Post on 16-Dec-2015
PUBLIC PRIVATE PARTNERSHIPS (PPP)
A few tax implication
Presented by JOHAN KOTZE
YOUR OWN ATTEMPT …
YOUR CLIENT’S SCENARIO
Your client is Egoli Health Services (Pty) Ltd
It is party to a PPP
And queries the tax implications of the money it is receiving pursuant to its obligation in terms of the PPP
YOUR CLIENT’S SCENARIO
Department of Health required an psychiatric unit
Tender terms:
‘Design, construction, maintenance, operation and finance’ of an institution / facility for psychiatric patients
Private party should design and construct the facility
Private party should finance the facility
Private party should then maintain and operate the facility
YOUR CLIENT’S SCENARIO - Continue
Tender terms continue:
Facility is to be provided on government land
Maintenance and operating period 25 years
Facility should accommodate 400 patients
Tender consideration: would be a fixed amount for the design and construction of
the facility and a variable amount for the maintenance and operation
YOUR CLIENT’S SCENARIO - Continue
Egoli Patient Services (Pty) Ltd was awarded the tender
Fixed portion for the design and construction: R120 million, payable over 10 years in equal installments
Variable portion for the maintenance and operation: R50 per patient per day, indexed annually
Facility was brought into use on 1 March 2009
Financial year 1 March 2009 – 28 February 2010:Fixed portion – R12 millionVariable portion – R7,3 million
YOUR CLIENT’S SCENARIO - Continue
Tax advice required by Egoli Patient Services (Pty) Ltd
How should
the fixed portion (R12 million) and
the variable portion (R7,3 million)
be treated for income tax purposes.
No other information provided and no advice pertaining CGT, VAT etc. required
WHAT IS A PPP ?
Defined in section 1‘a Public Private Partnership as defined in Regulation16 of the Treasury Regulations issued in terms of section 76 of the Public Finance Management Act, 1999 (Act No.1 of 1999)
Loosely: An arrangement between the Public Sector and Private Sector
Public Sector represented by a specific Department of Government
Private Sector normally represented by Special Purpose Company, on behalf of shareholders, financiers and other stakeholders
Could be for use of public assets or to perform institutional function
INCOME TAX ACT APPLICATION
A PPP is a normal taxpayer, but has TWO provisions in the Income Tax which specifically deals with it:
Section 10(1)(zI): Exemption
Section 11(g): Leasehold improvements
All other provisions equally important
Because the query is about income, the exemption is the only specific provision to be dealt with herein
LET’S START AT THE BEGINNING:BASIC FORMULA FOR TAX CALCULATION
Gross income XXX
Less: Exempt Income (XXX)
Income XXX
Less: Allowable deduction (XXX)
Taxable Income XXX
ARE THE AMOUNTS GROSS INCOME?
The first question about any amount which a taxpayer receives is whether the amount constitutes gross income?
Therefore does Egoli’s fixed portion of R12 million, in respect of design and construction, constitutes gross income?
And, does the variable portion R7,3 million, in respect of maintenance and operation, constitutes gross income?
GROSS INCOME - DEFINED
Section 1 – Definition:“gross income” in relation to any year or period of assessment, means –
(i) in the case of any resident, the total amount, in cash or otherwise, received by or accrued to or in favour of such resident; or
(ii) [in the case of any non-resident]
during such year or period of assessment, excluding receipts and accruals of a capital nature …
GROSS INCOME – PER FORMULA
Total amount in cash received by a resident XXX
Total amount in cash accrued to a resident XXX
Total amount in cash receive by, in favour of a resident XXX
Total amount in cash accrued to, in favour of a resident XXX
Total amount otherwise received by a resident XXX
Total amount otherwise accrued to a resident XXX
Total amount otherwise receive by, in favour of a resident XXX
Total amount otherwise accrued to, in favour of a resident XXX
XXX
LESS: Receipts of a capital nature (XXX)
LESS: Accruals of a capital nature (XXX)
GROSS INCOME XXX
GROSS INCOME – AMOUNT RECEIVED
Is the fixed portion of R12 million, in respect of design and construction, an amount?
YES
Is the fixed portion of R12 million, in respect of design and construction, received?
YES
Is the variable portion of R7,3 million, in respect of maintenance and operation, an amount?
YES
Is the variable portion of R7,3 million, in respect of maintenance and operation, received?
YES
GROSS INCOME – PER FORMULA - APPLICATION
Total amount in cash received by Egoli - in respect of design and construction
R12 million
Total amount in cash received by Egoli - in respect of maintenance and operation
R7,3 million
No other received or accrual
R19,3 million
LESS: Receipts of a capital nature ???
GROSS INCOME XXX
IS IT A RECEIPT OF A CAPITAL NATURE?
No definition of the phrase ‘of a capital nature’
In the normal course there is no difficulty to determine whether a receipt or accrual is income or capital in nature
Popular distinction is that capital is the income-producing machine, and the product is income
Capital = Tree; Income = apples
Position is not always so simple or clear, and the reported cases have introduced a wealth of subtle distinctions
IS IT A RECEIPT OF A CAPITAL NATURE? - Continue
It is necessary to consider the nature of the fixed portion of R12 million, in respect of the design and construction
It is also necessary to consider the nature of the variable portion of R7,3 million, in respect of the maintenance and operation
Are they grants or subsidies in nature?
IS IT A RECEIPT OF A CAPITAL NATURE? - Continue
What is a grant or subsidy?
No definition in Income Tax Act of ‘grant’ or ‘subsidy’
Can be described as: A sum of money given by a government or public body for a
particular purpose
A sum of money granted from public funds to help an industry or business, or to keep the price of a commodity or service low
To advance policy decision
IS IT A RECEIPT OF A CAPITAL NATURE? - Continue
‘Government grant’ defined as: ‘an appropriation, grant in aid, subsidy or contribution, in cash or kind, paid by a department listed in Schedule 1 to the Public Service Act, 1994 (Proclamation No. 103 of 1994), (other than a provincial administration), but does not include any amount paid in respect of the supply of any goods or any services to that department’
But only in relation to section 10(1)(y) – not relevant for this discussion
IS IT A RECEIPT OF A CAPITAL NATURE? - Continue
Two tax cases dealt with grants / subsidies:
Moolman v CIR (19 SATC 127)
ITC 1633
IS IT A RECEIPT OF A CAPITAL NATURE? - Continue
Moolman v CIR
Moolman was a wool-farmer
In 1940 the UK and SA had an arrangement and via this arrangement Moolman had to sell his wool to the UK
After the war in 1945 the UK had large stock of wool, sold in Australia
Profits were remitted to SA and Moolman received pro-rata share - agterskot
Was it capital or revenue in nature?
IS IT A RECEIPT OF A CAPITAL NATURE? - Continue
Moolman v CIR
Centlivres CJ said that:
’[it] is therefore clear that the amount was paid to the appellant in respect of wool sold by him in the course of his occupation as a wool-producer and was a profit made by him as a result of his operations as a wool-producer, and must be regarded as an addition to the purchase price which he obtained from the wool which he sold …
This being so that amount cannot be regarded as a receipt of a capital nature’
IS IT A RECEIPT OF A CAPITAL NATURE? - Continue
ITC 1633
The taxpayer was a manufacturer of motor vehicles and enjoyed certain excise duty rebates
Two main categories were taken into account - the foreign exchange saved by the use of local components and the foreign exchange earned by exports
The taxpayer contended inter alia that the rebates were capital in nature
IS IT A RECEIPT OF A CAPITAL NATURE? - Continue
ITC 1633Wunsh J:
The excise duties were normal deductible expenses and if an amount received has the effect of recouping expenditure, the recoupment is gross income and not capital in nature
There was no foundation to claim that if the ‘payment’ was intended ‘as an incentive to achieve certain economic, socio-economic, or political aims of the State, such payment would … constitute a capital accrual’
IS IT A RECEIPT OF A CAPITAL NATURE? - Continue
ITC 1633Wunsh J:
The rebate was not granted to finance the costs of capital items such as building and plant
There was no evidence that by opting to subscribe to the local content programme the taxpayer restricted its freedom to trade as it deemed fit
The taxpayer did not surrender any rights
IS IT A RECEIPT OF A CAPITAL NATURE? - Continue
ITC 1633Wunsh J:
The taxpayer was not contractually or in any way restricted from its right to trade
The taxpayer participated in the scheme in order to enable it to receive the rebates and so increased its profits
There was no substance in any of the arguments for the proposition that the rebates were of a capital nature
IS IT A RECEIPT OF A CAPITAL NATURE? - Continue
Therefore:
Subsidies may be receipts or accrual of a capital or income nature depending upon the purpose for which they are granted
If, for example, it is granted to establish an industry, it will be of a capital nature, since the subsidy goes towards the:
fixed capital or
income earning machine
IS IT A RECEIPT OF A CAPITAL NATURE? - Continue
But:
If the grant or subsidy is granted in respect of the taxpayer’s trading as such, for example:
to manufacturers or producers to encourage production
to encourage export
to compensate a taxpayer for keeping prices low
the grant or subsidy is income in nature
IS IT A RECEIPT OF A CAPITAL NATURE? - Continue
Is the fixed portion of R12 million, in respect of the design and construction, a receipt of a capital nature?
YES / NOYES
Is the variable portion of R7,3 million, in respect of the maintenance and operation, of a capital nature?
YES / NONO
GROSS INCOME – PER FORMULA - APPLICATION
Total amount in cash received by Egoli - in respect of design and construction
R12 million
Total amount in cash received by Egoli - in respect of maintenance and operation
R7,3 million
No other received or accrual
R19,3 million
LESS: Receipts of a capital nature by Egoli – in respect of design and construction
(R12 million)
GROSS INCOME R7,3 million
LET’S START AT THE BEGINNING:BASIC FORMULA FOR TAX CALCULATION
Gross income R7,3 million
Less: Exempt Income (XXX)
Income XXX
Less: Allowable deduction (XXX)
Taxable Income XXX
IS THE AMOUNT EXEMPT FROM TAX
Section 10(1)(zI) – Exemption provides the following
10. There shall be exempt from normal tax-(zI) any amount received by or accrued to or in favour of any
person from the Government, where-
(i) the amount is granted for the performance by that person of its obligations pursuant to a Public Private Partnership; and
(ii) that person is required in terms of that Public Private Partnership to expend an amount at least equal to that amount in respect of any improvements on land or to buildings owned by any sphere of government …
ANALYSIS OF SECTION 10(1)(zI)
Did Egoli receive any amount from Government?
Yes
ANALYSIS OF SECTION 10(1)(zI) - Continue
Is Egoli in a PPP, as defined?
Yes
ANALYSIS OF SECTION 10(1)(zI) - Continue
Was such amount granted to Egoli for the performance of its obligations pursuant to the PPP?
Yes
ANALYSIS OF SECTION 10(1)(zI) - Continue
How much was granted to Egoli for the performance of its obligations pursuant to the PPP?
A total of R19,3 million, i.e.:
R12 mllion in respect of the design and construction, and
R7,3 million in respect of the maintenance and operation
ANALYSIS OF SECTION 10(1)(zI) - Continue
Did the PPP require Egoli to expend an amount in respect of improvements on Government land?
YESIt was required to construct a psychiatric unit on Government land
ANALYSIS OF SECTION 10(1)(zI) - Continue
How much was expend on the psychiatric unit constructed on Government land?
Egoli advised that it spent R60 million on the psychiatric unit
ANALYSIS OF SECTION 10(1)(zI) - Continue
THEREFORE:The amount Egoli was granted pursuant to its obligations R19,3 millionThe amount Egoli expended on the improvements R60 million
The requirement in par. (ii) is that Egoli has to expend an amount at least equal to the amount it receives pursuant to the obligations
Did Egoli expend an amount at least equal to the amount received?
No, therefore the full amount falls wihin the requirement
Is it fair to say that Egoli could have an exemption up to R60 million on an annual basis?
TAX CALCULATION
Gross income R7,3 million
Less: Exempt Income (R19,3 million)
Income / (loss) (R12 million)
Is the above position correct?
Can the deduction of exempt income from gross income create a loss?
INCOME
Section 1 – Definition:“income” means the amount remaining of the gross income of any person for any year or period of assessment after deducting therefrom any amounts exempt from normal tax under Part I of Chapter II
How much would therefore remain from Egoli’s gross income after deducting the exempt PPP amount?
ANSWER TO EGOLI
Gross income R7,3 million
Less: Exempt Income (R19,3 million)
Income NIL
Less: Allowable deduction (XXX)
Taxable Income XXX
REALITY CHECK
Are you sure this is correct?
You have just given Egoli a double deduction?
1.By deducting the capital receipt in respect of the design and construction?
2. By deducting it as exempt as well?
You have also given Egoli an exemption for its operating income
CORRECT APPROACH
No magic to the term, contractor
Egoli was contracted to design and provide a psychiatric unit
The fixed portion of R12 million, in respect of the design and construction, is therefore a receipt for services rendered and revenue in nature
The exemption is still applicable
Cost of psychiatric unit should be considered in terms of section 11(a) & 23(f)
The key is that thepsychiatric unit is ‘trading stock’ as defined
THANK YOU