer to ‘municipalities’. The proposed amendments to sections 1 (definitions of ‘donation’, ‘grant’ and ‘person’), 8(5), 8(5A), 10(14), 11(2)(n), 11(2)(s), 15(2)(a), 15(2A), 23(3)(a), 23(3)(b), 46(c), 48(1)(a), 48(7) the proviso to 46, 48 and paragraph 5 of Schedule 1, are consequential upon the deletion of the definition of ‘local authority’ and the insertion of the definition of ‘municipality’ in section 1 of the VAT Act.

Definition of a ‘municipality’

A ‘municipality’ is now defined in section 1 of the VAT Act. It means an organ of the State within the local sphere of government, which exercises legislative and executive authority within an area determined in terms of the Local Government: Municipal Demarcation Act, 1998, and which has the power to levy a municipal rate in terms of section 2 of the Local Government: Municipal Property Rates Act, 2004, even if the power might not have been invoked. Therefore, all district municipalities are included in the definition of municipality as they all have the power to levy rates even though they may not be levying rates because they do not have a district management area in their present municipal area. However, a municipal entity will not be a ‘municipality’ as defined in section 1 of the VAT Act.


30

It is important to note that a municipality does not include any public entity listed in the Schedules to the Public Finance Management Act, 1999 (‘PFMA’). Therefore, it is clear that an entity which is listed in the PFMA cannot be a ‘municipality’ as defined in section 1 of the VAT Act.

Definition of ‘municipal rate’

The definition of ‘municipal rate’ is added to section 1 of the VAT Act. It means the amount levied in terms of section 2 of the Local Government: Municipal Property Rates Act, 2004 (Act No. 6 of 2004) by a municipality on ‘rateable property’ as defined in section 1 of that Act. This is to ensure that only the amount of property rates raised by the municipality is subjected to the zero rate and not the other charges for goods or services supplied by the municipality (e.g. water. electricity, entrance fees, sewage, etc).

A municipal rate does, however, not include:-

(a) a single charge levied by the municipality to an owner of rateable property for rates and other supplies such as, electricity, gas, water, drainage, removal or disposal of sewage or garbage or goods or services that are incidental to or necessary for the supply of such goods or services; or

(b) a rate levied in respect of supplies of goods or services as listed in (a) above.

The result will be that in the case where the municipality charges a flat rate as mentioned in (a) or a rate mentioned in (b) respectively, it will be taxable at the standard rate of 14%.

Liability of municipalities for tax and limitation of refunds

As a result of uncertainty in the past as to what constitutes a ‘transfer payment’, some municipalities applied the zero rate of tax to the deemed supply which arose in terms of section 8(5) of the VAT Act upon receipt of certain payments. For example, where a municipality received an ‘equitable share’ payment under the annual Division of Revenue Act, the payment gives rise to a deemed supply under section 8(5) of the VAT Act, which does not qualify for zero-rating in terms of section 11(2)(p) of the VAT Act as it read on 31 March 2005. As the municipality does not make an actual supply of goods or services in terms of section 7(1)(a) of the VAT Act in return for that payment, it is proposed that the VAT assessed on such payments qualifies to be reduced under this provision. In some of these cases, the incorrect application of the law has been corrected by the Commissioner by the issuing of assessments and the amounts due on these assessments are wholly or partly outstanding. If the tax due is to be paid by the Department which made the incorrectly treated ‘transfer payment’ to the municipality, additional funds would have to be made available to the municipality to pay the tax, which would result in a circular flow of funds in the Government sphere.

In order to address this situation, section 40B of the VAT Act provides that upon written application, the Commissioner must issue a reduced assessment in respect of certain amounts of tax, additional tax, penalty and interest which have been assessed and which are payable by a municipality. The reduced assessment only applies where, and to the extent that, the amount payable arose as a result of the incorrect application of the zero-rate in terms of sections 8(5) and 11(2)(p) of the VAT Act on an actual supply of goods or services made on or before 31 March 2005, and the amount is still outstanding on that date. This is where the municipality failed to charge VAT at the standard rate in terms of section 7(1)(a) of the VAT Act because it assumed that the payment in respect of those supplies qualified as a ‘transfer payment’ as defined in section 1.

The amount of the reduced assessment may not exceed the net balance of VAT which remains payable on 31 March 2005 by the municipality so that where any amount due to that municipality arose in any tax period subsequent to the tax period in which the assessment was raised and has been set off against the outstanding debt, or if any part of that amount has otherwise been recovered by SARS, that amount will not be taken into account. The reduced assessment may therefore not give rise to a refund of any tax, additional tax, penalty or interest paid in respect of the outstanding amount for any period prior to 1 April 2005.

In order to prevent the Commissioner from issuing assessments where no assessments have been raised before 1 April 2005 on the municipality, in regard to the incorrect application of the zero rate in terms of sections 8(5) and 11(2)(p) of the VAT Act for the period prior to 1 April 2005, the Commissioner may not raise any assessment to recover those amounts.


31

On the other hand, to prevent the claiming of refunds where the municipality has incorrectly paid output tax in terms of section 7(1)(a) of the VAT Act at the standard rate instead of the zero rate in terms of sections 8(5) and 11(2)(p) of the VAT Act on a “transfer payment”, section 40B(4) provides that the Commissioner may not refund any amount of tax, penalty or interest paid for a period prior to 1 April 2005.

Example 1

A municipality (vendor) supplies management services to the Department of Tourism. VAT should have been charged at 14% in respect of the actual services supplied in terms of section 7(1)(a) of the VAT Act, but both parties were under the mistaken impression that the payment received by the municipality was a zero-rated ‘transfer payment’. SARS raised an assessment against the municipality in the amount of R50 000 in March 2003. Since that date, SARS has recovered R35 000 of that amount by offsetting VAT refunds which were due to that municipality. The municipality still has a VAT liability of R15 000 plus penalty and interest thereon as at 31 March 2005. In terms of section 40B(2) of the VAT Act, the remaining tax liability of R15 000, plus the penalty and interest thereon must be reduced to nil by the issuing of a reduced assessment by the Commissioner, if written application is made by the municipality in this regard. This is because the entire tax liability relates to the incorrect application of the law referred to in that section.

Example 2

If in the case of the municipality in example 1, by 31 March 2005, SARS had not raised an assessment, in respect of the VAT payable on the consideration paid for the management services supplied, which should have been levied, in terms of section 7(1)(a) of the VAT Act, the Commissioner may not make any assessment to correct the previously incorrect application of the zero rate (section 40B(3) of the VAT Act).

Section 11 of the Value-Added Tax Act – BiofeulsIn his 2002 Budget Review the Minister of Finance announced the Government’s policy framework as regards environmentally friendly fuels.

The Minister announced that biofuels would-

• Enjoy a tax concession in respect of the general fuel levy;

• Enjoy the same concessions (i.e. rebates and drawbacks) as other fuels when used for certain purposes specified in any item to Schedule No. 4,5 and 6 to the Customs and Excise Act, 1964;

• Attract the same rate of excise duty applicable to other fuels;

• Be subject to the Road Accident Fund (RAF) levy if used in vehicles operated on public roads.

The amendment aligns the VAT Act to the provisions of the Customs and Excise Act, 1964, in respect of the references used for certain fuel levy goods. The amendment is also due to the supply of leaded petrol no longer being permitted as from 1 January 2006. The supply of certain fuel levy goods, which now also includes biodiesel, will be subject to VAT at the zero rate.

The amendment comes into operation on 1 April 2006.

Section 27 of the Value-Added Tax Act – Small scale farmers and other vendorsIn light of government’s efforts to ease small businesses’ administrative burden, the amendment increases the annual turnover limited to qualify as a small scale farmer falling within Category D or a small vendor falling within Category F from R1 million to R1,2 million.

The amendment came into operation on 1 July 2006 and applies in respect of any tax period commencing on or after that date.

Section 2 of the Tax on Retirement Funds Act – Tax rateThe Minister of Finance announced in the 2006 Budget Review that changes to the taxation of retirement funds are under consideration. To help South Africans accumulate adequate savings for retirement, the Minister proposed that the rate of tax on retirement funds be reduced.


32

Section 2 of the Tax on Retirement Funds Act provides for the levying and payment of tax on retirement funds. The tax was calculated at a rate of 18% of the taxable amount of an untaxed policyholder fund or retirement fund. The tax rate has been reduced to 9% for tax periods commencing on or after 1 March 2006.

Section 1 of the Uncertificated Securities Act, 1998 – Change in beneficial ownership of securitiesThe amendment clarifies that a change in the beneficial ownership of a security occurs when a company acquires or redeems its own securities

Section 5 and 5A of the Uncertificated Securities Act, 1998 – Change in beneficial ownership of securitiesThe amendments to section 5 and section 5A of the Uncertificated Securities Tax Act (UST) are in recognition of the fact that dividends and rights are on occasion ceded separately from the ownership of the full security.

The taxable amount on which UST is payable in respect of every change in beneficial ownership when the full beneficial ownership in a security is acquired will be the greater of-

• the amount declared by the person acquiring such security; or

• if no amount is so declared, or if the amount so declared is less than the lowest price of the securities on the date of the relevant transaction, the closing price of those securities on the date of the relevant transaction.

Where any of the rights or entitlements in the beneficial ownership of a security is acquired, the amount on which UST will be payable by the person who acquires those rights or entitlements, will be the greater of-

• the amount of the consideration declared by the person who acquires those rights or entitlements; or

• the fair market value of those rights or entitlements on the date of acquisition thereof.

The person who acquires the beneficial ownership of a security or who acquires any of the rights or entitlements shall be liable for the tax payable in respect of the change in beneficial ownership in a security or part thereof.

The amendments will apply to every change in beneficial ownership in any security effected by a participant on or after 1 July 2006 and for other transactions not effected by a member, on or after 1 January 2006.


33

THE REVENUE LAWS AMENDMENT ACT 20 OF 2006 AND SECOND REVENUE LAWS AMENDMENT ACT 21 OF 2006

The notes that follow draw extensively from the Explanatory Memorandum on the Revenue Laws Amendment Bill, 2006 and the Memorandum on the Second Revenue Laws Amendment Bill, 2006.

Section 1 of the Income Tax Act, 1962 – DefinitionsCompanyThe definition of ‘company’ now includes any co-operative.

Co-operativeThe definition of a ‘co-operative’ has been inserted and means a co-operative as defined in section 1 of the Co-operative Act 14 of 2006.

Section 1 of the Co-operative Act defines a co-operative as an autonomous association of persons united voluntarily to meet their common economic and social needs and aspirations through a jointly owned and democratically controlled enterprise organised and operated on co-operative principles.

ShareholderThe definition of ‘shareholder’ has been amended to include a member of a co-operative.

Connected personThe definition of a ‘connected person’ in relation to a company included:

i) its holding company

ii) its subsidiary

iii) another company, when both companies were subsidiaries of the same holding company

The amendment consolidates the above three paragraphs into a single paragraph as follows:

‘any other company that would be part of the same group of companies as that company as if the expression ‘at least 70%’ in paragraphs (a) and (b) of the definition of ‘group of companies’ in this section were replaced by the expression ‘more than 50%’

The amended definition of a connected person in relation to a company is-

• any other company that would be part of the same group of companies, if the expression ‘at least 70%’ in the definition of ‘group of companies’ was changed to read ‘more than 50%’;

• any person other than a company (as defined in the Companies Act) who individually or jointly (with any connected person of his) holds directly or indirectly, at least 20% of the company’s equity share capital or voting rights;

• any other company if at least 20% of the equity share capital of such company is held by such other company, and no shareholder holds the majority voting rights of such company;

• any other company if such other company is managed or controlled by-

aa) any person who or which is a connected person in relation to such first company; or

bb) any person who or which is a connected person in relation to a person contemplated in item aa) above.

DividendSubject to certain exclusions paragraph (c) of the definition has been amended and now provides that the redemption and reduction (other than as contemplated in (cA) of the definition (see below)) which is of share capital by a company (other than a collective investment scheme (see below)) triggers a dividend equal to so much of the sum of any cash and the value of an asset given to a shareholder as exceeds the cash equivalent of:


34

i) the amount by which the nominal value of the shares of that shareholder is reduced; or

ii) the nominal value of the shares so acquired from such shareholder.

Paragraph (cA) has been added to the definition which recognises a dividend in the event of the reduction of the capital of a company pursuant to that company acquiring its own shares by means of a distribution from any other company, the amount of any reduction of the profits of that company as were available for distribution to shareholders. Prior to this amendment the rules were unclear when a company recovered its own shares via a dividend from a subsidiary. This situation often arises in a group context if a subsidiary acquires shares of a parent company, followed by that subsidiary’s distribution of parent shares back to the parent. The amendment triggers the dividend treatment for the parent to the extent the parent’s earnings and profits are reduced (in addition to the usual dividend treatment for the subsidiary making the distribution).

It follows that share redemptions might trigger a dividend. Because collective investment schemes are companies, this redemption rule applies to redemptions by collective investment schemes. This dividend treatment (caused by redemption) can create uneven results between open-ended schemes and close-ended schemes because one form of scheme allows members to opt out via sales to third parties (including sales to management companies) while the other requires redemptions via the company. In the case of foreign collective schemes, dividends (caused by redemptions) are taxable at marginal rates whereas sales to third parties are generally taxable at capital gains rates (or exempt if sold by domestic collective investment schemes). In view of the above, the dividend treatment for all collective scheme redemptions has been eliminated.

The above amendments are effective from the date of promulgation of the Revenue Laws Amendment Act, 2006.

Section 8 of the Income Tax Act – Subsistence allowanceThe amendment to section 8(1)(c)(ii) provides that the Commissioner may determine the subsistence allowance rather than the Minister. In addition the allowance may now be determined by reference to a region or country.

It follows that the recipient of a subsistence allowance is deemed to have expended for each day or part of a day in the period during which he or she is absent from his or her usual place of residence, an amount in respect of meals and other incidental costs, or incidental costs only, determined by the Commissioner for that country or region, but limited to the amount of the allowance paid or granted to meet those expenses.

The current tax free rates relating to travel outside the Republic are likely to change in due course, the current rates are as follows:

• Travel in the Republic

- Allowance or advance to defray incidental costs only, R60 per day.

- Allowance or advance to defray the cost of meals and incidental costs, R196 per day.

• Travel outside the Republic

- Allowance or advance to defray the cost of meals and incidental costs, equivalent of US$190 per day.

Section 8C of the Income Tax Act – Vesting of equity instrumentsThe amendment extends the definition of market value to provide for the valuation of a private company where share incentive schemes are introduced for its employees.

The section 8C(7) definition of ‘market value’ now provides that in relation to a private company contemplated in section 20 of the Companies Act, 1973, or a company that would be regarded as a private company if it were incorporated under that Act, means an amount determined as its value in terms of a method of valuation–

i) prescribed in the rules relating to the acquisition and disposal of that equity instrument;

ii) which is regarded as a proxy for the market value of that equity instrument for the purposes of those rules; and


35

iii) used consistently to determine both the consideration for the acquisition of that equity instrument and the price of the equity instrument repurchased from the taxpayer after it has vested in that taxpayer.

In respect of any other company, the market value of an equity instrument means the price which could be obtained upon the sale of that equity instrument between a willing buyer and willing seller dealing freely at arm’s length in an open market and, in the case of a restricted equity instrument, had the restriction to which that equity instrument is subject not existed.

The above amendment is effective from the date of promulgation of the Revenue Laws Amendment Act, 2006.

Section 9D of the Income Tax Act – Controlled foreign companies (CFC)Since the introduction of the CFC regime in 1997, a number of amendments have come through in subsequent years to cater for the practicality of applying the provisions. We see further amendments in 2006.

Country of residence

The definition of a ‘country of residence’ has been added to the definitions and in relation to a CFC, it means the country where it has its place of effective management.

The country of residence definition is important for purposes of section 9D. Most of the anti-diversionary rules depend on whether a CFC operates within the CFC’s country of residence.

Some confusion existed as to the meaning of the ‘country of residence’ definition. Potential problems arose in situations where more that one jurisdiction had a claim on the tax residence of the CFC. Often the tax systems of two or more countries (including that of South Africa) could apply the definition with different meanings – at issue was which country’s perspective prevails.

In order to clarify the issue, the definition of ‘country of residence’ was amended to refer to the country where the CFC is ‘effectively managed’ (as opposed to country of incorporation) because the ‘effective management’ test is often utilized as the final tie-breaker for tax treaty purposes.

Foreign business establishment

The definition of a ‘business establishment’ is deleted and replaced with the definition of a ‘foreign business establishment’.

A CFC engaged in active foreign business generally does not result in South African taxable income. An exception applied if the business was truly active, had some nexus to the country of residence and was used for bona fide non-tax business purposes. The legislation set out several tests that were used in order to determine these features. Different sets of rules existed for ‘general’ places of business, places of extraction for natural resources; construction sites; farming; and international transport.

The definition of business establishment was found to be too rigid, making it difficult for South African companies that are conducting genuine non-tax business activities. Also, the definition failed to properly account for the country in which active business should be conducted. Lastly, confusion existed with regard to the locations for active business of international transport.

The amended foreign business establishment test is applied as follows:

1. Paragraph (a) - The general definition of foreign business establishment determines that the place of business must have a nexus in a single country outside South Africa.

2. Paragraphs (b) and (c) - The definitions of foreign business establishment for natural resource extraction/exploration and for construction now clarifying that these activities can take place at any location outside South Africa.

3. Paragraph (d) - The definition for a foreign business establishment in respect of agricultural land stipulates that the location must be within any single country outside South Africa.

4. Paragraph (e) - The definition of foreign business establishment has been relaxed for international transport, fishing and mineral resource exploration/extraction. These activities will now include


36

activities connected to ‘vehicles’ and ‘rolling stock’ (rail). Also, the current limitation that these activities must take place within a single country has been relaxed. Foreign business establishment transportation can now take place anywhere outside the Republic (in one or more foreign countries as well as international waters). It should be noted that temporary return of foreign transport to South Africa will not jeopardise foreign business establishment status as long as that return is not for purposes of generating transport income. Hence, the return of ships and aircraft solely for local repair will not be an issue. Similar concepts apply to fishing and natural resource exploration/extraction.

Other changes in terms of international transport, fishing and mineral resource extraction/exploration account for modern realities in terms of legal ownership of sizeable assets that need special ‘risk’ insulation. The new definition accordingly allows this aspect of the foreign business establishment test to be determined with reference to group companies operating in the same country of residence.

The definition of ‘foreign business establishment’, in relation to a CFC is important because in terms of section 9D(9)(b) income attributable to the foreign business establishment is disregarded i.e. it is not subject to tax in South Africa in terms of section 9D. The new definition reads as follows-

(a) a place of business with an office, shop, factory, warehouse or other structure which is used or will continue to be used by that controlled foreign company for a period of not less than one year, whereby the business of such company is carried on, and where that place of business-

(i) is suitably staffed with on-site managerial and operational employees of that controlled foreign company and which management and employees are required to render services on a full time basis for the purposes of conducting the primary operations of that business;

(ii) is suitably equipped and has proper facilities for such purposes; and

(iii) is located in any country other than the Republic and is used for bona fide business purposes (other than the avoidance, postponement or reduction of any liability for payment of any tax, duty or levy imposed by this Act or by any other Act administered by the Commissioner);

(b) any place outside the Republic where prospecting or exploration operations for natural resources are carried on, or any place outside the Republic where mining or production operations of natural resources are carried on, where that controlled foreign company carries on those prospecting, exploration, mining or production operations;

(c) a site outside the Republic for the construction or installation of buildings, bridges, roads, pipelines, heavy machinery or other projects of a comparable magnitude which lasts for a period of not less than six months, where that controlled foreign company carries on those construction or installation activities;

(d) agricultural land in any country other than the Republic used for bona fide farming activities directly carried on by that controlled foreign company; or

(e) a vessel, vehicle, aircraft or rolling stock used for the purposes of transportation or fishing, or prospecting or exploration for natural resources, or mining or production of natural resources, where that vessel, vehicle, rolling stock or aircraft is used solely outside the Republic for such purposes and is operated directly by that controlled foreign company or by any other company that has the same country of residence as that controlled foreign company and that forms part of the same group of companies as that controlled foreign company.

Paragraph b) of the definition of ‘foreign financial instrument holding company’ in section 9D(1) is amended and now reads as follows:

Foreign financial instrument holding company means a foreign financial instrument holding company as defined in section 41: Provided that in determining whether the prescribed portion of all the assets of the company and all influenced companies consist of financial instruments, the following assets must be wholly disregarded-

a) any share in any other company in the same associated group of companies; and

b) any instrument as defined in section 24J(1) entered into between companies which form part of the same associated group of companies:


37

Provided further that in making any such determination, paragraph (i) of the proviso to the definition of ‘foreign financial instrument holding company’ in section 41 shall not apply.

Section 9D(2A) defines the ‘net income’ of the CFC as the taxable income determined as if the CFC were a South African taxpayer. In arriving at the ‘net income’ certain adjustments must be made. The adjustment contained in proviso (c) has been amended and reads as follows:

‘no deduction shall be allowed in respect of any interest, royalties, rental or income of a similar nature paid or payable by that company to any other CFC (including any similar amount adjusted in terms of section 31) or any exchange difference determined in terms of section 24I in respect of any exchange item to which that CFC and other foreign company are parties where that CFC and that other CFC form part of the same group of companies, unless-

i) that resident has elected in terms of subsection (12) that the provisions of subsection (9) shall not apply in respect of the net income of that other CFC for the relevant foreign tax year, or

ii) that interest, rental, royalty, other income, adjusted amount or exchange difference is included in the net income of that other CFC;’

Following the introduction of the definition ‘foreign business establishment’, section 9D(9)(b) has been amended. This provides that when the net income is attributable to the foreign business establishment (including the disposal or deemed disposal of any assets forming part of that foreign business establishment) of a CFC, it must not be taken into account in determining the net income of the CFC.

Diversionary transaction rules provide for situation when the above exclusion does not apply.

In order to avoid taxation under the diversionary transaction rules, the CFC must have a bona fide business reason for operating in its particular country of residence outside South Africa. The ‘delivery’ test is one of the key tests used to determine if the CFC has this business rational by focusing on whether the CFC provides goods and services to local country end users (i.e. customers).

Multiple interpretation issues exist with regard to the meaning of ‘delivery’ (i.e. does this mean ‘legal’ delivery, how does one deal with in-transit shipping, etc…).

The amendment to section 9D(9)(b)(ii)(bb) and (cc) clarify that the term ‘delivery’ has a physical focus, not a legal one. In particular, physical delivery will be required to the client’s premises situated in the CFC’s country of residence. However, physical delivery need not be undertaken directly by the CFC (e.g. it could be effected by the customer or other parties). The policy in this area is to ensure that CFC’s operations have an appropriate nexus to the physical business needs of genuine local customers.

Services performed by CFCs

Section 9D(9)(b)(ii)(cc) taxed income derived from services performed by the CFC to a South African company unless those services are performed outside South Africa and those services relate directly to goods utilised outside South Africa. No exemption existed for services wholly unrelated to the provision of goods.

In a modern world, more and more services are provided without relation to underlying goods. While a need existed to be overly restrictive in this regard when the CFC regime was first established as an anti-avoidance measure, this regime has been relaxed in light of subsequent experience.

CFC services are no longer subject to taxation by virtue of the anti-diversionary rules in the following instances:

1. Section 9D(9)(b)(ii)(cc)(C) provides that CFC services mainly for clients situated in the same country of residence as the CFC will be exempt from diversionary treatment. No reason exists to tax services if they are rendered for legitimate client use in that foreign country.

2. Section 9D(9)(b)(ii)(cc)(D) provides that CFC services will no longer be subject to diversionary treatment if they do not give rise to South African deductions by a South African party holding a participation interest in that CFC. No potential for avoidance exists without a corresponding South African deduction that directly erodes the tax base. For example, assume South African company makes payment to fund R&D performed by its CFC outside the Republic, and this payment is not


38

allowed as a deduction. In this instance, the South African company is not eligible for deductions so no need exists to trigger CFC income (i.e. the denial of deductions can be matched against by the non-inclusion of income).

CFC sale of foreign intangibles

In 2005, the disposal of CFC intangibles became eligible for tax free treatment if:

(i) those intangibles were an integral part of CFC business activities;

(ii) was not acquired by that CFC within 18 months before the disposal at issue; and

(iii) the intangibles are disposed of as part of the disposal of the business to which the intangible was an integral part. In addition, this tax-free treatment applies only to intangibles created, devised and developed outside South Africa (South African intangibles is excluded. This exclusion of South African intangibles prevents double-dipping (South African deductions while the intangibles are created or enhanced in South Africa, followed by a tax-free sale of those intangibles by a CFC).

The 18 month holding period makes little sense any longer, especially in light of the exclusion for South African intangibles. Also, with regard to certain types of intangible property, it is difficult to decide the official commencement date of the 18 month holding period.

The 18 month holding period has been removed by the deletion of section 9D(9)(b)(iii)(cc)(B).

Matching of intra-group deductions and interest

Special rules exist for interest, royalties, rentals or income of a similar nature (including section 24I currency exchange differences) transacted between two CFCs that are part of the same group of companies held by a South African person having a direct or indirect participation interest in those CFCs. Normally, these items would give rise to a deduction and an inclusion of income on the other. Section 9D(2A) and (9)(fA) of the old CFC rules instead eliminated both the income and the offsetting deduction (acting as a form of offshore intra-group relief).

The mutual exclusion of matching deductions and income for offshore group CFCs was designed to assist taxpayers. Without this measure, CFC income could be trapped on one side of a South African taxpayer’s tax ledge without offset by the matching deduction (because separate CFCs can only give rise to net income, not net loss). This rule of mutual exclusion of deduction and income, however, does not work to the benefit of all CFC structures. Some CFC structures would instead benefit from a matching set of income and deductions once foreign taxes (and corresponding South African tax credits) are taken into account.

The amendment to section 9D(9)(fA) now makes the mutual exclusion of matching deductions and income for offshore groups CFCs elective. Taxpayers can either choose to include both the income and deduction or exclude both, based on the taxpayer’s individual circumstances.

The mutual exclusion rule is also extended for CFC intra-group situations falling outside section 9D(9)(fA). Situations can arise in which payments are deductible on one side but not taxable on the other by reasons other than section 9D(9)(fA). For instance, interest paid by one group CFC to another group CFC may be excluded from income under the working capital exception (section 9D(9)(b)(iii)(aa), not section 9D(9)(fA)). The new regime (section 9D(2A)) would accordingly deny the interest deduction because matching income is missing.

CFC ruling escape hatch

Over the years, issues have emerged in the context of CFCs that are very fact intensive. Writing prescriptive legislation has proven to be unhelpful (either too conservative (thereby hindering legitimate transactions) or too permissive (allowing for excessive tax avoidance).

Objective criteria often have the problem of being too theoretically prescriptive without accounting for the full scope of business realities (or for the variety of avoidance schemes). This problem escalates in the context of CFCs due to heightened level of complexity reflected in multinational cross-border transactions.

The amendment allows for a ruling system in terms of which the Commissioner can grant various CFC waivers on a case-by-case basis (so business practices can be properly balanced against avoidance without


39

going too far in either extreme). This process will allow for a series of informal rules to be developed that can later be legislatively codified. Rulings will only be given to the extent the Commissioner is satisfied that these rulings will not lead to an unacceptable erosion of the tax base. Any ruling issued by the Commissioner under these circumstances will generally be subject to the same procedures, terms and conditions as a SARS binding private ruling (with appropriate modifications).

Business establishment waiver for related CFC group employees, equipment and facilities

Under section 9D(10)(a)(i), the Commissioner may issue a ruling that allows a CFC to rely on related group CFCs when determining whether that CFC as a valid foreign business establishment under paragraph (a) of that definition. Reliance can be placed on related group CFC employees, equipment and facilities to the extent those CFCs are tax residents of the CFC at issue. Another key criteria is that this reliance on employees, equipment and facilities will be permitted only if the CFC’s place of business is integral or directly related to the group CFC on which reliance is placed.

Diversionary transaction waiver for centrally located operations

The diversionary rules generally subject certain sales of goods or services to immediate tax unless that CFC is providing goods and services to end-users within the same country of residence. However, occasions exist when a CFC locates itself in a country without tax being the dominant feature, even though no local end-users exist in that country. One circumstance in which this situation could arise is when a CFC is operating as a central location for goods and services to end-users in nearby countries.

In order to alleviate this circumstance, the Commissioner may waive the diversionary transaction rules if the CFC’s foreign business establishment serves as a central location for end-users in at least two neighbouring contiguous countries (section 9D(10)(a)(ii)). Contiguous means by land, but not by sea.

Passive income waiver for active royalties

Passive CFC income is generally subject to immediate taxation, even if attributable to a business establishment. Under current law, interest, dividends, capital gains, rents and royalties, etc... are largely viewed as passive. While some exceptions exist (such as the banking exception), no exception to passive treatment currently exists for royalties. Hence, royalties are always treated as passive, even if part and parcel of an active business. No prescriptive exemption was provided in terms of active royalties due to the inherently factual nature of the issue.

The Commissioner is now given the power to waive passive treatment for active royalties (section 9D(10)(a)(ii)). This waiver can be applied if that CFC directly and regularly creates, develops, substantially upgrades or adds value to (or provides substantial support services in respect of) intangibles giving rise to those royalties. The key is whether the activity is an ongoing value-enhancing process or merely a once-off event (followed by the mere collection of cash-flows).

Diversionary transaction and passive income waiver for high-taxed income

CFC taxation is mainly designed to prevent tax avoidance, but no tax avoidance can truly exist unless the shift outside South Africa reduces global taxation (aggregate taxes imposed by all countries). Under prior law, the designated country exception was designed to eliminate high-taxed countries from the ambit of CFC taxation, but this test eventually had to be scrapped as unsustainable. The most problematic aspect was the country list. The Commissioner is now given power to waive the diversionary transaction rules (subsection (9)(b)(ii)) and the passive income rules (subsection (9)(b)(iii)) for high-taxed CFC income on a case-by-case basis (without reliance on a country list). More specifically, this waiver will apply if the gross income of the CFC is subject to tax in a foreign country/countries that equals at least two thirds of the normal tax that would have been payable by the South African resident in respect of that CFC’s income (section 9D(10)(a)(iv)). The two-thirds calculation takes into account applicable tax treaties, tax credits and rebates of other countries. However, the two-thirds calculation ignores current and assessed losses (i.e. rate of tax on the CFC income at issue is largely analysed on a gross basis).

Financial services comparably-taxed waiver


40

Under the newly revised regime for foreign financial services, active foreign services will not be viewed as a foreign financial instrument holding company if that CFC conducts more business activity in the CFC’s country of residence than in any other single country (section 41 ‘foreign business establishment’ definition). Under the new rulings provisions, the Commissioner is given the power to disregard high-taxed activities in other countries outside the CFC’s country of residence (section 9D(10)(a)(v)). Income will be high-taxed under the same two-thirds test described earlier, except that the comparison is made between the CFC’s country of residence and the outside country (i.e. no comparison is made with South African taxes).

Commencement date

All the amendments to section 9D came into operation on 2 November 2006 and apply in respect of all years of assessment ending on or after that date.

Section 10 of the Income Tax Act – Foreign donor fundingSection 10(bA) has been added and provides for the exemption of the receipts and accruals of foreign governments, foreign government agencies and multinational organizations that provide foreign donor funding.

Section 10(c)(vi) has been added and provides for the exemption of salaries payable to foreign employees of foreign government agencies and certain multinational organisations.

Theses amendments apply to all years of assessment ending on or after 1 January 2007.

Section 10 and 30A of the Income Tax Act and Paragraph 65B of the 8 th Schedule to the Income Tax Act – Partial taxation of recreational clubsIntroduction

Subject to certain restrictions Clubs currently receive complete exemption from Income Tax in terms of section 10(1)(d)(iv)(aa). Furthermore any gain or loss upon the disposal of any asset used to produce this exempt income is disregarded for Capital Gains Tax purposes in terms of paragraph 64 of the Eighth Schedule.

The Commissioner has raised concerns regarding the tax treatment of Clubs. Clubs appear to be claiming exemption irrespective of whether their amenities are used by the general public or by their members. Furthermore, some clubs appear to be conducting a growing level of trading activities to raise funds in addition to membership contributions. The complete exemption enjoyed by recreational clubs is seen as iniquitous. Recreational clubs are treated more leniently than Public Benefit Organisations (PBOs). Previously, the income tax system provided complete exemption for PBOs, even if those activities included a small level of trading. Since 1 April 2006, a system of partial taxation was implemented. As a result, sizeable trading activities no longer put a PBO’s exempt status at risk. However, the quid-pro-quo of this change left certain trading activities of PBOs subject to taxation. This led to the review of the income tax status of clubs, which prior to the amendments could claim complete exemption – even for sizeable trading activities.

In view of the above, recreational clubs have become subject to a system of partial taxation. Clubs are now subject to exemption only to the extent their activities are based on the ‘mutuality principle.’ Under the mutuality principle, various taxpayers can join together for the sharing of expenses without that sharing triggering additional tax. In the case of recreational clubs, there is a sharing of ‘recreational’ expenses (e.g. expenses for sports and other capital facilities).

It appears that recreational clubs follow a sharing of expenses approach as their core business model (where they generally break-even annually). The common objective of clubs excludes pecuniary gain. The amendments narrow the exemption solely for these cost sharing situations. Income from non-members is generally subject to tax (i.e. leaving the members as a group largely in the same situation as if they had undertaken the activity without reliance on a separate legal entity).

The amendments are consistent with PBO rules. Section 10(1)(cO) is added to define the limits of the new system for partial taxation (separating exempt income from taxable income). Section 30A covers the conditions for exemption.


41

The new section 10(1)(cO))

The receipts and accruals of any recreational club approved by the Commissioner in terms of section 30A are exempt from income tax to the extent that they are derived:

(i) in the form of membership fees or subscriptions paid by its members;

(ii) from any business undertaking or trading activity that-

aa) is integral and directly related to the provision of social and recreational amenities or facilities for the members of that club (e.g. golf course fees and bar facility fees paid by members).

bb) is carried out on a basis substantially the whole of which is directed towards the recovery of cost; and

cc) does not result in unfair competition in relation to taxable entities;

(iii) from any fundraising activities of that club, which are of an occasional nature and undertaken substantially with assistance on a voluntary basis without compensation; and

(iv) from any other source (e.g. investment income and non-member income for club services and rentals) as long as these ‘other source’ receipts and accruals do not in total exceed the greater of:

aa) 5% of the total membership fees and subscriptions due and payable by its members during the relevant year of assessment; or

bb) R50 000.

This exemption is designed as a de minimis rule to keep smaller clubs off the register.

Similarly, expenditure incurred in producing exempt income (viz. levies, membership fees or subscriptions) cannot be offset against taxable club income falling outside the above categories.

Section 10(1)(cO) comes into operation on 1 April 2007 and applies to years of assessment commencing on or after that date.

Capital gains tax

Capital gains on the disposal of recreational club property will be subject to rollover treatment (i.e. exemption from capital gains tax with rollover of base cost). These rules essentially follow the same principles as the rollover provisions of paragraphs 65 and 66 of the Eight Schedule. The key condition is that all recreational club property must (i) be used mainly for providing social and recreational facilities, amenities and services and (ii) the property proceeds received on disposal must be reinvested in another recreational club directed-asset.

The new paragraph 65B of the Eighth Schedule reads as follows:

1) A recreational club approved in terms of section 30A may elect that this paragraph applies in respect of the disposal of an asset the whole of which was used mainly for purposes of providing social and recreational facilities and amenities for members of that club, where-

(a) proceeds accrue to that club in respect of that disposal;

(b) those proceeds are equal to or exceed the base cost of that asset;

(c) (i) an amount at least equal to the receipts and accruals from that disposal has been or will be expended to acquire one or more replacement assets all of which will be used mainly for such purposes;

(ii) the contracts for the acquisition of the replacement asset or assets have all been or will be concluded within 12 months after the date of the disposal of that asset; and

(iii) the replacement asset or assets will all be brought into use within three years of the disposal of that asset:

Provided that the Commissioner may extend the period within which the contract must be concluded or asset brought into use by no more than six months if all reasonable steps were taken to conclude those contracts or bring those assets into use; and


42

(d) that asset is not deemed to have been disposed of and to have been reacquired by that club.

2) Where a club has elected in terms of subparagraph (1) that this paragraph must apply in respect of the disposal of an asset, any capital gain determined in respect of that disposal must, subject to subparagraphs (3), (4) and (5) be disregarded when determining that club’s aggregate capital gain or aggregate capital loss.

3) Where a club acquires more than one replacement asset as contemplated in subparagraph (1), that club must, in applying subparagraphs (4) and (5), apportion the capital gain derived from the disposal of that asset to each replacement asset in the same ratio as the receipts and accruals from that disposal respectively expended in acquiring each of those replacement assets bear to the total amount of those receipts and accruals expended in acquiring all those replacement assets.

4) Where a club during any year of assessment disposes of a replacement asset and any portion of the disregarded capital gain which is apportioned to that asset, has not otherwise been treated as a capital gain in terms of this paragraph, that club must treat that portion of disregarded capital gain as a capital gain from the disposal of that replacement asset in that year of assessment.

5) Where a club fails to conclude a contract or fails to bring any replacement asset into use within the period prescribed in subparagraph (1)(d)(iii), that club must-

(a) treat the capital gain contemplated in subparagraph (2) as a capital gain on the date on which the relevant period ends;

(b) determine interest at the prescribed rate on that capital gain from the date of that disposal to the date contemplated in item (a); and

(c) treat that interest as a capital gain on the date contemplated in item (a) when determining that club’s aggregate capital gain or aggregate capital loss.

Paragraph 65B is effective as from the commencement of years of assessment ending on or after 1 January 2007.

The new section 30A

A recreational club means any section 21 company, society or other association of which the sole or principal object is to provide social and recreational amenities or facilities for its members (section 30A(1)). Club exemption is not automatic. Clubs must apply for Commissioner approval by providing copies of the club constitution or other establishment document (as well as subsequent submission of amendments) (section 30A(2)(a) and (b)). The Commissioner must grant approval if-

• the club carries on its activities in a non-profit manner;

• in respect of surplus funds, the club is prohibited from direct or indirect distribution thereof to any person during club operations or upon club dissolution (except as provided in (iii);

• on dissolution of the club it is required to transfer its assets and funds solely to any other club eligible for section 30A exemption or to certain PBOs;

• the club does not pay remuneration in excess of what is reasonable in the sector (nor bonus payments or commission based on a % of receipts and accruals), thereby preventing indirect profit distributions to employees;

• all members must be entitled to annual or seasonal membership; and

• members cannot be allowed to sell their membership rights or any entitlements thereof (again to prevent indirect profit distributions).

• the club does not participate in schemes to facilitate tax avoidance.

Penalties

Clubs in violation of section 30A risk losing their exemption if they do not rectify the position within a period specified by the Commissioner. In the event of the withdrawal of the approval by the Commissioner, the club must within 6 months take steps to transfer its remaining assets to another approved recreational club or specified PBO. If the club fails to transfer, or take reasonable steps to transfer its assets, an amount equal to


43

the market value of those assets that have not been transferred less its bona fide liabilities is deemed to be an amount of taxable income that accrued to it during the year of assessment when approval was withdrawn.

Effective Dates

Clubs will be given a transitional period in order to apply for approval for purposes of section 30A (section 30A(4)), much like the transitional period provided to PBOs under section 30. A reasonable transition period is especially important for smaller clubs who may not have the capability for speedy conversion.

Section 30A(4) provides that if a club applies for approval before the later of-

• 31 March 2009, or

• the last day of its first year of assessment,

then the Commissioner may approve that club for purposes of section 30A, or for the purposes of any provision contained in section 10 prior to the recent amendment, with retrospective effect.

Section 30A comes into operation on 1 April 2007 and applies to years of assessment commencing on or after that date.

Section 10(1)(h) of the Income Tax Act – Interest earned by non-residentsIf a non-resident acquires an interest bearing loan at a discount, the discount is deemed to be interest in terms of the provisions of section 24J of the Act. Section 10(1)(h) applied to interest in the common law sense and not to interest as defined in section 24J of the Act. Prior to the amendment, section 10(1)(h) provided that a non-resident is exempt on the ‘ordinary’ interest earned on the loan, but not on the discount (deemed to be interest in terms of section 24J of the Act) on the same loan. The amended section now includes interest as defined in section 24J.

The amendment comes into operation on 1 April 2007 and applies to years of assessment commencing on or after that date.

Section 10(1)(q) of the Income Tax Act – Scholarships and bursariesSection 10(1)(q) exempts bona fide scholarships and bursaries granted to an employee in order to study at a recognised educational or research institution from income tax in the employee’s hands. Taxation arose only if the Commissioner viewed the grant as a payment in lieu of salary (i.e., salary sacrifice). If an employer granted a bona fide scholarship or bursary to an employee’s relative, section 10(1)(q) provided limited relief (R2 000 per year) to relatives of low income employees.

The tax law also contained an anti-avoidance charge designed to dissuade employers from providing scholarships or bursaries as a form of salary sacrifice. Section 23(j) accordingly made these salary sacrifice payments non-deductible for employers.

Salary sacrifice as a component of the exemption created unnecessary difficulties in application. While justifiable as a matter of legal theory, this distinction makes little economic sense in light of the skills shortage within South Africa.

To simplify matters, the amendment provides that all bona fide scholarships and bursaries for employees will be tax-exempt regardless of whether or not elements of a salary sacrifice are present (section 10(1)(q)). Similarly, the denial of employer deductions for scholarship and bursary payments acting as a salary sacrifice were removed (i.e. section 23(j) was deleted).

Instead, bona fide scholarships and bursaries to an employee will be tax-exempt as long as the employee agrees to repay the employer if the employee fails to fulfil his or her scholarship or bursary obligation (section 10(1)(q)(i)). This repayment clause provides an incentive for employees to take their scholarship or bursary commitments seriously. However, the employee need not repay the employer if the failure directly results from death, ill-health, or injury (see also section 12H(5)(b) allowing comparable relief in terms of incomplete learnerships).

An inflationary adjustment was made to the R2 000 relief limit of bursaries or scholarships granted to relatives of employees. The new limit will be R3 000 (section 10(1)(q)(ii)).


44

The amended section 10(1)(q) reads as follows:

There will be exempt from tax ‘any bona fide scholarship or bursary granted to enable or assist any person to study at a recognised educational or research institution: Provided that if any such scholarship or bursary has been granted by an employer or an associated institution (as both are defined in the 7 th schedule) to an employee (as defined in the same paragraph) or to a relative of such employee in circumstances indicating that it would not have been granted had the employee not been an employee of that employer, the exemption of this paragraph shall not apply-

i) in the case of a scholarship or bursary granted to so enable or assist any such employee, unless the employee agrees to reimburse the employer for any scholarship or bursary granted to that employee if that employee fails to complete his or her studies for reasons other than death, ill-health or injury;

ii) in the case of a scholarship or bursary granted to enable or assist any such relative of an employee to study-

aa) if the remuneration derived by the employee during the year of assessment exceeded R60 000; and

bb) to so much of the scholarship or bursary contemplated in this subparagraph as in the case of any such relative exceeds R3 000 during the year of assessment.’

The amendment applies to all years of assessment commencing on or after 1 January 2007.

Section 10(1)(y) and (yA) of the Income Tax Act – Domestic and Foreign Government GrantsDomestic

Whilst considerable activity has been undertaken to clarify the VAT treatment of domestic government grants and assistance over the past few years, little comparable activity has occurred in respect of the Income Tax treatment. Most income tax exemptions for grants have been ad hoc with each form of exempt grant listed by name. In 2005 a generic provision was added with the decision for exemption left to the Minister (taking into account a variety of factors). Other issues at play involve collateral aspects of exemption to the extent exemption is available. These collateral aspects mainly relate to the depreciation and base cost of assets acquired out of exempt grant funds.

Foreign

South Africa is a recipient of Official Development Assistance (ODA). ODAs involve support from international donors in the form of grants and discounted financial assistance. International donors offering this support often seek to ensure that their support packages remain free from South African tax (mainly Income Tax and VAT) as a precondition for funding.

Reasons for change

Domestic

The tax relationship between the receipt of Government grants and the use of grant funds is not always clear. As a general rule, taxpayers should not be able to use tax-free grants to obtain subsequent tax benefits (i.e. ‘double-dip’). This ‘double-dipping’ may arise if exempt grant funds are used to acquire assets or operating expenditure, and the taxpayer then claims depreciation or deductible operating expense (as the case may be). Other instances arise in which Government may actively calculate the grant with an otherwise impermissible ‘double-dip’ in mind. Whilst some rules exist in this area, a comprehensive view seems lacking.

Another related issue involves Government payment for assets to destroy those assets. For instance, Government may acquire a sick animal solely to destroy that animal for health and safety reasons. As another example, Government is planning to acquire ‘unsafe’ taxis in order to terminate their use on the road. In both cases, Government is paying for the removal of those items for the general public good (i.e. to remove negative public externalities). These payments are currently treated as taxable exchanges without possible tax relief.

Foreign

The tax relief provisions within ODA agreements and their relationship to domestic tax law are not entirely clear. ODA agreements bear the stamp of the executive authority by virtue of section 231(3) of the Constitution. They do not however, override Parliamentary enacted legislation (only an act of Parliament can


45

alter another act of Parliament). Hence, SARS cannot comply with any exemption mandated by an ODA if that ODA is inconsistent with domestic tax law. The only remedy for a foreign party relying on an ODA agreement is to file a claim for a breach of that agreement (or to simply withdraw any further foreign donor support). Administrative problems also arise in terms of ODA agreements because of the uncertain role required of the Minister of Finance as well as communication of ODA relief to SARS. The net result is overall uncertainty that could deter future foreign donor support.

Amendments

Domestic

1. Anti-double-dipping rules

Government grants should not give rise to double-dipping regardless of whether those grants are used to fund assets or expenditure. The new regime disregards both subsequent expenditure and asset cost (for purposes of depreciation and for purposes of capital gains) if Government grants those exempt funds for purposes of acquiring the asset or funding that subsequent expenditure (section 23(n); paragraph 20(3)(b) of the Eighth Schedule).

The Minister, however, has the power to override this anti-double dipping rule if desired (proviso to section 23(n); proviso to paragraph 20(3)(b) of the Eighth Schedule). Instances may exist where Government will fund projects with the knowledge that double-dipping may be employed, and will accordingly take this double-dipping into account when setting funding amounts. In order to override this anti-double dipping rule, the Minister of Finance must state an intention to do so by way of notice in the Gazette.

2. Government scrapping payments

This proposal seeks to put Government scrapping payments on par with Government grants despite the fact that the grantee is disposing of an asset in exchange. As a general rule, these disposals will trigger gains and losses. However, the Minister of Finance may exempt the payment by way of notice in the Gazette (section 10(1)(y)). If the Minister of Finance exempts the payment, the collateral consequences follow the same path as exempt Government grants (i.e. no double dipping unless the Minister of Finance specifically desires otherwise when determining funding) (paragraph 64A(b) of the Eighth Schedule). A comparable rule exists in the VAT Act that will zero rate similar payments for sick animals (section 11(1)(r) of the VAT).

Foreign

ODA agreements potentially give rise to different consequences depending upon the nature of the agreement. In most cases, an ODA involves an outright grant of funds for the benefit of South African beneficiaries. The grant entails payment to foreign or local contractors with those contractors providing services/assets to assist South African beneficiaries (e.g. providing food, medical aid or housing).

Other less common forms of assistance may involve discounted loans or discounted technical services. In these latter cases, the foreign provider (i.e. foreign agency or multinational organization) may receive partial compensation (i.e. compensation at less than market value).

1. Grants

In the case of outright grants, the income tax issue at play is whether the contractor receiving foreign funds is exempt from tax on that receipt, even though that grant is for assisting South African beneficiaries (section 10(1)(yA)). Exemption under these circumstances requires several conditions:

i.) the grant must be within an umbrella ODA agreement pursuant to section 231(3) of the Constitution;

ii.) the grant must be pursuant to a project approved by the Minister of Finance after consultation with the Minister of Foreign Affairs;

iii.) the umbrella agreement must provide exemption as a precondition for funding; and

iv.) the Minister of Finance must announce his intent to exempt the grant by way of notice in the Gazette.

The rules against double dipping apply in terms of these grants without any Ministerial waiver (section 20(3)(n); paragraph 20(3)(b) of the Eighth Schedule).


46

In terms of VAT, project funding is zero-rated if approved by the Minister together with the Minister of Foreign Affairs. All taxable supplies made to the project will qualify for input tax deductions in the event that the Minister has approved the zero rating in terms of section 11(2)(q) of the VAT Act. If the Minister has not approved the zero-rating, the normal provisions of the VAT Act will apply.

2. Discounted loans and technical assistance

As discussed above, less common forms of assistance involve the foreign provision of discounted loans or technical services. These forms of assistance trigger potential tax consequences for the foreign party to the ODA (i.e. a foreign developmental agency or multinational organization). Foreign agencies will be exempt in these circumstances on the single condition that the agency has been appointed by a foreign government to administer the ODA (section 10(1)(bA)(ii)). Multinational organisations will only be exempt to the extent a project satisfies the same four conditions existing for independent contractors receiving grant funds to provide assistance (section 10(1)(bA)(iii)).

As dealt with earlier in these notes, foreign subjects (who are not South African tax residents) will receive exemption on their salary and emoluments. This exemption applies to agency employees if the agency is exempt and to multinational organisation employees to the extent of an exempt ODA project (section 10(1)(c)(vi)).

The amendments apply to years of assessment commencing on or after 1 January 2007.

Section 11(gB) of the Income Tax Act – Registration of intellectual propertyThe section has been extended to allow a tax deduction for expenditure incurred in registering and restoring patents and registering designs.

The amended section allows a tax deduction for:

• the grant, restoration or extension of a patent;

• the registration or extension of a design;

• the renewal of the registration of a trade mark.

The amendment applies in respect of expenditure incurred on or after 2 November 2006.

Section 11B of the Income Tax Act – Registration of intellectual propertySection 11B(2)(b) allowed a deduction for expenditure incurred for the-

• registration of any invention, patent, design, copyright or other property; and

• extending the period of legal protection, registration period, or the renewal of the registration.

The provision has been deleted for any expenditure incurred on or after 2 November 2006 and the deduction thereof is now dealt with in section 11(gB) (see above).

Section 11D of the Income Tax Act – Scientific or technological research and development

Position prior to the amendment

Section 11B of the Income Tax Act allows a 100% deduction for operating research and development (R&D) expenditure undertaken directly by the taxpayer (or by way of payment to any other person undertaken on behalf of the taxpayer). Expenditure incurred for the purpose of registering, extending or renewing any invention, patent, design, copyright or other intangible property is also fully deductible (even if that expenditure is otherwise of a capital nature).

In terms of capital expenditure, a depreciation allowance exists for the cost of any building, machinery or plant, utensils and articles used for the purpose of R&D. This allowance contains a write off period of 40% of cost in the 1st year that the asset is brought to use, followed by 20% for each of the following three years.

Reasons for change


47

Innovation, research and technological development are key factors for improved productivity (leading to new or improved products, processes or services). This enhanced productivity in turn leads to increased economic growth and international competitiveness. However, R&D is costly, involving high levels of technical risk. Given the high entry costs (and the indirect positive externalities for countries as whole), Governments sometimes provide extra support for local R&D via direct subsidies as well as through tax incentives (the latter of which operate as indirect subsidies). While South Africa offers a variety of direct subsidies for R&D, the South African tax regime for R&D does not provide substantial incentives. South Africa accordingly needs an improved set of R&D tax incentives to ensure that local R&D is not a global competitive disadvantage.

The amendment – New section 11D

Basic regime

The new regime for R&D contains two sets of incentives. Firstly, operating expenses will now be deductible at a 150 per cent level (section 11D(1)(a)). Secondly, the depreciation allowance for capital R&D will shift from the current 40:20:20:20 schedule to a new 50:30:20 schedule (section 11D(2)). Registration expenses incurred in registering, extending or renewing intellectual property (e.g. patents and designs) are fully deductible (section 11(gB).

In order for R&D expenditure to fall within this enhanced regime, R&D activities must be undertaken within South Africa (section 11D(1)(a)). In addition, this R&D must be performed for purposes of-

(i) The discovery of novel, practical and non-obvious information of a scientific or technological nature; or

(ii) The creation of any invention, patent, design or computer copyright or other similar property of a scientific or technological nature.

In other words, the R&D must be directed toward advancing scientific or technological knowledge (as opposed to routine learning associated with ongoing processes). Other forms of knowledge enhancement do not trigger incentives. For further clarity, section 11D(5) specifies forms of knowledge falling outside the incentive relate to:

(a) the prospecting for minerals or exploration for oil and gas,

(b) the management or enhancement of internal business processes,

(c) trade mark creation,

(d) social science and humanities, and

(e) market research, sales or marketing promotion

Part R&D Expenditure

In the case of expenditure partly for R&D purposes and partly for other purposes, the deduction of 150% of expenditure will be allowed to the extent that such expenditure is used for R&D purposes. Similar principles apply to buildings, machinery, plant, implements, utensils and articles partly used for R&D with only the R&D portion being eligible for the enhanced write off period of 50:30:20. Buildings (or parts thereof) will not be viewed as committed to R&D unless regularly used for R&D purposes and specifically equipped for R&D use (section 11D(4)).

Example:

Cost of the building is R1 000.

ResultR&D Building Use 50% 30% 20%

100% R&D use R500 deduction R300 deduction R200 deduction

25% R&D use R125 deduction R75 deduction R50 deduction

Recoupments


48

If a taxpayer recovers R&D expenditure that was already allowed as a deduction, this recovery will trigger a recoupment of that income. This recoupment equals the previously allowed deduction (not the expenditure) (section 11D(9)(a)).

Example

A taxpayer buys R100 of laboratory equipment for R&D purposes. The taxpayer is eligible for R150 of deductions. Taxpayer subsequently sells half the equipment for R60.

Result:

The taxpayer will be required to include R75 in income. The R75 amount represents recovery of 50% of the R&D expenditure.

If a taxpayer ceases using a building (or a part thereof) for R&D purposes, all deductions previously allowed will be recouped as income of the taxpayer. However, this recoupment is limited to 100% of the buildings cost to the taxpayer, less 10% for each year that the building, or part, was regularly used for such purpose (section 11D(9)(b)).

Example

A taxpayer buys a building for R1 000. The taxpayer uses the building for R&D activities for 7 months in that year and deducts a depreciation allowance of R500 in the first year. Six months into the following year, the taxpayer stops using the building for R&D purposes.

Result

Section 11D(9)(b) requires the taxpayer to include R500 of the allowance in income, limited as follows:

100% of cost of building R1 000

less 10% of the cost of the building for the one year of R&D use 100

900

The full R500 must be included in income.

No doubling of the 150% deduction

Special rules are required to prevent the artificial doubling of the 150% deduction in terms of the same activity. If a taxpayer hires another business to perform R&D on the taxpayer’s behalf, only the party that initially commits the funds obtains the benefit of the 150% deduction (section 11D(7)).

Example

A company hires Independent Contracting Business to conduct qualifying R&D activities on Company’s behalf. The company pays R1 000 for the activity with the company receiving control over that R&D. Independent Contracting Business spends the R1 000 on employees and equipment to satisfy the R&D contract.

Result

Only the company is eligible for the 150% deduction of the R1 000 expenditure. Independent Contracting Business is not eligible for the 150% deduction because it received the funds from the company to conduct the R&D. Independent Contracting Business would be eligible for a deduction of R1 000 for expenditure it incurred for conducting its business.

Government grants

The 150% deduction does not fully apply to R&D projects funded by Government grants (section 11D(8)). If a taxable Government grant is received by the taxpayer to fund the R&D expenditure incurred, the 150% is allowed only to the extent that the expenditure exceeds twice the amount of the Government grant. The net


49

result is that the 150% deduction does not apply in the case of 50/50 matching grants. If the Government grant is exempt from tax, no deduction is allowed equal to double the grant.

Example

A taxpayer receives a taxable government grant of R600. The taxpayer spends the R600 and an additional R1 400 on qualifying R&D activities.

Result

The taxpayer is eligible for the 150% deduction for only R800 (R2 000 – R1 200) of the R&D expenditure. The other R1 200 (R600 x 2) falls outside the 150% regime. The total deduction is therefore R2 400 which is 150% of R800 plus R1200.

Reporting requirements

Taxpayers claiming the 150% R&D deduction or the 50:30:30 R&D allowance must submit information about the R&D project to the Minister of Science and Technology (section 11D(11)). The Minister of Science and Technology will annually report to Parliament the number and type of R&D activities that qualified for the R&D incentives (section 11D(12)). The goal of this information reporting requirement is to measure the success of the new R&D incentives.

Effective Dates

The new R&D regime under section 11D will come into effect in respect of expenditure incurred on or after 2 November 2006.

Old section 11B

The old R&D regime under section 11B will no longer apply to any expenditure incurred on or after 2 November 2006, however if the 40:20:20:20 allowance was being claimed in terms of section 11B(3) for a building, machinery, plant, implement, utensils or articles of a capital nature brought into use for the first time on or before 2 November 2006, section 11B will continue to apply.

Section 12E of the Income Tax Act – Small business corporationsIntroduction

Co-operatives are taxed at the corporate tax rate of 29% and allowed special deductions on certain forms of income distributed to their members. However, co-operatives were not eligible for small business tax incentives provided in section 12E as they did not qualify as ‘small business corporations’ in terms of that definition.

Small co-operatives bore a heavier tax burden than their company and close corporation counterparts due to the lack of availability of small business relief. This resulted an undesirable situation for small entrepreneurs as to their preferred mode of business. It was mentioned in the 2006 Budget Review that the tax dispensation relating to co-operatives would be adjusted in light of the new Co-operatives Act of 2005.

The changes are limited solely to the small business rules of section 12E. This lack of overall change is largely due to the fact that the Co-operatives Act of 2005 is not yet operative, and the fact that the National Treasury is still gathering information on the business operation of co-operatives. Moreover, even when the Co-operatives Act of 2005 comes into effect, it will only apply after a three-year transition period.

Small business relief

The definition of ‘small business corporation’ has been amended by the inclusion of co-operatives. With this inclusion, co-operatives will fully enjoy the small business tax benefits provided in section 12E.

Membership in consumer co-operatives and friendly societies

Section 12E disqualifies small corporations from incentives otherwise granted therein if a shareholder (or member) of such small business corporation is also a shareholder (or member) of another corporation. This


50

disqualification (necessary to avoid business income splitting) is subject to certain exceptions. These exceptions relate to holdings in non-business entities, such as a body corporate established to provide housing for its members in a townhouse complex.

Along these lines, two other forms of non-business shareholdings (or membership) will now be permitted without triggering disqualification of small business relief (despite the technical holding of shares of membership interests).

• Firstly, natural persons will be allowed to act as members of non-business co-operatives without nullifying small business relief for otherwise qualifying small business corporations (section 12E(4)(a)(ii)(dd)). These non-business co-operatives include consumer buy-aids, social co-operatives (such as child nursery facilities) and funeral societies.

• Secondly, natural persons will be allowed to act as members of friendly societies (section 12E(4)(a)(ii)(ee)).

Investment income

The definition of ‘investment income’ in section 12E(4)(c) has been amended to limit rentals to those derived from immovable property only.

Personal service

The definition of ‘personal service’ in section 12E(4)(d) has been amended. The requirement to employ at least four full-time employees (other than any employee who is a shareholder or member or is a connected person in relation to a shareholder or member) has been relaxed to three or more.

The above amendments are effective as from the commencement of years of assessment ending on or after 1 January 2007.

Sections 18A, 30 and the 9th Schedule to the Income Tax Act - Public Benefit Organisations (PBOs)Since the complete revision of the tax system for PBOs in 2001, Government has continued to adjust the tax system in order to further assist PBOs. While most of the major issues have been resolved, the 2006 proposed amendments address certain anomalies.

Tax rates for PBO trading activities

PBO trading activities that result in taxable income are presently subject to tax based on the legal form of the PBO. If a PBO is registered as a company, its taxable income will be subject to tax at a rate of 29% whilst a PBO registered as a trust will be subject to tax at a rate of 40%.

The taxation of PBO trading activities at different rates causes an undue tax burden for PBOs operating as trusts (i.e. being subject to the 40%). Many PBOs are established as trusts to save administration costs or as a matter of convenience. No reason exists to discriminate in terms of rates purely on the basis of legal form, especially when all PBOs otherwise operate under the same general tax principles (unlike ‘for-profit’ companies and trusts, which operate differently for tax purposes).

The taxable income of all PBOs will be subject to tax at a flat rate of 29% for years of assessment ending during the 12 months ending on 31 March 2007.

Refining the PBO activity list

Housing PBOs

In 2003, Government expanded the scope of exempt housing PBO activities:

• the PBO limitation on housing assistance to poor and needy recipients was liberalised so that exempt housing PBO activities could include assistance for the benefit of low-income earners (i.e. households with income up to R3 500 as is consistent with the housing code.

• certain housing PBO activities qualified to receive tax-deductible donations.


51

• legislation not only covers direct procurement but other forms of housing assistance, such as subsidised housing loans (these only qualify for exemption; not eligibility for tax-deductible donations).

Despite the liberalisation in 2003, the scope of PBO housing activities was still too limited. Many legitimate organisations remained outside PBO relief.

The first amendment related to the current PBO housing ceiling which is increased to cover beneficiaries earning beyond R3 500 per month. The proposed level of increase will not be stated in the legislation but instead left to the Ministerial discretion, taking into account existing Housing Policy established by the Department of Housing (paragraph 3(a) of Part I of the Ninth Schedule; paragraph 5(a) of Part II of the Ninth Schedule).

The second amendment relates to PBOs that issue guarantees in respect of low income housing loans, and they will now be eligible for tax exemption under similar conditions as PBOs engaged in low income housing loans (as determined in the regulations issued by the Minister) (paragraph 3(f) of Part I of the Ninth Schedule).

Conservation, environment and animal welfare PBOs

Previously, only a limited number of PBO activities were eligible to receive tax-deductible donations. This limitation is due to the concern that deductible donations could lead to tax avoidance and/or undue erosion of the tax base. Conservation, environment and animal welfare generally fell outside tax-deductible donation status. On the other hand, PBOs carrying on the establishment and management of transfrontier conservation areas can receive tax deductible donations up to 31 March 2010.

Government has received ongoing requests to extend the list of PBOs eligible for tax-deductible donations so as to include conservation, environment and animal welfare. This extension was announced in the 2006 Budget and affected by notice in the Gazette on 26 April 2006. The extension has been included in the Income Tax Act by an amendment to section 18A and an extension of Part II of the Ninth Schedule to cover all activities listed under the heading ‘Conservation, Environment and Animal Welfare’ within Part I of the Ninth Schedule (paragraph 4 of Part II of the Ninth Schedule).

Foreign established charities

Most foreign charities fail to enjoy South African PBO status. This failure does not stem from the nature of the activity but by virtue of more technical aspects of South African tax legislation.

Many foreign charities established in developed countries seek to provide assistance around the world. These foreign charities typically receive most of their funding in their home country with a portion of funds allocated to the Southern African region. As a policy matter, foreign charitable donor support should be encouraged, but technical tax issues may act as a barrier, especially if that foreign support attracts South African income tax.

South African tax law requires all exempt PBOs to transfer all of their assets to another South African PBO (or to a South African sphere of government or to an exempt South African parastatal) upon dissolution. This requirement makes little sense for foreign charities. Donors and fiduciaries of a foreign charity cannot be expected to transfer their global assets to South African PBOs upon dissolution merely to satisfy South African PBO requirements.

Foreign established charities operating within South Africa should be exempt from South African tax on slightly different terms. Specific PBO exemption is now made for foreign charities operating as an agency or branch within South Africa (section 30(1)(a)(ii)). However, foreign PBOs of this nature must prove that they have PBO exempt status in their home country as a precondition for South African PBO exemption (section 30(1)(a)(ii)).

The key difference to a local PBO relates to the dissolution requirement. Upon dissolution, foreign established charities are no longer required to transfer their global assets to another South African PBO (or to a South African sphere of government or to an exempt South African parastatal) (section 30(3)(b)(iv)). Only local donations (or income or assets derived therefrom) of the foreign charity need satisfy the dissolution requirement. Foreign donations (or income or assets derived therefrom) can be transferred anywhere upon dissolution, even if controlled by branch or agency within South Africa upon dissolution.


52

Qualifying foreign established PBOs will receive full income tax exemption. However, in no case will a foreign PBO be eligible to receive tax-deductible donations (section 18A(1)).

Liberalising permissible PBO investments

PBOs were limited to a strict set of passive investments. Some of these investments required approval by the Financial Services Board and the Director of Non-Profit Organisations. If a PBO contravened the investment rules stipulated in the Income Tax Act, tax exempt status could be withdrawn. The permissible investments rules were designed to ensure that PBOs did not engage in risky passive investments or conduct passive investment on a scale that constituted trading activities.

The system of limiting investments for PBOs inhibited PBOs from receiving optimal returns on investments (which could then be applied for the public benefit). The tax system is not the appropriate place to assess financial risk, and the concerns against trading are already covered by other aspects of the PBO tax system.

The section 30(3)(b)(ii) limitations on permissible passive investments have been deleted with PBOs being allowed to invest as desired.

Capital gains on disposal of PBO assets

In terms of the old CGT rules, PBOs were subject to capital gains tax on sale assets not directly used for public benefit activities. This rule was consistent with the income tax act rules applicable to PBOs.

The application of these provisions created a problem on the assessment of CGT on assets that are used for dual purposes, e.g., for trading and public benefit activities or assets that undergo a change of use.

The new paragraph 63A(a) provides that a section 30(3) approved PBO, must disregard a capital gain or capital loss determined for an asset if it did not use that asset on or after valuation date in carrying on a business undertaking or trading activity.

The new paragraph 63A(b) provides that a section 30(3) approved PBO must disregard a capital gain or capital loss determined for an asset if substantially the whole of the use of that asset by it on or after valuation date was directed at-

i) a purpose other than carrying on a business undertaking or trading activity; or

ii) carrying on a business undertaking or trading activity contemplated in section 10(1)(cN)(ii)(aa), (bb) or (cc).

Paragraph 64(b) has been deleted because of the introduction of the paragraph 63A.

These CGT amendments apply as from the commencement of years of assessment ending on or after 1 January 2007.

Definition of PBO - Concept of public benefit

A non-profit organisation was regarded as a PBO if its sole object was carrying on one or more of the public benefit activities listed in the Ninth Schedule.

The ‘sole object test’ for purposes of determining whether a non-profit organisation would be classified as a PBO was too restrictive, especially given prior amendments recognising that PBOs could utilise trading activities as a source of funding.

The ‘sole object test’ has been relaxed. A non-profit organisation will be regarded as a PBO if its sole or principal object is carrying on one or more of the public benefit activities listed in the Ninth Schedule.

Paragraph (c) of the definition of ‘public benefit organisation’ required that the activities of a PBO be carried on:

i) for the benefit of or is accessible to the general public at large, including a specific sector of the general public, but not small and exclusive groups.

ii) each activity carried on by the PBO is for the benefit of, or is readily accessible to, the poor and needy; or

iii) the PBO is at least 85% funded by donations, grants from any organ of state or any foreign grants.


53

In line with the relaxation referred to above, ii) and iii) have been deleted with the result that only the i) remains.

Administration - Dual registration

Section 30(3)(g) required that a PBO register with the Director of Non-profit Organisations (NPO) as a precondition for exempt status. PBOs would be exempt from this dual registration requirement only if both the Director of the NPO and the Commissioner so approved.

The dual registration process caused an undue compliance burden for PBOs. The NPO Act’s registration requirements are voluntary and not mandatory. Many PBOs are accordingly of the view that NPO registration offers no benefits besides tax.

The dual registration requirement has been removed with the deletion of section 30(3)(g). SARS will now grant exemption to PBOs without NPO registration as a precondition.

However section 30(3C) has been inserted whereby the Commissioner, following a request from the Director of Non-Profit Organisations, may withdraw approval in terms of section 30(5) if a PBO is convicted of an offence under the NPO Act.

Miscellaneous administration – Provisional tax

Some PBOs may become provisional taxpayers with the advent of the partial system of taxation.

The impact of partial PBO taxation on provisional payments was not considered when partial taxation was imposed. Application of provisional payments in this context has accordingly given rise to unintended compliance and administrative difficulties.

Paragraph (a) of the definition of ‘provisional taxpayer’ in paragraph 1 of the 4 th Schedule has been amended and all section 30(3) approved PBOs are exempt from the provisional tax system. This exemption will last only for a three-year transitional period as from the first year of assessment commencing on or after 1 April 2007 (or a later date set by the Commissioner).

Miscellaneous administration – Withdrawal of approval

PBOs found in violation of section 30 or its founding document at it related to section 30 may have their PBO status withdrawn. If these violating PBOs failed to transfer their remaining assets to another approved PBO within the prescribed time period, they would be subject to tax on their accumulated net revenue that has not been transferred.

The calculation of the accumulated net revenue was difficult and time-consuming in many cases as the records (possibly dating back many years) that track historically accumulated profits had never been prepared.

Section 30(7) has been amended by the removal of the term accumulated net revenues. The amount that is deemed to be taxable income is equal to the market value of its assets that have not been transferred less an amount equal to its bona fide liabilities.

Commencement dates

The amendments to section 30 came into operation on 2 November 2006 and apply to years of assessment commencing on or after that date.

The amendments to section 18A are effective as from the commencement of years of assessment ending on or after 1 January 2007.

The amendments to the Ninth Schedule are effective from the date of promulgation of the Revenue Laws Amendment Act, 2006.



54

The amendment to section 23(k) extends the permissible deductions available to personal service companies and personal service trusts.

It now reads as follows:

‘No deduction shall be made in respect of any expenses incurred by-

i) a labour broker as defined in the 4th Schedule, other that a labour broker in receipt of a certificate of exemption issued in terms of paragraph 2(5) of the 4th Schedule;

ii) a personal service company as defined in the 4th Schedule; or

iii) a personal service trust as defined in the 4th Schedule,

other than other than any expense which constitutes an amount paid or payable to any employee of such labour broker, company or trust for services rendered by such employee, which is or will be taken into account in the determination of the taxable income of such employee and, in the case of such personal service company or personal service trust, any expense, deduction or contribution contemplated in paragraphs (c), (i) and (l), of section 11, expenses in respect of premises, finance charges, insurance, repairs and fuel and maintenance in respect of assets, if such premises or assets are used wholly and exclusively for purposes of trade.’


Section 24I of the Income Tax Act – Foreign currency transactionsSection 24I provides a comprehensive mark-to-market regime for foreign currency gains and losses that are largely designed to follow financial accounting. However, anomalies arise where section 24I is not in line with accounting because section 24I predates recent changes. One area of concern involves currency hedges for the acquisition of shares. Currency gains and losses to hedge these acquisitions often trigger tax consequences even though these gains and losses often go unrecognized in terms of income statements required by International Financial Reporting Standards. The amendment to section 24I(11A)) seeks to remedy situations of this kind.

More specifically, the new provision exempts currency gains and losses stemming from forward exchange contracts and foreign currency option contracts used to hedge foreign company acquisitions by residents. The acquisition must be of foreign shares amounting to at least 20% of the equity share capital of the foreign company to be acquired and the foreign company must qualify as a controlled foreign company in relation to the acquiring resident after the acquisition. However, given the elective nature of the financial statement rules in this area, the exemption for the gain or loss will apply only to the extent the gain or loss is not reflected in the income statement of the resident for International Financial Statement Reporting purposes.

The amendment applies to any acquisition of equity shares occurring during a year of assessment ending on or after 31 December 2006.

Section 24J of the Income Tax Act – Incurral and accrual of interestAll amounts payable or receivable in terms of an instrument are taken into account in determining the yield to maturity rate to be applied to calculate the interest incurral or accrual in terms of section 24J. The net amount receivable or payable is equal to the interest accrued or incurred under an instrument. An amendment ensures that amounts actually paid and received, taken into account to determine a yield to maturity rate or accrual amounts, do not qualify for a deduction under section 11(a), or are not included in gross income. The amendment to section 24J(5)(a) and (b) give effect to this.

The amendments are effective as from the commencement of years of assessment ending on or after 1 January 2007.

Section 26B and the Tenth Schedule to the Income Tax Act - Oil and Gas Exploration and ProductionSouth Africa’s investment regime for oil and gas exploration and production was established in terms of prospecting lease OP26 (granted in 1965). The OP26 agreement contains fiscal stabilisation clauses that freeze the Income Tax as of 1977. The net result is that oil and gas companies have a choice in terms of


55

each provision of the tax acts – choose the 1977 regime or the current regime (whichever the oil and gas company views as more favourable). This fiscal stabilisation regime acts as an incentive to invest in ‘high risk’ exploration activities that require substantial upfront capital investment.

While South Africa is rich in many hard minerals, South Africa has not shared the same success in respect of oil and gas reserves. Exploration over the past thirty years has revealed only small deposits offshore in the South and in the West (all of which are small in comparison to both global and regional standards). However, a few companies remain interested in the region, especially given recent high oil prices.

At issue is the pending termination of the OP 26 regime, which is expected to expire as of 30 June 2007. Uncertainty around the renewal of the fiscal provisions contained in OP 26 led to certain companies postponing any further investment until this uncertainty is resolved. Given the high risks and historically low rewards, few active companies in the area would remain interested if the key features of the OP 26 regime are not renewed.

Government intends to formalise key aspects of OP26 into explicit law, thereby creating transparency and certainty for oil and gas exploration/production. The new regime will be easier for SARS enforcement and taxpayer compliance because both sides will have improved access to the rules of the game. Core aspects of the regime will be renewed whereas lesser aspects will fall away.

New Tenth Schedule override

The amendments create a new Tenth Schedule. This Tenth Schedule creates a special override for oil and gas companies. Oil and gas exploration and production will essentially be subject to the provisions of the Income Tax Act including Secondary Tax on companies, subject to the provisions of the Tenth Schedule (all of which have overriding effect)(section 26B(1) and (2)). However, the General Anti-Avoidance Rule of Part IIA of Chapter III can be asserted notwithstanding the Tenth Schedule (section 26B(3)).

List of Tenth Schedule provisions

1. Coverage (paragraph 1)

The Tenth Schedule incentives apply only to oil and gas companies. In order to qualify as an oil and gas company, the company at issue must satisfy a two prong test.

First, the company must either hold an oil and gas right listed within the Mineral and Petroleum Resources Development Act, 2002 (Act No. 28 of 2002) or engage in exploration or production with respect to those rights. The companies can either be domestic or foreign residents.

Second, the oil and gas company cannot be engaged in any other form of trade (but can hold investments). For instance, foreign oil and gas operations would push a company outside the eligibility requirements of the regime because those foreign operations would constitute impermissible oil and gas company trade. Note that an oil and gas company includes a company that engages in refining of gas derived in respect of any oil and gas right held by that company.

The Tenth Schedule is mainly directed toward oil and gas income. Oil and gas income means the receipts, accruals or gains derived by an oil and gas company in respect of any oil and gas right. These receipts, accruals and gains can be derived from the sale of oil and gas commodities as well as the leasing or disposal of oil and gas rights.

Note: The definition of the “Republic” (within section 1) has been amended to take cognisance of South African Tax Treaty model, which makes reference to international law and is in line with same.

2. Income tax rates (paragraph 2)

This paragraph represents the prime fiscal stability feature. The rate of tax on South African oil and gas companies will not exceed the general 29% company rate, notwithstanding changes to other parts of the Income Tax Act. The rate for South African branches of foreign companies may not exceed 32% (in lieu of the 34% rate usually applied to foreign companies (as a proxy in lieu of the Secondary Tax on Companies (‘STC’)). Holders of OP26 rights currently are not subject to STC (see below) and as a result are not subject to the 3% (proxy) surcharge.

3. Dividend tax rates (paragraph 3)

As a general rule, distributions of oil and gas profits of an oil and gas company cannot be subject to tax at a rate in excess of 5% (paragraph 3(1)). Hence, the current Secondary Tax on Companies is limited to 5%. This general rule is subject to two deviations.


56

Firstly, any oil and gas company will receive the benefit of a zero% maximum rate if that oil and gas company’s sole oil and gas rights directly or indirectly stems from previously existing OP 26 rights (paragraph 3(2)). Hence, any oil and gas company holder of a new order oil and gas right receives the benefit of the zero% regime if that right relates to an OP 26 right previously held by that holder. Any holding of new order rights not stemming from these OP 26 rights prevents outright application of the zero% ceiling. This rule essentially rewards current participants who are arguably taking the highest risks (as opposed to later entrants who may emerge after more significant deposits are found).

Secondly, both the 0 and 5% ceilings will be non-applicable if that company is engaged in refining (i.e. is vertically integrated)(paragraph 3(3)); normal dividend taxes will apply. The goal is to assist entrants attempting to uncover new oil and gas finds, a high risk endeavour (not to assist processes such as refining that will undoubtedly occur within South Africa in any event).

4. Foreign currency gains or losses (paragraph 4)

Generally, currency gains and losses are subject to tax and determined with reference to the Rand. However, companies under the OP 26 regime are not subject to taxation of currency gains and losses. If the general rule for currency were to be employed, most oil and gas companies would be subject to currency gain and loss taxation on the bulk of their earnings (oil sales and purchases of equipment).

In order to maintain this relief, oil and gas companies can determine their currency gains or losses solely with reference to the currency translation method used by that company for financial reporting purposes (paragraph 4(1)). Hence, dollar based oil and gas companies can rely on the dollar as their base currency for tax purposes.

Notwithstanding the above, all taxes due must eventually be translated into Rands in order to make payment to SARS in Rands. This translation into Rands occurs by applying the average exchange rate for that year (paragraph 4(2); see section 1: ‘average exchange rate’ definition).

The currency used by an oil and gas company for financial reporting may only be changed with the approval by the Commissioner (paragraph 4(3)(a)). The Commissioner may allow this change only if satisfied that the change is not solely or mainly for the reduction of tax liability (paragraph 4(3)(b)).

Example:

Oil and Gas Company, a company with a December 31 financial year-end, uses the U.S. dollar as its currency for financial reporting. Oil and Gas Company sells oil for $100 million, makes purchases of $116 million. In terms of working capital, Oil and Gas Company generates $20 million and GBP5 million.

Result.

The U.S. dollar acts as Oil and Gas Company’s base currency for tax purposes. Currency gains or losses do not result from any U.S. dollar earnings. However in respect of the U.K. pounds, currency gains or losses are based on the difference between exchange rates between dollars and pounds. At financial year end, all taxes due (initially determined in dollars) must be translated into Rands (at the average exchange rate).

5. Oil and gas deductions (paragraph 5)

There are three sets of rules for oil and gas exploration and production expenditures (as opposed to other forms of expenditures, such as expenditures for refining). The first set deals with operating expenses (OPEX). The second set deals with capital expenditures (CAPEX). The third set deals with ring-fencing.

5.1 OPEX (paragraph 5(1))

All oil and gas operating expenditures are deductible to the extent those expenditures are for oil and gas exploration or production. These deductible expenditures implicitly include expenditures arising during pre-exploration or pre-production periods (as well as pre-exploration or pre-production finance charges).

5.2 CAPEX (paragraph 5(1) and (2))

Oil and gas capital expenditures are deductible like operating expenditure, but are also eligible for a percentage uplift. Oil and gas exploration capital expenditure generates an additional 100% deduction. Oil and gas production capital expenditure generates an additional 50% deduction. The uplift acts as an incentive to invest in high-risk, high cost capital expenditure that probably represents long-term sunken capital. Exploration is given a higher uplift due to the higher nature of the risk (and to compensate for the fact these losses will probably not be useable against income for a longer period than production expenses).


57

The above rules for capital expenditure are subject to one exception. Costs of acquiring oil and gas rights cannot be deducted (i.e. must merely be added to base cost for CGT purposes) unless that acquisition is covered by the participation treatment rules of paragraph 7(3)).

5.3 Ring-fencing (paragraph 5(3), 5(4) and 5(5))

As a general rule, all oil and gas exploration and production losses are ring-fenced against all oil and gas income and income derived from refining gas. No restrictions are imposed that would ring-fence the losses of a particular well against the income from the same well (i.e. there is no ‘per oil well’ ring-fencing). In addition, the new regime allows 10% of the excess losses to be used as an offset against other forms of income (e.g. investment income). The purpose of this rule is to provide relief for ordinary working capital. Any assessed loss remaining after the set off is carried forward to the succeeding year of assessment.

Example:

Oil and Gas Company generates $192 million in oil production receipts plus another $25 million from bond interest on working capital. Oil and Gas Company incurs $80 million in oil operating expenditures as well as $60 million for oil capital expenditures (i.e. for a new oil rig).

Result.

Oil and Gas Company has total oil losses of $200 million ($80 million plus $120 million (i.e. $60 million times 2). This $200 million amount completely offsets the $192 million amount, leaving an $8 million excess. Of this $8 million excess, $800 000 can be used to offset the $25 million working capital income. At the end of the day, Oil and Gas Company is taxed on the $24.2 million of interest income ($25 million – $800 000) and has $7.2 million of excess oil and gas loss ($8 million – $800 000) as a carry forward into the following year.

6. Thin capitalisation (paragraph 6)

Generally, the income tax system has rules against thin capitalisation. Thin capitalisation prevents taxpayers from deducting interest in respect of excessive amounts of debt in relation to equity. The Tenth Schedule provides a safe harbour against the thin capitalisation rules found elsewhere in the Income Tax (i.e. section 31(3)).

The thin capitalisation safe harbour involves two basic steps.

First, the oil and gas company determines whether it owes interest-bearing loans, advances or debts to foreign connected persons in relation to that company (loans, advances or debts are interest bearing for a particular year only if they bear interest that year).

Second, those loans, advances or debts are measured against the total fixed capital of that company.

If those loans, advances or debts do not exceed three times the value of the total fixed capital (being share capital, share premiums and accumulated net realised and unrealised profits), the oil and gas company is free from any thin capitalisation rules found elsewhere. Fixed capital take net accumulated profits into account, net accumulated losses are implicitly ignored. The three-to-one measurement is calculated on the last day of the oil and gas company’s year of assessment.

The Commissioner may disregard excessive levels of debt if that excess occurs only for temporary periods.

Example:

Company X, a South African oil and gas company with a December 31 financial year-end, is wholly owned by Foreign Company. Company X owes R600 million to various independent banks as well as R300 million to Foreign Company. All loans are interest bearing. Company X has received R150 million to date for the issue of its equity shares outstanding (but only has a history of accumulated losses).

Result.

Regardless of the existence of section 31(3) or any earlier thin capitalisation rules, Company X will not be disallowed from deducting any interest (or finance charges) in relation to its loans owed to Foreign Company because its loans are viewed as excessive in relation to fixed capital. The R600 million of Foreign Company debts do not exceed the three-to-one ratio in terms of total equity outstanding at the end of the year (i.e. which is equal to R150 million).

7. Disposal of oil and gas rights (paragraph 7)

7.1 Additional options (paragraph 7(1))


58

Special rules apply to disposals of oil and gas rights by oil and gas companies. In addition to the basic rules provided elsewhere in the Income Tax Act, the Tenth Schedule contains two elections. The oil and gas company disposing of any oil and gas right to another company may elect to have either rollover treatment or participation treatment. The election may be in the form and manner determined by the Commissioner (who may, among others, find it necessary for the disposing company to send official notice to the acquirer). These elections apply only to oil and gas rights that have a market value in excess of tax cost (i.e. base cost in the case of a capital gains asset or cost price in the case of trading stock). Loss assets (i.e. those with a tax cost in excess of market value) simply trigger losses upon disposal as allowed elsewhere in the Income Tax Act.

7.2 Rollover treatment (paragraph 7(3))

If rollover treatment is elected, the selling oil and gas company is deemed to have disposed of an oil and gas right for an amount equal to the tax cost of the right disposed of, regardless of whether that right is a capital asset or trading stock. The net effect is to eliminate all capital or ordinary gain upon disposal for the seller. The acquiring company is similarly deemed to have acquired the oil and gas right for the same tax cost (i.e. the tax cost rolls over from the seller to the buyer). This regime essentially follows the same paradigm as Part III of Chapter II of the Income Tax Act (company restructuring rules). The rollover regime allows the seller to avoid gain with the purchaser bearing the price of acquiring the seller’s reduced tax cost (in lieu of a market value tax cost).

7.3 Participation treatment (paragraph 7(3))

If participation treatment is elected, the selling oil and gas company treats all gains on the disposal of an oil and gas right as ordinary revenue regardless of whether that right is capital or trading stock. Meanwhile, the acquiring company, if an oil and gas company, obtains an immediate deduction equal to the deemed ordinary revenue gain included by the selling company. The participation regime essentially allows the transferor to transfer ordinary losses to the acquirer.

Example:

Company X, an oil and gas company, holds multiple oil and gas rights off the South African coast, including a Block A offshore right. Company X acquired the off-shore right for $30 million and that right is worth $100 million as of 15 July 2008. Company X has $400 million in excess oil and gas losses. Company X has agreed to sell the Block A offshore right for $100 million in cash to Company Y, another oil and gas company. Assume Company X held the oil and gas right as a capital asset before the sale.

Result.

Both Company X and Company Y have three choices:

(i) If no election is made, basic capital gains tax principles apply. Under this scenario, Company X has $70 million of capital gain ($100 million – $30 million). Company Y meanwhile obtains a $100 million base cost in the oil and gas right acquired.

(ii) If a rollover election is made, the sale does not trigger any capital gains tax for Company X. Company Y obtains a $30 million base cost in the oil and gas right acquired.

(iii) If a participation election is made, Company X has ordinary revenue equal to $70 million (which will be offset by the $400 million of excess losses). Company Y obtains a $70 million immediate deduction and obtains a $30 million amount as the tax cost in the oil and gas right acquired.

8. Fiscal stability (paragraph 8)

A fiscal stability clause is viewed as important tool to facilitate future oil and gas investment (given the high costs of initial sunken capital, combined with high risk and delayed potential profit). The revised regime will accordingly provide fiscal stability on a company-by-company basis. In order to effectuate this regime, the Minister of Finance will be given the power, after consultation with the Department of Minerals and Energy, to enter in fiscal stability agreements when each oil and gas company receives a ‘new order’ oil and gas right.

This fiscal stability agreement will remain in place over the full life of a ‘new order’ right. In addition, fiscal stability will remain if exploration rights are renewed or are converted into a production right. However, oil and gas companies may unilaterally rescind these agreements if so desired (i.e. if subsequent tax law becomes more taxpayer favourable than the regime currently proposed).

Example:


59

Company X, an oil and gas company, enters the region in 2007 for the purpose of oil exploration and production. Company X obtains an oil and gas right in 2007. Company X renews the exploration right in 2012 and eventually converts that right to a production right in 2014. In 2044, Company Y renews the production right.

Result.

The Minister has the power to enter into a fiscal stability agreement with Company X. If the agreement arises in 2007, the 2007 version of the Tenth Schedule remains in effect from 2007 through 2044 (the full period of the initial exploration right, the period of exploration renewal and the period of the initial production right). The Minister may choose to enter into a new agreement on 2044 with the terms set by the tax law on that date.

Effective date

The new oil and gas regime will become operational on 2 November 2006 in respect of any year ending on or after that date.

Section 37A of the Income Tax Act – Mining environmental rehabilitation fundsIntroduction

In terms of the Mineral and Petroleum Resources Development Act of 2002 (MPRDA), mining companies must make financial provision for the environmental rehabilitation of mining areas upon closure. Methods used for financial provision include reserves set aside within a rehabilitation company, society, association or trust (i.e. a rehabilitation fund). Contributions to these funds are deductible, and the growth in these funds is tax-free. The tax system provides these benefits as an incentive for environmental preservation.

While Government is comfortable with the objectives of the rehabilitation fund mechanism, this mechanism has given rise to practical administrative problems, including:

(i) a lack of co-ordination between the Department of Minerals and Energy (DME) and South African Revenue Services (SARS) in terms of approvals and regulatory provisions;

(ii) unnecessary complexities in terms of the deduction contribution formula;

(iii) concerns about compliance in terms of fund document amendments; and

(iv) various uncertainties and complexities involving contraventions by rehabilitation funds.

The amendments unify the deduction contribution rules of section 11(hA) and the exemption rules of section 10(1)(cH). The changes address the above-mentioned concerns and ensure that all contributions, distributions and withdrawals cater solely for mining rehabilitation upon closure.

The new unified regime contains the same tax benefits as the previous mining rehabilitation regime. Contributions are deductible in terms of the new section 37A and fund growth is exempt from tax in terms of the new section 10(1)(cP). A benefit of the new regime is the removal of the formula limit previously contained in section 11(hA), section 37A allows for all contributions to the rehabilitation fund to be tax deductible.

Eligible contributing parties

Section 37A(1)(d) allows for a wider group of persons to be eligible for deductible contributions, namely-

(i) Holders of new and old order mineral rights as classified under the Mineral and Petroleum Resources Development Act, 2002 (Act No. 28 of 2002);

(ii) Persons engaged in prospecting, exploration, mining or production in terms of new and old order mineral rights as classified under the Mineral and Petroleum Resources Development Act, 2002 (Act No. 28 of 2002) (even if no mineral rights are held by those persons); and

(iii) Any person, after approval by the Commissioner, paid cash to that company or trust and that payment was not part of any transaction, operation or scheme to shift the deduction from another person in favour of the person seeking approval.

Example 1:


60

Company X owns 70% of the shares of Company Y (with the other 30% held by an independent trust formed on behalf of various individuals). Company Y is a special purpose vehicle that merely holds a new order mineral right. Company X engages in all mining activities with respect to that right.

Result.

Both Company X and Company Y may make deductible contributions to a mining rehabilitation fund. Company Y holds the right, and Company X is engaged in mining with respect to that right.

Example 2:

Company Z has entered into a long-term agreement for the purchase of coal generated from a new order right held by Company X. Company Z converts all the coal to energy on a regular basis. As part of the long-term agreement, Company Z agrees to regularly contribute to the mining rehabilitation fund established for the new order mining right.

Result.

Company Z can make deductible contributions to the mining rehabilitation fund after approval from the Commissioner. No reason exists for the Commissioner to deny this approval solely based on these facts.

Eligible mining rehabilitation funds

Mining rehabilitation funds are eligible for incentives only upon certain conditions, as provided below. These conditions are essentially the same as prior law with a few technical adjustments and clarifications (note: funds have been limited to trusts or company legal forms, as only these forms currently exist in practice).

(i) The funds must have the sole object of mining environmental rehabilitation in terms of rights governed by the Mineral and Petroleum Resources Development Act, 2002 (Act No. 28 of 2002) on premature or final closure, decommissioning, and to deal with post closure latent environmental impacts (section 37A(1)(a)).

(ii) The funds can only hold permitted assets (section 37A(2)). These permitted assets are mainly limited to various forms of well regulated domestic financial instruments (including shares) subject to domestic regulation (section 37A(2)(a)). The only significant deviation is for other investments held before 18 November 2003 (i.e. before the effective date of the initial requirement)(section 37A(2)(d)). The goal is to limit the investment portfolio to assets that are relatively liquid and easy to value (for the benefit of regulatory oversight). Funds cannot invest in financial instruments issued by persons making contributions to the mining rehabilitation fund at issue.

(iii) The funds cannot make impermissible distributions (section 37A(1)(c)). In other words, funds cannot withdraw benefits for reasons other than for mine rehabilitation on closure. Moreover, excess reserves available on completion of rehabilitation will not revert to taxpayers. Excess reserves must be transferred to another fund established by the taxpayer for mining rehabilitation activities (or to a general trust account prescribed by the Minister of Minerals and Energy and subject to approval by the Commissioner) (section 37A(3)). Excess amounts held by funds (i.e. amounts exceeding the anticipated mining rehabilitation liability) can also be transferred to other funds before termination with approval from both the Minister of Minerals and Energy and the Commissioner (section 37A(4)).

Penalties

The new mining rehabilitation regime wholly revises the penalty system for contraventions in order to simplify administration. The new regime contains three penalties:

(i) If the company or trust holds impermissible investments (investments outside the list prescribed in section 37A(2)), the entity is taxed on the market value of those impermissible assets as if that market value was fully received as income (section 37A(6)).

(ii) If the company or trust makes impermissible withdrawals (e.g. used for other profit making activities not related to rehabilitation or closure), section 37A(7) will tax these withdrawals at market value in the hands of the persons defined in section 37A(1)(d).


61

(iii) The Commissioner may, as he deems necessary, penalties equal to twice the market value of all property held if a trust or company is in violation of any provisions (including the holding of impermissible investments of the making of impermissible withdrawals) (section 37A(8)).

Effective dates

The new regime will have an effective date for years of assessment commencing on or after 2 November 2006. In terms of deductible contributions, the formula approach of section 11(hA) will be limited solely to years of assessment commencing before 2 November 2006 (section 37A(1)).

Deductions previously deferred for being in excess of the amount allowed by the formula will continue to be deferred as long as the pre-effective date regime still applies. If any excess remains afterwards, it will become immediately deductible at the end of the first year of the new regime (because the excess will no longer be limited by the formula).

Insertion of Part IIA of Chapter III of the Income Tax Act – General anti-avoidance ruleSection 103 of the Income Tax Act contained the General Anti-Avoidance Rule (GAAR). In order to invoke section 103 the Commissioner had to be satisfied that four elements exist. These requirements were as follows -

1. There must be a ‘transaction, operation or scheme’;

2. It must result in the avoidance, reduction or postponement of a tax contained in the Income Tax Act;

3. It must have been entered into or carried out in a manner not normally employed for bona fide business purposes, other than obtaining a tax benefit or it must have created rights and obligations that would not normally be created between persons dealing at arm’s length for a transaction, operation or scheme of that nature; and

4. It must have been entered into solely or mainly for the purpose of avoiding, postponing or reducing a liability for payment of any tax, duty or levy imposed under any law administered by the Commissioner.

Once the second requirement was satisfied, a rebuttable presumption arose that the sole or main purpose of the transaction was to obtain a tax benefit.

The requirements remained the same outside the context of business, except that the first leg of the third requirement is satisfied if the transaction, operation or scheme is entered into or carried out in a manner that would not normally be employed for a transaction, operation or scheme of that nature.

When the requirements to invoke section 103 had been satisfied the Commissioner was empowered to determine liability for tax as if the transaction had not been entered into or carried out, or, alternatively, ‘in such manner as in the circumstances of the case he deems appropriate for the prevention or diminution of such avoidance, postponement or reduction’.

Section 103(1) has proven to be an inconsistent and, at times, ineffective deterrent to the increasingly sophisticated forms of impermissible tax avoidance that certain advisors and financial institutions are putting forward and being implemented by some taxpayers. In addition it has become clear that section 103(1) provisions have not kept up with international developments. Finally, uncertainty has arisen with respect to the application of section 103(1) in the alternative due to conflicting Court decisions in this regard.

Section 103(1) has been deleted and the new GAAR is inserted as Part IIA of Chapter III of the Income Tax Act. It opens by describing what an ‘impermissible avoidance arrangement’ is in section 80A. The powers that the Commissioner has over an impermissible avoidance arrangement are set out in section 80B. The remaining provisions expand on these first two provisions and deal with certain procedural issues that arise.

The requirements for an impermissible avoidance arrangement may be summarised as follows.

1. An arrangement,

2. plus the tax effect

3. results in an avoidance arrangement

4. plus the sole or main purpose is tax avoidance,


62

5. plus a tainted element,

6. Results in an impermissible tax avoidance

Section 80L

This section contains the definitions.

‘arrangement’ means any transaction, operation, scheme, agreement or understanding (whether enforceable or not), including all steps therein or parts thereof, and includes any of the foregoing involving the alienation of property.

‘avoidance arrangement’ means any arrangement that results in a tax benefit.

‘impermissible avoidance arrangement’ means any avoidance arrangement described in section 80A.

‘party’ means any-

a) person;

b) permanent establishment in the Republic of a person who is not a resident;

c) permanent establishment outside the Republic of a person who is a resident;

d) partnership; or

e) joint venture,

who participates or takes part in an arrangement.

‘tax’ includes any tax, levy or duty imposed by the Income Tax Act or any other Act administered by the Commissioner.

‘tax benefit’ includes any avoidance, postponement or reduction of any liability for tax.

With the exception of ‘impermissible avoidance arrangement’, which refers to section 80A, and ‘party’ these definitions draw heavily on the provisions and interpretation of section 103.

Section 80A – Impermissible tax avoidance arrangements

This section provides that an avoidance arrangement (an arrangement which results in a tax benefit) is an impermissible avoidance arrangement if:

1. Its sole or main purpose was to obtain a tax benefit; and

2. A tainted element is present. There are three tainted elements although their formulation may vary depending on the context in which an arrangement was carried out or entered into.

2.1 Abnormality (sections 80A(a)(i), 80A(b) and 80(c)(i));

2.2 Lack of commercial substance (section 80A(a)(ii)); or

2.3 Misuse or abuse of the provisions of the Act (section 80A(c)(ii)).

The abnormality element is largely based on section 103.

The lack of commercial substance element is expanded on later in section 80C.

The misuse or abuse element has its inspiration in Canadian and certain European jurisdictions approaches to impermissible tax avoidance. The two new elements are intended,

a) to remedy the well-recognised weaknesses in the current abnormality requirement, and

b) to expand the scope of the GAAR to address as many forms of impermissible tax avoidance as possible.

Section 80B – Tax consequences of impermissible tax avoidance

This section provides the Commissioner with specific remedies to impermissible tax avoidance, as well an additional general remedy closely modelled on that provided for in section 103(1).


63

Section 80B also introduces a requirement that the Commissioner make compensating adjustments that he is satisfied are necessary and appropriate to ensure the consistent treatment of all parties to an impermissible avoidance arrangement. Such compensating adjustments are subject to the normal three year prescription rules (sections 79, 79A(2)(a) and 81(2)(b)) with respect to assessments that have already been issued, since they may result in both additional and reduced assessments.

Any determination in terms of section 80B is subject to objection and appeal in terms of section 3(4).

The compensating adjustments set out in Section 80B(1) provide that the Commissioner may determine the tax consequences under the Income Tax Act of any impermissible avoidance arrangement for any party by-

(a) disregarding, combining, or re-characterising any steps in or parts of the impermissible avoidance arrangement;

(b) disregarding any accommodating or tax-indifferent party or treating any accommodating or tax-indifferent party and any other party as one and the same person;

(c) deeming persons who are connected persons in relation to each other to be one and the same person for purposes of determining the tax treatment of any amount;

(d) reallocating any gross income, receipt or accrual of a capital nature, expenditure or rebate amongst the parties;

(e) re-characterising any gross income, receipt or accrual of a capital nature or expenditure; or

(f) treating the impermissible avoidance arrangement as if it had not been entered into or carried out, or in such other manner as in the circumstances of the case the Commissioner deems appropriate for the prevention or diminution of the relevant tax benefit.

Section 80C – Lack of commercial substance

This section provides a general rule for determining whether an avoidance arrangement lacks commercial substance for the purposes of section 80A. It also provides for a non-exclusive set of characteristics that serve as indicators of a lack of commercial substance.

The general rule is that an avoidance arrangement lacks commercial substance if it would result in a significant tax benefit for a party but does not have a significant effect upon either the business risks or the net cash flows of that party.

Indicators of a lack of commercial substance include:

a) a divergence between the legal substance of an avoidance arrangement as a whole and the legal form of its individual steps. These provisions draw upon precedent in both the United Kingdom and the United States and would adopt what the House of Lords has referred to as an ‘unblinkered’ approach to complex multi-step composite transactions. It expands the scope of the narrow common law doctrine of substance over form;

b) the inclusion or presence of-

i) round trip financing as described in section 80D;

ii) an accommodating or tax indifferent party as described in section 80E; or

iii) elements that have the effect of offsetting or cancelling each other. This indicator draws upon precedent in the United Kingdom and other jurisdictions that gave rise to the so-called ‘fiscal nullity’ doctrine. It is targeted primarily at complex schemes, typically involving complex financial derivatives, that seek to exploit perceived loopholes in the law through transactions in which one leg generates a significant tax benefit while another leg effectively neutralises the first leg for non-tax purposes.

Other factors that would tend to indicate a lack of commercial substance would include, for example, the absence of a reasonable expectation of pre-tax profit or an expectation of pre-tax profit that is insignificant in comparison to the amount of the expected tax benefit.

Section 80D – Round trip financing


64

This section provides a non-exclusive description of round trip financing. This essentially relates to a transfer of funds between or among parties resulting directly or indirectly in a tax benefit and a significant reduction, offset or elimination of business risk. Tracing, timing, sequence, means, or manner of the transfers are not taken into account, given the fungibility of funds.

By way of comparison, the concept is analogous to the concept of ‘round robin financing’ in Australia and ‘circular cash flows’ in the United States.

Section 80E – Accommodating or tax indifferent parties

This section provides a description of an accommodating or tax indifferent party. The provisions in subsection (1) are widely drawn to cover as wide a range of possible mechanisms for achieving this status. Subsection (2) focuses upon the ways in which these parties are typically used in impermissible avoidance arrangements in order to refine the scope of the section. Subsection (3) provides two safe harbours. The first comes into play where income tax actually paid in other jurisdictions amounts to more than two-thirds of the income tax that would have been paid in the Republic. The second relates to ongoing active business operations in connection with the avoidance arrangement that are carried out through a substantial business establishment in the Republic or elsewhere.

Section 80F – Treatment of connected persons and accommodating or tax indifferent parties

Connected persons and accommodating or tax indifferent parties are often used to give the illusion of commercial substance in a specific entity and circumvent anti-avoidance rules. Accordingly the Commissioner is empowered to combine connected persons and disregard an accommodating or tax indifferent party or combine it with another party for the purposes of determining whether an avoidance arrangement lacks commercial substance or whether a tax benefit exists.

Section 80G – Presumption of purpose

This section is analogous to the provisions of section 103(4) that provided for a rebuttable presumption that an arrangement that provides a tax benefit was entered into or carried out for the sole or main purpose of tax avoidance. It also makes it clear that a step in or part of an avoidance arrangement may have a different purpose from the arrangement as a whole. A step or part with the sole or main purpose of obtaining a tax benefit may thus no longer be ‘camouflaged’ by a legitimate purpose of the arrangement as a whole.

Section 80H – Application to steps in or parts of an arrangement

This section confirms that the Commissioner may apply the GAAR to steps in or parts of an arrangement.

Section 80I – Use in the alternative

This section clarifies that the Commissioner may apply the GAAR as an alternative basis for raising an assessment.

Section 80J - Notice

This section provides that the Commissioner must give notice, with reasons, of an intention to invoke the GAAR. The taxpayer generally has 60 days to reply to the notice but may request an extension to reply. On receipt of the reply or expiry of the period for a reply the Commissioner has 180 days to raise further queries, withdraw the notice, or invoke the GAAR. If additional information comes to the knowledge of the Commissioner the reasons for invoking the GAAR may be modified or a new notice may be issued if a prior notice has been withdrawn.

Section 80K - Interest

This section carries over the provisions of section 103(6) and provides that interest may not be waived in terms of section 89quat(3) or (3A) if the GAAR has been invoked.


65

Sections 80A to 80L - Commencement date

The new sections are deemed to have come into operation on 2 November 2006 and apply to an arrangement (or any steps in it or parts of it) entered into on or after that date.

Insertion of Part IIB of Chapter III of the Income Tax Act – Reportable arrangementsThe old Section 76A of the Income Tax Act came into operation on 1 March 2005. It provides for the reporting of two classes of arrangement. The first relates to arrangements that result in a tax benefit and are subject to an agreement that provides for the variation of interest, fees etc. if the actual tax benefits from the arrangement differ from the anticipated tax benefit. The second relates to a special inclusion list, which deals with two types of hybrid debt and equity instruments.

Section 76A is intended to give the Commissioner early warning of arrangements that are potentially tax driven. The Commissioner is then in a position to take appropriate action to counter abuse more quickly than would otherwise be the case.

The number and nature of the transactions disclosed to SARS since the promulgation of section 76A has proved disappointing. Taxpayers have raised a number of technical points to argue that they need not disclose the arrangements they had entered into. Whether or not these arguments had merit, the practical result is that the desired level of reporting has not been achieved.

The new General Anti-Avoidance Rule (GAAR) also provides for the opportunity to link the reportable arrangements legislation to the factors that are indicative of a lack of commercial substance for GAAR purposes.

Subject to the exclusion list discussed below, the reportable arrangements legislation is generally triggered when an arrangement-

• provides for interest, finance costs, fees or other charges that are partly or wholly dependent on the assumptions relating to the tax treatment of that arrangement (otherwise than by reason of any change in any law administered by the Commissioner);

• has any of the characteristics of, or characteristics which are substantially similar to, the indicators of a lack of commercial substance in terms of the proposed GAAR;

• is or will be disclosed by any participant as a financial liability for purposes of Generally Accepted Accounting Practice but not for income tax purposes;

• does not result in a reasonable expectation of a pre-tax profit for any participant; or

• results in a reasonable expectation of a pre-tax profit for any participant that is less than the value of those tax benefits to that participant on a present value basis.

The section 76A special inclusion list is retained but the five year threshold for reporting hybrid equity and debt instruments is extended to ten years to ensure that restructuring these instruments to fall outside the legislation will be more commercially challenging.

The section 76A exclusion list of arrangements that are unlikely to be tax driven, such as ‘plain vanilla’ loans and leases, is largely retained, as is the Minister’s authority to include or exclude arrangements for disclosure by way of regulation.

The responsibility for disclosing a reportable arrangement is principally placed on its promoter, as this is the person most likely to have full insight into its operation.

In the absence of a promoter who is a resident, the responsibility falls on all participants, although this responsibility falls away if another participant confirms in writing that the required disclosure has been made. This ensures that disclosure is made in the most comprehensive manner while minimising the duplication of disclosure submissions.

The information to be disclosed is similar to the section 76A requirement, except that a list of the arrangement’s agreements must be submitted instead of a complete set of agreements. This will reduce the compliance cost with respect to the initial disclosure of an arrangement. Once the required information has been disclosed the Commissioner will issue a reportable arrangement number to each participant in an arrangement for administrative purposes only. Additional information, including agreements, may be requested if an arrangement is selected for further analysis.


66

Finally, the penalty for non-disclosure of reportable arrangements is set at R1 million, but may be reduced where-

• there are extenuating circumstances and the non-disclosure is remedied within a reasonable time; or

• it is disproportionate in relation to the assumed tax benefit of the arrangement.

The maximum penalty of R1 million reflects the substantial amounts typically at stake in reportable arrangements.

The above amendments are introduced by way of Part IIB of Chapter III sections 80M to 80T. These come into operation on a date to be fixed by the President by proclamation in the Gazette. The president may fix different dates for different provisions of these sections.

The repeal of section 76A will come into operation on a date to be fixed by the President by proclamation in the Gazette.

On 1 March 2005 SARS issued a guide on the application of section 76A which is available on the SARS website.

Section 102 of the Income Tax Act – RefundsAny refund due to a taxpayer in terms of Section 102 is now subject to the de minimus rules of section 102A.

Section 102(2) has been amended by the addition of two new paragraphs dealing with situations where the Commissioner may not authorise a refund-

a) the amount to be refunded is less than R100 or less than such other amount as the Commissioner may determine by Notice in the Gazette; or

b) that person has failed to submit a return for any year of assessment as required by the Income Tax Act, until that person has furnished such return as required.

Section 102(4) has been added and provides that amounts not refunded under section 102(1) due to the refund being less than R100, are carried forward to the immediately succeeding year of assessment.

The amendments are effective as from the date of promulgation of the Revenue Laws Amendment Act, 2006.

Section 103 of the Income Tax Act – Anti avoidance provisionsThe deletion of subsections (1) and (3) are consequential to the introduction of the new general anti avoidance rules contained in sections 80A to 80L.

The remaining provisions of section 103 are aimed at providing the Commissioner with a remedy to situations where an assessed loss in a company or trust is utilised by a taxpayer introducing income into that company or trust.

Paragraph 5 of the Second Schedule to the Income Tax Act – Retirement fund withdrawalsAmounts payable by Retirement Annuity Funds

Retirement Annuity Funds could not pay any amount to a paid-up member prior to that member reaching the age of 55. The reason for this prohibition is to ensure that the money is preserved until retirement.

The Minister of Finance and the Long-term Insurance Industry signed a Statement of Intent in December 2005. In terms of this agreement, persons who became paid-up members (i.e. members of a retirement fund who prematurely discontinued contributing to the fund) after 1 January 2001 will be guaranteed a minimum benefit. These benefits will be taxed on a similar basis to a surplus apportionment benefit.

A problem arises once a member becomes a paid-up member (i.e. the member ceases to make contributions to the fund). If the member has a low fund value upon becoming a paid-up member, ongoing industry costs may exceed growth. The effect of the low fund value and high costs will result in negative


67

growth in the individual paid-up member’s fund interest (and may even result in no value being preserved by the time of retirement).

Example:

Mr A is a member of a retirement annuity fund. At the age of 45, he is retrenched and can no longer afford to make monthly contributions to his retirement annuity fund. He informs his broker that he will no longer contribute to this fund. At this date, his member’s interest in the fund is R4,000. He cannot withdraw this amount from the fund due to the restrictions in the Income Tax Act. The gross annual growth on his member’s interest is 8%, but the costs amount to R750 per annum. Ten years later he becomes entitled to a benefit from the fund, but his fund value is now 0.

The amendment to the definition of ‘retirement annuity fund’ in Section of the Income Tax Act effectively allows the fund value of a paid up member to be paid out if the fund value is less than an amount to be determined by the Minister. This amount will be adjusted from time to time in consultation with the Financial Services Board in order to ensure that a paid-up member is not prohibited from accessing money that will eventually be consumed by industry costs.

Taxation of withdrawal and retirement benefits

A member of a pension or provident fund will become entitled to a withdrawal benefit if that employee ceases to be employed. Upon employment cessation, a member can make an election to have the benefit transferred to another retirement fund or to withdraw the benefit. A transfer to another retirement fund will not be subject to tax, but a withdrawal will result in the benefit effectively being taxed at the member’s highest average rate of tax for the year in which the benefit accrues or the previous year.

A member of a pension, provident of retirement annuity fund who retires from the fund becomes entitled to a retirement benefit. This benefit is payable in the form of an annuity, a lump sum or a combination. Annuities are taxed when paid to the individual (e.g. monthly), and lump sums are taxed upon retirement. These annuities and lump sum payments are subject to withholding tax and retirement fund administrators have to apply for a tax directive before lump sums may be paid out.

Members withdrawing or retiring from a retirement fund after the effective date of the Pension Fund Amendment Act (“PFAA”) (7 December 2001) are now guaranteed a minimum benefit. However, members who withdrew or retired before the effective date enjoyed no comparable protection. In order to provide former members with some additional benefit, the PFAA also provides that any fund surplus be apportioned in line with the PFAA. Former members may therefore join in this surplus apportionment.

Should benefits be paid to former members who previously withdrew from the fund, these benefits will be taxable as the former members cannot make an election to have the benefit transferred to another retirement fund. Benefits payable to former members who previously retired from the fund will be taxed as a withdrawal benefit and not as a retirement benefit.

In terms of the amendment to paragraphs 5 and 6 of the 2nd Schedule, benefits accruing after withdrawal (or retirement) from the fund will be subject to the same elections that were available to them upon the earlier withdrawal (or earlier retirement). This amendment effectively provides former members with the option of preserving additional benefits payable by retirement funds, thereby postponing the tax liability.

Payment of benefits in terms of the surplus apportionment process and the Statement of Intent (indicated above) will result in numerous additional payments to be settled within the foreseeable future. Applying for a tax directive in these circumstances will frustrate the timely settlement of these payments and may result in low income earners suffering a higher tax cost than is due. These payments will therefore not be subject to withholding tax, provided these payments are settled within a three year period (paragraph 9(3) of the 4 th

Schedule to the Income Tax Act).

Effective date

The emended paragraph 5(1) is deemed to have come into operation on 1 January 2006.

Paragraph 1 of the 4th Schedule to the Income Tax Act – Relief for small personal service entities


68

The personal service company and personal service trust definitions were introduced into tax legislation with effect from 1 April 2000 (hereinafter referred to as personal service entities (or ‘PSEs’). These definitions and related amendments seek to discourage employees from disguising their employer/employee relationships by offering their services through a company or trust. Entities falling within these definitions trigger:

(i) an obligation on the payer to withhold employees tax at a rate of 34% on all payments to the payee PSE; and

(ii) a denial of tax deductions for the PSE, except for salaries.

Government was approached by various industry representatives about the cash-flow hardships of the PSE regime imposed on small businesses. The main concern is the overly broad anti-avoidance aspects of the PSE regime that fail to distinguish between avoidance mechanisms versus common legitimate business practices.

Narrowing the scope of the PSE regime

Three amendments have been implemented to limit the scope of the PSE definitions.

1. If a client controls or supervises how and when the work is performed, the entity providing the service automatically qualifies as a PSE under old law. In reality, however, many clients control or supervise work performed by the entity on a limited basis for quality control purposes or to avoid major disruptions of the client’s business. This control or supervision does not necessarily constitute an employer/employee relationship. The amendment accordingly limits the PSE regime to situations where the client controls or supervises how the work is performed but only if that work must be performed at the client’s premises (paragraph 1(b) of the definitions of ‘Personal Service Company’ and ‘Personal Service Trust’ within the 4th Schedule). The main area of avoidance involves employees reporting to work at the employer’s premises (and under their full supervision) while artificially claiming independent status.

2. If a client makes regular payments to an entity providing a service, under the old law the entity automatically qualified as a PSE. In reality, regular payments are a frequent feature of legitimate ongoing business relationships, not necessarily an automatic feature of an employer/employee relationship. This requirement has been deleted (paragraph 1(c) of the definitions of ‘Personal Service Company’ and ‘Personal Service Trust’ within the 4th Schedule).

3. This involves the PSE safe harbour (i.e. the escape hatch from the PSE definition despite the existence of other facts or circumstances). Under the old law, an entity escaped PSE status regardless of any other facts and circumstances if that entity had 4 or more unconnected employees who were engaged in rendering services to clients. The amendment reduces this number to 3 or more unconnected employees who are engaged in rendering services to clients. (see words following paragraph 1(d) of the definitions of ‘Personal Service Company’ and ‘Personal Service Trust’ within the 4th Schedule).

Relaxation of client withholding

Under the old law, clients bore the onus of proving that payments to an entity did not qualify as a payment to a PSE. Failure to treat an entity as a PSE (i.e. failure to withhold 34% of the payment) when PSE treatment is actually required triggers a potential liability for clients (in addition to the entity). Many clients accordingly opted for the conservative route and withheld employees tax when making payments to small entities to avoid tax risk.

In order to alleviate this tendency of over-withholding for risk adverse clients, the onus of proof on the client is relaxed. A client can now rely on an affidavit or solemn declaration issued by the small entity that it is not a PSE as long as the client makes this reliance in good faith (new paragraph 2(1A) of the Fourth Schedule). The client will then be absolved from the failure to withhold (even if it later comes to light that the small entity was (in fact) a PSE).

Taxation of net profits

See earlier in these notes the details of amendments to section 23(k) in terms of which the deductions a PSE may claim have been extended.


69

With the admission of new deductions, imposition of a flat 34% level of withholding can now far exceed the actual net liability owed. This flat 34% level of withholding may impose severe cash-flow constraints on small businesses (even if refundable at a later date). The new amendment provides relief for this over-withholding by allowing the Commissioner to issue a directive for a lower rate that more closely matches the final tax liability (paragraph 11(a) of the Fourth Schedule).

Effective date

The amendments to the 4th Schedule are effective from the date of promulgation of the Revenue Laws Amendment Act, 2006.

Paragraph 9 of the 4th Schedule to the Income Tax Act – Withholding tax on lump sums from pensions, provident funds and retirement annuity fundsSee earlier in these notes for details of this amendment which is contained in the section dealing with Paragraph 5 of the Second Schedule to the Income Tax Act – Retirement fund withdrawals

The amendment applies to any lump sum award received by or accrued to the employee on or before 10 November 2006 or such later date that the Minister may determine by notice in the Gazette.

Paragraph 11 of the 8th Schedule to the Income Tax Act – Issue or cancellation of a member’s interest in a close corporationThe amendment clarifies that the issue or cancellation of a member’s interest in a close corporation does not constitute a disposal of an assets by the close corporation.


Paragraph 20 of the 8th Schedule to the Income Tax Act – Base cost of assets inherited from a non-residentIn terms of paragraph 40 of the 8th Schedule a deceased person is treated as having disposed of his or her assets to his or her deceased estate for proceeds equal to the market value of those assets at the date of death of the deceased and the deceased estate is treated as having acquired those assets at that value. When the assets are distributed by the deceased estate to heirs and legatees the assets are treated as having been distributed to them at the base cost of the deceased estate and to have been acquired by them at that value. The effect is that the deceased is taxed on any capital gains made on the deemed disposal of the assets at market value to the deceased estate and the heirs and legatees inherit the assets at a base cost equal to the market value at date of death of the deceased plus any expenditure qualifying as part of the base cost during the process of winding up the estate. Paragraph 40 deals with the assets of the deceased estates of residents and the assets of mentioned in paragraph 2(1)(b) in the case of non residents (i.e. immovable property and rights and interests in such property in the Republic and assets of a permanent establishment in the Republic).

Paragraph 40 does not provide for the determination of the base cost of an asset inherited by a resident, other than the assets mentioned in paragraph 2(1)(b), from the deceased estate of a non resident.

A new paragraph 20(2)(h)(v) has been inserted into the 8 th Schedule. It provides that the base cost of an asset which was acquired by way of inheritance from the deceased estate of a person who at the time of his death was not resident is the sum of-

aa) the market value of the asset immediately before the death of the deceased; and

bb) any qualifying expenditure contemplated in paragraph 20 incurred by the executor of that deceased estate in respect of that asset in the process of liquidation or distribution of that deceased estate

Note the new paragraph does not cover immovable property as this is dealt with in paragraph 40 read with paragraph 2(1)(b).



70

Paragraph 29(5) of the 8th Schedule to the Income Tax Act – Submission dates of certain valuation date valuationsIn terms of paragraph 29(5) of the 8 th Schedule a person wishing to make use of the market value method to determine the valuation date value of a pre-valuation date asset was required to-

a) value the asset on or before 30 September 2004, and

b) lodge the prescribed form (CGT 2L) as required in paragraph 29(6).

In most cases the form CGT 2L must be submitted together with the tax return for the year of assessment in which the asset was sold. High value assets were subject to special rules and the form CGT 2L should have been submitted with the first tax return submitted after 30 September 2004. The values are as follows:

• assets the market value of which exceeds R10 million;

• intangible assets (other than financial instruments) the market value of which exceeds R1 million; and

• unlisted shares, when the market value of all the shares held by a person in a company exceeds R10 million.

An amendment to paragraph 29(5) allows the Commissioner to permit the use of a market valuation obtained by a person within the period prescribed by paragraph 29(4) but which was not attached to the relevant income tax return. Proof must be submitted to the Commissioner that the valuation was performed before 30 September 2004.

Paragraph 62(e) of the 8th Schedule to the Income Tax Act – Donations and bequests to approved recreational clubsThe amendment is to ensure that donations and bequests to section 30A approved recreational clubs are disregarded for CGT purposes.

Paragraph 64A(b) of the 8th Schedule to the Income Tax Act – Government scrapping paymentsParagraph 64A(b) has been inserted into the 8 th Schedule to provide that where a person disposes of an asset to the government for destruction, any capital gain or capital loss must be disregarded, if the Minister of Finance has by notice in the Gazette identified the relevant programme or scheme for purposes of paragraph 64A(b).


Paragraph 67 of the 8th Schedule to the Income Tax Act – Deceased estates and roll over provisionsIn terms of paragraph 40 a deceased person is treated as having disposed his or her assets to his or her deceased estate for proceeds equal to the market value of those assets at the date of death of the deceased and the deceased estate is treated as having acquired those assets at that value.

When the assets are distributed by the deceased estate to heirs and legatees the assets are treated as having been distributed to them at the base cost of the deceased estate and to have been acquired by the heirs and legatees at that value.

The effect of this is that the deceased is taxed on any capital gains made on the deemed disposal of the assets at market value to the deceased estate and the heirs and legatees inherit the assets at a base cost equal to the sum of the market value on the date of death of the deceased, plus any expenditure qualifying as part of the base cost incurred during the process of liquidating the estate.

One exception to the general application of paragraph 40 is a disposal of an asset by a deceased person to his or her surviving spouse upon death. In these circumstances paragraph 67 provides that any capital gain or capital loss made on that disposal is disregarded. The surviving spouse is treated as having acquired the asset on the same date, for the same expenditure and used the asset in the same manner as the deceased


71

person. The effect is that any capital gain or capital loss made on the disposal of the asset is deferred until the asset is disposed of by the surviving spouse.

Where the heirs or legatees decide to enter into a redistribution agreement of the assets and one of the parties to the agreement is the surviving spouse, paragraph 67 it was not clear how the provisions of paragraph 40 and paragraph 67 interact. Paragraph 67 did not expressly provide for the circumstances where the surviving spouse, heirs and legatees enter into a redistribution agreement. A further problem was that subparagraph (2) provided that the paragraph apply if the asset accrues to the surviving spouse upon the death of the deceased spouse. The asset does not, however, accrue on death of the deceased spouse but only after confirmation of the liquidation and distribution account.

The amendments to paragraph 67(2)(a) now clarifies the position and deceased spouse is treated as having disposed of the asset if ownership of the asset is acquired by the surviving spouse. The effect of this is that the paragraph will only operate when it is clear what assets the surviving spouse has received. This will occur almost exclusively when there is confirmation of the liquidation and distribution account. In the case where there is a redistribution agreement the liquidation and distribution account will reflect the effect of the agreement.

Further amendments are made to sub-items of paragraph 67(1)(b) as follows-

Sub-item (ii) – Paragraph 20 of the 8 th Schedule deals with different kinds of expenditure in respect of an asset which includes, amongst other, expenditure for acquisition, valuation, disposal, establishing, maintaining and improving. The sub-item only dealt with acquisition expenditure and has been extended to all expenditure contemplated in paragraph 20. In addition the sub-item only provided for expenditure incurred by the deceased spouse to be brought into account by the surviving spouse and now provides that expenditure incurred by the executor of the estate of the deceased spouse also be brought to account by the surviving spouse.

Sub-item (iii) - This sub-item also only applied to expenditure incurred by the deceased spouse and has been extended to apply to expenditure incurred by the executor of the estate of the deceased spouse.

Sub-item (iv) - The sub-item only dealt with the use of the asset by the deceased spouse and is amended so that the use of the asset by the executor of the deceased estate also be brought to account.


Paragraph 80 of the 8th Schedule to the Income Tax Act – Capital gain attributed to beneficiaries of a trustParagraph 80 (2) of the Eighth Schedule applies where–

• a capital gain arises in a trust (for example, as a result of the sale of an asset to a third party) during a year of assessment, and

• the trustee vests that capital gain in a resident beneficiary during the same year of assessment.

In these circumstances the capital gain is disregarded in the trust and is taxed in the hands of the beneficiary.

Some commentators expressed concern that the old wording did not permit-

• the attribution of a portion of a capital gain in a single beneficiary, or

• the attribution of a capital gain in multiple beneficiaries.

The amendment to paragraph 80(2) confirms that the portion of a capital gain can be attributed to a beneficiary or beneficiaries.


Section 9 of the Finance and Financial Adjustments Act, 1977 – Tax treatment of different spheres of domestic and foreign government


72

The old law

The Income Tax Act contains various forms of exemption for different spheres of Government. National and provincial governments are fully exempt under section 10(1)(a). Certain institutions, boards and bodies subject to the Public Finance Management Act, 1999 (Act No. 1 of 1999)(‘PFMA’) are exempt from income tax under section 10(1)(cA), along with their wholly owned subsidiaries. Municipalities receive exemption as a ‘local authority’ under section 10(1)(b), but municipal entities that are subject to the Municipal Finance Management Act, 2000 (Act No. 32 of 2000)(‘MFMA’) are fully taxable.

Reasons for change

The Income Tax system fails to provide a coherent regime for Government entities. These changes relate to the ‘local authority’ definition contained in section 1 and other specialised non-privately controlled entities.

Amendments

A. Local councils, boards and committees

The various references to local councils, boards and committees are outdated. The definition of local authority will accordingly be scrapped in line with the new system for local government as prescribed by the Local Government: Municipal Structures Act, 1998 (Act No. 117 of 1998). Henceforth, only ‘municipalities’ (Categories A, B and C) will be exempt as opposed to ‘local authorities’. Collateral changes in this regard have been made in the Value-added Tax Act along with corresponding changes to the Transfer Duty Act.

B. Water boards

Some water boards are exempt by virtue of paragraph (b) of the ‘local authority’ definition, some are exempt by virtue of section 10(1)(cA) while a small group of others may be subject to tax. The new regime simply creates a new exemption for all water service providers (listed under either the PFMA or MFMA) regardless of their legal form.

C. Regional services councils and the joint services board

The old exemption for regional services councils and the joint services board are deleted as obsolete. Similar deletions are made to the Transfer Duty Act.

D. Regional Electricity Distributors (the ‘REDs’)

Government is in the process of restructuring electricity distribution. In the future, this function will be consolidated into entities (known as the REDs) for more efficient coordination. The transfer of electricity distribution operations from municipalities to REDs triggers various tax issues. For instance, all activities conducted by municipalities are fully exempt from income tax; whereas, the REDs are subject to income tax because electricity distribution is a commercial business activity (as opposed to a regulatory activity). The shift from exempt to fully taxable status could, however, undo some of the benefits of the desired consolidation, especially if full taxation takes immediate effect. In order to provide for transitional relief, the newly created REDs will be exempt from income tax for all years of assessment commencing before 1 January 2014 (or a later date determined by the Minister if necessary) (section 10(1)(t)(viii). Correlative adjustments are also made for the Value-Added Tax Act.

Note: Eskom will not benefit from any of the proposed changes (i.e. the amendment will apply only to electricity distributors established after 1 January 2005. Eskom has long been fully taxable so continued taxation should not impact electricity restructuring process. However, asset transfers by Eskom to the REDs may require further legislative change at a later date.

E. Traditional councils

The tax status of traditional councils (as contemplated in the Communal Land Rights Act, 2004 (Act No. 11 of 2004) has never been clear. Traditional councils may have been exempt by virtue of

(i) the reference to councils in the ‘local authority’ definition of section 1 of the Income Tax Act,

(ii) as an institution, board or body under section 10(1)(cA), or

(iii) section 9 of the Finance and Financial Adjustments Act Consolidation Act, 1977 (Act No. 11 of 1977). All three sets of rules have accordingly been deleted or adjusted in this regard

because traditional councils should not be viewed as a Constitutional 4 th arm of Government, income tax exemption for traditional councils will be eliminated in the long-term. This amendment act retains the exemption but with a termination date to be set by the Minister. The termination date serves as notice to


73

traditional councils that the income tax exemption will be eliminated while giving time for other legislative adjustments (if necessary).

F. Foreign governments

The amendments clarify the tax treatment of foreign governments and exempt the receipts and accruals of any sphere of any foreign government (i.e. national, provincial and local)(section 10(1)(bA)(i)). Other foreign government controlled bodies (e.g. foreign government-owned parastatals) are fully taxable, with the possible exception for developmental agencies (see section 10(1)(bA)(ii)).

Section 8(27), 10(26) and 16(3)(m) of the Value-Added Tax Act – Excessive considerationThe new subsection is added to ensure that in circumstances where a vendor receives any amount that is in excess of the consideration charged for that supply and such excess amount is not refunded, output tax will be payable on the excess portion of the amount received. The vendor will have to account for output tax on the excess amount of money received on the last day of the tax period which ends 4 months after the excess amount was received. In the event that the excess amount is refunded by the vendor, he or she will be entitled to claim input tax.


Example 1:

Vendor A, registered in category B, issues a tax invoice to John for R114 (invoice no. 10 dated 01 March 2006) and sends a statement to him a week later.

John pays Vendor A R114. His wife on receiving the statement also pays Vendor A R114 on 30 April 2006 in respect of the same invoice. Vendor A retains both payments and does not refund the overpayment received from John’s wife.

VAT Treatment:

1. The excess payment of R114 received by Vendor A will be treated as a deemed supply and output tax will be payable.

2. Vendor A will be liable to account for output tax amounting to R14 (i.e R114 x 14/114) during the August 2006 tax period, which is the last day of the tax period during which the 4 month period ends, i.e. the 4 month period is calculated from 30 April 2006 and therefore ends on 31 August 2006. (also see amendment to section 10(26) which deems the consideration for the supply).

Example 2:

Same facts as the above example, however Vendor A refunds (see new section 16(3)(m)) the overpayment received from John’s wife on 25 September 2006.

VAT Treatment:

Vendor A on refunding the overpayment of R114 to John on 25 September 2006 will be entitled to input tax of R14 in the October 2006 tax period.

Section 15(2) of the Value-Added Tax Act – Payment basis of accountingWith the introduction in the Taxation Laws Amendment Act, 2006, of the new definition of ‘municipality’ in section 1 of the Value-Added Tax Act, certain entities which previously fell within the definition of a ‘local authority’ in section 1 of the Value-Added Tax Act, no longer fell within the definition of ‘municipality’. As a result, these entities would not qualify to account for VAT on the payments basis. The basis for extending the list to the vendors mentioned below to account for VAT on the payments basis is that these vendors are rendering similar services, e.g. electricity, gas, water, drainage, removal or disposal of sewage or garbage to that of municipalities. Regional electricity distributors (REDS) will be assuming the duties of providing electricity and collecting the fees for such services from the general public. The proposed amendment will therefore ensure that the REDS account for VAT on the payments basis. As a result, the transfer of the


74

electricity distribution businesses to the REDS will not result in an adjustment in terms of section 2(4)(a) of the Value-Added Tax Act, 1991.

The amendment extends the list of vendors who may account for VAT on the payments basis to that of:

(a) any water board or any other institution which has powers similar to those of any such board which is listed in Part B of Schedule 3 of the Public Finance Management Act, 1999, and which entity would have fallen within the definition of ‘local authority’ in section 1 of the Value-Added Tax Act, as it read prior to that definition being deleted as from 1 July 2006;

(b) a regional electricity distributor, being an electricity distribution services provider established after 30 June 2005 that is-

• a public entity regulated under the Public Finance Management Act, 1999;

• a wholly owned subsidiary or entity of that public entity if the operations of the subsidiary or entity are ancillary or complementary to the operations of that public entity; or

• a company as contemplated in paragraph (a) of the definition of ‘company’, which is wholly owned by one or more municipalities;

(c) municipal entities as defined in section 1 of the Local Government: Municipal Systems Act, 2000 (Act No. 32 of 2000), and which supplies electricity, gas, water, drainage, removal or disposal of sewage or garbage.

The amendment will be effective from 1 July 2006.

Section 16(2) of the Value-Added Tax Act – Time limit to claim input taxVendors have 5 years to claim input tax from the date on which a tax invoice for that supply should have been issued as contemplated in section 20(1), i.e. within 21 days from the date of the supply. However, instances exist where the vendor will not be in possession of a tax invoice, as the provisions of section 20(1) are not applicable. The amendment ensures that, where a vendor is not required to be in possession of a tax invoice, in respect of the acquisition of goods or services, the vendor may deduct input tax from the amount of output tax attributable to a later tax period which ends no later than five years after the end of the tax period during which-

• goods were entered for home consumption in terms of the Customs and Excise Act;

• second-hand goods were acquired or goods as contemplated in section 8(10) were repossessed;

• the agent should have notified the principal as contemplated in section 54(3); or

• in any other case, the vendor for the first time became entitled to such deduction and for which a tax invoice is not required for the claiming of such deduction.


Example:

A vendor, registered in category C, purchases fixed property from a non-vendor and pays transfer duty on 1 October 2006. As the transaction is not subject to VAT, the vendor will not be in possession of a tax invoice.

Result.

In terms of the proposed amendment to the second proviso to section 16(2), the vendor will be entitled to claim the notional input tax within 5 years after the end of the tax period during which the vendor for the first time became entitled to such deduction i.e. the vendor has 5 years from the October 2006 tax period to submit the input tax claim. The last tax period in which the vendor may therefore submit the input tax claim is in the October 2011 tax period.

Section 16(3) of the Value-Added Tax Act – Prize or winningsWhere a vendor awards a prize or winnings, the vendor will be entitled to claim an amount limited to the VAT incurred (section 16(3)(d)). In the case of second-hand goods, the vendor will be entitled to a deduction of


75

the notional input tax. The amendment to 16(3)(d) clarifies that the vendor who awards a prize or winnings is also, as from 1 February 2006, entitled to a deduction limited to the input tax, i.e. VAT, transfer duty or stamp duty paid. The amendment therefore extends the deduction to not only the VAT, but also the transfer duty and stamp duty paid.

The amendment is deemed to come into operation on 1 February 2006.

Section 17(2)(a) of the Value-Added Tax Act – Entertainment expenditureEntertainment expenses are generally denied as input tax. Section 17(2)(a)(ii) allows a vendor to claim input tax on personal subsistence in respect of the vendor’s employees or office holders, who are by reason of their duties, away from their usual working-place or their usual place of residence. However, vendors are often required to pay for the costs (which include VAT) in respect of meals, refreshments and accommodation of self-employed natural persons, which the vendor contracts with to render services.

The amendment to section 17(2)(a)(ii) extends the current provision of personal subsistence, being that of meals, refreshments or accommodation, to self employed natural persons. This will now entitle vendors who are required to pay costs (which include VAT) for the personal subsistence of self employed natural persons, to deduct input tax on such expenses. This will only apply where the self employed natural persons are by reason of the contractual obligations with the vendor obliged to spend any night away from their usual place of residence and usual working place.

The term ‘self employed natural person’ is defined in section 17(2)(a)(ii).


Section 20(8) of the Value-Added Tax Act – Record keeping for second-hand goodsA vendor, being the recipient of second-hand goods (not being a taxable supply), is not required to keep records as envisaged in terms of section 20(8), where the consideration in money for the supply of second-hand goods does not exceed R20. The amendment increases this amount to R50.

The requirements to keep records in terms of section 20(8), must be complied with when the supply exceeds R50 or such other amount as determined by the Commissioner.


Section 22(3) of the Value-Added Tax Act – Deemed output tax on cessation of enterpriseWhen a vendor registered on the invoice basis claimed input tax on supplies and fails to pay the supplier within 12 months, the vendor is required to account for output tax in terms of section 22(3) on the that portion of the amount that remains unpaid.

An anomaly existed in the VAT Act in that no output tax adjustment is required where the vendor de-registers for VAT purposes, had not paid the supplier of the goods or services, had claimed input tax, but had not accounted for output tax due to the fact that the 12 month period had not expired.

The amendment to proviso (ii) of section 22(3) ensures that output tax is accounted for at the time the vendor ceases to be a vendor in terms of section 8(2) and when that vendor has not fully paid the supplier of the goods or services.

A new proviso has been added to section 22(3), proviso (iii). This ensures that when a vendor has already accounted for the output tax payable as required in terms of section 22(3) the provisions of proviso (ii) will not apply.


Section 31(1) of the Value-Added Tax Act – Additional assessment


76

Section 32(5) prohibits the Commissioner for an issuing additional assessment once as assessment has been issued and the vendor has accepted it, or not objected to it.

Section 31(1) has been amended to allow the Commissioner to issue an additional assessment, notwithstanding section 32(5), to the extent that it is found that the vendor has not complied with the provisions of the VAT Act.

This authority to issue additional assessments is in line with the authority given to the Commissioner in terms of the Income Tax Act.


Section 41 and 41A of the Value-Added Tax Act – Written decisions by the CommissionerAn amendment to section 41(a) ensures that the provisions of section 41A or 41B, will, where applicable, apply to section 41.

Section 41(c) has been amended with the insertion of a second proviso. It allows the Commissioner to withdraw any written decision issued prior to 1 January 2007 where the Commissioner prescribes that the written decision does not have a binding effect. Such withdrawal will be from the date of the written notification thereof by the Commissioner. The withdrawal of the written decision where any contractual obligation was incurred in accordance with the written decision given by the Commissioner to the person concerned before such withdrawal to supply or receive the goods or services concerned, may not affect his or her liability for the payment of tax in accordance with such decision or the entitlement or otherwise to a deduction of tax, as determined in accordance with such decision, as the case may be. The amendment restricts the operation of the provisions of section 41(c) to written decisions issued on or before 31 December 2006.

Any written decision issued prior to 1 January 2007 in respect of supplies made after 1 January 2007, shall not be binding, except to the extent that the Commissioner confirms, in writing, that such written decision is binding. The amendment allows the Commissioner to withdraw any written decision issued prior to 1 January 2007 where the Commissioner prescribes that the written decision does not have binding effect. Such withdrawal will be from the date of the written notification thereof by the Commissioner.

The withdrawal of the written decision where any contractual obligation was incurred in accordance with the written decision given by the Commissioner to the person concerned before such withdrawal to supply or receive the goods or services concerned, may not affect the liability or non-liability of that person for the payment of tax in accordance with such decision or his entitlement or otherwise to a deduction of tax, as determined in accordance with such decision.

New section 41A

The amendment allows the Commissioner to issue binding ‘VAT rulings’ or ‘VAT class rulings’, which is a written statement by the Commissioner in respect of the application or the interpretation of the VAT Act. The amendment furthermore, ensures that the provisions applicable to ‘advance tax rulings’ catered for in the Income Tax Act, will apply mutatis mutandis.

‘VAT rulings’ will be issued under the provisions of ‘binding private rulings’ whereas ‘VAT class rulings’ will be issued under the provisions of ‘binding class rulings’.

The ‘VAT rulings’ and ‘VAT class rulings’ will not be subject to any fees as envisaged in the Income Tax legislation governing ‘advance tax rulings’. In terms of the proposed amendment, the Commissioner will only be required to publish decisions that set a new precedent.

The amendments to section 41 and section 41A are deemed to have come into operation on 1 January 2007.

Section 44(1) of the Value-Added Tax Act – Additional assessment


77

Prior to the amendment, section 44(1)(ii), section 44(3)(b) and section 44(4) set the minimum refund amount at R25.

All these sections have been amended and refunds will not be refunded if the amount is less than R100 or such other amount as the Commissioner may determine by notice in the Gazette.


Schedule 1 of the Value –Added Tax Act – 2010 FIFA World CupSchedules 1 and 2 of the Revenue Laws Amendment Act, 2006 – Special tax measures relating to the 2010 FIFA World CupIntroduction

As part of the bid to host the 2010 FIFA World Cup, the South African Government issued various guarantees to FIFA. Government Guarantee No. 3 deals with Customs duties and Government Guarantee No. 4 deals with other taxes. Both guarantees are supported by a Tax Ruling issued by the Commissoiner. Following the award of the 2010 FIFA World Cup to South Africa, representatives of Government, FIFA and the Local Organising Committee met to clarify the intent and scope of these two guarantees and the Tax Ruling. The proposed legislation gives effect to the agreement reached.

Tax-free bubble concept

Legislative provision is made for the concept of a ‘tax-free bubble’ in terms of Income Tax and VAT (not other taxes). This ‘tax-free bubble’ will be restricted to FIFA-designated Sites for the periods specified. To the extent the ‘tax-free bubble’ applies, the profit on goods sold or services rendered will not be subject to any form of Income Tax, and the VAT will be applied at the zero rate. Conversely, from an income tax perspective, expenses incurred in production of exempt income will not be permitted as deductions. A reasonable allocation of expenses attributable to the exempt sales must be made. This factual allocation is to be a matter between SARS and the taxpayer where the taxpayer is otherwise subject to tax. VAT on supplies (goods and services) will be zero-rated; and hence, input credits will be claimable by the vendors concerned.

In terms of goods, the goods must be consumable and semi-durable goods (as opposed to fixed capital investments). In terms of services, the services rendered must be:

(i) intrinsic to the staging of the Championship,

(ii) enjoyed or partially utilised at a Site, and

(iii) paid for by individual members of the general public, FIFA or the Local Organising Committee.

Tax relief within the ‘tax-free bubble’ applies to both non-residents and residents.

The ‘tax-free bubble’ will only be operative in respect of the following sub-components of a FIFA-designated Site (and for the periods) as set out below –

(i) The ‘tax-free bubble’ is mainly intended to cover the Stadia, any Exclusion Zone, any official Championship-related parking areas, Championship press and television centres (including the International Broadcast Centre), VIP Areas and any other areas or facilities as may be agreed in good faith by FIFA and SARS utilised for Official Events. This concession will be allowed for the period commencing one week before the 2009 FIFA Confederation Cup and ending immediately after the closing ceremony. A similar period will be allowed for the 2010 FIFA World Cup South Africa.

(ii) Training sites will be part of the ‘tax-free bubble’ for official FIFA sanctioned training days.

(iii) Official host city public viewing venues will be part of the ‘tax-free bubble’ for Championship match days; and

(iv) The FIFA Flagship Store will be part of the ‘tax-free bubble’ for six months before the 2009 Confederations Cup until one month after the Closing Ceremony of the 2010 FIFA World Cup.

FIFA retail outlets


78

FIFA stores, store-in-store outlets and kiosk outlets outside of Sites are not considered to be within ‘tax-free bubbles’ (and accordingly not eligible for tax relief). Concession operated outlets (for food and beverages, as well as merchandise) within Sites will be within ‘tax-free bubbles’. FIFA is permitted to nominate one FIFA Flagship Store. This store will be viewed as a Site (and hence a tax-free bubble) as long as no tobacco products or cosmetics are sold at this store and all alcoholic beverages are only sold for consumption within an in-store restaurant.

Associated persons

All references to natural persons or entities shall mean–

(i) in the case of natural persons, that natural person; and

(ii) in the case of entities (other than FIFA or FIFA Subsidiaries), that entity and any affiliated entity, if that entity holds at least 20% of the ordinary equity of the affiliated entity and the activities or services rendered by the affiliated entity are directly connected to the Championship.

Specifics of Guarantee No. 3 (Customs)

Persons qualifying for relief in respect of import taxes where such goods are re-exported in terms of Clause 1 of Government Guarantee No. 3, shall include only the following qualifying persons –

(i) FIFA and FIFA subsidiaries;

(ii) FIFA National Associations;

(iii) FIFA Confederations;

(iv) Media Representatives;

(v) Commercial Affiliates;

(vi) Merchandising Partners;

(vii) Licencees;

(viii) The FIFA Flagship Store operator;

(ix) FIFA Designated Service Providers as well as the pitch importer, Concession Operators; Hospitality Service Providers; design servicers; event management and marketing operations, servicers and office suppliers;

(x) The Host Broadcaster, Broadcasters and Broadcast Rights Agencies; and

(xi) Any employee, not resident in the Host Country for income tax purposes, of any of the above entities who is temporarily seconded to the Host Country (in respect of household goods, motor vehicles or other goods normally associated with such relocation).

The following imports by a person contemplated in (i) to (xi) above will be free from any import taxes –

(i) Trading stock, being consumable or semi-durable goods, provided it is imported by a qualifying person with the intention of resale at a Site or re-export within the Re-export timeframe;

(ii) Samples of trading stock, being consumable or semi-durable goods not for re-sale, provided they are imported by qualifying persons with the intention of distribution at a Site or re-export within the Re-export Timeframe;

(iii) Capital goods, consumable goods and promotional materials, not for resale and individually of little value, for use by a person listed in (i) to (xi) above in connection with the Championship or re-export within the Re-export Timeframe; and

(iv) Household furniture and other household effects, one motor vehicle and equipment for the exercise of a trade by an employee of a qualifying person who is temporarily seconded to the RSA for the purposes of the 2010 FIFA World Cup.

Where goods imported free from any import taxes are not sold, distributed, used, or re-exported as required, customs duty and VAT will become payable on the lower of cost or market value on the earlier

• of the date of their disposal,


79

• use not in connection with the Championship, or

• expiry of the Re-export Timeframe

as if the goods were imported on that date.

Where goods imported free from any import taxes are not sold, distributed, used, or re-exported as contemplated above, but are donated to another person they must be treated as follows-

(i) Where goods are donated to a person exempt from income tax in terms of section 10 or an approved public benefit organisation, and the goods are disposed of by the that person within five years of the donation, import taxes will become payable on the lower of cost or market value on the date of the donation and as if the goods were imported on that date; and

(ii) Where goods are donated to any other person, import taxes will become payable on the lower of cost or market value on the date of donation, and as if the goods were imported by the donee (recipient) on that date.

Specifics of Guarantee No. 4 (Other Taxes, Duties and Levies)

In terms of this guarantee, the following entities are exempt from liability in respect of all South African taxes not covered by Government Guarantee No.3 unless specifically stated to the contrary –

(i) FIFA;

(ii) FIFA Subsidiaries; and

(iii) The Participating National Associations (excluding SAFA)

Furthermore, in respect of employees who are residents of the Republic of South Africa for tax purposes, FIFA and FIFA’s subsidiaries will contribute and withhold Unemployment Insurance Contributions and will also contribute Skills Development Levies. Such returns and payments will be made as and when due. FIFA and FIFA’s subsidiaries will, however not withhold employees’ tax in respect of these same employees. FIFA and FIFA’s subsidiaries will supply SARS with a list of these employees and the total remuneration paid annually to each employee.

In terms of this guarantee, regardless of residence for tax purposes, the entities listed below are exempt from income tax in respect of income derived from the sale of goods (being consumable goods and semi-durable goods) or services rendered provided the services rendered are

(i) intrinsic to the staging of the Championship,


(iii) paid for by individual members of the general public, FIFA or the Local Organising Committee

at Sites, as defined, and, where VAT is applicable, must levy VAT at the zero rate on all supplies of such goods or services at these Sites. The entities are as follows–

(i) Commercial Affiliates;

(ii) Licensees;

(iii) The Host Broadcaster, Broadcasters and Broadcast Rights Agencies;

(iv) Merchandising Partners;

(v) FIFA Designated Service Providers (see definition);

(vi) Concession Operators;

(vii) Hospitality Service Providers; or

(viii) The FIFA Flagship Store operator.

FIFA Designated Service Providers ((v) above) are the only entities that may sell goods or render services for consumption, usage or enjoyment outside of Sites, provided that such goods or services are directly connected to the Championship and are within the parameters for which such entity has been accredited by FIFA. This is in respect of income tax only.


80

Where any entity contemplated in (i) to (viii) above is exempt from income tax on income derived from the sales of goods (being consumable goods and semi-durable goods) or services rendered provided the services so rendered are

(i) intrinsic to the staging of the Championship, (ii)


(iii) paid for by individual members of the general public, FIFA or the Local Organising Committee

at Sites, as defined, any expenditure (whether direct or indirect) incurred in producing that exempt income will not be permitted as a deduction for income tax purposes.

No withholding tax is to be levied on Championship-related payments between FIFA, FIFA’s Subsidiaries, the Commercial Affiliates, Licensees, the Host Broadcaster, Broadcasters, Broadcast Rights Agencies, Merchandising Partners or the FIFA Designated Service providers.

Income arising from any good sold for foreign consumption or service rendered outside of South Africa by persons who are not residents for tax purposes in South Africa will not be attributed on a source basis to having been derived in South Africa as a result of that person’s sponsoring of the Championship or broadcasting of the Championship.

Where a qualifying natural person (as listed below) is not resident for income tax purposes in the Republic, that person will not be subject to South African income taxes with respect to income derived from activities connected to the Championship. Qualifying natural persons are as follows–

(i) All members of the FIFA Delegation;

(ii) Championship referees and assistant referees;

(iii) Participating National Association Officials;

(iv) FIFA Confederation Officials;

(v) Media Representatives;

(vi) All Commercial Affiliate staff;

(vii) All Merchandising Partner staff;

(viii) All FIFA Designated Service Providers staff; and

(ix) Host Broadcaster, Broadcast Rights Agency, and Broadcast staff

However, the following natural persons, not resident for income tax purposes in the Republic, are excluded from the exemption contemplated above–

(i) Team members, as defined;

(ii) Directors and personnel of SAFA; and

(iii) Directors and personnel of the Local Organising Committee.

Withholding taxes are to be levied in respect of non-resident Team members in accordance with international practice.

FIFA, FIFA Subsidiaries and the Participating National Associations, excluding SAFA, are to be treated on the same basis as diplomatic missions for VAT purposes in respect of the acquisition of goods and services directly relating to the Championship.

Notwithstanding any other provision relating to VAT, ticket sales will be subject to VAT at the standard rate of 14%. Should FIFA, a FIFA subsidiary or any Participating National Association choose to sell tickets as the principal ticket seller or as one of the principal ticket sellers then FIFA, its subsidiary or any Participating National Association must account for output VAT in respect of these sales, but may be registered for VAT and be entitled to claim input VAT. In other words, FIFA, its subsidiary or any Participating National Association will be liable to the Commissioner for the payment of VAT collected on the sale of tickets in the aforementioned circumstances.

In respect of hospitality sales (excluding hospitality sales for hospitality within a Site), hotel and accommodation charges the standard VAT rate of 14% is to be applied. Should FIFA, a FIFA subsidiary or any Participating National Association choose to sell hospitality off-site or accommodation as the principal seller or as one of the principal sellers then FIFA, its subsidiary or any Participating National Association


81

must account for output VAT in respect of these sales. In other words, FIFA, its subsidiary or any Participating National Association will be liable to SARS for the payment of VAT collected on the sale of off-site hospitality or accommodation in the aforementioned circumstances.

Government Guarantee No. 4 does not include the following taxes–

(i) Fuel taxes;

(ii) Excise duties;

(iii) The Plastic Bag Levy;

(iv) Air Passenger Departure tax;

(v) Provincial taxes (gambling taxes and motor vehicle license fees)

(vi) Local Government taxes (Property rates)

Administrative Aspects

All aspects pertaining to the calculation of import taxes as contemplated in Government Guarantee No.3 and other taxes, duties and levies as contemplated in Government Guarantee No.4, shall be a matter between the South African Revenue Service and the taxpayer concerned.

Where any person abuses one or more of the exemptions or concessions contemplated in this agreement by misrepresenting the purpose of an import, overstating sales within a tax-free bubble, understating purchases or expenses in respect of sales in a tax-free bubble or by any other method, SARS may, in addition to any other remedies that may be available to it, withdraw that person’s entitlement to any of the exemptions and concessions contemplated in this agreement, in whole or in part, with effect from the date that an exemption, waiver or concession was first claimed. Any such withdrawal will take place in consultation with FIFA.

Date of Implementation

The proposed legislation giving effect to the MOU agreed between FIFA and the South African Government will come into effect, retrospectively, as from 1 April 2006.

Section 14 of the Unemployment Insurance Act – State old-age pensionsIn 2003 the Unemployment Insurance Act, 2001 was amended to effectively exclude those unemployed who receive a monthly State old-age pension (SOAP) in terms of the Social Assistance Act, 1992. The amendment essentially reinforced an already existing disparity between the Unemployment Insurance Contributions Act, 2002, and the Unemployment Insurance Act, 2001 in that the Unemployment Insurance Act denies benefits to SOAP pensioners although they would have been liable to contribute to the fund in terms of the Unemployment Contributions Act if employed.

The Minister announced in the 2005 Budget Review that efforts be made to properly align the Unemployment Insurance Contributions Act with the Unemployment Insurance Act in order to ensure that all parties paying into the system would receive full benefits.

As the benefits paid in terms of the Unemployment Insurance Act are directly linked to the contributions made by an employee and the period over which such contributions are made, the amendment to section 14 of the Unemployment Insurance Ac now enables an employed individual who is receiving a SOAP and who is liable for Unemployment Insurance Fund contributions to qualify for benefits from the fund should that individual become unemployed despite the fact that he or she is in receipt of a SOAP.


82

Documents

TAX UPDATE - Home Page - Fasset · Web viewAnti-avoidance rules will be introduced to prevent taxpayers from transferring new assets into shareholdings held for the three year period