Delegate Handbook - Fasset

2012 Budget and Tax

Update

March 2012

Workbook

Facilitated by Itukisa (Pty) Ltd.

The views expressed in this workbook are not necessarily reflective of the official views of Fasset.

2012 Budget and Tax Update

2012 BUDGET AND TAX UPDATE

CONTENTS

PART 1 -TAX PROPOSALS .................................................................................................................... 6

Budget 2012 .................................................................................................................................................................. 6

INDIVIDUALS ................................................................................................................................................................ 6 Tax tables 2012/13 6 Tax tables 2011/12 6 Rebates 6 Tax threshold 6 Tax saving per annum 7 Interest and taxable dividend exemption 7 Monthly monetary caps for tax-free medical scheme contributions 7 Monthly medical scheme tax credits 7 CGT exclusions (natural persons) 8 Travel allowance: Deemed expenditure table with effect from 1 March 2012 8 Travel allowance: Deemed expenditure table effective to 28 February 2012 8 Subsistence allowance: Deemed expenditure daily limits 9

RETIREMENT AND PRE-RETIREMENT LUMP SUM BENEFITS ............................................................................. 13 Pre-retirement lump sums 13 Retirement fund lump sum withdrawal benefits ( No change) 13 Retirement and death lump sums and severance benefits received on or after 1 March 2011 13 Retirement fund lump sum benefits table ( No change) 13 Retirement and death lump sums and severance benefits received before 1 March 2011 13 Retirement fund lump sum benefits table 13

CORPORATE TAX RATES ......................................................................................................................................... 14 Normal tax 14 Tax rates for qualifying small business corporations 14 Presumptive turnover tax on micro businesses 14 Secondary tax on companies (STC) 15 Dividends tax 15 Trusts 15

OTHER TAXES ........................................................................................................................................................... 15 Estate duty 15 Donations Tax 15 Capital gains tax (CGT) 15 The effective CGT rates are as follows: 15 Transfer duty 16 Securities Transfer Tax 16

BUDGET COMMENTARY ........................................................................................................................................... 16 Overview 16 Main tax proposals 16 Relief for individuals 16 Medical deductions converted to medical tax credits 17 Funding options for national health insurance 17 Encouraging household savings 17 Retirement reforms 17 Gambling 18 Increase in capital gains tax rates 18 Business taxes 18 International taxation 20


Excise duties on tobacco and alcohol 20 Taxation of luxury goods 21 Indirect taxes 21 Tax administration 22 Miscellaneous tax amendments 23 Tax policy research projects 27

PART 2 – TAX UPDATE ........................................................................................................................ 28

DEVELOPMENTS OVER THE LAST YEAR ............................................................................................................... 28 Tax judgements delivered in 2011 30 Interest Rate Changes 31

AMENDMENTS TO THE LEGISLATION .................................................................................................................... 31

2012 TABLES, RATES AND THRESHOLDS.............................................................................................................. 32

INDIVIDUALS, EMPLOYMENT AND SAVINGS ......................................................................................................... 38 Third Rebate For The Elderly 38 Standard Income Tax on Employees 39 Medical Scheme Credits and Deductions 39 Travel Allowance 45 Executive Share Schemes – Dividends Received From Employee Share Trusts 46 Employer-Provided Long-Term Insurance – Taxation Of Proceeds On Payout 47 Employer-Owned Insurance Policies – Cession Of Compensation And Pure Risk Policies 49 Employer- Provided Indemnity Insurance – Employer Contributions Treated As A Taxable Benefit 53 Fringe Benefits 56 Provisional Tax 57

RETIREMENT AND RELATED ISSUES ..................................................................................................................... 59 Severance Employment Benefits and the Rating Formula 59 Retirement Annuity Contributions 59 Second Schedule 59

BUSINESSES.............................................................................................................................................................. 61 Definitions 61 Pre-Production Interest 63 Small Business Corporations 63 Learnership Allowances 64 Micro – Business Turnover tax 64 Film Owners – Allowance and Exemption 67 Capital Allowances on Foundations 72 Research and Development 72 Industrial Policy Projects 80 Venture Capital Companies 81 Industrial Buildings 86 Urban Development Zones 87 Group Relief Provisions 87 Section 41 - General 92 Asset – For – Share Transactions 93 Amalgamation Transactions 96 Intra- Group Transactions 99 Unbundling Transactions 101 Liquidation, Winding- Up and Deregistration 103 Secondary Tax on Companies 104 Debt Without A Set Maturity Date – Anti Avoidance 105

DIVIDENDS TAX AND ANTI-AVOIDANCE PROVISIONS ....................................................................................... 107 Accrual Versus Cash Accounting 107


Contributed Tax Capital (CTC) 108 Rebate For Dividends Tax On Income Of Foreign Companies 109 Dividends Tax – Collateral definition issues 110 Foreign Dividends 113 Dividends Tax – In Specie Dividends 113 Anti-Avoidance – Hybrid Equity Instruments And Independently Secured Or Third-Party Backed Shares 117 Anti-Avoidance – Dividend Stripping Adjustments 122 Anti-Avoidance – Dividend Cessions 125 Value Extraction tax – Removal thereof 128 Passive Holding Companies 129

INTERNATIONAL PROVISIONS .............................................................................................................................. 130 Timing Of Rebates For Foreign Taxes On Income 130 Special Foreign Tax Credit For Management Fees 131 Unification Of Source Rules 132 Blocked Foreign Funds 138 Offshore Cell Companies 138 Reform Of The Controlled Foreign Company (CFC) Regime 139 Single Charge For Company Emigration 149 Controlled Foreign Company Restructuring 150 Headquarters Companies 152 Foreign Dividends – A New Dispensation 155 Foreign Exchange Gains and Losses – Foreign share acquisition Hedges 159 Transfer Pricing 160 Withholding Tax on Interest 163

CAPITAL GAINS TAX ............................................................................................................................................... 167 Annual Exclusion 167 Foreign Currency – Repeal of Capital Gain Rules 167 Assets Disposed Of In A Foreign Currency 168 Disposal Of Small Business Assets 169 Disposal Of Equity Shares In Foreign Companies 169 Company Distributions 171 Transfer of residence from company or trust 177

SPECIALISED ENTITIES AND CIRCUMSTANCES ................................................................................................. 182 Shares Deemed To Be Capital In Nature 182 Reportable Arrangements 183 Islamic financing – Amendments to the 2010 legislation 183 Proposed Sukuk 185 Deduction Of Donations By Collective Investment Schemes, and 187 Conduit Principle For Ordinary Distributions By Collective Investment Schemes 187 Recreational Clubs 189 Public Benefit Organisations (PBOs) 189 Road Accident Fund Payouts 190 Employee Compensation Fund Entities 191

TRANSFER DUTY .................................................................................................................................................... 192 Definitions 192 Imposition of Duty 192 Sharia Compliant Financing Arrangements 193 Fair Value determination 194 Exemptions 194

VALUE –ADDED TAX ............................................................................................................................................... 195 Sharia compliant financing arrangements 195 Delinking VAT From Transfer Duty 195 Micro - Business Turnover Tax 197 Temporary Relief For The Rental Of Residential Property By Developers 198 Intra-Warehouse Transfers 202


Minimum VAT Exemption For Imported Services 202 Input Tax Denied 203 Discount Vouchers 203 Unpaid Group Member Debt 204 Synchronising VAT and Customs Relief For Temporary Imports 206

UNEMPLOYMENT INSURANCE CONTRIBUTIONS ............................................................................................... 206

SECURITIES TRANSFER TAX ................................................................................................................................. 207 Dividend Cessions 207 Sharia Compliant Financing Arrangements 208 Regional Electricity Distributors 208 Temporary Adjustment To The Broker – Member Exemption 208

TAX ADMINISTRATION BILL ................................................................................................................................... 210 Background 210 Objects of the TAB 210 Arrangement of the 272 sections of the TAB, 2011 211 Memorandum on the Objects of the Tax Administration Bill, 2011 218


PART 1 -TAX PROPOSALS BUDGET 2012

The notes that follow draw extensively from the SARS Budget Tax Proposals 2012.

INDIVIDUALS

TAX TABLES 2012/13

Taxable income

R Rate of tax

0 - 160 000 18%

160 001 - 250 000 28 800 + 25% of the excess over R160 000




617 001 - 178 940 + 40% of the excess over R617 000

TAX TABLES 2011/12

Taxable income

R Rate of tax

0 - 150 000 18%





580 001 - 168 250 + 40% of the excess over R580 000

REBATES

2012/13

R

2011/12

R

2010/11

R

Primary 11 440 10 755 10 260

Secondary (Age 65 and over) 6 390 6 012 5 675

Tertiary rebate (Age 75 and over) 2 130 2 000 0

TAX THRESHOLD

2012/13

R

2011/12

R

2010/11

R

Below age 65 63 556 59 750 57 000

Age 65 to 74 99 056 93 150 88 528

Age 75 and over 110 889 104 261 88 528

The proposed changes to the tax tables and rebates attempt to eliminate the effects of inflation on income tax liabilities and result in a reduced tax liability for taxpayers at all income levels. These tax reductions are set out below:


TAX SAVING PER ANNUM

Age below 65

Taxable income R

R63 556 – R150 000 685

R160 000 – R235 000 1 385

R250 000 – R325 000 2 135

R346 000 – R455 000 3 185

R484 000 – R580 000 4 055

R617 000 and above 4 795

Age above 65 to 74

Taxable income R

R99 056 – R150 000 1 063

R160 000 – R235 000 1 763

R250 000 – R325 000 2 513

R346 000 – R455 000 3 563

R484 000 – R580 000 4 433

R617 000 and above 5 173

Age above 75 and above

Taxable income R

R99 056 – R150 000 1 193

R160 000 – R235 000 1 893

R250 000 – R325 000 2 643

R346 000 – R455 000 3 693

R484 000 – R580 000 4 563

R617 000 and above 5 303

INTEREST AND TAXABLE DIVIDEND EXEMPTION

2012/13

R

2011/12

R

2010/11

R

Natural persons below age 65 22 800 22 800 22 300

Age 65 and over 33 000 33 000 32 000

Of the above, the amount that can be applied to foreign interest and dividends

deleted 3 700 3 700

MONTHLY MONETARY CAPS FOR TAX-FREE MEDICAL SCHEME CONTRIBUTIONS

2012/13

R

2011/12

R

2010/11

R

Taxpayer and first dependant n/a 720 670

Each additional dependant n/a 440 410

MONTHLY MEDICAL SCHEME TAX CREDITS

2012/13

R

2011/12

R

2010/11

R

Taxpayer and first dependant 230 n/a n/a

Each additional dependant 154 n/a n/a


CGT EXCLUSIONS (NATURAL PERSONS)

2012/13

R

2011/12

R

2010/11

R

Annual exclusion for capital gains or losses 30 000 20 000 17 500

Annual exclusion in year of death for capital gains or losses 300 000 200 000 120 000

Primary residence exclusion for capital gains or losses 2 000 000 1 500 000 1 500 000

Disposal of a small business when a person is over age 55 1 800 000 900 000 750 000

Max assets to qualify as a small business above 10 000 000 5 000 000 5 000 000

TRAVEL ALLOWANCE: DEEMED EXPENDITURE TABLE WITH EFFECT FROM 1 MARCH 2012

Value of the vehicle R

Fixed cost R

Fuel cost c/km

Maintenance cost c/km

0 - 60 000 19 492 73.7 25.7

60 001 - 120 000 38 726 77.6 29.0

120 001 - 180 000 52 594 81.5 32.3

180 001 - 240 000 66 440 89.6 36.9

240 001 - 300 000 79 185 102.7 45.2

300 001 - 360 000 91 873 117.1 53.7

360 001 - 420 000 105 809 119.3 65.2

420 001 - 480 000 119 683 133.6 68.3

480 001 - 119 683 133.6 68.3

Alternative to the rate table:

Where the distance travelled for business purposes does not exceed 8 000 kilometers per annum, no tax is payable on an allowance paid by an employer to an employee up to the rate of 316 cents per kilometer, regardless of the value of the vehicle.

This alternative is not available if other compensation in the form of an allowance or reimbursement is received from the employer in respect of the vehicle.

TRAVEL ALLOWANCE: DEEMED EXPENDITURE TABLE EFFECTIVE TO 28 FEBRUARY 2012

Value of the vehicle

R

Fixed cost

R

Fuel cost

c/km

Maintenance cost

c/km

0 - 60 000 19 492 64.6 26.4

60 001 - 120 000 38 726 68.0 29.2

120 001 - 180 000 52 594 71.3 31.9

180 001 - 240 000 66 440 77.7 35.0

240 001 - 300 000 79 185 87.0 44.7

300 001 - 360 000 91 873 93.9 54.2

360 001 - 420 000 105 809 100.9 65.8

420 001 - 480 000 119 683 113.1 67.6

480 001 - 119 683 113.1 67.6

Alternative to the rate table: Where the distance travelled for business purposes does not exceed 8 000 kilometers per annum, no tax is payable on an allowance paid by an employer to an employee up to the rate of 305 cents per kilometer, regardless of the value of the vehicle.


This alternative is not available if other compensation in the form of an allowance or reimbursement is received from the employer in respect of the vehicle.

SUBSISTENCE ALLOWANCE: DEEMED EXPENDITURE DAILY LIMITS

The following amounts will be deemed to have been actually expended by a recipient to whom an allowance or advance has been granted or paid:

2012/13

R

2011/12

R

2010/11

R

Where the accommodation, to which that allowance or advance relates, is in the Republic and that allowance or advance is paid or granted to defray -

Incidental costs only R93 per day R88 per day R85 per day

The cost of meals and incidental costs R303 per day R286 per day R276 per day

Where the accommodation, to which that allowance or advance relates, is outside the Republic and that allowance or advance is paid or granted to defray the cost of meals and incidental costs, an amount per day determined in accordance with the following table for the country in which that accommodation is located -

Daily amount for travel outside the Republic

Country Currency Amount 2012/2013 Amount 2011/2012

Albania Euro 97 97

Algeria Euro 103 94

Angola US $ 340 340

Antigua and Barbuda US $ 220 220

Argentina US $ 91 91

Armenia US $ 220 279

Austria Euro 108 108

Australia Aus $ 188 194

Azerbaijani US $ 145 145

Bahamas US $ 191 191

Bahrain B Dinars 36 36

Bangladesh US $ 79 79

Barbados US $ 202 202

Belarus Euro 76 72

Belgium Euro 140 145

Belize US $ 152 152

Benin Euro 89 89

Bolivia US $ 64 64

Bosnia-Herzegovina Euro 78 78

Botswana Pula 518 518

Brazil US $ 146 146

Brunei Darussalam US $ 88 88

Bulgaria Euro 92 92

Burkina Faso Euro 92 92

Burundi US $ 138 138

Cambodia US $ 79 79

Cameroon Euro 206 206

Canada Can $ 157 156

Cape Verde Islands Euro 65 65

Central African Republic Euro 94 94

Chad Euro 121 121

Chile US $ 103 103

China (PR of) US$ 129 129



Colombia US $ 94 94

Comoro Island Euro 128 96

Cook Islands NZ $ 201 201

Cote D'Ivoire Euro 97 97

Costa Rica US $ 74 74

Croatia Euro 116 116

Cuba Euro 133 120

Cyprus Euro 114 114

Czech Republic Euro 90 90

Democratic Republic of Congo US $ 288 221

Denmark Danish Kroner / Euro 1 469 190

Djibouti US $ 99 99

Dominican Republic US $ 99 99

Ecuador US $ 110 110

Egypt US $ 118 120

El Salvador US $ 193 193

Equatorial Guinea Euro 130 130

Eritrea US $ 92 92

Estonia Euro 91 91

Ethiopia US $ 65 65

Fiji US $ 78 78

Finland Euro 154 154

France Euro 141 141

Gabon Euro 144 144

Gambia Euro 105 105

Georgia US $ 95 261

Germany Euro 107 107

Ghana US$ / Euro 132 114

Greece Euro 120 120

Grenada US $ 151 151

Guatemala US $ 83 83

Guinea Euro 78 78

Guinea Bissau Euro 59 59

Guyana US $ 118 118

Haiti US $ 109 109

Honduras US $ 186 186

Hong Kong HK $ 1 000 1 000

Hungary Euro 85 86

Iceland ISK 23 786 29 827

India Indian Rupees / US $ 4 791 100

Indonesia US $ 86 86

Iran US $ 92 81

Iraq US $ 125 125

Ireland Euro 240 240

Israel US $ 162 122

Italy Euro 127 121

Jamaica US $ 151 151

Japan Yen 17 466 16 655

Jordan US $ 172 167

Kazakhstan US $ 130 121

Kenya US 116 116

Kiribati Aus $ 233 233

Korea US$ / WON 154 154

Kuwait US $ 166 166

Kyrgyzstan US $ 172 172

Laos US $ 79 79



Latvia US$ / Euro 147 147

Lebanon US $ 139 139

Lesotho Rand 750 750

Liberia US $ 97 97

Libya US $ 112 112

Lithuania Euro 154 154

Macau HK $ 1 196 1 196

Macedonia Euro 100 100

Madagascar Euro 107 107

Madeira Euro 290 290

Malawi Kwacha/US $ 21 699 21 699

Malaysia Ringgit/US $ 338 338

Maldives US $ 202 202

Mali Euro 182 164

Malta Euro 132 132

Marshall Islands US $ 255 255

Mauritania Euro 178 178

Mauritius US $ 106 106

Mexico US $ 86 86

Moldova US $ 117 165

Mongolia US $ 69 69

Montenegro Euro 119 119

Morocco Dirhams / US $ 1 034 106

Mozambique US $ 69 95

Myanmar (Burma) US $ 140 140

Namibia Rand 779 787

Nauru Aus $ 278 278

Nepal US $ 64 64

Netherlands Euro 112 123

New Zealand NZ $ 174 174

Nicaragua US $ 288 288

Niger Euro 99 99

Nigeria Euro 121 121

Niue NZ $ 252 252

Norway NOK 1 685 1 641

Oman Rials Rials Omani 69 68

Pakistan Paki Rupees / US $ 5 775 66

Palau US $ 252 252

Palestine US $ 147 default below

Panama US $ 98 98

Papa New Guinea Kina 285 285

Paraguay US $ 70 70

Peru US $ 124 124

Philippines US $ 119 110

Poland Euro 95 95

Portugal Euro 107 110

Qatar Riyals 600 600

Republic of Congo Euro 149 149

Reunion Euro 164 164

Romania Euro 76 76

Russia Euro 167 136

Rwanda US $ 83 89

Samoa Tala 325 325

Sao Tome Euro 86 86

Saudi Arabia Saudi Riyal 453 453

Senegal Euro 95 95



Serbia Euro 81 81

Seychelles Euro 275 275

Sierra Leone US $ 90 90

Singapore Singapore $ 201 201

Slovakia Euro 101 101

Slovenia Euro 85 85

Solomon Islands Sol Island $ 912 912

Spain Euro 111 111

Sri Lanka US $ 86 86

St. Kitts & Nevis US $ 227 227

St. Lucia US $ 215 215

St. Vincent & The Grenadines US $ 187 187

Sudan US $ 121 121

Suriname US $ 107 107

Swaziland Rand 818 818

Sweden Sw Krona 1 285 1 285

Switzerland S Franc 201 201

Syria US $ 95 95

Taiwan New Taiwan $ 3 279 3 544

Tajikistan US $ 108 97

Tanzania US $ 96 96

Thailand Thai Baht 4 179 3 849

Togo Euro 78 78

Tonga Pa’anga 216 216

Trinidad & Tobago US $ 213 213

Tunisia Tunisian Dinar 121 121

Turkey US $ 111 111

Turkmenistan US $ 125 125

Tuvalu Aus $ 339 339

Uganda US $ 90 90

Ukraine Euro 103 84

United Arab Emirates Dirhams 653 653

United Kingdom B Pounds 124 124

Uruguay US $ 109 109

USA US $ 142 142

Uzbekistan Euro 117 117

Vanuatu US $ 161 161

Venezuela US $ 338 338

Vietnam US $ 94 94

Yemen US $ 94 94

Zambia US $ 119 119

Zimbabwe US $ 120 182

Other countries not listed US $ 215 215


RETIREMENT AND PRE-RETIREMENT LUMP SUM BENEFITS

PRE-RETIREMENT LUMP SUMS

RETIREMENT FUND LUMP SUM WITHDRAWAL BENEFITS ( NO CHANGE) Taxable lump sum

R

Rate of tax

0 - 22 500 0%

22 501 - 600 000 18% of the amount exceeding R 22 500

600 001 - 900 000 R103 950 + 27% of the amount exceeding R600 000

900 001 - R184 950 + 36% of the amount exceeding R900 000

Retirement fund lump sum withdrawal benefits consist of lump sums from a pension, pension preservation, provident, provident preservation or retirement annuity fund on withdrawal (including assignment in terms of a divorce order). Tax on a specific retirement fund lump sum withdrawal benefit (X) is equal to –

tax determined by applying the tax table to the aggregate of that lump sum X plus all other retirement fund lump sum withdrawal benefits accruing from March 2009 and all retirement fund lump sum benefits accruing from October 2007 and all severance benefits accruing from March 2011; less

tax determined by applying the tax table to the aggregate of all retirement fund lump sum withdrawal benefits accruing before lump sum X from March 2009 and all retirement fund lump sum benefits accruing from October 2007 and all severance benefits accruing from March 2011.

RETIREMENT AND DEATH LUMP SUMS AND SEVERANCE BENEFITS RECEIVED ON OR AFTER 1 MARCH

2011

RETIREMENT FUND LUMP SUM BENEFITS TABLE ( NO CHANGE)

Taxable lump sum

R

Rate of tax

0 - 315 000 0%

315 001 - 630 000 R0 + 18% of the amount exceeding R315 000


945 001 - and above R141 750 + 36% of the amount exceeding R945 000

RETIREMENT AND DEATH LUMP SUMS AND SEVERANCE BENEFITS RECEIVED BEFORE 1 MARCH 2011

RETIREMENT FUND LUMP SUM BENEFITS TABLE

Taxable lump sum

R

Rate of tax

0 - 300 000 0%

300 001 - 600 000 R0 + 18% of the amount exceeding R300 000


900 001 - and above R135 000 + 36% of the amount exceeding R900 000

Retirement fund lump sum benefits consist of lump sums from a pension, pension preservation, provident, provident preservation or retirement annuity fund on death, retirement or termination of employment due to redundancy or termination of employer’s trade. Severance benefits consist of lump sums or by arrangement with an employer due to relinquishment, termination, loss, repudiation, cancellation or variation of a person’s office or employment. Tax on a specific retirement fund lump sum benefit or a severance benefit (Y) is equal to –


tax determined by applying the tax table to the aggregate of that lump sum or severance benefit Y plus all other retirement fund lump sum benefits accruing from October 2007 and all retirement fund lump sum withdrawal benefits accruing from March 2009 and all other severance benefits accruing from March 2011; less

tax determined by applying the tax table to the aggregate of all retirement fund lump sum benefits accruing before lump sum Y from October 2007 and all retirement fund lump sum withdrawal benefits accruing from March 2009 and all severance benefits accruing before severance benefit Y from March 2011.

CORPORATE TAX RATES

Years of assessment ending between 1 April and 31 March

NORMAL TAX 2012/13 2011/12

Non-mining companies 28% 28%

Close corporations 28% 28%

Employment companies (personal service provider) 28% 33%

Taxable income of a non-resident company (SA branch) 28% 33%

TAX RATES FOR QUALIFYING SMALL BUSINESS CORPORATIONS

Years of assessment ending between 1 April 2012 and 31 March 2013

Taxable income

R

Rate of tax

0 - 63 556 0%

63 557 - 350 000 7% of the amount over R63 556

350 001 - R20 051 + 28% of the amount over R350 000

Years of assessment ending between 1 April 2011 and 31 March 2012

Taxable income

R

Rate of tax

0 - 59 750 0%



PRESUMPTIVE TURNOVER TAX ON MICRO BUSINESSES

Years of assessment ending on 28 February 2013

Taxable Turnover

R

Rate of tax

0 - 150 000 0%


300 001 - 500 000 R1 500 + 2% of the amount over R300 000



Years of assessment ending on 29 February 2012

Taxable Turnover R

Rate of tax

0 - 150 000 0%






SECONDARY TAX ON COMPANIES (STC)

Rate of STC on dividends declared -

17 March 1993 – 21 June 1994 15%

22 June 1994 – 13 March 1996 25%

14 March 1996 – 30 September 2007 12.5%

01 October 2007 – 31 March 2012 (even if paid later than 31 March 2012) 10%

DIVIDENDS TAX

Rate of Dividends tax on dividends declared and paid -

On or after 1 April 2012 15%

TRUSTS

The tax rate on trusts (other than special trusts) remains unchanged at 40%.

OTHER TAXES

ESTATE DUTY

Rate of estate duty on the dutiable amount of an estate -

Death prior to 14 March 1996 15%

Death between 15 March 1996 and 30 September 2001 25%

Death or after 01 October 2001 20%

Primary abatement: R3 500 000 (2013: R3 500 000) plus unused portion of the primary abatement of a pre-deceased spouse

DONATIONS TAX

Payable at a flat rate on the value of property donated by a resident -

Prior to 14 March 1996 15%

Between 15 March 1996 and 30 September 2007 25%

On or after 01 October 2007 20%

Annual exemption for natural persons: R100 000 (2013: R100 000)

CAPITAL GAINS TAX (CGT)

THE EFFECTIVE CGT RATES ARE AS FOLLOWS:

Taxpayer Inclusion

Rate (%)

Statutory

Rate (%)

Effective

Rate (%)

Individuals 33.3 0 – 40 0 – 13.32

Trusts

Special 33.3 0 – 40 0 – 13.32

Other 66.6 40 26.64

Companies

Ordinary 66.6 28 18.65

Small business corporation 66.6 0 – 28 0 – 18.65

Employment company (personal service provider) 66.6 28 18.65

Foreign company (SA branch) 66.6 28 18.65

Micro-business subject to turnover tax 0 0 0


Taxpayer Inclusion

Rate (%)

Statutory

Rate (%)

Effective

Rate (%)

Life assurers

Individual policyholders fund 33.3 30 9.99

Company policyholders fund 66.6 28 18.65

Untaxed policyholders fund - - -

Corporate fund 66.6 28 18.65

TRANSFER DUTY

Transfer duty rates applicable to all persons on purchase agreements concluded on or after 23 February 2011 (unchanged)

Property value

R

Rate of tax

0 - 600 000 0%

600 001 - 1 000 000 3%

1 000 001 - 1 500 000 R12 500 + 5%

1 500 001 - and above R37 000 + 8%

SECURITIES TRANSFER TAX

From 1 July 2008, STT replaced stamp duties and uncertificated securities tax on marketable securities. STT is levied at a flat rate of 0,25% on the taxable amount on any transfer of a security (listed and unlisted securities).

BUDGET COMMENTARY

(Extracted from the SARS 2012 Budget Tax Proposals)

OVERVIEW

The 2012 tax proposals support a sustainable fiscal framework over the medium term, while facilitating economic growth and a more competitive economy. Reforms will improve the fairness of the tax system, ensuring that income from capital is taxed more appropriately. Measures are proposed to encourage household savings. Financing options for national health insurance as part of a strengthened public health system will be explored.

Meeting South Africa’s development challenges requires sufficient revenue to fund key expenditure priorities, while ensuring that public debt and debt-service costs are contained, and avoiding overburdening taxpayers. Government is taking steps to improve the efficiency of public expenditure and to root out corruption.

MAIN TAX PROPOSALS

Personal income tax relief of R9.5 billion

Relief for micro and small businesses

Implementing the dividend withholding tax at 15%

An increase in effective capital gains tax rates

Reforms to the tax treatment of contributions to retirement savings

Further reforms to the tax treatment of medical scheme contributions

Higher taxes on alcohol and tobacco products.

RELIEF FOR INDIVIDUALS

To ensure that the direct personal income tax burden on individuals remains reasonable, personal income tax brackets and rebates are adjusted to take account of inflation or “bracket creep”, as well as provide limited real tax relief. The 2012 Budget proposes direct personal income tax relief to individuals amounting to R9.5 billion.


The primary rebate has been increased to R11 440 per year for all individuals. The secondary rebate, which applies to individuals aged 65 years and over, is increased to R6 390 per year. The third rebate, which applies to individuals aged 75 years and over, is increased to R2 130 per year. The threshold below which individuals are not liable for personal income tax is increased to R63 556 of taxable income per year for those below the age of 65, R99 056 per year for those aged 65 to 74, and R110 889 for age 75 and over.

MEDICAL DEDUCTIONS CONVERTED TO MEDICAL TAX CREDITS

Medical tax credits are a more equitable form of relief than medical deductions because the relative value of the relief does not increase with higher income levels. As announced in the 2011 Budget, income tax deductions for medical scheme contributions for taxpayers below 65 years will be converted into such credits. Monthly tax credits will be increased from R216 to R230 for the first two beneficiaries and from R144 to R154 for each additional beneficiary with effect from 1 March 2012. From that date onwards (apart from those with disabilities), where medical scheme contributions in excess of four times the total allowable tax credits plus out-of-pocket medical expenses combined exceed 7.5% of taxable income, they can be claimed as a deduction against taxable income.

To ensure improved equity of the tax system and to help curb increases in health costs, additional medical deductions will be converted into tax credits at a rate of 25% for taxpayers aged below 65 years with effect from 1 March 2014. Also with effect from the same date, employer contributions to medical schemes on behalf of ex-employees will be deemed a taxable fringe benefit and such ex-employees will be able to claim the appropriate tax credits.

Taxpayers 65 years and older, and those with disabilities or with disabled dependants, can currently claim all medical scheme contributions and out-of-pocket medical expenses as a deduction against their taxable income. The tax credits will, as from 1 March 2014, apply to all taxpayers. However, taxpayers 65 years and older and those with disabilities or disabled dependants will be able to convert all medical scheme contributions in excess of three times the total allowable tax credits plus out-of-pocket medical expenses into a tax credit of 33.3%. Note that the 7.5% threshold will not apply in the case of taxpayers 65 years and older and those with disabilities or with disabled dependants.

FUNDING OPTIONS FOR NATIONAL HEALTH INSURANCE

National health insurance is to be phased in over a 14-year period beginning in 2012/13. The new system will provide equitable health coverage for all South Africans. Plans to begin the first phase of national health insurance, and initial funding requirements, are discussed in some detail in Chapter 6 of the Budget Review. Over time, the new system will require funding over and above current budget allocations to public health. Funding options include an increase in the VAT rate, a payroll tax on employers, a surcharge on the taxable income of individuals, or some combination of the above.

Achieving an appropriate balance in the funding of national health insurance is necessary to ensure that the tax structure remains supportive of economic growth, job creation and savings. The role and implications of co-payments or user charges under certain circumstances (for example, to limit overuse and risky behaviours) will also be explored. A discussion paper will be published by end-April 2012.

ENCOURAGING HOUSEHOLD SAVINGS

To encourage greater savings among South Africans, tax-preferred savings and investment accounts are proposed as alternatives to the current tax-free interest-income caps. This will encourage a new generation of savings products. Returns generated within these savings and investment vehicles (including interest, capital gains and dividends) and withdrawals will be tax exempt. Aggregate annual contributions could be limited to R30 000 per year per taxpayer, with a lifetime limit of R500 000, to ensure that high net-worth individuals do not benefit disproportionately. The design and costs (banking and other fees) of these savings and investment vehicles may be regulated to help lower-income earners to participate.

Government proposes to introduce tax-preferred savings and investment vehicles by April 2014. A discussion document will be published by May 2012 to facilitate consultation and refine these proposals.

RETIREMENT REFORMS

To encourage South Africans to save for retirement, contributions by employees and employers to pension, provident and retirement funds will be tax deductible by individual employees.

Individual taxpayer deductions will be set at 22.5 and 27.5%, for those below 45 years and 45 and above respectively, of the higher of employment or taxable income. Annual deductions will be limited to R250 000 and R300 000 for taxpayers below 45 years and 45 and above respectively. A minimum monetary threshold of R20 000 will apply to allow low-income earners to contribute in excess of the prescribed percentages. Non-deductible contributions (in excess of the thresholds) will be exempt from income tax if, on retirement, they are taken as either part of the lump sum or as annuity income. Measures to address some of the complexities of defined benefit pension schemes will be considered. These amendments will come into effect on 1 March 2014.


A rollover dispensation similar to the current retirement annuity contributions will be adopted to allow flexibility in contributions for those with fluctuating incomes. Contributions towards risk benefits and administration costs within retirement savings will be included in the maximum percentage allowable deduction.

Lump sum withdrawals upon retirement from pension and retirement annuity funds are restricted to a maximum of one-third of accumulated savings. Consultations will be held with interested parties on a uniform approach to retirement fund withdrawals, taking into account vested rights and appropriate transitional arrangements.

GAMBLING

The 2011 Budget proposed a withholding tax on gambling winnings above R25 000. After broader consultation, a national gambling tax based on gross gambling revenue will be introduced. This tax, effective from 1 April 2013, will take the form of an additional 1 per cent national levy on a uniform provincial gambling tax base. A similar tax base will be used to tax the national lottery.

INCREASE IN CAPITAL GAINS TAX RATES

Capital gains tax was introduced in 2001 at relatively modest rates and has remained unchanged for the past 10 years. This reform has helped to ensure the integrity and progressive nature of the tax system. To enhance equity, effective capital gains tax rates will be increased. The inclusion rate for individuals and special trusts will increase to 33.3 per cent, shifting their maximum effective capital gains tax rate to 13.3 per cent. The inclusion rate for other entities (companies and other trusts) will increase to 66.6 per cent, raising the effective rate for companies to 18.6 per cent and for other trusts to 26.7 per cent. These changes will come into effect for the disposal of assets from 1 March 2012.

To limit the impact of capital gains taxation on middle-income households, the exemption thresholds for individual capital gains and for primary residences will be adjusted significantly. The following exemptions for individual capital gains are increased from 1 March 2012:

The annual exclusion from R20 000 to R30 000

The exclusion amount on death from R200 000 to R300 000

The primary residence exclusion from R1.5 million to R2 million

The exclusion amount on the disposal of a small business when a person is over age 55 from R900 000 to R1.8 million

The maximum market value of assets allowed for a small business disposal for business owners over 55 years increases from R5 million to R10 million.

BUSINESS TAXES

Dividends tax

As announced previously, the dividend withholding tax will come into effect on 1 April 2012, bringing an end to the secondary tax on companies. Pension funds that are exempt from income tax will receive their dividends tax free. For equity reasons it is proposed that the dividend withholding tax come into effect at 15% – five percentage points higher than the previous secondary tax on companies rate. Income from capital can be derived as interest income, dividends or capital gains, all of which should be taxed equitably.

High-income individuals tend to receive a larger portion of their income in the form of dividends and capital gains. The higher rate will also help to mitigate some of the revenue losses when switching from the secondary tax on companies to the new tax. The estimated net loss as a result of these changes will be R1.9 billion.

Collateral amendments stemming from the implementation of the new dividend withholding tax

Removal of the 33% rate for foreign companies: Foreign companies with domestic income are subject to a 33% rate of tax, while domestic companies are subject to a 28% rate plus a 10% secondary tax. The additional 5% charge is a proxy for the lack of any secondary tax on foreign companies. This charge will be dropped in light of the repeal of the secondary tax on domestic companies.

Removal of the 33% rate for personal service providers: Personal service providers are similarly subject to a 33% rate, which will also be reduced to 28%.


Removal of the higher gold formula rate: Gold companies have the choice of two gold formula rates – the standard formula or the higher formula. Companies choosing the higher formula are exempt from the secondary tax on companies. With the repeal of the secondary tax on companies, the higher formula will be removed as superfluous.

Removal of the proposed passive holding company regime: Government initially proposed a passive holding company regime to come into effect with the implementation of the dividend withholding tax to correct potential arbitrage between different tax rates. With the dividend withholding tax coming into effect at a 15% rate, these arbitration concerns are greatly reduced. The initially proposed passive holding company regime will be dropped.

Shortened period for transitional credits: The dividends tax contains transitional credit relief stemming from the pre-existing secondary tax on companies. These credits are set to last for up to five years into the new regime. However, given the delayed implementation of the dividends tax (and the fact that the new regime has a higher rate), the transitional credit period will be reduced to three years.

Turnover tax for micro businesses

Several reforms of the turnover tax for micro businesses (with annual turnover below R1 million) were announced in 2011. Building on these reforms, micro businesses will be given the option of making payments for turnover tax, VAT and employees’ tax at twice-yearly intervals from 1 March 2012. It is further envisaged that a single combined return will be filed on a twice-yearly basis from 1 March 2013. The number of returns required for these taxes will fall from about 18 per year to only two a year in 2013. The build-up of tax liability will require such taxpayers to ensure that funds are available when payment is due.

Limiting excessive debt in business

Public debate on section 45 of the Income Tax Act (1962) and private equity acquisitions has highlighted the need to improve the classification of corporate financing.

The main problem is the erroneous classification of certain instruments as “debt” to generate interest deductions for the debtor, when such instruments more accurately represent equity financing. Similarly, in some private equity transactions, where creditors receive exempt interest income, the deductibility of interest payments deprives the fiscus of revenue. Excessive debt can also give rise to excessively risky transactions that may represent “credit risk” for the domestic market.

To address these concerns, government will enact a revised set of reclassification rules deeming certain debt to be equivalent to shares. In 2013 government will also consider an “across-the-board” percentage ceiling on interest deductions, relative to earnings before interest and depreciation, to limit excessive debt financing.

Debt used to fund share acquisitions

Unlike most countries, South Africa does not allow for interest to be deductible when debt is used to acquire shares. Section 45 has been used as an indirect acquisition technique to facilitate the deduction of interest payments by allowing debt to be formally matched against underlying assets as opposed to shares. Given the acceptance of section 45 as an indirect share acquisition tool, it is now proposed that the use of debt to directly acquire controlling share interests of at least 70% be allowed. However, the interest associated with this form of debt acquisition will be subject to the same controls applied to section 45 acquisitions.

Special economic zones

Legislation will introduce special economic zones, which will build on the industrial development zone policy. The main aim is to improve governance, streamline procedures and provide more focused support to businesses operating within these zones. In support of this initiative, the following tax interventions will be explored:

A possible reduction in the headline corporate income tax rate for businesses within selected zones (as determined by the Minister of Finance after consultation with the Minister of Trade and Industry).

An income tax exemption for the operators of special economic zones.

An additional deduction from taxable income for the employment of workers earning below a predetermined threshold.


Incentives for the construction of affordable housing

There is insufficient affordable housing stock for middle-income households above the income thresholds for RDP-type housing, but who cannot afford high mortgage finance. To address this “gap market”, a tax incentive for developers (and employers) to build new housing stock (at least five units in compliance with prescribed standards) for sale below R300 000 per dwelling is under consideration. Options include either a tax credit or a deduction at either a fixed rand amount per unit or as a percentage of the value of the dwelling. This proposal will be refined after public consultation. Policy alignment with existing housing incentives and attempts to unblock regulatory bottlenecks will also be considered.

Some low-income employees receive financial assistance from their employers to acquire a house. The current tax hurdles associated with such assistance will also be explored.

INTERNATIONAL TAXATION

Dual-listed companies and other offshore reorganisations

In 2011, government introduced rollover rules for some offshore reorganisations. The purpose was to give South African multinationals more flexibility when restructuring offshore subsidiaries, and to curtail the use of the offshore participation exemption to avoid tax.

Now that steps have been taken to bring misuse of section 45 under control, government proposes to introduce an offshore section 45 provision. It would also appear that unbundlings are used to facilitate dual-linked structures that allow for foreign operations to be shifted outside South Africa’s tax jurisdiction. The participation exemption will be curtailed if the transaction indirectly strips value from a South African multinational.

Rationalisation of withholding tax on foreign payments

International investors are subject to a final withholding tax when receiving royalties unless a tax treaty provides otherwise. They will also be subject to a final withholding tax on interest income as from 2013, subject to tax treaty exemptions. Government proposes to coordinate and streamline the procedures, rates and times for all of these withholding tax regimes, including the adoption of a uniform rate of 15%.

EXCISE DUTIES ON TOBACCO AND ALCOHOL

The excise duties on tobacco products are determined in accordance with a targeted total tax burden (excise duties plus VAT) of 52% of the retail price. Increases in excise duties on tobacco products of between 5 and 8.2% are proposed.

The current targeted total tax burdens (excise duties plus VAT) on alcoholic beverages are 23, 33, and 43% of the weighted average retail selling price of wine, clear beer and spirits respectively. Following an announcement in Budget 2011, the appropriateness of these benchmark tax burdens was reviewed.

It is now proposed to retain the current benchmark for wine but to increase the targeted benchmark tax burdens for beer and spirits to 35 and 48% respectively. These increases will be phased in over two years. The resulting increases in excise duties on alcoholic beverages for this year range between 6 and 20%. The increase will complement broader efforts to reduce alcohol abuse.

The proposed adjustments to some of the alcohol and tobacco taxes are as follows:

Traditional African beer – no change

Malt beer – increases by 9c to R1.01 per 340ml can

Fortified wine – increases by 17.5c per 750ml bottle

Unfortified wine – increases by 13.5c per 750ml bottle

Sparkling wine – increases by 42c per 750ml bottle

Spirits – increases by R6 to R36 per 750ml bottle

Ciders and alcoholic fruit beverages – increases by 8.6c to 98c per 330ml bottle

Cigarettes – increases by 58c to R10.32 per packet of 20

Pipe tobacco increases by 24c to R3.22 per 25g


TAXATION OF LUXURY GOODS

From 1 October 2012, government proposes to subject the following items to ad valorem tax at the indicated rates:

Aeroplanes and helicopters with a mass exceeding 450kg but not 5 000kg at 7%

Motorboats and sailboats longer than 10m at 10%.

INDIRECT TAXES

Climate change: carbon emissions tax

A carbon tax will contribute to the global response to mitigate climate change. A modest carbon tax will begin to price carbon dioxide emissions so that the external costs resulting from such emissions start to be incorporated into production costs and consumer prices. This will also create incentives for changes in behaviour and encourage the uptake of cleaner-energy technologies, energy-efficiency measures, and research and development of low-carbon options.

Proposed design of carbon emissions tax to help mitigate global climate change

Following public consultation, government has revised its concept design for a carbon tax, and a draft policy paper will be published for comment in 2012. The proposed design features include:

Percentage-based rather than absolute emissions thresholds, below which the tax will not be payable.

A higher tax-free threshold for process emission, with consideration given to the limitations of the cement, iron and steel, aluminium and glass sectors to mitigate emissions over the near term.

Additional relief for trade-exposed sectors.

The use of offsets by companies to reduce their carbon tax liability.

Phased implementation.

The tax will apply to carbon dioxide equivalent (CO2e) emissions calculated using agreed methods. A basic tax-free threshold of 60% (with additional concession for process emissions and for trade-exposed sectors) and maximum offset percentages of 5 or 10% until 2019/20 is proposed. Additional relief will be considered for firms that reduce their carbon intensity during this first phase. The reduction in carbon intensity will be measured with reference to a base year or industry benchmark. Tax-free thresholds will be reduced during the second phase (2020 to 2025) and may be replaced with absolute emission thresholds thereafter. Alignment with the proposed carbon budgets as per the national climate change response white paper (2011) will be important

A carbon tax at R120 per ton of CO2e above the suggested thresholds is proposed to take effect during 2013/14, with annual increases of 10% until 2019/20. Revenues from the tax will not be earmarked, but consideration will be given to spending to address environmental concerns. Incentives such as the proposed energy-efficiency tax incentive and measures to assist low-income households will be supported. See Annexure C for further details.

Electricity levy

The electricity levy generated from non-renewable sources will be increased by 1c/kWh to 3.5c/kWh. The additional revenue will be used to fund energy-efficiency initiatives such as the solar water heater programme. This arrangement will replace the current funding mechanism that is incorporated into Eskom’s annual tariff application. It will enhance transparency and enable government to use alternative agencies to deliver on energy-efficiency initiatives. The net impact on electricity tariffs should be neutral.

Fuel Taxes

Government proposes to increase the general fuel levy and Road Accident Fund (RAF) levy by 20c/l and 8c/l respectively with effect from 4 April 2012. The table below shows the fuel tax rates and estimated fuel tax burden expressed as a percentage of retail and wholesale prices.


2010/2011 2011/2012 2012/2013

93 Octane Diesel 93 Octane Diesel 93 Octane Diesel

c / litre petrol petrol petrol

General fuel levy 167.50 152.50 177.50 162.50 197.50 182.50

Road Accident Fund Levy 72.00 72.00 80.00 80.00 88.00 88.00

Customs and excise levy 4.00 4.00 4.00 4.00 4.00 4.00

Illuminating paraffin marker 0.00 0.01 0.00 0.01 0.00 0.01

Total 243.50 228.51 261.50 246.51 289.50 274.51

Pump price: Gauteng (as in 785.00 701.85 884.00 814.05 1,077.00 1,026.69

February)¹

Taxes as % of pump price 31.0% 32.6% 29.6% 30.3% 26.9% 26.7%

1. diesel (0.05% sulphur) wholesale price (retail price not regulated)

Value-Added Tax

Square Kilometre Array

South Africa (in cooperation with other African countries) is bidding to host the Square Kilometre Array (SKA), an international collaboration to build the world’s largest radio telescope. SKA is eligible for income-tax exemption under existing public-benefit provisions. Under consideration is providing VAT relief either in the form of a refund mechanism or the zero-rating of consideration received by the project and for imported goods and services if South Africa were to win the bid.

Financial services

Government will eliminate the VAT zero-rating of interest earned on loans to non-residents to level the playing field.

Review of VAT on indirect exports and temporary imports

The policy, legislation and administration of the VAT treatment of indirect exports of goods by road will be reviewed to ensure that exporters are not prejudiced and that the fiscus continues to be protected against potential abuses.

Government will review the VAT treatment of temporary imports to promote local processing and beneficiation, while protecting the fiscus.

TAX ADMINISTRATION

During 2012/13, the South African Revenue Service (SARS) will increase its focus on cross-border cooperation. In addition, several other administrative areas will receive attention.

Tax Administration Bill

The bill has been approved by Parliament. It incorporates the common administrative elements of current tax law into one piece of legislation, and makes further improvements in this area. The bill is expected to be promulgated and most of its provisions brought into force in 2012.

Voluntary disclosure programme

By mid-February 2012, SARS had captured 17 938 applications for relief, concluded agreements to the value of R941 million and collected R718 million in related tax.

High net-worth individuals

There is room for improvement in the service offered to this segment and in compliance. This will be a focus area for SARS in the coming year.

Corporate income tax modernisation

Modernisation efforts now shift to corporate income tax. Over the next 12 months SARS will improve its audit capability and align declarations to International Financial Reporting Standards where possible.


Customs transformation

The transformation of SARS customs is starting to gain momentum, and additional steps will be taken over the period ahead to achieve fully integrated electronic customs capability.

Tax ombud

During 2012, South Africa will establish a dedicated ombud for tax matters. The office is intended to provide taxpayers with a low-cost mechanism to address administrative difficulties that cannot be resolved by SARS.

MISCELLANEOUS TAX AMENDMENTS

Provided below is a series of miscellaneous tax amendments proposed for the upcoming tax legislative cycle.

Employment, individuals and savings

Employee share schemes

Many companies use employee share schemes to motivate employees and to meet black economic empowerment objectives. Most of these schemes are based on the use of employee share trusts. These trusts obtain funding from an employer-company, with a trust holding the shares for the benefit of the employees. While this legitimate practice is to be supported, these schemes are often mixed with executive share schemes that tend to undermine tax. This has resulted in audit controversy and legislative uncertainty. To address these concerns, it is proposed that the various types of employee share schemes be reviewed to eliminate loopholes and possible double taxation. The review will also consider the interrelationship between employer deductions and employee share scheme income. The incentive regime for low-income earner share schemes also needs to be reviewed and possibly merged into a single employee share scheme regime. These issues will be resolved over a two-year period.

False job terminations

Employees cannot withdraw funds from employer-provided retirement schemes before retirement unless an employee terminates employment with that employer. In some instances, employees terminate their employment solely to gain access to employer-provided retirement funds. In the most egregious circumstances, employees quit employment only to be rehired by the same employer shortly thereafter. Access to withdrawal under these artificial circumstances will no longer be permitted.

Determination of the value of fringe benefits

In certain cases, the Income Tax Act prescribes the use of a formula to calculate the value of a fringe benefit to be taxed in the hands of the employee. However, in these cases, it is sometimes possible for the employer to determine or obtain the actual cost of providing the fringe benefit to the employee (for example, actual business and private kilometres travelled by an employee using a company vehicle, and employers that provide rented vehicles to their employees as “company vehicles”). To create a better match between the employees’ tax withheld and the tax calculation on assessment, it is proposed that, where possible and practical, the employer be allowed to use actual cost to determine the value of the fringe benefit for the employee.

Employer-owned insurance intended to cover a contingent liability

In 2011, the taxation of employer-provided insurance was rationalised. One of the aims of this rationalisation was to ensure that deferred compensation policies are not disguised as key person insurance. One unresolved issue relates to the purpose for which genuine key person insurance is intended. Insurance to cover against operating losses due to the loss of an employee clearly should be deductible for an employer if desired. On the other hand, deducting premiums for insurance to purchase ownership interests of an employee-shareholder or to repay the allocation of debt guaranteed by an employee-shareholder is questionable. The continued allowance of deductible premiums in these latter circumstances will be explored, along with other tax issues relating to this form of insurance. These issues will be resolved in 2012 or 2013 (depending on the press of other matters).

Taxation of payouts from South African or foreign retirement funds

There are currently a number of anomalies in the tax treatment of lump sum and annuity payouts from South African or foreign retirement funds, depending on whether a South African resident or a non-resident receives the payout. An important factor is whether the services that relate to the payout were rendered in South Africa or elsewhere. The issue will receive due consideration during the course of 2012 and 2013.

Taxation of divorce order-related retirement benefits

The “clean-break” principle was introduced to private-sector funds in 2007 so that divorcing spouses could fully separate their pension interests without any ongoing connection. This principle will also form part of the Government Employees Pension Fund (GEPF). The National Treasury proposes that the taxation of retirement interests paid out as a result of divorce orders for the GEPF should roughly mirror private-sector funds:


In the case of retirement fund payouts stemming from divorce orders issued on or after 13 September 2007, each individual spouse will be responsible for the tax on the portion that they receive.

The transitional rules applicable to private-sector funds are extended to GEPF payouts, so that retirement fund payouts stemming from divorce orders issued prior to 13 September 2007 will not lead to any tax consequences for either spouse.

Formula C, which preserves a public-sector fund member’s right to a tax-free retirement benefit prior to 1 March 1998, will be extended to the non-member’s portion of the pre-1 March 1998 interest.

The proposed date of implementation is 1 March 2012.

Although the introduction of the “clean-break” principle in private-sector funds has been largely successful, there are still some anomalies that result in continued engagement. It is proposed that these anomalies be addressed so that the overall tax treatment of all divorce-order retirement benefits paid out as a result of a divorce order will fully apply the clean-break principle from 1 March 2012.

Learnership allowances

Employers are eligible for an additional allowance for each registered learnership (in addition to the general deduction for employee expenses). Employers, however, do not qualify for this allowance if the learner did not complete a prior registered learnership. This prohibition will be re-examined. A further problem arises when registration is delayed owing to reasons outside the employer’s control, but the allowance begins only upon official registration. The commencement date will be adjusted so that these delays do not undermine the benefit of the additional allowance.

Employee-related fringe benefit

The revised threshold for employee accommodation increases from R59 750 to R63 556.

Business

Debt cancellations and restructurings

Given the weaker economic climate over the past several years, some taxpayers are at risk of becoming insolvent and are seeking to reduce or restructure their debt. In 2011, the National Treasury announced its intention to eliminate the unintended tax impact of debt reductions in the case of debt workouts (the treatment of debt cancellations or reductions as capital gain or ordinary revenue). The goal would be to create a simplified regime to determine the tax impact on the debtor when debt is unilaterally reduced or cancelled without full consideration, and to eliminate adverse tax consequences when the debt relief merely restores the debtor to solvency. Specific rules will also be required to address situations where creditors agree to convert their debt interests into an equity stake as partial compensation.

Company law reform and company restructurings

The comprehensive rewrite of the Companies Act (2008) has given rise to a set of anomalies in relation to tax, especially in the case of reorganisations and other share restructurings. As many of the tax rules relating to company reorganisations have been in place for 10 years, a review is appropriate. Government will hold a series of workshops to review the nature of company mergers, acquisitions and other restructurings to better understand their practical use. These workshops will lay the foundation for tax changes (and possibly changes to company law) over a two-year period. An immediate focus area will be share-for-share recapitalisations of a single company.

Mark-to-market taxation of financial instruments

The taxation of financial instruments on a mark-to-market basis has long been under consideration. This form of taxation aligns the tax treatment to financial accounting, which greatly simplifies audit and compliance. It is proposed that this project begin in earnest, using certain changes as pilot projects. First, the current system of mark-to-market taxation for foreign currency instruments should be moved closer to modern accounting standards. Second, the mark-to-market treatment of other financial instruments for tax purposes should be expanded and revised. Changes include expanding the elective regime to cover a wider set of financial assets and liabilities. However, the revised system will be subject to explicit SARS approval so that the regime can be fully controlled during the pilot phase. Ongoing changes can be expected in this area over the next few years based on practical experience.

Review of tax system for insurers

The global insurance industry is undergoing reforms associated with solvency assessment and management projects. These rules will change the way insurers determine their reserves. There are several related tax issues:

In the case of short-term insurers, certain reserves form the basis for tax deductions while providing a safety cushion for the insurers. To date, the regulatory and tax impact of these reserves has not been fully coordinated, leading to anomalies that have both positive and negative effects for short-term insurers. Captive insurers have also raised longstanding issues for the fiscus.


The principles of the four fund trustee system of taxation relating to long-term insurers has long been in need of review, Long-term insurers hold and administer assets on behalf of various categories of policyholders, in addition to managing assets for the benefit of shareholders. In recognition of these relationships, long-term insurance products are subject to the four funds system, with the insurer being taxed on return on assets as trustee for the policyholder. However, once the system moves beyond basic theory, it is often unclear whether issues should be determined from a policyholder perspective or a corporate shareholder perspective, and how the two perspectives can be combined. The system also lacks any correlation with the system of accounting, making factual verification and reconciliation difficult, if not impossible.

These concerns necessitate a comprehensive review of the tax system for insurers. To simplify the task, it is proposed that the tax system for calculating short-term insurance reserves be addressed in 2012, with long-term insurers being addressed in 2013. A short paper on long-term insurers will be circulated for comment by mid-2012.

Government grants

Unless a specific exemption exists, government grants are subject to tax when paid to a taxable entity. A comprehensive review is being undertaken to determine which grants should be exempt to avoid undue taxation (or unintended additional administration). This review will result in an explicit legislative list of exempt grants, updated annually, to improve transparency and ease of administration. The current regulatory regime will also remain in place in the interim. It should be noted, however, that tax expenditure related to tax-exempt grant funding will not be deductible, depreciable or allowed as any other tax offset against the grantee’s taxable income, because government, not the grantee, bears these costs.

Sales of trading stock to connected persons

The tax system has rules to prevent character mismatches through related (connected) person sales. Under these rules, taxpayers purchasing assets from connected persons receive a tax cost that is the lower of the purchaser’s or the connected person’s tax cost. While this anti-avoidance rule can be supported from a capital gains tax perspective, it does not need to apply to trading stock because connected persons’ sale of trading stock is unlikely to give rise to manipulation. Trading stock will accordingly be removed from the anti-avoidance connected-person sale rules.

Contingent liabilities associated with the sale of business operations

In 2011, concerns were raised about the tax effect of the sale of a business subject to potential contingent liabilities. These liabilities were giving rise to concerns of potential double taxation or double non-taxation. After much debate, the proposed legislation was withdrawn in favour of an interpretative approach. Interpretative guidance, with legislative refinements, is expected later in the year.

Share issue mismatches

The issuing of shares by a company does not give rise to ordinary or capital gain because any amounts received represent a cash contribution. However, it has come to government’s attention that certain taxpayers are seeking to use this rule to shift value to new shareholders without paying the full tax due. Most of these schemes rely on the receipt of consideration in excess of the value of the shares issued. It is proposed that the exemption for the issue of shares be limited to their value, with the excess being subject to tax.

Share block conversions to sectional title

Company liquidations are generally subject to tax to preserve the company dual-level tax system (a tax on company income plus distribution of that income). The conversion of share block companies into sectional title schemes can create a tax problem. In form, this conversion is a company liquidation, but in substance it is merely a change to direct interest from an indirect interest in the underlying property. In these situations, the property owner has swapped interests in favour of a more modern approach. It is proposed that these liquidations receive tax-free rollover treatment.

Supporting structure for energy projects

Energy projects such as wind, solar and hydroelectric facilities are eligible for accelerated depreciation on a 50:30:20 basis. At issue are the foundations and supporting structures associated with these arrangements. Accelerated depreciation will be extended to these ancillary structures.

Extension of the urban development zone incentive

The incentive for buildings (new and renovated) in urban development zones is set to expire in 2014. Government is considering extending this incentive, subject to the receipt of current legislatively required municipal progress reports and a review of their effectiveness. In addition, the cut-off date poses a problem because it is based on when buildings are brought into use rather than the date of initial construction. It is proposed that the cut-off date be re-examined along with any other anomalies associated with the incentive.


Captive finance vehicles

Some taxpayers use artificial financing vehicles to eliminate income. In some of these schemes, the parent company transfers trade receivables at discounted rates, followed by the return of the discount via tax-free preference share dividends. Other schemes provide for the same manipulation through the artificial over-payment of insurance, services or other deductible payments. These schemes give rise to income tax concerns, and they may also be problematic for VAT. It is proposed that these schemes be reviewed for potential elimination.

Industrial policy incentives – section 12I

Section 12I of the Income Tax Act provides a tax incentive for qualifying companies in respect of investment and training. The experience gained thus far in administering the programme has revealed two areas in which legislative adjustments will result in a more streamlined process. First, the requirement for tax clearance certificates of all connected parties is an administrative burden. A relaxation of this requirement is under consideration. Second, it is proposed that companies should submit monitoring reports until the allowance is exhausted or until all requirements of the programme are met.

International

South African investment into Africa

Over several years, South Africa has introduced several initiatives to reduce potential double-tax costs when investing into Africa. Management services have been an issue, especially the question of whether foreign withholding taxes on these services are eligible for foreign tax credits. Besides clarifying further anomalies in this area, active South African management over controlled foreign subsidiaries may trigger dual-residence tax status, even though all day-to-day operational activities are being conducted abroad. This situation arises because there are practical difficulties associated with local conditions. It is proposed that this dual-residence tax status be removed if the tax of the foreign country is roughly on par with otherwise applicable South African tax. Alternatively, the issue can be resolved as a matter of interpretation.

Many South African loans to foreign African subsidiaries essentially operate as additional share capital contributions – their purpose is to provide for a more flexible use of capital, not to avoid South African tax. However, the formal use of a loan often gives rise to transfer pricing concerns because these loans do not generate annual interest. It is proposed that these loans be treated as shares in line with the decision to treat certain forms of debt as shares.

Local managers of foreign funds

Foreign investment funds often rely on active managers in South Africa for direction regarding African fund assets. However, this form of guidance often raises tax risks, especially the risk that this form of management will be viewed as South African effective management in tax terms, giving rise to a worldwide tax on all fund assets. This risk has deprived local fund managers of foreign investment fund business and has even forced certain local fund managers to relocate abroad. It is proposed that a legislative carve-out be created for foreign investment funds so that these funds are not inadvertently subject to worldwide taxation.

Ongoing refinements to headquarter company relief

Over the past two years, special rules have been enacted that provide tax and exchange control relief for South African headquarter companies. While most issues have been resolved, some outstanding problems are being uncovered as foreign investors seek to use the regime. These anomalies mainly focus on transfer-pricing concerns and headquarter companies that rely on foreign currency for their operations. These anomalies will be addressed to encourage regional headquarter company investment.

Value-Added Tax

Clarification of the date of liability for VAT registration

A person that becomes liable to register for VAT (on account of reaching the compulsory threshold of R1 million) must apply to SARS for registration as a vendor within 21 days. That person cannot charge VAT on supplies until they have been registered as a vendor by SARS. There are no transitionary rules in the VAT Act that address this issue. It is proposed that the liability date for VAT be clarified to streamline the transition from a non-vendor to a vendor.

Bargaining councils

Bargaining councils regulate collective agreements and conduct dispute resolution for their members. These councils levy an administration fee that is payable by employees. However, the activities of a bargaining council do not fall within the ambit of an employee organisation, and are arguably subject to VAT. These activities are similar to that of an employee organisation and should similarly be exempt from VAT.

Instalment credit agreements

Movable goods supplied through an instalment credit agreement take the form of a sale or a lease. Depending on the form, finance charges and/or insurance (the lessee accepts the full risk of destruction of the asset) is payable. Shariah law prohibits the charging of interest or the placing of risk or insurance responsibilities on the client, owing to the element of chance. It is proposed that the provisions governing instalment credit agreements in the VAT Act be amended to accommodate products that are compliant with Shariah law.


Debit and credit notes

The VAT Act contains specific scenarios that justify the issuing of a credit or debit note. For instance, if a vendor issues a tax invoice for an incorrect amount (for example, R100), the vendor cannot justify the issue of a credit note (the invoice amount was R50 and not R100) within the specified conditions in the VAT Act. It is also unlawful to issue more than one tax invoice for the same supply. It is proposed that the specified conditions in the VAT Act under which a vendor can issue credit or debit notes to correct incorrect tax invoices be extended.

VAT double charge for goods removed from an industrial development zone

Movable goods imported into a customs controlled area (CCA) of an industrial development zone are exempted from customs duty and VAT. A deemed VAT charge is triggered if the goods are temporarily removed from the CCA and not returned within 30 days. For customs purposes, the removal of the goods leads to a voucher of correction, processed by customs, and VAT on importation is payable. The result is that double VAT is charged. It is proposed that this double charge be eliminated.

Political parties

The receipts and accruals of any political party registered in terms of the Electoral Act (1998) are exempt from income tax. The VAT Act does not contain a specific provision for political parties, which results in uncertainty. As a result, it is unclear whether the receipts and accruals of a political party can be construed as “consideration” for taxable supplies or a “donation”. The latter view seems more consistent with the nature and mandate of political parties as there is no reciprocal performance between the political party and the donor(s) concerned. It is proposed that the receipts and accruals of political parties be exempted from VAT.

Imported goods sold prior to entry for home consumption

A foreign company that sells goods that enter South African territorial waters may be required to register for VAT if this activity is continuous or regular. The recipient (buyer and vendor) is liable for import VAT on the clearance of the goods for home consumption. As a result, the recipient is liable for two VAT charges on the same amount. It is proposed that the VAT provisions relating to goods sold by foreign companies prior to entry for home consumption be reviewed.

Customs

Implementation of one-stop border post agreement with Mozambique

The agreement between South Africa and Mozambique on combined border control posts on the Mozambique-South Africa border and its implementing annexures have been submitted to Parliament for ratification. Although the Customs Act contains provisions for implementing such an agreement, ratification by Parliament will necessitate amendments to a wide range of legislation regulating the movement of people, goods and means of conveyance into and out of South Africa. These amendments will be proposed after ratification of the agreement and consultation between the affected organs of state.

TAX POLICY RESEARCH PROJECTS

The following tax policy research projects will be undertaken or completed during 2012/13:

Reforms to the primary, secondary and tertiary rebates in the context of a review of the means testing for the old age grant and with the intention to introduce a child and/or dependant tax rebate/credit.

Taxation of financial instruments (including derivatives).

Long-term insurance companies – review of the taxation, accounting and regulatory practices of the four fund system.

Taxation of income from capital (interest income, dividends, capital gains, rental) to be reviewed to ensure greater equity and minimise opportunities for tax arbitrage.

VAT treatment of public passenger transport.

The implementation and importance of user charges and other fees.

Taxation of transport fuels – review to determine the equitable treatment of all transport fuels based on their environmental characteristics (for example, CO2 emissions) and energy content.


PART 2 – TAX UPDATE These notes cover tax developments over the last year, including SARS’ documentation and regulations released during 2011 and early 2012 and the 2011 Amendment Acts promulgated late 2011 and early 2012. The list is not exhaustive. You will recognise edited versions of the Explanatory Memoranda which make up the bulk of these notes.

DEVELOPMENTS OVER THE LAST YEAR

Useful guides issued or revised by SARS during 2011

Issue date Subject

February 11 Statutory rates of tax – 2012 year of assessment

February 11 Tax guide for small business 2010/11

February 11 Taxation in South Africa 2010/11

March 11 Table 1 – Interest rates on outstanding tax or payable on refunds

March 11 Table 2 – Interest rates payable on credit amounts (overpayment of provisional tax) under section 89quat(4)

March 11 Table 3 – Interest-free or low interest loans subject to income tax “Official rate of interest”

March 11 A quick guide to Advanced Tax Rulings

March 11 Comprehensive guide to Advance Tax Rulings

March 11 External guide – Labour Brokers

March 11 External policy – Labour Brokers

March 11 Transfer duty on e-filing – a quick guide

April 11 External reference guide- Transfer Duty

May 11 Guide for disposal of residence from a company or trust

June 11 Reference guide – Provisional tax 2012

June 11 External policy – Provisional tax

July 11 Tax guide for Micro Businesses 2011 - 12

August 11 How to complete your IT14 (Companies) – Quick guide

September 11 Guide on how to submit a request for remission of non-compliance penalties

September 11 Guide to request for Objection and Appeal – Admin penalties

September 11 New SARS Power of Attorney (POA) template

September 11 Frequently asked questions – Dispute administration

September 11 Frequently asked questions – Penalty management and penalty debt management

October 11 External reference guide – Tax Clearance Certificate

November 11 Business requirements specification – Medical scheme fees tax credit

November 11 Guide for completion and submission of the IT14 return e-filing

November 11 How to complete the Supplementary Declaration (IT14SD) forms for Co’s and CC’s

December 11 The ABC of CGT for Companies – Issue 4 updated

December 11 The ABC of CGT for Individuals – Issue 5 updated

December 11 Comprehensive guide to CGT – Issue 4 updated

Interpretation Notes issued or revised during 2011

Issue date No. Subject

10 January 11 60 Income tax: Sections 11(o), 20B, 24M: Loss on disposal of depreciable assets

15 March 11 13 (Issue 3) Income tax: Section 23(m) deductions: Limitation of deductions for employees and office holders

15 March 11 28 Income tax: Sections 11(a), 23(b), 23(m): Home office expenses incurred by persons in employment or persons holding an office

29 March 11 61 VAT: Remission of interest in terms of section 39(7)(a)

30 March 11 55 Taxation of directors and employees on vesting of equity instruments

30 March 11 62 Income tax: Sections 8B, 10(1)(nC), 11IA: Broad-based employee share plan

19 September 11 63 Income tax: Sections 1, 6quat, 9A, 9D(6), 9G and 25D: Rules for the translation of amounts measured in foreign currencies

30 September 11 43 (Issue 3) Income Tax: Section 9C: Circumstances in which certain amounts received or accrued from the disposal of shares are deemed to be of capital nature


Draft Interpretation Notes issued during 2011

Issue date No. Subject

18 February 11 - Income tax: Exemption of Bodies corporate established under the Section Titles Act No 95 of 1986, share block companies established under the Share Blocks Control Act No 59 of 1980 and associations of persons managing the collective interests common to all members

30 March 11 - Income tax: Scholarships and Bursaries

31 March 11 - VAT: Documentary proof required for zero rating of goods or services

9 September 11 - Income tax: Discussion paper on interpretation note 6 – Place of effective management

20 October 2011 - Income tax: Tax implications of rental income from tank containers

Binding private rulings issued or revised during 2011

Note: Binding Private Rulings (BPR) are published in terms of section 76O of the Income Tax Act. A BPR does not have any binding effect upon the Commissioner unless that ruling applies to a person in accordance with section 76J. In addition a BPR may not be cited in any proceedings before the Commissioner or the courts other than a proceeding involving the applicant or co-applicant for that ruling. Thus, you cannot rely upon a binding private ruling that has been issued to someone else, even if the facts of your own transaction are similar to those described in the published ruling. These rulings are therefore published for general guidance only.

BPR No. Subject

106 Income tax: Application of Section 24C to a maintenance trust

107 Recoupment of lease premium and rental amounts previously allowed as deductions in respect of a leased property

Binding class rulings issued or revised during 2011

Note: Binding Class Rulings (BCR) are published in terms of section 76O of the Income Tax Act. A BCR does not have any binding effect upon the Commissioner unless that ruling applies to a person in accordance with section 76J of the Act. A binding class ruling may not be cited in any proceeding before the Commissioner or the courts other than a proceeding involving the applicant or co-applicant for that ruling. Thus, you cannot rely upon a binding class ruling that has been issued to someone else, even if the facts of your own transaction are similar to those described in the published ruling. These rulings are therefore published for general guidance only.

BCR No. Subject

25 Income tax implications for employees/senior executives in relation to a share option plan/share appreciation rights plan

26 Income tax: Tax status of bursaries awarded to students

27 Income tax: Tips held for safekeeping by employers and subsequently paid over to employees at regular intervals

28 Capital gains tax: Market value of a share immediately after a dividend distribution

29 Income tax: Deductibility of contingent liabilities taken over when buying the assets and liabilities of another company within the same group of companies

30 Income tax: Equity instruments acquired in terms of share value incentive plan

31 Income tax: Income distributed by a discretionary trust and benefit units allocated to beneficiaries by virtue of employment

Binding general rulings issued or revised during 2011

Note: Binding General Rulings (BCR) are published in terms of section 76P of the Income Tax Act regarding interpretation of the Act or the application or interpretation of the Act in respect of a particular set of facts and circumstances or transaction as defined in section 76B of the Act.


BGR No. Subject

5 VAT: Discounts, rebates and incentives in the motor industry

6 VAT: Discounts, rebates and incentives in the fast moving consumable goods industry

7 Income tax: Wear-and-tear or depreciation allowance

8 Income tax: Application of the principles enunciated by the Brummeria case

9 Taxes on income and substantially similar taxes for purposes of South Africa's tax treaties

TAX JUDGEMENTS DELIVERED IN 2011

Constitutional Court

Minister of Safety and Security v GW van der Merwe and 14 others (90/10) [2011] ZACC 19 (7 June 2011)

Criminal Procedures Act – Section 20, 21 and 25; whether search and seizure warrants are valid despite their failure to mention the offences to which the search relates.

Supreme Court of Appeal

CSARS v MultiChoice Africa (218/10) [2011] ZASCA 41 (29 March 2011)

Customs and Excise - Classification of articles for customs duty; interpretation of statutes; ordinary meaning of enactment leading to repugnance; interpretation of enactment so as to give effect to the legislature's intention.

CSARS v Founders Hill (509/10) [2011] ZASCA 66 (10 May 2011)

Income Tax - Section 89quat; proceeds of sale of land sold by a realisation company was taxable as income: realisation

company that acquires land in order to sell it, trades in that land.

First South African Holdings v CSARS (372/10) [2011] ZASCA 67 (11 May 2011)

Income Tax - Section 79A; interpretation; date of commencement.

Engelbrecht v The State (446/10) [2011] ZASCA 068 (17 May 2011)

Criminal Procedures Act - Criminal law - alleged fraudulent scheme defrauding SARS of approximately R1,6 million in terms of output VAT not paid (ref. s.11(1)(a) of Value-Added Tax Act, 1991).

CSARS v Labat (669/10) [2011] ZASCA 157 (28 September 2011)

Income Tax – s 11(gA)(iii) – allowable deductions for the acquisition of intellectual property rights – meaning of ‘expenditure’ – shares issued as consideration not ‘expenditure’.

CSARS v South African Custodial Services (Pty) Ltd (131/10) [2011] ZASCA 233 (30 November 2011)

Income Tax – s 79A – finality of assessment – whether letter from Commissioner a revised assessment – s 22(2A) – deductibility of cost of building prison in terms of concession agreement on land owned by State – sub-contractor, not respondent incurring expenses concerning materials and equipment – cost of building prison not deductible in terms of s 11(a) – s 11(bA) – interest and related fees deductible.

High Court

Pitro Rossi v CSARS (SGHC) 2010/34417 (22 February 2011)

Income Tax - Section 81 read with 107A; section 102; employees' tax; refunds; dispute; jurisdiction.

Edrees Amed Hathurani v CSARS (NGHC) 76878/10 (1 April 2011)

Income Tax - Section 88A-E; settlement agreement not complying with requirements.

D C King v CSARS (NGHC) 54768/2008 (8 June 2011)

Income Tax - Sections 88 and 91; rule 66 of Uniform Rules of the Court; outstanding debt to the State and interest; warrant of execution of immovable property issued; immovable property to be sold to cover debt to the State and interest.

Tax Court

ITC VAT 382 (13 June 2011) (Western Cape CT)


VAT - Whether certain services were subject to VAT in terms of s.7(1)(c); buying back of shares; whether services could be set off against input tax credit.

ITC 12895 (15 June 2011) (Pretoria)

Income Tax - Definition of "gross income" in s.1 - par.(e) vs par.(eA); application on pre-retirement withdrawal from Municipal Pension Fund.

ITC 12856 (1 August 2011) (South Gauteng Jhb)

Income Tax - Whether loss of mining income can be set off against taxable income derived from non-mining activities or whether it have to be deducted from income derived from profitable mines Sections 11 and 83; interpretation of section 36(7E) and section 36(7F).

ITC 12760, 12828, 12756 (14 September 2011) (Western Cape CT)

Income Tax - Deferred delivery share incentive scheme; Sections 8A and 8C; par. 2(a) of Seventh Schedule.

ITC VAT 712 (3 November 2011) (South Gauteng Jhb)

VAT - Sections 7, 11, 12 and the proviso to section 2(1); whether currency exchange services rendered in the duty free area of the airport are to be VAT zero-rated.

ITC 12008 and VAT 471 (7 December 2011) (Pretoria)

VAT - Sections 20(8) and 55; whether appellant is entitled to input tax despite failing to meet requirements of section 20(8).

Income Tax - Sections 11(a) and 73(a); whether appellant is entitled to deductions of section 11(a) despite lack of proof.

INTEREST RATE CHANGES

Date of change Prescribed interest rate payable to SARS

Prescribed interest rate payable by SARS

Official interest rate for fringe benefits purposes

01.03.2008 14% 10% 12%

01.07.2008 15% 11%

01.09.2008 13%

01.03.2009 11.5%

01.05.2009 13.5% 9.5%

01.06.2009 9.5%

01.07.2009 12.5% 8.5% 8.5%

01.08.2009 11.5% 7.5%

01.09.2009 10.5% 6.5% 8%

01.07.2010 9.5% 5.5%

01.10.2010 7%

01.03.2011 8.5% 4.5% 6.5%

AMENDMENTS TO THE LEGISLATION

The Taxation Laws Amendment Act No. 24 of 2011, promulgated 10 January 2012 (Gazette 34927) and the Taxation Laws Second Amendment Act 25 of 2011, promulgated on 14 December 2011 (Gazette 34867), which amended the –

1.1. Income Tax Act,1962;

1.2. Customs and Excise Act, 1964;

1.3. Transfer Duty Act, 1949;

1.4. Value-Added Tax Act, 1991;

1.5. Revenue Laws Amendment Act, 2008;

1.6. Taxation Laws Amendment Act, 2009;

1.7. Taxation Laws Amendment Act, 2010;

1.8. Securities Transfer Tax Act, 2007;

1.9. Mineral and Petroleum Resources Royalty Act, 2008;


1.10. Unemployment Insurance Contributions Act, 2002;

1.11. Make provision for special zero-rating in respect of goods and services supplied by Cricket SA.

Most of these amendments are explained in the notes below. Extensive use has been made of the Explanatory Memorandum on the Draft Taxation Laws Amendment Bill, 2011, in the preparation of these notes.

2012 TABLES, RATES AND THRESHOLDS

The following tables and thresholds for the 2012 year of assessment are an edited version of the rates and thresholds section of the Explanatory Memorandum on the Taxation Laws Amendment Bill, 2011.

TABLES

Individuals and special trusts

Taxable income Rate of tax

Not exceeding R150 000 18 % of the taxable income

Exceeding R150 000 but not exceeding R235 000 R27 000 plus 25% of amount by which taxable income exceeds R150 000




Exceeds R580 000 R168 250 plus 40% of amount by which taxable income exceeds R580 000

Trusts


All taxable income 40% of taxable income

Companies (other than those dealt with below)


All taxable income 28% of the taxable income

Small business corporations


Not exceeding R59 750 0% of taxable income

Exceeding R59 750 but not exceeding R300 000 10% of the amount by which the taxable income exceeds R59 750

Exceeding R300 000 R24 025 plus 28% of the amount by which the taxable income exceeds R300 000

Registered micro businesses

Taxable turnover Rate of tax

Not exceeding R150 000 0% of taxable turnover

Exceeding R150 000 but not exceeding R300 000 R1% of amount by which taxable turnover exceeds R150 000

Exceeding R300 000 but not exceeding R500 000 R1 500 plus 2% of amount by which taxable turnover exceeds R300 000

Exceeding R500 000 but not exceeding R750 000 R5 500 plus 4% of amount by which taxable turnover exceeds R500 000

Exceeds R750 000 R15 500 plus 6% of amount by which taxable turnover exceeds R750 000

Gold mining companies


On gold mining taxable income Under a formula

On non-gold mining taxable income 28% of the taxable income

On non gold mining taxable income if exempt from STC

35% of the taxable income


On recovery of capital expenditure Greater of average rate or 28% of the taxable income

PBO company and trusts


All taxable income 28% of the taxable income

Employment companies



Company personal service providers



Long-term insurance companies


Taxable income of individual policyholder fund 30% of taxable income

Taxable income of company policyholder fund 28% of taxable income

Taxable income of corporate fund 28% of taxable income

Non-resident companies


All taxable income from South African source 33% of taxable income

Retirement lump sum withdrawal benefits

Taxable income from benefits Rate of tax


Exceeding R22 500 but not exceeding R600 000 18% of taxable income exceeding R22 500

Exceeding R600 000 but not exceeding R900 000 R103 950 plus 27% of taxable income exceeding R600 000

Exceeding R900 000 R184 950 plus 36% of taxable income exceeding R900 000

Retirement lump-sum and severance benefits

Taxable income from benefits Rate of tax


Exceeding R315 000 but not exceeding R630 000 R0 plus 18% of taxable income exceeding R315 000

Exceeding R630 000 but not exceeding R945 000 R56 700 plus 27% of taxable income exceeding R630 000

Exceeding R945 000 R141 750 plus 36% of taxable income exceeding R945 000

Rebates

Description Amount

Primary rebate R10 755

Secondary rebate R6 012

Tertiary rebate R2 000


THRESHOLDS

General savings thresholds

Description Reference to Income Tax Act Monetary amount

Broad-based employee share schemes

Maximum exemption for shares received by an employee under a broad-based employee share plan

Definition of a ‘qualifying equity share’ in section 8B(3)

R50 000

Maximum deduction for shares issued by an employer under a broad-based employee share plan

The proviso to section 11(lA) R10 000

Exemption for interest and certain dividends

Exemption for foreign dividends and interest from a source outside South Africa that are not otherwise exempt

Section 10(1)(i)(xv)(aa) R3 700

For persons 65 years or older, exemption for interest from a source within South Africa that is not otherwise exempt

Section 10(1)(i)(xv)(bb)(A) R33 000

For persons younger than 65 years, exemption for interest from a source within South Africa that is not otherwise exempt

Section 10(1)(i)(xv)(bb)(B) R22 800

Annual donations tax exemption

Exemption for donations made by entities Section 56(2)(a) and the proviso to it R10 000

Exemption for donations made by individuals Section 56(2)(b) R100 000

Capital gains exclusions

Annual exclusion for individuals and special trusts Paragraph 5(1) of the Eighth Schedule R20 000

Exclusion on death Paragraph 5(2) of the Eighth Schedule R200 000

Exclusion for disposal of a primary residence (based on amount of capital gain or loss on disposal)

Paragraph 45(1)(a) of the Eighth Schedule R1,5 million

Exclusion for disposal of primary residence (based on amount of proceeds on disposal)

Paragraph 45(1)(b) of Eighth Schedule R2 million

Maximum market value of all assets allowed within the definition of a ‘small business’ on disposal when the person is over the age of 55 years

Definition of a ‘small business’ in paragraph 57(1) of Eighth Schedule

R5 million

Exclusion amount on disposal of a ‘small business’ when the person is over the age of 55 years

Paragraph 57(3) of Eighth Schedule R900 000

Retirement savings thresholds


Deductible retirement fund contributions

Pension fund monetary ceiling for contributions Proviso to section 11(k)(i) R1 750

Pension fund monetary ceiling for arrear contributions

Paragraph (aa) of proviso to section 11(k)(ii) R1 800

Retirement annuity fund monetary ceiling for contributions (if also a member of a pension fund)

Section 11(n)(aa)(B) R3 500

Retirement annuity fund monetary ceiling for contributions (if not a member of a pension fund)

Section 11(n)(aa)(C) R1 750

Retirement annuity fund monetary ceiling for arrear contributions

Section 11(n)(bb) R1 800

Permissible lump-sum withdrawals upon retirement

Pension fund monetary amount for permissible lump-sum withdrawals

Paragraph (ii)(dd) of proviso to paragraph (c) of definition of ‘pension fund’ in section 1

R50 000

Retirement annuity fund monetary amount for permissible lump-sum withdrawals

Paragraph (b)(ii) of proviso to definition of ‘retirement annuity fund’ in section 1

R50 000


Deductible business expenses for individuals


Car allowance

Ceiling on vehicle cost Section 8(1)(b)(iiiA)(bb)(A) R480 000

Ceiling on debt relating to vehicle cost Section 8(1)(b)(iiiA)(bb)(B) R480 000

Employment-related fringe benefits


Exempt scholarships and bursaries

Annual ceiling for employees Paragraph (ii)(aa) of proviso to section 10(1)(q) R100 000

Annual ceiling for employee relatives Paragraph (ii)(bb) of proviso to section 10(1)(q) R10 000

Medical scheme contributions

Monthly ceiling for schemes with one beneficiary Section 18(2)(c)(i)(aa) R720

Monthly ceiling for schemes with two beneficiaries Section 18(2)(c)(i)(bb) R1 440

Additional monthly ceiling for each additional beneficiary

Section 18(2)(c)(i)(cc) R440

Awards for bravery and long service Paragraphs (a) and (b) of further proviso to paragraph 5(2) of the Seventh Schedule

R5 000

Employee accommodation Paragraph 9(3)(a)(ii) of the Seventh Schedule R59 750

Accommodation for expatriate employees Paragraph 9(7B)(ii) of the Seventh Schedule R25 000

Exemption for de minimis employee loans Paragraph 11(4)(a) of the Seventh Schedule

R3 000

Additional employer deductions for learnerships

Monetary ceiling of additional deduction for the employer when using a learnership agreement with an employee

Section 12H(2) R30 000

Monetary ceiling of additional deduction for the employer for an employee completing a learnership agreement

Section 12H(3) and (4) R30 000

Monetary ceiling of additional deduction for the employer involving a learnership agreement with an employee with a disability

Section 12H(5)

R20 000

Depreciation


Small-scale intellectual property Paragraph (aa) of proviso to section 11(gC) R5 000

Urban Development Zone incentive Section 13quat(10A) R5 million

Miscellaneous


Low-cost housing

Maximum cost of residential unit where that residential unit is an apartment in a building

Paragraph (a) of definition of ‘low-cost residential unit’ in section 1

R250 000

Maximum cost of residential unit where that residential unit is a building

Paragraph (b) of definition of ‘low-cost residential unit’ in section 1

R200 000

Industrial policy projects

Maximum additional investment allowance for greenfield projects with preferred status

Section 12I(3)(a) R900 million



Maximum additional investment allowance for other greenfield projects

Section 12I(3)(a) R550 million

Maximum additional investment allowance for brownfield projects with preferred status

Section 12I(3)(b) R550 million

Maximum additional investment allowance for other brownfield projects

Section 12I(3)(b) R350 million

Maximum additional training allowance (per employee)

Section 12I(5)(a) R36 000

Maximum additional training allowance for industrial policy projects with preferred status

Section 12I(5)(b)(i) R30 million

Maximum additional training allowance for other industrial policy projects

Section 12I(5)(b)(ii) R20 million

Minimum cost of manufacturing assets for greenfield projects

Section 12I(7)(a)(i)(aa) R200 million

Amounts to be taken into account in determining whether an industrial project constitutes a brownfield project

Section 12I(7)(a)(i)(bb)(A) Section 12I(7)(a)(i)(bb)(B)

R30 million R200 million

Venture capital companies

After 36 months least 80% of the expenditure incurred by a venture capital company must be incurred for qualifying shares in a junior mining company assets, with assets of which the book value does not exceed the amount indicated immediately after the issue

Section 12J(6A)(b)(i)

R300 million

After 36 months, at least 80% of the expenditure incurred by a venture capital company must be incurred for qualifying shares in company, other than a junior mining company, with assets of which the book value does not exceed the amount indicated.

Section 12J(6A)(b)(ii) R20 million

Presumptive turnover tax

A person qualifies as a micro business for a year of assessment when the qualifying turnover of that person for that year does not exceed the amount indicated

Paragraph 2(1) of the Sixth Schedule

R1 million

Maximum of total receipts from disposal of immovable property and assets of a capital nature by a micro business

Paragraph 3(e) of the Sixth Schedule R1,5 million

Minimum value of individual assets and liabilities for which a micro business is required to retain records

Paragraphs 14(c) and (d) of the Sixth Schedule R10 000

Public benefit organisations

PBO trading income exemption Section 10(1)(cN)(ii)(dd)(ii) R200 000

Deduction of donations to transfrontier parks Section 18A(1C)(a)(ii) R1 million

Housing provided by a PBO: maximum monthly income of beneficiary household

Paragraph 3(a) of Part I of the Ninth Schedule and paragraph 5(a) of Part II of the Ninth Schedule

R7 500

Recreational clubs

Club trading income exemption Section 10(1)(cO)(iv)(bb) R120 000

Prepaid expenses

Maximum amount of deferral Paragraph (bb) of the proviso to section 23H(1) R80 000

Small business corporations

Maximum gross income Section 12E(4)(a)(i) R14 million

Housing associations

Investment income exemption Section 10(1)(e) R50 000


Administration


Investment income exempt from provisional tax

For natural persons below age 65 years – an ‘investment’ income of

Paragraph 18(1)(c)(ii) of the Fourth Schedule

R20 000

For natural persons over age 65 years – a ‘total’ taxable income of

Paragraph 18(1)(d)(i) of the Fourth Schedule

R120 000

SITE threshold Items (a) and (b) of paragraph 11B(2) and items (a), (b)(ii) and (b)(iii) of paragraph 11B(3) of the Fourth Schedule

R60 000

Threshold for automatic appeal to High Court Section 83(4B)(a) R50 million

Other Taxes

Value-added tax

Description Reference to the Value-Added Tax Act Monetary amount

Registration

– Compulsory Section 23(1)(a) R1 million

– Voluntary Section 23(3)(b), (c) and (d) R50 000

– Commercial accommodation Paragraph (a) of the definition of ‘commercial accommodation’ in s 1

R60 000

– Payments basis of VAT registration Section 15(2)(b)(i) R2,5 million

– Exception to payments basis: for supplies of goods or services made by a vendor

Section 15(2A) R100 000

Tax invoices

– Abridged tax invoice Section 20(5) R3 000

– No tax invoice required Section 20(6) R50

Tax periods

– Category C (monthly) submission of VAT 201 return Section 27(3)(a)(i) R30 million

– Category D (6-monthly) submission of VAT 201 return

Section 27(4)(c)(i) R1,5 million

– Category F (4-monthly) submission of VAT 201 return

Section 27(4B)(a)(i) R1,5 million

Transfer duty

Imposition

Value Rate of tax

Does not exceed R600 000 0%

Exceeding R600 000 but not exceeding R1 million 3% on such value

Between R1 million and R1,5 million 5% on such value plus R12 000.

Exceeds R1,5 million 8% on such value plus R37 000.

Diamond export levy

Rate and exemptions Applicable levy

Exemption from levy (levy not applicable in following instances) 5% of gross sales

Large producers

– 40% of the producer’s gross sales must be to South African diamond beneficiators, and

– total gross sales must exceed R3 billion

Medium producers

– 15% of the producer’s gross sales must be to South African diamond beneficiators, and

– total gross sales exceeds R20 million but does not exceed R3 billion


Rate and exemptions Applicable levy

Small producers

– total gross sales does not exceed R20 million

Royalty Act

Rate and exemptions

Royalty formulae Rate

– Refined: 0,5 +[EBIT / (gross sales × 12,5)] × 100 Cannot exceed 5%

– Unrefined: 0,5 + [EBIT / (gross sales × 9)] × 100 Cannot exceed 7%

Exemption for small business

– Gross sales of extractor does not exceed R20 million

Estate duty

Rates, thresholds and abatement

Description Rate or amount

Imposition of estate duty 20% of the dutiable amount of the estate

Reduction of duty payable

Reduced as follows of the second dying dies within 10 years of the first dying:

– 2 years 100%

– 2 to 4 years 80%

– 4 to 6 years 60%

– 6 to 8 years 40%

– 8 to 10 years 20%

Exemption

Abatement R3,5 million

INDIVIDUALS, EMPLOYMENT AND SAVINGS

THIRD REBATE FOR THE ELDERLY

Amendment to section 6(2) of the Income Tax Act.

Background

The tax system contained two rebates applicable to natural persons – a primary rebate and a secondary rebate. The primary rebate is available to all natural persons; whereas, the secondary rebate is available solely to persons of age 65 or more.

Reasons for change

The purpose of the rebates is to provide relief for subsistence living. The secondary rebate recognises that subsistence living may be higher at old age due to ill-health and loss of job opportunities. The net effect of this rebate is to shelter passive income, regardless of source (e.g. annuities and interest). At issue is the depth of the relief. Many elderly persons, especially those of more advanced age, are under pressure with risk-free yields dropping nationally as well as globally. This decline on risk-free yields has a unique impact on the elderly who are seeking stable income in their final years. Given this impact, many elderly persons are seeking some form of tax relief to maintain sufficient funding without direct subsidies from Government.

In order to provide further relief for persons of advanced age, a third rebate has been introduced. Persons of age 75 or more will now be entitled to a third rebate (in addition to the previous two rebates). This third rebate will equal R2 000 tax relief to maintain sufficient funding without direct subsidies from Government.

Amendments to give effect to the above

Section 6(2)(c) has been added and provides for a tertiary rebate if the taxpayer was or, had he or she lived, would have been 75 years of age on the last day of the year of assessment, an amount of R2 000.

Effective date

The amendment comes into operation on 1 March 2011 and applies to years of assessment commencing on or after that date.


________________________________

STANDARD INCOME TAX ON EMPLOYEES

Amendment to section 6(5) of the Income Tax Act.

Section 6(5)

Section 6(5) was introduced in 2010 and contained errors that have now been rectified. As was originally intended, the rules relating to the transitional phase-out of SITE will apply solely to taxpayers whose full remuneration falls within SITE (not just the amounts attributable to ‘net remuneration’). These transitional rules relate to all taxes under the Income Tax Act (not just the normal tax).

Effective date

The amended section 6(5) comes into operation on 1 March 2011 and applies to years of assessment commencing on or after that date.

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MEDICAL SCHEME CREDITS AND DEDUCTIONS

Insertion of section 6A and amendment of section 18 of the Income Tax Act, deletion of paragraph 2(4)(e) of the Fourth Schedule, amendment of paragraph 2(4)(f) of the Fourth Schedule, addition of paragraph 9(6) of the Fourth Schedule and amendment of paragraph 12A(5)(d) of the Seventh Schedule to the Income Tax Act.

Background

Even though the income tax system does not generally allow for deductions in respect of personal consumption, medical expenses remain a notable deviation. An incentive exists for taxpayers to make contributions to medical schemes. Taxpayers making these contributions receive a set level of monthly deductions depending on the number of persons utilising the scheme. These deductions are premised on contributions associated with average minimum benefits associated with all domestic medical schemes. Over the years, the level of permissible deductions for these contributions has been adjusted upward on an annual basis.

Reasons for change

Several years ago, deductions for medical scheme contributions were switched from a 2/3rds approach to a set formula because the 2/3rds formula awarded taxpayers with more expensive plans. This 2/3rds formula was viewed as providing unfair benefits for upper income families that could afford more expensive plans. The revised system of set monthly numerical deductions was designed to level the playing field. Currently at issue is the use of deductions. It is now contended that the current deduction system still operates to the unfair benefit of wealthier taxpayers. The net effect of a deduction in respect of low-taxed workers is an effective savings of as low as 18% of the contributions; whereas, wealthier individuals achieve an effective savings of up to 40%. A need has also been identified to accommodate situations where a taxpayer is incurring medical expenditure in respect of the taxpayer’s immediate family for whom he or she is liable for family care and support. This accommodation is especially prevalent where a member of the taxpayer’s immediate family is disabled or elderly.

The changes

Annual adjustment for the current tax year

For the 2012 year of assessment, deductions for monthly medical contributions will again be raised. Monthly contributions are set at R720 for the benefit of the taxpayer and at R720 for the benefit of the first dependant (normally the taxpayer’s spouse). Deductible contributions for coverage relating to other dependents are set at R440 per dependant.

Conversion to a credit system

In the longer term, the deduction system for medical scheme contributions will be converted into a credit system in respect of all taxpayers. (However, the full deduction for medical scheme contributions currently in place in the case of taxpayers 65 years of age and older will remain at least temporarily). Under the credit system, all taxpayers under 65 years of age will receive a tax credit for monthly medical contributions that will equally benefit all taxpayers in nominal terms.

In particular, taxpayers will receive a monthly tax credit of R216 per month for themselves and their spouses. In terms of other dependants, these credits will be set at R144 per person. The credit will be non-refundable and will operate in the same way as the first, second and third rebates.


Broadening of ‘dependant’ definition

Taxpayers who incur medical expenditure for immediate family for whom they are liable for family care and support is now recognised by the tax system. To this end, the definition of ‘dependant’ in section 18 has been broadened so as to allow a taxpayer to claim the related expenditure in line with the taxpayer’s regime where the expenditure is either allowed in full, or subject to the 7,5% of taxable income limit.

Please note that this broadened definition of ‘dependant’ has not been extended to section 6A for purposes of calculating the tax credits. Instead section 6A contains the old definition of ‘dependant’, see below.

Example

Facts: A single taxpayer under 65 years of age, and not disabled, incurs medical expenses on behalf of his or her mother. This taxpayer is liable for family care and support in respect of his or her mother.

Result: The taxpayer will be able to add the expenditure incurred in respect of his or her mother to his own medical expenditure. The taxpayer will accordingly be able to claim a deduction to the extent that this total amount exceeds 7, 5% of his taxable income.

Discussion document

A discussion document has been issued that further clarifies the policy associated with the conversion from deductions to credits in respect of medical scheme contributions. The discussion document also investigates the use of a tax credit system in respect of out-of pocket medical expenses.


Section 6A has been inserted.

(1) A rebate to be known as the medical scheme fees tax credit must be deducted from the normal tax payable by a taxpayer who is a natural person, unless the taxpayer is entitled to a rebate under section 6(2)(b).

(2)(a) The medical fees tax credit applies in respect of fees paid by the taxpayer to –

(i) a medical scheme registered under the Medical Schemes Act No 131 of 1998 ; or

(ii) a fund which is registered under any similar provision contained in the laws of any other country where the medical scheme is registered.

(2)(b) The amount of the medical scheme fees tax credit must be –

(i) R216, in respect of benefits to the taxpayer;

(ii) R432, in respect of benefits to the taxpayer and one dependant; or

(iii) R432, in respect of benefits to the taxpayer and one dependant, plus R144 in respect of benefits to each additional dependant,

for each month in that year of assessment in respect of which those fees are paid.

(3) For the purposes of this section, any amount contemplated in subsection (2) that has been paid by –

(a) the estate of a deceased taxpayer is deemed to have been paid by the taxpayer on the day before his or her death; or

(b) an employer of the taxpayer is, to the extent that the amount has been included in the income of that taxpayer as a taxable benefit in terms of the Seventh Schedule, deemed to have been paid by that taxpayer.

(4) For the purposes of this section a ‘dependent’ in relation to a taxpayer means a ‘dependant’ as defined in section 1 of the Medical Schemes Act No 131 of 1998.

Effective date

The insertion of section 6A comes into operation on 1 March 2012 and applies to years of assessment commencing on or after that date.

Several amendments have been made to Section 18

Section 18(1):

(b) now includes qualifying expenses as amounts (other than amounts recoverable by the taxpayer or his or her spouse) which were paid by the taxpayer during the year of assessment to a duly registered -

(i) medical practitioner, dentist, optometrist, homeopath, naturopath, osteopath, herbalist, physiotherapist, chiropractor or orthopedist for professional services rendered or medicines supplied to the taxpayer, his or her spouse or his or her children, or any dependant of the taxpayer; or


(ii) nursing home or hospital or any duly registered or enrolled nurse, midwife or nursing assistant (or to any nursing agency in respect of the services of such a nurse, midwife or nursing assistant) in respect of the illness or confinement of the taxpayer, his or her spouse or his or her children, or any dependant of the taxpayer; or

(iii) pharmacist for medicines supplied on the prescription of any person mentioned in subparagraph (i) for the taxpayer, his or her spouse or his or her children, or any dependant of the taxpayer; and

(c) any amounts (other than amounts recoverable by the taxpayer or his or her spouse) which were paid by the taxpayer during the year of assessment in respect of expenditure incurred outside the Republic on services rendered or medicines supplied to the taxpayer or his or her spouse or children, or any dependant of the taxpayer, and which are substantially similar to the services and medicines in respect of which a deduction may be made under paragraph (b) of this subsection; and

(d) any expenditure that is prescribed by the Commissioner (other than expenditure recoverable by the taxpayer or his or her spouse) necessarily incurred and paid by the taxpayer in consequence of any physical impairment or disability suffered by the taxpayer, his or her spouse or child, or any dependant of the taxpayer.

Section 18(2)(a) has not been amended and the amounts for medical and dental expenses and contributions to funds are not limited when the taxpayer is entitled to the over 65 years rebate.

Section 18(2)b) now reads that where the taxpayer, his or her spouse or his or her child is a person with a disability, the aggregate of -

(i) the sum of the amounts referred to in subsection (1)(b), (c) and (d) (see above); and

(ii) so much of the contributions made by the taxpayer as contemplated in subsection (1)(a) as exceeds four times the amount of the medical scheme fees tax credit in respect of that taxpayer in terms of section 6A; or

The monetary amounts in Section 18(2)(c)(i) have been amended for the 2012 year of assessment and increase the amounts that may be deducted for contributions made to a medical scheme by a taxpayer. The increased amounts are as follows:

(aa) R720 for each month in that year in respect of which those contributions were made solely with respect to the benefits of that taxpayer;

(bb) R1 440 for each month in that year in respect of which those contributions were made with respect to the benefits of that taxpayer and one dependant; or

(cc) where those contributions are made with respect to the taxpayer and more than one dependant, the amount referred to in item (bb) in respect of the taxpayer and one dependant plus R440 for every additional dependant for each month in that year in respect of which those contributions were made;

Section 18(2)(c) has then been further amended but only with effect from the 2013 year of assessment and limits the amount deductible in all other situations to the following:

(c) in any other case -

(i) so much of the contributions made by the taxpayer during the relevant year of assessment as contemplated in subsection (1)(a), as exceeds four times the amount of the medical scheme fees tax credit in respect of that taxpayer in terms of section 6A; and

(ii) so much of the sum of all amounts contemplated in subsection (1)(b), (c) and (d),

as in the aggregate exceeds 7,5% of the taxpayer’s taxable income (excluding any retirement fund lump sum benefit and retirement fund lump sum withdrawal benefit) as determined before allowing any deduction under this subparagraph.

Section 18(3) is unchanged and defines the term ‘disability’.

Section 18(4)(a) has been substituted and now provides that for the purposes of this section ‘child’ means the taxpayer’s child or child of his or her spouse who was alive during any portion of the year of assessment, and who on the last day of the year of assessment-

(a) was unmarried and was not or would not, had he lived, have been-

(i) over the age of 18 years;

(ii) over the age of 21 years and was wholly or partially dependant for his maintenance upon the taxpayer and has not become liable for the payment of normal tax in respect of such year; or

(iii) over the age of 26 years and was wholly or partially dependant for his maintenance upon the taxpayer and has not become liable for the payment of normal tax in respect of such year and was a full time student at an educational institution of a public character; or

(b) in the case of any other child, was incapacitated by a disability from maintaining himself or herself and was wholly or partially dependant for maintenance upon the taxpayer and has not become liable for the payment of normal tax in respect of such year.


The proviso to subsection (4) has been deleted.

Section 18(4A) has been inserted and provides that for the purposes of this section ‘dependant’ in relation to a taxpayer means—

(a) his or her spouse;

(b) his or her child and the child of his or her spouse;

(c) any other member of his or her immediate family in respect of whom he or she is liable for family care and support; and

(d) any other person who is recognised as a dependant of that person in terms of the rules of a medical scheme or fund contemplated in subsection (1)(a)(i) or (ii), at the time the contributions contemplated in subsection (1)(a) were made, the amounts contemplated in subsection (1)(b) or (c) were paid or the expenditure contemplated in subsection (1)(d) was incurred and paid.

Section 18(5) remains unchanged and deals with treatment of medical contributions made by the estate or employer of a deceased taxpayer.

Effective date

The amended capped amounts in section 18(2)(i)(aa), (bb) and (cc) and the deletion of the proviso to section 18(4) are deemed to come into operation on 1 March 2011 and apply in respect of the year of assessment commencing on or after that date.

All the other amendments to section 18 come into operation on 1 March 2012 and apply to years of assessment commencing on or after that date.

Example

Sid, Ed, Di, Tom and Eric are married, live in South Africa, under the age of 65 years and each has two children. None of the family members have a disability. Each family is a member of a medical scheme. Their earnings, medical scheme contributions and medical expenses are as follows:

Sid Ed Di Tom Eric

Cash salary 300 000 312 000 324 000 336 000 348 000

Employer’s contribution to the medical scheme 48 000 36 000 24 000 12 000 -

Total cost to company 348 000 348 000 348 000 348 000 348 000

Employee’s contribution to the medical scheme - 12 000 24 000 36 000 48 000

Capped amount (R1 440 + (2 × R440) x 12 months) 27 840 27 840 27 840 27 840 27 840

Medical expenses paid and not recovered from medical scheme 20 000 20 000 20 000 20 000 20 000

They have no other earnings. The only deduction that they are entitled to is the section 18 medical and dental expenditure.

Treatment for 2012 year of assessment

Sid Ed Di Tom Eric

Employer’s contribution 48 000 36 000 24 000 12 000 -

Taxable fringe benefit 48 000 36 000 24 000 12 000 -

Cash salary 300 000 312 000 324 000 336 000 348 000

Add: Taxable fringe benefit 48 000 36 000 24 000 12 000 -

Taxable income before deduction 348 000 348 000 348 000 348 000 348 000

Medical deduction

Own contribution - 12 000 24 000 36 000 48 000

Add: Deemed contribution 48 000 36 000 24 000 12 000 -

Total contribution 48 000 48 000 48 000 48 000 48 000

Part 1 of the deduction limited to 27 840 27 840 27 840 27 840 27 840

Taxable income before section 18 deduction 348 000 348 000 348 000 348 000 348 000

Less: Part 1 of the deduction 27 840 27 840 27 840 27 840 27 840

Taxable income before Part 2 of the deduction 320 160 320 160 320 160 320 160 320 160

Section 18 reduction % × 7,5% × 7,5% × 7,5% × 7,5% × 7,5%


Sid Ed Di Tom Eric

Section 18 reduction amount 24 012 24 012 24 012 24 012 24 012


Less: Part 1 of the deduction 27 840 27 840 27 840 27 840 27 840

Non-deductible portion 14 160 14 160 14 160 14 160 14 160

Add: Medical expenses paid 20 000 20 000 20 000 20 000 20 000

34 160 34 160 34 160 34 160 34 160

Reduced by (see above) 24 012 24 012 24 012 24 012 24 012

Part 2 of the deduction 10 148 10 148 10 148 10 148 10 148

Add: Part 1 (see above) 27 840 27 840 27 840 27 840 27 840

Section 18 deduction 37 988 37 988 37 988 37 988 37 988


Less: Section 18 deduction 37 988 37 988 37 988 37 988 37 988

Taxable income 310 012 310 012 310 012 310 012 310 012

Treatment for 2013 year of assessment

Assuming the tax credits and capped amounts proposed in the 2012 budget remain as announced for the 2013 year of

assessment.

Sid Ed Di Tom Eric

Employer’s contribution 48 000 36 000 24 000 12 000 -

Taxable fringe benefit 48 000 36 000 24 000 12 000 -

Medical scheme fees tax credit

Amount (R460 + (2 × R154)) x 12 months 9 216 9 216 9 216 9 216 9 216

Four times the medical scheme fees tax credit 36 864 36 864 36 864 36 864 36 864

Cash salary 300 000 312 000 324 000 336 000 348 000

Add: Taxable fringe benefit _48 000 _36 000 24 000 12 000 -

Taxable income before deduction 348 000 348 000 348 000 348 000 348 000

Section 18 reduction % × 7,5% × 7,5% × 7,5% × 7,5% × 7,5%

Section 18 reduction amount 26 100 26 100 26 100 26 100 26 100

Medical deduction

Own contribution - 12 000 24 000 36 000 48 000

Add: Deemed contribution 48 000 36 000 24 000 12 000 -


Less four times the medical scheme fees tax credit 36 864 36 864 36 864 36 864 36 864

11 136 11 136 11 136 11 136 11 136

Add: Medical expenses paid 20 000 20 000 20 000 20 000 20 000

31 136 31 136 31 136 31 136 31 136

Reduced by (see above) 26 100 26 100 26 100 26 100 26 100

Section 18 deduction 5 036 5 036 5 036 5 036 5 036


Less: Section 18 deduction 5 036 5 036 5 036 5 036 5 036

Taxable income 340 660 340 660 340 660 340 660 340 660

Medical scheme fees tax credit 9 216 9 216 9 216 9 216 9 216


Amendments made to the 4th Schedule

An employer must deduct employees’ tax from the employee’s ‘balance of remuneration’ and not from his gross remuneration. Paragraph 2(4) sets out how to determine an employee’s ‘balance of remuneration’. Amendments have been made to deal with the new treatment of medical scheme contributions.

Contributions to medical schemes

Paragraph 2(4)(e) has been deleted.

Prior to deletion it provided as follows:

2(4)(e)(i), that in determining an employee’s ‘balance of remuneration’ his remuneration had to be reduced by contributions by the employee, who was below the age of 65, to a qualifying medical scheme if the employer effects payment of the contributions to the medical scheme as does not exceed the amount that was deductible under section 18(2)(c)(i).

2(4)(e)(ii), that in determining an employee’s ‘balance of remuneration’ his remuneration had to be reduced by, at the option of the employer, contributions by the employee, who was below the age of 65, to a qualifying medical scheme as does not exceed the amount that was deductible under section 18(2)(c)(i) in respect of which proof of payment has been furnished to the employer.

Effective date

The deletion of paragraph 2(4)(e) of the 4th Schedule comes into operation on 1 March 2012 and applies to years of assessment commencing on or after that date.

Donations made by the employer on behalf of the employee

Following from the deletion of paragraph 2(4)(e), paragraph 2(4)(f) has been amended. It now provides as follows:

(f) so much of any donation made by the employer on behalf of the employee-

i) as does not exceed 5% of that remuneration after deducting therefrom the amounts contemplated in items (a) to (d); and

ii) for which the employer will be issued a receipt as contemplated in section 18A(2)(a).

Effective date

The amended paragraph 2(4)(f) of the 4th Schedule comes into operation on 1 March 2012 and applies to years of assessment commencing on or after that date.

Medical scheme fees tax credit

Paragraph 9 directs as to the amount of employees’ tax to be deducted from an employee’s ‘balance of remuneration’. A new paragraph has been added, namely, paragraph 9(6). It provides that there must be deducted from the amount to be withheld or deducted by way of employees’ tax, as contemplated in paragraph 2 the amount of the medical scheme fees tax credit that applies in respect of that employee in terms of section 6A if-

(a) the employer effects payment of the medical scheme fees as contemplated in section 6A(2)(a), or

(b) the employer does not effect payment of the medical scheme fees as contemplated in section 6A(2)(a), at the

option of the employer, if proof of payment of those fees has been furnished to the employer.

Importantly, the above amendment results in this deduction being from the amount of employees’ tax payable and no longer

a deduction in the determination of the employee’s ‘balance of remuneration’.

Effective date

Paragraph 9(6) comes into operation on 1 March 2012 and applies to years of assessment commencing on or after that date.

Amendments made to the 7th Schedule to the Income Tax Act

Medical scheme contributions

Benefit - Paragraph 2(i)

Paragraph 2(i) of the Seventh Schedule has not been amended. It provides that for the purposes of this Schedule and of paragraph (i) of the definition of ‘gross income’ in section 1 of this Act, a taxable benefit is deemed to have been granted by an employer to an employee in respect of his employment with his employer, if as a benefit or advantage of or by virtue of such employment or as a reward for services rendered or to be rendered by him to the employer-

(i) the employer has during a period directly or indirectly made a contribution or payment to a fund contemplated in paragraph (b) of the definition of a ‘benefit fund’ in section 1 [a registered medical scheme] for the benefit of any employee or the dependants of any employee;…


Valuation – Paragraph 12A

Paragraph 12A(1) has not been amended. It provides that the cash equivalent of the value of the taxable benefit contemplated in paragraph 2(i) is so much of the amount of any contribution or payment made by the employer during the year of assessment, directly or indirectly, to a medical scheme registered under the Medical Schemes Act 131 of 1998, or to a fund that is registered under a similar provision contained in the laws of another country where the medical scheme is registered, for the benefit of any employee or his dependants, as defined in that Act.

‘Nil’ values – Paragraph 12A(5)

Under paragraph 12A(5)(d), a nil value was given to any ‘fringe benefit’ awarded to a person who during the relevant year of assessment is entitled to a rebate under section 6(2)(b) (over 65 years of age on the last day of the year of assessment). This nil value concession has been deleted.

The amended paragraph 12A(5) provides as follows:

No value shall be placed in terms of this paragraph on the taxable benefit derived from an employer by--

(a) a person who by reason of superannuation, ill-health or other infirmity retired from the employ of such employer; or

(b) the dependants of a person after such person's death, if such person was in the employ of such employer on the date of death; or

(c) the dependants of a person after such person's death, if such person retired from the employ of such employer by reason of superannuation, ill-health or other infirmity;

(d) a person who during the relevant year of assessment is entitled to a rebate under section 6(2)(b).

Effective date

The deletion of paragraph 12A(5)(d) comes into operation on 1 March 2012 and applies to taxable benefits derived on or after that date.

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TRAVEL ALLOWANCE

Amendment to section 8(1)(b)(iiiA)(bb) of the Income Tax Act.

Background

The amendment increases the maximum amount on which actual expenses in respect of wear and tear and finance charges may be claimed against a travel allowance. As a result of this amendment, the maximum amount is now R480 000. This amendment aligns the maximum cost of a vehicle with the maximum value of a

vehicle according to the rate per kilometer table fixed by the Minister of Finance on 25 February 2011 by notice in the Gazette.

The effect is that when a vehicle costs more than R480 000, the wear and tear or depreciation allowance must be determined as if it had cost R480 000. And if it was purchased under a suspensive sale agreement, then the total debt used in the determination of the amount of finance charges incurred is limited to R480 000.


The monetary amounts in section 8(1)(b)(iiiA)(bb) have been increased from R400 000 to R480 000.

Section 8(1)(b)(iii) provides that when a travel allowance is based on the actual distance travelled by the recipient in using a motor vehicle on business (excluding private travelling), or the actual distance is proved to the satisfaction of the Commissioner to have been travelled by the recipient, the amount expended by the recipient on business travelling is, unless the contrary appears, deemed to be an amount determined on the actual distance at the rate per kilometre fixed by the Minister of Finance by notice in the Gazette for the category of vehicle used;

Section 8(1)(b)(iiiA)(aa) applies when the vehicle is being leased. It provides that when the portion of the allowance or advance that is claimed by the recipient to be actually expended is calculated based on accurate data furnished by him in respect of a vehicle that is being leased, the total amount of payments in respect of that lease may not in a year of assessment exceed an amount of the fixed cost determined by the Minister in the notice contemplated in section 8(1)(b)(ii), for the category of vehicle used.

Section 8(1)(b)(iiiA)(bb) applies when the vehicle is not being leased. It has been amended and now provides that when the portion of the allowance or advance that is claimed by the recipient to be actually expended is calculated based on accurate data furnished by him for a vehicle that is not being leased,

(A) its wear and tear must be determined over a period of seven years from the date of original acquisition by that

recipient and its cost must for this purpose be limited to R480 000, or another amount determined by the Minister

by notice in the Gazette, and


(B) the finance charges in respect of any debt incurred in respect of purchase of the motor vehicle must be limited to

an amount that would have been incurred had the original debt been R480 000, or another amount determined by

the Minister in (A) above.

Effective date

The amended section 8(1)(b)(iiiA)(bb) is deemed to have come into operation on 1 March 2011 and applies to years of assessment commencing on or after that date.

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EXECUTIVE SHARE SCHEMES – DIVIDENDS RECEIVED FROM EMPLOYEE SHARE TRUSTS Amendment to section 10(1)(k(i)(dd) of the Income Tax Act.

Background

Disposal or vesting of restricted share incentive schemes

Anti-avoidance rules exist to prevent taxpayers from disguising high-taxed salary through the use of restricted share (or share-based) incentive schemes that would otherwise trigger low taxed (or even no-taxed) income or capital gains. These anti-avoidance rules essentially trigger ordinary revenue when these instruments are disposed of by employees (or fully vest for their benefit). The triggering events are designed to be delayed so that the appreciation associated with these schemes is fully taxed. The anti-avoidance rules at issue technically apply to ‘restricted equity instruments’. The term ‘equity instrument’ is fairly expansive, including shares and share-based rights associated with shares. These share-based rights even include contractual rights or obligations, the value of which is determined directly or indirectly with reference to a share. In order for an equity instrument to be viewed as a restricted equity instrument, these equity instruments must contain one or more restrictions that mainly relate to the disposal or ownership of those instruments.

Dividends from share incentive schemes

In 2010, further amendments were added to prevent avoidance schemes stemming from the dividend aspect of restricted share (or share-based) incentive schemes. More specifically, dividends in respect of equity instruments are treated as ordinary revenue unless the instruments constitute an equity share or the dividend itself constitutes an equity instrument. The purpose of these dividend rules is to prevent taxpayers from converting high-taxed salary into low (or no) taxed dividends. The schemes of concern relate to special shares whose sole value relates to dividend rights held by employees.

Reasons for change

The newly added anti-avoidance rule of 2010 appears to be an effective mechanism for preventing the use of dividends from restricted shares (or share-based) incentive schemes as a mechanism to disguise salary. However, the new rule is seemingly overly broad, covering transactions never intended. Of particular concern is the holding of shares through employee trusts. While employee trusts are a common source of mischief, many employee trusts exist simply as a matter of administrative convenience in order to simplify administration of widely targeted employee shares. Some of these trusts contain restrictions so that the employees retain some interest in the employer for a meaningful duration. This form of restriction is common in the case of black economic empowerment. Hence, the 2010 legislation inadvertently imposes ordinary revenue treatment in respect of dividends arising from almost all employee share trusts.

The change

The new legislation retains ordinary treatment for restricted equity share schemes as a general rule, but the revised legislation contains a carve-back. The purpose of the carve-back is to limit the new anti-avoidance rule without re-opening pre-existing avoidance. More specifically, if the only shares held by a trust, are unrestricted equity shares, those dividends will be excluded from the anti-avoidance rule.

Example

Facts: Company X creates an employee share scheme trust. Company X lends R10 million to the trust, which acquires a specified number of ordinary shares in Company X. The shares in the trust will vest in the employees after a period of five years. The dividends received by the trust on the shares are used to pay off the Company X loan, with the balance paid to employees.

Result: The dividends received by the Company X as repayment for loan amount as well as dividends received by employees are not subject to the anti-avoidance rules. These dividends will accordingly retain their exemption from normal tax despite the holding of the shares in a restricted equity trust.


Changes to the legislation to give effect to the above

Section 10(1)(k)(i)(dd) has been amended.

Prior to its amendment it read as follows:

The section 10 exemption shall not apply:

(dd) to any dividend in respect of a restricted equity instrument as defined in section 8C, unless—

A) the restricted equity instrument constitutes an equity share; or

B) the dividend constitutes an equity instrument as defined in that section;

In its amended from it reads as follows:

The section 10 exemption shall not apply:

(dd) to any dividend in respect of a restricted equity instrument as defined in section 8C, unless—

(A) the restricted equity instrument constitutes an equity share, other than an equity share that would have constituted a hybrid equity instrument as defined in section 8E(1) but for the three-year period requirement contemplated in that definition; or

(B) the dividend constitutes an equity instrument as defined in that section; or

(C) the restricted equity instrument constitutes an interest in a trust and, where that trust holds shares, all of those shares constitute equity shares, other than equity shares that would have constituted hybrid equity instruments as defined in section 8E(1) but for the three-year period requirement contemplated in that definition.

Effective date

The amendment is deemed to have come into operation on 1 January 2011 and will apply to dividends received or accrued on or after that date.

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EMPLOYER-PROVIDED LONG-TERM INSURANCE – TAXATION OF PROCEEDS ON PAYOUT

Amendment to paragraphs (d) and (m) of the definition of ‘gross income’ in section 1 of the Income Tax Act and section 10(1)(gG) and (gH) of the Income Tax Act and paragraph 55 of the Eighth Schedule to the Income Tax Act.

Background

Objective of employer-owned long-term insurance policies

Businesses take out long-term insurance to guard against loss, and individuals acquire their own insurance for the benefit of themselves (or their dependants or designated nominees). However, under certain circumstances, employers take out insurance in the event of death, disability or severe illness of their employees. More specifically, the insurance proceeds can be intended for the benefit of:

1. The employer (for example, keyperson risk policies or a policy of insurance intended to fund a buyout of ownership in the event that one of the owners dies); or

2. The employees or their dependants (for example, employer-owned death or permanent disability risk policies, employer-owned income protection risk policies; or employer owned compensation policies).

In the case of risk policies, the policy payouts are either in the form of a lump sum paid out to the beneficiaries (such as in the case of a death benefit) or in an annuity format (such as in case of income protection policies). In the case of investment policies, the policy proceeds are typically paid out in the form of a lump sum.

Flow of policy proceeds

As stated previously, an employer can either take out an employer-owned insurance policy that relates to the death, disablement or severe illness of employees for the employer’s benefit or for the benefit of the employees. In the case where the employer intends to benefit, the structure is simple. The employer pays the premiums, and the employer is the beneficiary under the policy entitled to the benefits. However, in the case where the employer intends for the employee to benefit from the proceeds payout, there are two possible structures:

1. The policy can be structured so that the employee is the direct beneficiary, resulting in the proceeds being paid directly by the insurer to the employee; or

2. The policy can be structured so that the proceeds payout is made by the insurer to the employer as the beneficiary under the policy. In this case, there is a corresponding obligation on the employer (usually in terms of an agreement between the employer and the employee) to pay over the proceeds (or their equivalent) to the employee. This structure effectively leaves the employer in a neutral position with the benefit being received by the employee.


Tax impact of policy proceeds

The tax treatment associated with policy proceeds received in respect of insurance policies (risk and/or investment) is governed by a combination of case law, legislation and practice. Basic case law appears to generally view lump sum proceeds as capital in nature (thereby falling outside of ordinary revenue).

In respect of the income tax treatment, special legislative rules (which were amended in 2010) exist for employer-owned insurance policies. The 2010 amendments were an attempt to clarify the tax treatment of the different types of employer-owned insurance policies in respect of policy payouts, taking into account the deduction for premiums paid.

In the case of capital gains, an explicit set of capital gain rules exist for long-term insurance proceeds. Original holders and beneficiaries are often free from capital gains taxation with secondary holders being subject to capital gains tax. The capital gains tax treatment for secondary holders was designed to eliminate the secondary market in respect of endowment plans. The capital gains tax also contains a few additional exemptions with long-term insurance policy proceeds conceivably becoming subject to capital gains tax if the proceeds arise in circumstances that fall between the exemption gaps.

Reason for change

In order to create certainty in the industry, it is necessary to:

1. Create a unifying theoretical theme that recognises and caters for the various types of employer-owned insurance policies;

2. Create a tax regime in which tax consequences designed for a certain type of policy can be isolated; and

3. Clarify the ordinary revenue and capital gains tax treatment of proceeds derived from employer-owned insurance policies.

In particular, the 2010 amendments did not sufficiently separate the various types of insurance policies from a legislative point of view, resulting in unintended consequences, and uncertainty. Given these concerns, the 2010 legislation has been repealed and a new set of provisions created to cater for existing and new employer-owned insurance policies.

The change

Basic paradigm

In view of the above, a new comprehensive set of rules has been introduced to address the tax treatment of proceed payouts from employer-owned insurance policies. Application of these rules will essentially fall into the following paradigm:

1. If premiums were funded with post-tax contributions, policy proceeds will be tax-free; or

2. If the premiums were funded with pre-tax contributions, policy proceeds will be taxable.

Basic rules

As a general rule, all amounts directly or indirectly received or accrued from an insurer in terms of an employer-owned insurance policy (risk and/or investment) are initially included as gross income. The effect of the general rule is that the policyholder and/or the employee may be taxed on the policy proceeds.

The inclusion of policy proceeds in gross income will typically cover proceeds payable upon the contingency of death, disability, or severe illness. Loans or advances granted by an insurer based on the value of the policy will similarly be included in gross income.

The second rule is that gross income in respect of employer-owned insurance policies may be eligible for one of two overall exemptions:

1. An exemption for policyholders (employers) receiving proceeds in terms of a policy where the benefit was intended for the policyholder; and

2. An alternative exemption for the employee, in the case of the employee or his/her dependants or nominees receiving the proceeds.

As a side matter, the tax regime for policy proceeds (i.e. the inclusion and exclusions) does not apply if the proceeds of a policy are part of an ‘approved’ group life plan associated with pension or provident fund membership. In the case of an ‘approved’ group life plan, the policy proceeds will be received by the pension or provident fund involved. The pension or provident fund will in turn pay the proceeds received to the member, or his/her dependant.

The amounts so paid will be taxed under the retirement tax regime (i.e. pursuant to the lump sum formula), or alternatively as an annuity, without regard to the new rules proposed.

Proceeds received by the employer (paragraph (m) of the ‘gross income’ definition)

In respect of a proceeds payout in the case of an employer-owned insurance policy where the policy proceeds are received by the policyholder (the employer), the policyholder will be taxed, subject to a particular exemption. The exemption relates to keyperson plans where the policyholder did not choose to be eligible for the deduction of the premiums as from 1 March 2012 onwards. Restated for clarification, if the employer policyholder receives the insurance proceeds in respect of an employer-owned insurance risk policy for the benefit of the employer on or after 1 March 2012, the proceeds will be exempt from tax unless the policyholder elected in the policy agreement to be eligible to claim the premiums as deductions.


It should be noted that no exemption is available for the employer in the case of proceeds received by the employer in respect of an employer-owned insurance policy that is intended for the benefit of an employee. The employer will be taxed on the policy proceeds received (as an inclusion of the proceeds in gross income). However, the employer will be eligible for a deduction when paying over the proceeds to an employee (if there is an obligation to do so), leaving the employer in a tax neutral position.

Proceeds received by the employee (paragraph (d) of the “gross income” definition)

As is the case with policy proceeds received by an employer, an employee will be taxed on policy proceeds stemming from an employer-owned insurance policy. Furthermore, the employee will be taxed regardless of whether the policy proceeds are received by the employee, or the dependant or nominee of the employee. Lastly, the employee will be taxed irrespective of whether the policy proceeds are received directly (from the insurer) or indirectly (from the employer). Similar to the case where policy proceeds are received by an employer, the employee will be entitled to an exemption in respect of the policy proceeds received if the premiums were funded with post-tax contributions. More specifically, insurance proceeds received by the employee (or his/her dependants or nominees) on or after 1 March 2012 will be exempt in the hands of the employee:

1. In the case of pure risk policies, if the premiums on or after 1 March 2012 were taxable in the hands of the employee as a fringe benefit, unless a subsequent deduction was also available (for example in the case of employer-owned income protection risk policies).

2. In the case of any other policy, if all the premiums payable in respect of the policy were indeed taxed as a fringe benefit in the hands of the employee.

In respect of the employer’s Pay-As-You-Earn obligation, if the exemption discussed above applies, the employer does not have an obligation to declare any income on the IRP5 tax certificate of the employee. However, where the exemption does not apply, the employer will have an obligation to deduct employees’ tax from the proceeds payout regardless of whether:

1. The policy proceeds are paid to the employee or the employee’s dependant or nominee; or

2. The proceeds are paid by the employer (indirect receipt) or by the insurer (direct receipt).

Capital gains tax

As under the old legislation, second-hand long-term insurance policies will remain subject to capital gains tax. The intention is to continue to discourage the trade in second-hand policies (that is, policies purchased from or ceded to another person by the original beneficial owner).

The following changes have been introduced:

1. All risk policies are specifically excluded from the application of capital gains tax (including second-hand policies). The nature of a risk policy prohibits these policies from being regularly traded as a ‘second-hand’ policy because these policies do not have inherent tradable value.

2. A specific exemption from capital gains tax has also been introduced in respect of employer owned long-term insurance policies if the amount to be taxed is included in the gross income of any person, regardless of whether that amount is subsequently exempted from gross income.

Therefore, when policy proceeds from an employer-owned insurance policy are exempted from gross income, the exemption should not trigger an adverse capital gains result. In effect, the exemptions should be broad enough to effectively exempt the policy proceeds from the income tax as well as from the capital gains tax regime.

The other existing exclusions remain within the capital gains regime for long-term insurance.

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EMPLOYER-OWNED INSURANCE POLICIES – CESSION OF COMPENSATION AND PURE RISK

POLICIES

Amendment to paragraph (d)(iii) of the definition of ‘gross income’ in section 1 of the Income Tax Act, section 10(1)(gG) and section 23(p) of the Income Tax Act.

Background

Employer-owned compensation policies

Deferred compensation policies (as with share option schemes) were used as a method of providing benefits to selected employees on retirement. This type of policy was a hybrid investment/risk policy. Most often, structured with the weighting towards investment and a small life cover element.

Under this previous regime, the employer enjoyed a deduction in respect of each premium paid upfront on the hybrid investment/risk policy. However, there was no concurrent inclusion of income for the employee in respect of the premiums as long as the employee has no vested right in the policy. In effect this regime allowed for an annual tax mismatch of premiums.


Employer-owned pure risk policies

Employers enter into employer-owned pure risk policies for their own benefit (key-person policies), or for the benefit of their employees (employer-owned death or permanent disability risk policies). When the employee exits the service of the employer, the need for the employer to continue with the policy ceases. Instead of allowing the policy to lapse, employers often cede these policies to their ex-employees. Once the employee takes over the policy, the employee will have the obligation to pay the premiums and have the benefit of being the policyholder. At this stage, there is a cessation of the employer’s involvement with the policy upon cession with the employee assuming all risks and entitlements.

Reason for change

Government indicated in 2010 that deferred compensation policies should be discontinued because these policies cause a tax mismatch as discussed above. However, because many of these policies were in existence at the time, it was determined that an exit strategy is needed for the policyholder (employer) to escape the structure. Pure risk policies do not have any inherent value. Therefore, the cession of a pure risk policy to an employee should not generate a tax event for either the employer or the employee. Despite this lack on inherent value, it is understood that for reasons of health or age the employee may be better off continuing with the risk policy than taking out a new risk policy.

The change

Pre-1 March 2012 compensation plans

In respect of old deferred compensation plans, a legislative exit route has been made available to policyholders so that these policies can exit the system. The employer has the option to exercise one of the following exit routes, once the policy has been made paid-up (i.e. when the employer ceases contributing to the policy):

1. Cede the policy: The employer can cede the policy to the employee. In this case, the value of the policy as at the date of cession will be included in the income of the employee. The income will not be taxable as a ‘severance benefit’ regardless of the circumstances of the cession.

2. Make the policy paid-up: The employer can elect to receive the proceeds from the policy and thereupon pay those proceeds over to the employee. The employer will be in a tax neutral position with an inclusion and a deduction in respect of the value of the proceeds. The employee will be taxed on the proceeds received from the employer (and these amounts will be included for Pay-As-You-Earn withholding). Again, the proceeds will not be taxable as a ‘severance benefit’, regardless of the circumstances of the payout.

If the employer decides to continue making payments on the policy, the employer will be obliged to tax the employee on the value of the premiums paid as a fringe benefit from 1 March 2012 onwards. Once the policy pays out, the employer will be in a tax neutral position with an inclusion and a deduction in respect of the value of the proceeds (provided that the employer has an obligation to pay over the proceeds). However, the employee will be taxed on the proceeds received from the employer in full (with consequent Pay-As-You-Earn withholding) without regard to the ‘severance benefit’ rules. The net result is disadvantageous from a tax point of view, thereby necessitating the escape routes above.

Compensation plans from 1 March 2012

As per the general rule in effect from 1 March 2012, all premiums paid in respect of employer-owned investment policies for the benefit of employees must be included in the income of the employees as a taxable fringe benefit.

As a result, any cession or payout in respect of that insurance policy will not be taxable as long as ‘all’ the premiums paid by the employer have actually been subjected to tax as a fringe benefit in the hands of the employee.

Cession of compensation pure risk policies

The cession of pure risk policies will not generate income in the hands of the employee. This exclusion applies regardless of how the previous policyholder (i.e. the previous employer) treated the policy from a tax point of view.

Changes to the legislation giving effect to the above

Amendments to the Taxation Laws Amendment Act 7 of 2010

Exemption

Section 10(1)(gF) was inserted by the Taxation Laws Amendment Act 7 of 2010. It provided that there would be exempt from normal tax-

any value required to be taken into account in determining the gross income of any person in respect of the cession by another person of a policy contemplated in section 11(w) ceded to or in favour of that person-

i) where that person is-

aa) an employee or director of that other person or a connected person in relation to the employee or director;

bb) the estate of the employee or director; or

cc) any person who is or was wholly or partly dependent for his or her maintenance upon the employee or director; and

ii) where that policy was concluded before 1 January 2011.


Section 10(1)(gF) came into operation on 1 January 2011 and applied to a policy ceded on or after 1 January 2012.

The Taxation Laws Amendment Act 24 of 2011 has deleted the provision that enacted section 10(1)(gF).

Effective date

The deletion of the provision that enacted section 10(1)(gF) is deemed to have come into operation on 24 August 2010. Since section 10(1)(gF) applied to a policy ceded on or after 1 January 2012, the deletion of it results in its provisions never applying.

Deduction

Section 11(w) was substituted by the Taxation Laws Amendment Act 7 of 2010. In its substituted form section 11(w)(i) provided a deduction for expenditure incurred by a taxpayer on premiums payable under a long-term insurance policy of which he was the policyholder, when the expenditure incurred by him on the premiums payable was included in the taxable income of his employee or director.

Under section 11(w)(ii), a deduction was available for expenditure incurred by a taxpayer on premiums payable under a long-term insurance policy of which he was the policyholder, when-

he was insured against a loss by reason of the death, disablement or severe illness of his employee or director,

it was a risk policy with no cash value or surrender value prior to its maturity date or the death of the employee or director whose life was insured under it,

it was not the property of a person other than himself at the time of the payment of the premium. Provided that a premium paid was not disallowed as a deduction by reason of it being held by his creditor other than a person contemplated below (certain listed beneficiaries) as security for his debt, and

no transaction, operation or scheme existed under which an amount recoverable under it or an amount equivalent to or in lieu of this amount was made over by him to or in favour of certain listed beneficiaries.

The certain listed beneficiaries referred to above were-

the employee or director or a connected person in relation to the employee or director,

the estate of the employee or director, or

a person who was wholly or partly dependent for his maintenance upon the employee or director.

The amended section 11(w) came into operation as from the commencement of years of assessment commencing on or after 1 January 2011 and applied to premiums incurred on or after that date. The provision that amended section 11(w) has now been deleted. And the provision that provided the commencement date of the amended section 11(w) has also been deleted.

Effective date

The deletion of the provision that amended section 11(w) is deemed to have come into operation as from the commencement of years of assessment commencing on or after 1 January 2011 and applies to premiums incurred on or after that date. Since the date of the cancelling-out provision co-insides with the commencement date of the amended section 11(w), its effect is that the provisions of the previous of section 11(w) were not amended by the Taxation Laws Amendment Act 7 of 2010.

Amendments to legislation

Paragraph (d) of the definition of ‘gross income’ in section 1 of the Income Tax Act has been amended

Paragraph (d) of the definition of ‘gross income’ now reads as follows:

(d) any amount (other than an amount contemplated in paragraph (a)), including any voluntary award, received or accrued—

(i) in respect of the relinquishment, termination, loss, repudiation, cancellation or variation of any office or employment or of any appointment (or right or claim to be appointed) to any office or employment;

(ii) by or to a person, or dependant or nominee of the person, in respect of proceeds from a policy of insurance where the person is or was an employee or director of the policyholder; or

(iii) by or to a person, or dependant or nominee of the person, in respect of any policy of insurance (other than a risk policy with no cash value or surrender value) that has been ceded to—

(aa) the person;

(bb) a dependant or nominee of the person; or


(cc) a pension fund, pension preservation fund, provident fund, provident preservation fund or retirement annuity

fund, for the benefit of the person, or dependant or nominee of the person, by—

(A) the employer or former employer of the person; or

(B) the company of which the person is or was a director:

Provided that—

(aa) the provisions of subparagraphs (i) and (ii) shall not apply to any lump sum award from any pension fund, pension preservation fund, provident fund, provident preservation fund or retirement annuity fund;

(bb) any such amount which becomes payable in consequence of or following upon the death of any person shall be deemed to be an amount which accrued to such person immediately prior to his or her death;

(cc) for the purposes of subparagraphs (ii) and (iii), any amount received by or accrued to a dependant or nominee of a person shall be deemed to be received by or to accrue to that person.

Effective date

The amendment to paragraph (d) of the definition of ‘gross income’ comes into operation on 1 March 2012 and applies in respect of receipts and accruals on or after that date.

Paragraph (m) of the definition of ‘gross income’ in section 1 of the Income Tax Act has been amended

Paragraph (m) of the definition of ‘gross income’ now reads as follows:

(m) any amount received or accrued in respect of a policy of insurance of which the taxpayer is the policyholder, where the policy relates to the death, disablement or severe illness of an employee or director (or former employee or director) of the taxpayer, including by way of any loan or advance: Provided that—

(i) any amount so received or accrued shall be reduced by the amount of any such loan or advance which is or has been included in the taxpayer’s gross income;

(ii) to the extent that paragraph (a) or (d) of this definition applies to an amount, this paragraph does not apply to that amount.

Effective date

The amendment to paragraph (m) of the definition of ‘gross income’ is deemed to have come into operation on 1 January 2011.

Sections 10(1)(gG) and (gH) have been inserted

Sections 10(1)(gG) and (gH) provide that there shall be exempt from normal tax-

(gG) any amount received by or accrued to a person as contemplated in subparagraph (ii) or (iii) of paragraph (d) of the definition of ‘gross income’-

(i) in the case of a policy that is a risk policy with no cash value or surrender value, if the amount of premiums paid in respect of that policy by the employer of the person has been deemed to be a taxable benefit of the person in terms of the Seventh Schedule since the later of-

(aa) the date on which the employer or company contemplated in those subparagraphs became the policyholder of that policy; or

(bb) 1 March 2012,

unless the amount of the premiums paid was deductible by the person in terms of section 11(a);

(ii) in the case of any other policy, if an amount equal to the aggregate of the amount of any premiums has been included in the income of the person as a taxable benefit in terms of the Seventh Schedule since the date on which the policy was entered into;

(gH) in respect of a policy of insurance contemplated in section 11(w)(ii), where it is not stated that section 11(w)(ii) applies to premiums payable in respect of that policy as contemplated in section 11(w)(ii)(dd)(A) or (B), any amount received or accrued in respect of that policy.

Effective date

Both sections 10(1)(gG) and (gH) come into operation on 1 March 2012 and apply to amounts received or accrued on or after that date.

Prohibition of deduction

Sections 23(p) and (q) of the Income Tax Act have been repealed from the date they were introduced, the effect is that neither section 23(p) nor (q) ever came into operation. A new section 23(p) has then been introduced to provide that no deduction will be available for the value of a cession of a policy of insurance and reads as follows:

23(p) No deduction will be allowed for the value in respect of any cession of a policy of insurance ceded by a taxpayer to-


(i) any-

(aa) employee (or former employee);

(bb) director (or former director); or

(cc) dependant or nominee of the employee (or former employee) or director (or former director), of the taxpayer; or

(ii) any pension fund, pension preservation fund, provident fund, provident preservation fund or retirement annuity fund for the benefit of any-

(aa) employee (or former employee);

(bb) director (or former director); or

(cc) dependant or nominee of the employee (or former employee) or director (or former director), of the taxpayer.

Effective date

The amended section 23(p) comes into operation on 1 March 2012 and applies to policies ceded on or after that date.

Amendment to paragraph 55 of the Eighth Schedule to the Income Tax Act

Paragraph 55 determines when a person must disregard any capital gain or capital loss determined on a disposal that resulted in the receipt or accrual of an amount from certain insurance policies. The provision of paragraph 55 have been extended with the addition of paragraph (e) and (f). These provide as follows:

(e) in respect of a risk policy with no cash value or surrender value; or

(f) if the amount received or accrued constitutes an amount contemplated in section 10(1)(gG) or (gH).

Effective date

The amendments to paragraph 55 of the Eighth Schedule come into operation 10 January 2012 and apply in respect of disposals made on or after that date.

________________________________

EMPLOYER- PROVIDED INDEMNITY INSURANCE – EMPLOYER CONTRIBUTIONS TREATED AS A

TAXABLE BENEFIT

Amendment to section 11(w) and 23B of the Income Tax Act, addition of item (cA) to paragraph 2(4) of the Fourth Schedule to the Income Tax Act, amendment to paragraph 2(e), the addition of paragraphs 2(k) and 12C of the Seventh Schedule to the Income Tax Act.

Background

A. Policy types

Employers generally enter into four different types of policies for the benefit of their employees or directors, or for their dependants and nominees (for the purposes of employer owned insurance policies discussed in this section, reference will hereinafter only be made to ‘employees’). These four types of policies are as follows:

Employer-funded death or permanent disability risk policies conducted through an ‘approved’ plan (i.e. group long-term insurance with the pension or provident fund being the policyholder);

Employer-owned death or permanent disability risk policies through an ‘unapproved’ plan (i.e. an insurance policy where the employer is the policyholder);

Employer-owned income protection risk policies; and

Employer-owned compensation policies.

Each of these policies makes payment upon the death, disability, or severe illness of an employee of the taxpayer.

In the case of unapproved plans, the parties to whom the proceeds must be paid may vary. The policy can be structured so that the proceeds can be paid directly to the employees or to the employer. If the payout is made to the employer, a side arrangement usually exists so that the employer is obligated to turn over the insurance proceeds (or their equivalent) to the employees.

It must be noted in the case of employer-funded death or permanent disability risk policies that are conducted through an approved pension or provident fund, that the tax treatment follows the same paradigm as employer contributions to employer-retirement funds. As a result, no fringe benefit will be generated in the case of employer-funded death or permanent disability risk policies conducted through an ‘approved’ plan.


B. Long- and short-term insurance policies

Employer-owned insurance policies relating to the death, disability or severe illness of an employee can be structured as a long-term or short-term insurance policy. In the case of a long-term insurance policy, there is often a direct link between the employees that are the subject of the policy and the premiums payable. For instance, the premium may be based on the value of the employee’s income that must be replaced. However, in the case of short-term insurance there is often no direct link between individual employees and the value of the premium payable; the value of the premium is instead determined based on the total risk profile of the employee group. This form of short-term insurance typically provides incidental insurance relating to employees (e.g. in the case of work-related casualties or fire).

C. ‘For the benefit of the employee’

As stated previously, an insurance policy can be intended directly or indirectly for the benefit of an employee. The employee can be the named beneficiary of the insurance policy. Alternatively, the employer can have an obligation in terms of the employment contract to pay the proceeds over to the employee. It is also possible that, in the absence of a formal obligation to pay over the proceeds, the established practice of the employer might indicate that the employer has the intention to benefit the employee. In each of these cases, the view is that the employer paid the premiums under the insurance policy directly or indirectly for the benefit of the employee.

Reasons for change

If an employer incurs premiums in respect of a policy of insurance that relates to the death, disability or severe illness of employees for the direct or indirect benefit of those employees, the employees may deduct the premiums incurred in respect of that policy. However, the payment of the insurance premiums shall give rise to a simultaneous fringe benefit inclusion for the employees. The net effect should be a deduction for the employer and a matching inclusion for the employee so that the fiscus is in a neutral position with regard to time-value-of-money principles.

Alternatively, if an employer is the named beneficiary but has a side arrangement with the employee (or a mere intention or practice to pay over the policy proceeds to its employees), the tax impact should be the same as for payments made directly by the insurer to the employee. The employer is effectively incurring the expense of a ‘service’ for the benefit of the employee. Nonetheless, the lack of explicit language gave rise to unnecessary disputes with some taxpayers taking the position that many of these indirect arrangements are beyond the reach of the fringe benefit regime.

The change

A. Employer insurance contributions as a fringe benefit

In view of the need for clarity, explicit fringe benefit rules have been added for employer-owned insurance policies for the direct or indirect benefit of employees. Fringe benefit inclusions for these benefits will equal employer premium contributions (i.e. will be deemed to be the value of the taxable fringe benefit). These fringe benefit inclusions will be taken into account for employees’ tax purposes.

It must be noted that even in cases where an employer-owned insurance premium falls outside of the ambit of the explicit fringe benefit rules discussed above, new paragraph 2(k) of the Seventh Schedule may apply to treat other forms of employer-provided insurance as a taxable employer-provided service.

B. Employer-owned income protection risk policies

Employer-provided disability policies will largely follow the same paradigm as ‘unapproved’ group plans that protect against death. However, a long-held distinction exists between two forms of disability plans –

income capacity, versus

income protection.

Income capacity plans: Individual income capacity plans operate just like individual life plans (no deduction for the employee, but a tax-free payout of proceeds).

Furthermore, employer-owned income capacity plans operate just like employer-owned life plans (deductible employer premiums matched by employee fringe benefit inclusions, and a tax-free payout). These fringe benefit inclusions for premiums will be taken into account for employees’ tax purposes.

Income protection plans: On the other hand, in the case of an individual income protection plan, the individual is incurring an expense related to the production of income with the premium being deductible by the individual.

The corollary is that the payment of the proceeds results in gross income (refer notes on employer-provided long term insurance – taxation of proceeds on payout). Similarly in the case of an employer-owned income protection plan, employees should be entitled to a deduction to the extent of the fringe benefit incurred as a result of the employer paid insurance premium. To ensure that the deduction will be available to the employee, the premium paid by the employer will be deemed to have been paid by the employee to the extent of the fringe benefit incurred. The employer administration around employees’ tax will comprise the inclusion of the fringe benefit and the deduction of the premium. The result will be a monthly set-off, and the employee will be in a tax neutral position.


C. Employer-owned compensation policies

In the past, the premiums paid by an employer in respect of hybrid investment/risk policies for the benefit of employees were generally not included as a fringe benefit, particularly in the case of deferred benefit schemes. Instead, these policies were treated as taxable upon payout of the proceeds. As part of the general rule in respect of employer-provided benefits (see above), this position will now be rectified.

Going forward, the employer will have to include the premium as a fringe benefit in the income of the employee (under the explicit fringe benefit rules inserted). Because these policies will now generate a fringe benefit for the employee, policyholders (employers) may seek to end the arrangement. (Refer notes on employer provided insurance policies – cession of compensation and pure risk policies).


Section 11(w) has been substituted

Section 11(w) provides a deduction for expenditure incurred by a taxpayer in respect of any premiums payable under a policy of insurance (other than a policy of insurance solely against an accident as defined in section 1 of the Compensation for Occupational Injuries and Diseases Act, 1993 (Act No. 130 of 1993)) of which the taxpayer is the policyholder, where-

(i) (aa) the policy relates to the death, disablement or severe illness of an employee or director of the taxpayer; and

(bb) the amount of expenditure incurred by the taxpayer in respect of the premiums payable under the policy is deemed to be a taxable benefit granted to an employee or director of the taxpayer in terms of paragraph 2(k) of the Seventh Schedule; or

(ii) (aa) the taxpayer is insured against any loss by reason of the death, disablement or severe illness of an employee or director of the taxpayer;

(bb) the policy is a risk policy with no cash value or surrender value;

(cc) the policy is not the property of any person other than the taxpayer at the time of the payment of the premium: Provided that any premium paid shall not be disallowed as a deduction by reason of the policy being held by a creditor of the taxpayer as security for a debt of the taxpayer; and

(dd) in respect of any policy entered into-

(A) on or after 1 March 2012, the policy agreement states that this paragraph applies in respect of premiums payable under that policy; or

(B) before 1 March 2012, it is stated in an addendum to the policy agreement by no later than 31 August 2012 that this paragraph applies in respect of premiums payable under that policy.

Effective date

The substitution of section 11(w) comes into operation on 1 March 2012 and applies in respect of premiums incurred on or after that date.

Section 23B prohibitions have been extended

Section 23B(5) has been added which states that no deduction is allowed under section 11(a) for expenditure incurred by a taxpayer on a premium paid under a policy of insurance contemplated in section 11(w).

Effective date

Section 23B(5) of the Income Tax Act comes into operation on 1 March 2012 and applies to premiums incurred on or after that date.

Paragraph 2 of the Fourth Schedule to the Income Tax Act has been amended

Paragraph 2(4)(cA) has been added to the deductible amounts. An employee’s remuneration must now be reduced by, amongst other things, any premium deemed to have been paid by the employee in terms of paragraph 12C(2) of the Seventh Schedule.

Effective date

The amendment to paragraph 2(4)(cA) of the Fourth Schedule to the Income Tax Act comes into operation on 1 March 2012 and applies to premiums incurred on or after that date.

Paragraph 2 of the Seventh Schedule to the Income Tax Act has been amended

Supply of service to an employee

In paragraph 2(e) a reference to item (j) has been replaced by a reference to subparagraph (j) or (k). See below


Benefits in respect of insurance policies

A new taxable benefit has been added to the list of taxable benefits as set out in paragraph 2. The new paragraph 2(k) reads as follows: The employer has during any period made any payment to any insurer under an insurance policy directly or indirectly for the benefit of the employee or his or her spouse, child, dependant or nominee.

Effective date

The amendment to paragraph 2(e) of the Seventh Schedule to the Income Tax Act comes into operation on 1 March 2012 and applies to premiums incurred on or after that date.

Paragraph 2(k) of the Seventh Schedule to the Income Tax Act comes into operation on 1 March 2012 and applies to premiums incurred on or after that date.

Benefits in respect of insurance policies

Paragraph 12C has been added to the Seventh Schedule of the Income Tax Ac and provides as follows:

(1) The cash equivalent of the value of a taxable benefit deemed to have been granted as contemplated in paragraph 2(k) is the amount of any expenditure incurred by an employer during a year of assessment in respect of any premiums payable under a policy of insurance directly or indirectly for the benefit of an employee or his or her spouse, child, dependant or nominee.

(2) Where any premium is paid in terms of a policy of insurance contemplated in section 23(m)(iii), the amount of any premium paid by the employer of that employee must, to the extent that the amount has been deemed to be a taxable benefit in terms of paragraph 2(k), be deemed to have been paid by that employee.

(3) Where an appropriate portion of any expenditure contemplated in subparagraph (1) cannot be attributed to the employee for whose benefit the premium is paid, the amount of that expenditure in relation to that employee is deemed, for the purposes of subparagraph (1), to be an amount equal to the total expenditure incurred by the employer during that year of assessment for the benefit of all employees divided by the number of employees in respect of whom the expenditure is incurred.

Effective date

Paragraph 12C of the Seventh Schedule to the Income Tax Act comes into operation on 1 March 2012 and applies to premiums incurred on or after that date.

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FRINGE BENEFITS

Amendment to Paragraphs 2, 7, 9 and 12A of the Seventh Schedule to the Income Tax Act.

Paragraph 2(b) of the Seventh Schedule has been amended

Paragraph 2(b) of the Seventh Schedule relates to the right of an employee to private use of assets as an employee fringe benefit. The value of this use is determined in accordance with paragraphs 6 and 7. The amendment deletes the references to specific subparagraphs because these paragraphs need to be read in their entirety.

The amended paragraph 2(b) reads as follows:

(2) For the purposes of this Schedule and of paragraph (i) of the definition of ‘gross income’ in section 1 of this Act a taxable benefit shall be deemed to have been granted by an employer to his employee in respect of the employee’s employment with the employer, if as a benefit or advantage of or by virtue of such employment or as a reward for services rendered or to be rendered by the employee to the employer-

(a) ….

(b) the employee has been granted the right to use any asset (other than any residential accommodation or household

goods supplied with such accommodation) for his private or domestic purposes either free of charge or for a consideration

payable by the employee which is less than the value of such use, as determined under paragraph 6 in the case of an asset

other than a motor vehicle or under paragraph 7 in the case of a motor vehicle; or….

Effective date

The amendment to paragraph 2(b) of the Seventh Schedule to the Income Tax Act is deemed to come into operation on 1 March 2011 and applies to years of assessment commencing on or after that date.

Judicial long distance commuting

Paragraph 7 of the Eighth Schedule deals with the right of use of motor vehicles.


Background

A taxable fringe benefit arises when employees use employer-owned vehicles for private purposes. Taxation of this fringe benefit is reduced by the distances travelled for business purposes. Daily work commuting (i.e. travel between the taxpayer’s place of residence and place of employment) is not viewed as business travel. Taxpayers claiming the motor vehicle allowance similarly cannot claim the allowance against daily work commuting.

Reason for change

Many judges face a unique work commute situation. Judges are often required to serve various courts, many of which are spread far and wide from one another. For instance, some judges may be required to travel long distances to reach the district courts versus the Supreme Court of appeal in Bloemfontein in order to carry out their duties.

These judges cannot be expected to regularly shift homes to shorten their shifting work locations. In order to alleviate this situation, judges are afforded the use of Government-owned vehicles to complete these various journeys as part of their compensation packages.

In 2010, the fringe benefit rules for motor vehicles became substantially more restrictive to prevent taxpayers from obtaining undue benefits in respect of employer-provided vehicles. These changes have had the unfortunate effect of adversely impacting judges who utilize Government-owned vehicles for long-distance work commuting.

The change

Due to their unique circumstances, judges will be allowed to treat their daily work commute as business travel for purposes of determining the fringe benefit impact of employer-provided vehicles. Like all other taxpayers claiming work-related travel, judges are required to maintain a logbook to record the distances associated with their work-related travel (which now includes work commuting). Judges can claim fringe benefit relief on assessment or obtain monthly relief from employees’ tax withholding (by virtue of the 80 / 20 relief mechanism).

Change to paragraph 7 of the Seventh Schedule to give effect to the above

A new subparagraph 8A has been inserted into paragraph 7 of the Seventh Schedule.

Paragraph 7(8A) reads as follows:

For the purposes of subparagraphs (7) and (8), if the employee contemplated in those subparagraphs is a ‘judge’ or a ‘Constitutional Court judge’ as defined in section 1 of the Judges’ Remuneration and Conditions of Employment Act, 2001 (Act No. 47 of 2001), the kilometres travelled between the judge’s place of residence and the court over which the judge presides must be deemed to be kilometres travelled for business purposes and not for private purposes.

Effective date

Paragraph 7(8A) of the Seventh Schedule to the Income Tax Act is deemed to have come into operation on 1 March 2011 and applies in respect of years of assessment ending on or after that date.

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

Symbol ‘B’ in the formula in paragraph 9(3)(a)(ii) has been changed from R54 200 to R59 750. A formula is used to determine the rental value of residential accommodation. Once the rental value has been determined, the value of the taxable fringe benefit is determined by the deduction of any rental consideration paid by the employee from the rental value (paragraph 9(2)). The formula for the rental value is set out in paragraph 9(3)(a).

Effective date

The amendment to paragraph 9(3)(a)(ii) is deemed to have come into operation as from the commencement of years of assessment commencing on or after 1 March 2011.

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PROVISIONAL TAX

Amendment to the definition of ‘provisional taxpayer’ in section 1 of the Fourth Schedule to the Income Tax Act and amendment to paragraph 18 of the Fourth Schedule to the Income Tax Act.

Definition of a ‘provisional taxpayer’

The amendment to paragraph (cc) improves the technical linkage to the entities described in section 10(1)(e) as initially intended.

The amended definition of a ‘provisional taxpayer’ reads as follows:

A ‘provisional taxpayer’ means a,

a) person (other than a company) who derives by way of income an amount that does not constitute remuneration or an

allowance or advance contemplated in section 8(1),


b) company, and

c) person who is notified by the Commissioner that he is a provisional taxpayer,

but shall exclude, a

(aa) PBO as contemplated in paragraph (a) of the definition of a ‘public benefit organisation’ in section 30(1) that has been

approved by the Commissioner in terms of section 30(3),

(bb) recreational club as contemplated in the definition of a ‘recreational club’ in section 30A(1) that has been approved by

the Commissioner in terms of section 30A(2),

(cc) body corporate, share block company or association of persons contemplated in section 10(1)(e), and

(dd) person exempt from the payment of provisional tax in terms of paragraph 18.

Effective date

The amended definition of a ‘provisional taxpayer’ is deemed to have come into operation as from the commencement of years of assessment ending on or after 1 January 2012.

Paragraph 18(1)(c) and (d) of the Fourth Schedule have been amended to incorporate the changes to taxation of dividends

The amended paragraph 18 provides as follows:

1) There shall be exempt from payment of provisional tax--

a) [deleted by Revenue Laws Amendment Act No. 31 of 2005]

b) any person in respect of whose liability for normal tax for the relevant year of assessment payments are required to be

made under section 33 of this Act;

c) any natural person who on the last day of that year will be below the age of 65 years and who does not derive any income

from the carrying on of any business, if-

i) the taxable income of that person for the relevant year of assessment will not exceed the tax threshold; or

ii) the taxable income of that person for the relevant year of assessment which is derived from interest, foreign dividends

and rental from the letting of fixed property will not exceed R20 000.

d) any natural person (other than a director of a private company) who on the last day of the year of assessment will be over

the age of 65 years, if the Commissioner is satisfied that such person's taxable income for that year-

i) will not exceed R120 000;

ii) will not be derived wholly or in part from the carrying on of any business; and

(iii) will not be derived otherwise than from remuneration, interest, foreign dividends, dividends on shares in any mutual

building society or rental from the letting of fixed property.

Effective date

The amended paragraph 18 comes into operation 1 April 2012.

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RETIREMENT AND RELATED ISSUES

SEVERANCE EMPLOYMENT BENEFITS AND THE RATING FORMULA

Amendment to sections 5 and 6 of the Income Tax Act.

Correcting a cross reference date in section 5(10)

Two amendments correct the date when the cross-reference to section 7A(4A) is deleted. More specifically, the effective date of the deletion will be moved from 1 January 2010 to 1 March 2011 (consistent with the date when severance benefits paid by an employer are taxed in terms of the lump sum benefit tables).

Effective date

The first amendment comes into operation as from the commencement of years of assessment ending on or after 1 January 2010. The second amendment comes into operation on 1 March 2011 and applies to amounts received or accrued on or after that date.

Section 6 rebates

An amendment to section 6(1) adds ‘severance benefit’ to the amounts which are excluded from being taxed according to the normal tax rates for natural persons. An amount taxed as a “severance benefit” is taxed as a lump sum benefit under the retirement tax table.

Effective date

The amended section 6(1) comes into operation on 1 March 2011 and applies to years of assessment commencing on or after that date.

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RETIREMENT ANNUITY CONTRIBUTIONS

Amendment to sections 11(n)(i)(aa) of the Income Tax Act.

The amendment adds ‘severance benefit’ to amounts which a taxpayer may not take into account when calculating the permissible deduction for retirement annuity fund contributions. An amount taxed as a “severance benefit” is taxed as a lump sum benefit under the retirement tax table.

The amended section 11(n)(i)(aa)(A) reads as follows:

A deduction can be claimed for so much of the total current contributions to any retirement annuity fund or funds made during the year of assessment by any taxpayer as a member of such fund or funds as does not in the case of the taxpayer exceed the greatest of-

(A) 15% of an amount equal to the amount remaining after deducting from, or setting off against, the income derived by the taxpayer during the year of assessment (excluding income derived from any retirement funding employment (being the income or part thereof referred to in the definition of ‘retirement-funding employment’ in section 1), and any retirement fund lump sum benefit, retirement fund lump sum withdrawal benefit and severance benefit) the deductions or assessed losses admissible against such income under this Act (excluding this paragraph, sections 17A, 18 and 18A and items (c) to (i), inclusive, of paragraph 12(1) of the First Schedule).

Effective date

The amendment is deemed to come into operation on 1 March 2012.

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SECOND SCHEDULE

Amendment to paragraph 4 and 6 of the Second Schedule to the Income Tax Act.

Paragraph 4(1) of the Second Schedule has been amended

The amendment clarifies that the general timing rules are subject to paragraphs 3 and 3A dealing with the death of members, former members and the death of successor members.


The amended paragraph 4(1) reads as follows:

Notwithstanding the rules of a pension fund, pension preservation fund, provident fund, provident preservation fund or retirement annuity fund, and subject to paragraphs 3 and 3A, any lump sum benefit shall be deemed to have accrued to a member of such fund on the earliest of the date-

(a) on which an election is made in respect of which the benefit becomes recoverable;

(b) on which any amount is deducted from the benefit in terms of section 37D(1)(a), (b) or (c) of the Pension Funds Act, 1956 (Act No. 24 of 1956);

(c) on which the benefit is transferred to another pension fund, pension preservation fund, provident fund, provident preservation fund or retirement annuity fund;

(d) of his or her retirement; or

(e) of his or her death,

and shall be assessed to tax in respect of the year of assessment during which such lump sum benefit is deemed to accrue.

Effective date

The amended paragraph 4(1) is deemed to have come into operation as from the commencement of years of assessment ending on or after 1 January 2012.

Paragraph 6(1)(a) of the Second Schedule has been amended

The basic philosophy for permitted transfers between retirement savings funds is to permit the transfer of less restrictive funds to equal or more restrictive funds. The amendment accordingly permits all fund transfers to retirement annuity funds (the most restrictive type of retirement fund).

The amended paragraph 6(1)(a) reads as follows:

(1) The deduction to be allowed for the purposes of paragraph 2(1)(a)(ii) or (b) is an amount equal to-

(a) in the case of-

(i) a lump sum benefit contemplated in paragraph 2(1)(b)(iA), so much of the benefit as is paid or transferred for the benefit of the taxpayer from a-

(aa) pension fund into any pension fund, pension preservation fund or retirement annuity fund;

(bb) pension preservation fund into any pension fund, pension preservation fund or retirement annuity fund;

(cc) provident fund into any pension fund, pension preservation fund, provident fund, provident preservation fund or retirement annuity fund;

(dd) provident preservation fund into any pension preservation fund, provident fund, provident preservation fund or retirement annuity fund; and

(ee) retirement annuity fund into any retirement annuity fund; and

ii) a lump sum benefit contemplated in paragraph 2(1)(b)(iB), so much of the benefit as is paid or transferred for the benefit of the taxpayer from-

aa) pension fund into any pension fund, pension preservation fund or retirement annuity fund;

bb) pension preservation fund into any pension fund, pension preservation fund or retirement annuity fund;

cc) provident fund into any pension fund, pension preservation fund, provident fund, provident preservation fund or retirement annuity fund;

dd) provident preservation fund into any pension preservation fund, provident fund, provident preservation fund or retirement annuity fund; and

ee) retirement annuity fund into any retirement annuity fund; and…

Effective date

The amendments to paragraph 6 of the Second Schedule to the Income Tax Act come into operation on 1 March 2012.

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BUSINESSES

DEFINITIONS

Amendment of section 1 of the Income Tax Act.

The amendment to ‘connected person’ modifies the connected person definition for group ownership and company ownership so as to take into account voting rights (in addition to the focus on ‘equity shares’). Voting rights are an important part of a meaningful ownership interest that connects various persons.

Effective date

The above amendments all come into operation on 1 January 2012.

The definition of ‘contributed tax capital’, ‘dividend’, ‘foreign dividend’ ‘foreign return of capital’ and paragraph (g), (gA), (jA) and (k) of the definition of ‘gross income’ have been amended. Refer to detailed notes on Dividends Tax. In addition, the amendment to ‘contributed tax capital’ clarifies how the reduction of contributed tax capital reduction is applied in the case of new company residents versus pre-existing company residents.

Effective date

This first amendment to ‘contributed tax capital’ is deemed to have come into operation on 1 January 2011 and the second amendment to ‘contributed tax capital’ on 1 April 2012. Please refer to the Act for the effective dates of the other amendments.

The definition of ‘equity share’ has been amended and now means any share or similar interest in a company, excluding any share or similar interest that, neither as respects dividends nor as respects capital, carries any right to participate beyond a specified amount in a distribution. Please note the further amendment with a different effective date below.

Effective date

This amendment is deemed to have come into operation on 1 January 2011.

The definition of ‘equity share’ has been further amended to mean any share in a company, excluding any share that, neither as respects dividends nor as respects returns of capital, carries any right to participate beyond a specified amount in a distribution.

Effective date

This amendment comes into operation on 1 April 2012.

The definition of ‘financial instrument’ has been amended by deletion of the term ‘stock’ because modern usage of the term suggests shares and not debt.

Effective date

This amendment comes into operation on 1 January 2012.

The definition of a ‘foreign partnership’ has been amended to include a foreign entity because certain foreign conduits are technically entities (e.g. limited liability companies).

Effective date

The insertion of the definition of a ‘foreign partnership’ comes into operation for a foreign partnership that is established or formed before 24 August 2010, as from the commencement of years of assessment commencing on or after 1 October 2011, and for a foreign partnership that is established or formed on or after 24 August 2010, as from the date of its establishment or formation.

Paragraph (d) and (m) of the definition of ‘gross income’ have been substituted. Refer to detailed notes on Employer Provided Long Term Insurance.


Effective date

The amendments are deemed to have come into operation on 1 March 2012 and apply to receipts and accruals on or after that date.

Paragraph (e) of the definition of ‘gross income’ has been substituted and now reads as follows: ‘a retirement fund lump sum benefit or retirement fund lump sum withdrawal benefit other than any amount included under paragraph (eA)’. The change clarifies the inter-relationship of gross income in respect of legitimate lump sum amounts taken into account under the retirement and withdrawal tables and these are now excluded from gross income.

Effective date

This amendment is deemed to come into operation from commencement of years of assessment commencing on or after 1 January 2012.

The definition of ‘headquarter company’ has been substituted. Refer to detailed notes on Headquarter Companies.

Effective date

This amendment is deemed to have come into operation from commencement of years of assessments commencing on or after 1 January 2011.

The definition of ‘living annuity’ has been substituted to allow the beneficiary upon the death of the annuitant to continue with the annuity, commute the annuity in full for a lump sum, or exercise a combination of the previous options.

Effective date

The above amendment comes into operation on 1 March 2012.

The definition of ‘pension fund’ has been substituted to allow for employers to subsequently join that fund. As a practical matter subsequent entry of membership regularly occurs in the case of umbrella funds.

Effective date

This amendment is deemed to come into operation from commencement of years of assessment commencing on or after 1 January 2012.

The definition of ‘pension preservation fund’ has been amended. The basic philosophy for permitted transfers between retirement savings funds is to permit the transfer of less restrictive funds to equal or more restrictive funds. The amendment accordingly permits pension preservation funds to be additionally transferred from provident and provident preservation funds (as opposed to transfers solely from pension and pension preservation funds).

Effective date

The amendments come into operation on 1 March 2012.

The definition of ‘retirement annuity fund’ has been amended. The basic philosophy for permitted transfers between retirement savings funds is to permit the transfer of less restrictive funds to equal or more restrictive funds. The amendment accordingly permits retirement annuity funds to be additionally transferred from pension preservation funds and pension preservation funds (as opposed to transfers solely from pension, provident and other retirement annuity funds).

Effective date

The amendments come into operation on 1 March 2012.

A definition of ‘return of capital’ has been inserted. Refer to detailed notes on Dividends Tax.

Effective date

This amendment is deemed to come into operation on 1 January 2011.


The definition of ‘severance benefit’ has been amended to prevent amounts that have been taxed under the lump sum benefit tables from being included in gross income.

Effective date

The amendments are deemed to have come into operation on 1 March 2012 and apply to receipts and accruals on or after that date.

A definition of ‘share’ has been inserted to clarify that the term includes ‘similar’ equity interests, mainly to better account for a variety of foreign ownership interests. Refer detailed notes on Dividends Tax.

Effective date


The definition of ‘shareholder’ has been deleted. Refer detailed notes on Dividends Tax.

Effective date


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PRE-PRODUCTION INTEREST

Deletion of section 11(bA) of the Income Tax Act.

The amendment deletes section 11(bA). Prior to its deletion it provided for a deduction for pre-production interest and ‘related’ finance charges. We are told in the explanatory memorandum that the reason for the deletion is that section 11(bA) was obsolete in light of the business start-up deduction rules contained in section 11A. The latter also allow for the deduction of pre-start-up interest expenses.

Unfortunately the provisions of section 11(bA) and 11A are not the same and the deletion of section 11(bA) will result in pre-production interest not being deductible if assets are brought into use after trade has started.

Effective date

The deletion of section 11(bA) comes into effect on 1 January 2012 and applies in respect of years of assessment commencing on or after that date.

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SMALL BUSINESS CORPORATIONS

Amendments to section 12E of the Income Tax Act.

Investment income

The definition of ‘investment income’ in section 12E(4(c)(i) has been amended to clarify that it covers both local and foreign dividends. In its amended form it reads as follows:

(i) any income in the form of dividends, foreign dividends, royalties, rental derived in respect of immovable property, annuities or income of a similar nature, and

ii) any interest as contemplated in section 24J (other than any interest received by or accrued to any co-operative bank as contemplated in paragraph (a)(ii)(ff)), any amount contemplated in section 24K and any other income which, by the laws of the Republic administered by the Commissioner, is subject to the same treatment as income from money lent, and

iii) any proceeds derived from investment or trading in financial instruments (including futures, options and other derivatives), marketable securities or immovable property.

Effective date

The amendment to section 12E(4)(c) comes into operation on 1 April 2012.

http://www.acts.co.za/tax/24j__incurral_and_accrual_of_interest.htm

http://www.acts.co.za/tax/24k__incurral_and_accrual_of_amounts_in_respect_of_interest_rate_agreements_.htm


Personal service

The definition of personal service in section 12E(4)(d) has been amended to include a co-operative to be consistent with the amended definition of ‘small business corporation’ in section 12E(4(a). ‘Personal service’ now means:

In relation to a company, co-operative or close corporation, means any service in the field of accounting, actuarial science, architecture, auctioneering, auditing, broadcasting, consulting, draftsmanship, education, engineering, financial service broking, health, information technology, journalism, law, management, real estate broking, research, sport, surveying, translation, valuation or veterinary science, if-

(i) that service is performed personally by any person who holds an interest in that company, co-operative or close corporation; and

(ii) that company, co-operative or close corporation does not throughout the year of assessment employ three or more full-time employees (other than any employee who is a shareholder of the company or member of the co-operative or close corporation, as the case may be, or who is a connected person in relation to a shareholder or member), who are on a full-time basis engaged in the business of that company, co-operative or close corporation of rendering that service.

Effective date

The amendment to section 12E(4)(d) is deemed to come into operation as from the commencement of years of assessment ending on or after 1 January 2012.

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LEARNERSHIP ALLOWANCES

Amendment to section 12H of the Income Tax Act.

The section 12H learnership allowance has been extended to 2016. The definition of a ‘registered learnership agreement’ in section 12H(1) is the provision that has been amended to give effect to the extension. It now reads as follows:

(a) a contract of apprenticeship entered into before 1 October 2016 and registered in terms of section 18 of the Manpower Training Act, 1981 (Act No. 56 of 1981), if the minimum period of training required in terms of the Conditions of Apprenticeship prescribed in terms of section 13(2)(b) of that Act before the apprentice is permitted to undergo a trade test is more than 12 months; or

(b) a learnership agreement that is–

(i) registered in accordance with the Skill Development Act, 1998, and

(ii) entered into between a learner and an employer before 1 October 2016.

Effective date

The amendments to section 12H are deemed to come into operation as from the commencement of years of assessment ending on or after 1 January 2012.

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MICRO – BUSINESS TURNOVER TAX

Amendment to paragraph 3 and 10 of the Sixth Schedule to the Income Act.

Background

The turnover tax system seeks to encourage the informal sector and other small businesses to enter the tax system by lowering the barriers of entry associated with the normal income tax system. In essence, small businesses under the turnover tax system are subject to a low rate of tax on a gross basis without deductions. The turnover tax potentially applies to businesses with an annual turnover of up to R1 million.

Reason for change

Two years after introduction, the objectives of the turnover tax have not been realised. Only a small number of taxpayers have registered for the turnover tax, most of which have migrated from pre-existing registration under the normal income tax. While all of the reasons associated with these difficulties are still under examination, certain design aspects of the turnover tax appear to be problematic. Most notably, the rate structure may be too high for many informal businesses.

The prohibition from being registered under the value-added tax may also be partly to blame because many businesses must be so registered if these businesses are to be viewed as credible by clients. The three-year lock-in period may also be a deterrent to businesses registering for the turnover tax.


The change

In view of the above, the attributes associated with the turnover tax have been enhanced.

First and foremost, the rate structure has been alleviated. The turnover band to which the zero rate of tax is applicable have been increased from R100 000 to R150 000. The other rates have also been reduced from 1, 3, 5 and 7% down to 1, 2, 4 and 6%.

Secondly, the value-added tax and the turnover tax have been completely de-linked. Vendors registered under the value-added tax may now freely register under the turnover tax if these taxpayers believe that it is in their best interests to do so.

On a related note to the extent SARS uncovers a wholly unregistered informal business, SARS now have the power to register the business for turnover tax or income tax. This power will ensure that taxpayers cannot alternate between both tax systems as a mechanism to artificially slow the audit process. SARS also has the power to note certain details of businesses and their owners if those businesses are not legally compelled to register for tax and submit tax returns.

Lastly, the three-year lock-in period has been relaxed by doing away with the exit and re-entry rules. This relaxation effectively means that a micro business can voluntarily exit the turnover tax system at the end of any year of assessment. However taxpayers that exit the turnover tax will no longer be allowed to re-enter the turnover tax system. The new system was not designed to be a ‘lesser of’’ system with taxpayers regularly switching between the normal and the turnover tax on an opportunistic basis to pay less tax.

Changes to the 6th Schedule to the Income Tax Act to give effect to the above

Paragraph 3 of the 6th Schedule deals with persons that do not qualify as micro businesses

Paragraph 3 has been amended and now provides as follows:

A person does not qualify as a micro business for a year of assessment where-

a) that person at any time during that year of assessment holds any shares or has any interest in the equity of a company other than a share or interest described in paragraph 4;

b) more than 20% of that person’s total receipts during that year of assessment consists of-

i) where that person is a natural person (or the deceased or insolvent estate of a natural person that was a registered micro business at the time of death or insolvency), income from the rendering of a professional service; and

ii) where that person is a company, investment income and income from the rendering of a professional service;

c) at any time during that year of assessment that person is a ‘personal service provider’ or a ‘labour broker’, as defined in the Fourth Schedule, other than a labour broker in respect of which a certificate of exemption has been issued in terms of paragraph 2(5) of that Schedule;

d) [deleted by the Taxation Laws Amendment Act, No. 7 of 2010];

e) the total of all amounts received by that person from the disposal of-

i) immovable property, used mainly for business purposes; and

ii) any other asset of a capital nature used mainly for business purposes, other than any financial instrument, exceeds R1,5 million over a period of three years comprising the current year of assessment and the immediately preceding two years of assessment, or such shorter period during which that person was a registered micro business;

f) in the case of a company-

i) its year of assessment ends on a date other than the last day of February;

ii) at any time during its year of assessment, any of its shareholders is a person other than a natural person (or the deceased or insolvent estate of a natural person);

iii) at any time during its year of assessment, any of its shareholders holds any shares or has any interest in the equity of any other company other than a share or interest described in paragraph 4: Provided that the provisions of this item do not apply to the holding of any shares in or interest in the equity of a company, if the company-

aa) has not during any year of assessment-

A) carried on any trade; and

B) owned assets, the total market value of which exceeds R5 000; or

bb) has taken the steps contemplated in section 41(4) to liquidate, wind up or deregister: Provided further that this paragraph ceases to apply if the company has at any stage withdrawn any step so taken or does anything to invalidate any step so taken, with the result that the company will not be liquidated, wound up or deregistered;

iv) it is a public benefit organisation approved by the Commissioner in terms of section 30; or

v) it is a recreational club approved by the Commissioner in terms of section 30A;

g) in the case of a person that is a partner in a partnership during that year of assessment-

i) any of the partners in that partnership is not a natural person;


ii) that person is a partner in more than one partnership at any time during that year of assessment; or

iii) the qualifying turnover of that partnership for that year of assessment exceeds the amount described in paragraph 2.

iv) [has been deleted];

h) [has been deleted].

Effective date

The amendments to paragraph 3 of the Sixth Schedule to the Income Tax Act come into operation as from the commencement of years of assessment commencing on or after 1 March 2012.

Paragraph 6 of the 6th Schedule deals with inclusions in taxable income

Paragraph 6(b) has been amended by the addition of the term ‘foreign dividend’ to take into account the changes to taxation of dividends. It now provides as follows:

The taxable turnover of a registered micro business includes-

a) 50% of all receipts of a capital nature from the disposal of-

i) immovable property, mainly used for business purposes, other than trading stock; and

ii) any other asset used mainly for business purposes other than any financial instrument; and

b) in the case of a company, investment income (other than dividends and foreign dividends).

Effective date

The amendment to paragraph 6(b) of the Sixth Schedule to the Income Tax Act comes into operation on 1 April 2012.

Paragraph 8 of the 6th Schedule deals with registration of micro businesses

Paragraph 8(3) has been amended. The amended paragraph 8 now provides as follows:

(1) A person that meets the requirements set out in Part II may elect to be registered as a micro business-

a) before the beginning of a year of assessment or such later date during that year of assessment as the Commissioner may prescribe by notice in the Gazette; or

b) in the case of a person that commenced business activities during a year of assessment, within two months from the date of commencement of business activities.

(2) A person that elected to be registered in terms of subparagraph (1) must be registered by the Commissioner with effect from the beginning of that year of assessment.

(3) A person that is deregistered in terms of-

a) paragraph 9 or 10 may not again be registered as a micro business.

b) [has been deleted].

Effective date

The amendments to paragraph 8(3)(a) and (b) of the Sixth Schedule to the Income Tax Act comes into operation on 1 April 2012.

Paragraph 10 of the 6th Schedule deals with compulsory deregistration of micro businesses

Paragraph 10(4) has been deleted. The amended paragraph 10 now provides as follows:

(1) A registered micro business must notify the Commissioner within 21 days from the date on which-

(a) the qualifying turnover of that registered micro business for a year of assessment exceeds the amount described in paragraph 2, or there are reasonable grounds for believing that the qualifying turnover will exceed that amount; or

(b) that registered micro business is disqualified in terms of paragraph 3.

(2) The Commissioner must, subject to subparagraph (3), deregister a registered micro business with effect from the beginning of the month following the month during which the event as described in subparagraph (1)(a), (1)(b) or (4) occurred.

(3) The Commissioner may direct that a person remains a registered micro business if the Commissioner is satisfied that the increase in the qualifying turnover of that person to an amount greater than the amount described in paragraph 2 is of a nominal and temporary nature.

(4) [has been deleted].

Effective date

The deletion of paragraph 10(4) of the Sixth Schedule to the Income Tax Act comes into operation as from the commencement of years of assessment commencing on or after 1 March 2012.

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FILM OWNERS – ALLOWANCE AND EXEMPTION

Introduction of section 12O and amendment to section 10(1)(zG) and 24F of the Income Tax Act.

Background

Film tax allowance

South Africa’s income tax system contains an incentive to stimulate the production of films within South Africa.

The previous incentive was in the form of an allowance (i.e. a 100% upfront deduction for film production that would otherwise be non-deductible as capital in nature). However, if the investor supplying the funds obtains those funds through borrowing, the deduction applied only to the extent that the investor is at risk in respect of that borrowing. This allowance contained a myriad of requirements, many of which sought to ensure that the costs relate to production while others seek to ensure that the film is largely local in nature.

South African Film and Television Production and Co-Production Incentive from the Department of Trade and Industry (DTI)

In order to provide South African film production with initial cash-flows that are designed to operate as a catalyst for investment, the DTI provides an incentive for eligible films (called the South African Film and Television Production and Co-Production Incentive, which became operative on 30 June 2004). The funds of an awarded incentive are released in tranches based on the fulfilment by the producers of certain film production milestones. To this end, incentive funds are typically only awarded once the investors have made an initial injection of their own funds (toward the total production budget) with additional DTI incentive funds added as specified film milestones are reached. In particular, equal amounts of the incentive funds are disbursed in tranches upon:

The date that confirmation that the completion bond is registered;

The date that principal photography commences;

The date that principal photography is complete;

The date of completion of the final mix (i.e. roughly the date that the film is ready for distribution); and

The date that the applicant submits the final claim to the DTI.

The DTI incentive contains certain procedural criteria (see DTI programme guidelines for South African Film and Television Production and Co-productions issued 28 January 2008). These criteria include the required creation of a domestic company to act as a special purpose corporate vehicle (SPCV).

The purpose of the SPCV is to separately account for DTI funding (and investor funding) as applied to film production costs (in terms of financial reporting and in terms of other requirements such as black economic empowerment). The income tax contains ancillary rules in support of the DTI incentive by treating the incentive as exempt income for the SPCV. The incentive can be passed tax-free onto the film owners.

Investor access to the DTI incentive typically occurs in the form of a loan repayment, a cession, or as a dividend from the SPCV. Investor involvement with the SPCV generally depends on whether the DTI incentive is awarded before or after film production.

If film production begins after having secured the DTI incentive, investors make an initial loan to the SPCV so that the SPCV can use investor funds to make the film. The investors are then repaid a portion of their initial loan as the SPCV collects the DTI incentive upon film production reaching certain milestones as outlined above.

If film production begins before having secured the DTI incentive, investors again make an initial loan to the SPCV upfront so that the SPCV can use investor funds to make the film with the loans partly repaid via the DTI incentive at the end of the process once DTI funds are secured.

It should be noted that no investor should ever receive more from the DTI than a partial return of their funding. The DTI incentive is designed only as partial subsidy.

Nature of film income

The profits of film production come at several levels. As an initial matter, it is hoped that film profits are made through cinema release. Successful films typically generate subsequent profit through distribution via DVD or through television programming. Less than successful films go straight to DVD or television. Investors obtain the fruits of their investment through ‘exploitation rights’ (that generate proportionate sales, licensing income and ancillary revenue).

Role of the collection account management agreement

Although producers and investors retain ownership of film production rights, the parties involved typically enter into a collection account management agreement with an independent third party (i.e. the collection account manager (CAM)). Basically, the primary function of the CAM is to administer the collection and distribution of revenues to investors arising from their ‘exploitation rights’ (relating to cinema, DVD and television rights, etc.). The CAM function is one of pure agent for allocating funds among investors.


Reasons for change

The upfront allowance for film production has largely been unsuccessful. Still worse, the incentive has created fertile ground for tax schemes, whereby certain investors mainly sought to obtain deductions with little regard for the underlying film. In these circumstances, the allowance has been more of an incentive for tax advisors and other financial facilitators as opposed to the development of a viable film industry.

The main problem with the incentive is the incentive’s emphasis on cost - the greater the cost, the greater the incentive. This emphasis has caused certain taxpayers to generate artificial losses. While ‘at risk’ rules exist to curb this practice, it is questionable whether these rules have been fully effective.

At an audit level, SARS has properly sought to intervene in order to protect the fiscus. However, this intervention has meant that many legitimate investors have avoided the incentive due to the audit risk.

Still others continue to utilise the incentive with the goal of subsidising ‘cultural’ films not intended for profit (i.e. as a self-styled deduction for amounts that would not be deductible if contributed to a public benefit organisation designed to promote culture).

The change

Overview

In view of the above, the accelerated write-off has been removed and replaced by an exemption. More specifically, income for exploitation rights allocable to initial investors (from qualifying films) will be wholly exempt. This change in focus will eliminate the incentive to escalate costs. However, taxpayers will be entitled to claim a limited net loss for expenditures after a two-year period. Taxpayers claiming this net loss will loss the benefit of the exemption going forward.

Qualifying criteria

In order to qualify for an exemption, taxpayers must satisfy the following criteria:

1. The production must be derived from a film;

2. The film must be approved as a local production or co-production;

3. The income must be allocable to the initial investors;

4. The income must be derived in respect of exploitation rights; and

5. The income must fall within a 10-year period.

1. Film requirement

In respect of the first requirement, the production must qualify as a feature, documentary or animation as defined by the DTI programme guidelines (see DTI programme guidelines for South African Film and Television Production and Co-productions issued 28 January 2008). More specifically,

A feature film entails:

A film commonly screened as the main attraction in commercial cinemas;

A film with a duration of no less than 90 minutes (or in the case of a large format (IMAX) film, no less than 45 minutes); and

A film shot and processed to commercial theatrical release standards for cinema exhibition or television broadcast, direct-to-video or DVD.

A documentary entails:

A non-fictional informative or educational programme or series recording real people or events that may involve some dramatisation;

A programme no less than 90 minutes in length (or in the case of a large format (IMAX) film, no less than 45 minutes); and

A programme shot and processed to commercial theatrical release standards for cinema exhibition, television broadcast, direct-to-video or DVD (including a series limited to 13 episodes).

An animation entails:

A sequence of frames that, when played in order at sufficient speed, presents a smoothly moving image for broadcast, projection, new media and network use in an entertaining, educational, informative or instructive manner; and

Hand-drawn images (2d animation), digitised video, computer-generated images (3D and flash animation), live action objects or a combination thereof.


2. Pre-approval required

As a second requirement, both local productions and co-productions must be preapproved by the National Film and Video Foundation (NFVF) in order to qualify for relief. Approval is available for both local productions and co-productions (the latter falling within the definition of a co-production film pursuant to a formal international agreement between South Africa and another country concerning the co-production of films). Approval by the NFVF of a film either as a local production or co-production must be granted in view of the scoring criteria (to be released by the NFVF) for assessment as a South African film (i.e. a film with significant local South African content). The NFVF will operate in an oversight and monitoring capacity to ensure that the exemption applies to genuine profit-seeking films.

3. Initial investors

As a general matter, two sets of investors may be involved in film production. Firstly, ‘pre-production investors’ join before principal photography begins; while secondly, ‘mid-production investors’ often join a production after film photography. For both sets of investors, the exemption will automatically apply. Mid-production investors will, however, not be eligible for the exemption where funds are provided for purposes other than to buffer against funding shortfalls that could eventuate during production (i.e. to compensate pre-production investors).

The exemption is limited to these initial and new investors because these parties are the ones taking the key risks associated with production of the film. In addition, the incentive does not apply to broadcasters as defined in section 1 of the Broadcasters Act, 1999 (Act No. 4 of 1999), and connected persons thereto. Investments in these scenarios contain a guaranteed level of profit because the films are produced merely for pre-determined sales or use by the broadcaster.

Example:

Facts: A and B (who are pre-production investors) own the production rights to produce a local film, which is completed in 2016. Principal photography is stopped in 2014 due to a shortfall in funding. C and D join as mid-production investors (after principal photography but before completion date) and receive proportionate exploitation rights for providing funding to buffer against the shortfall. After completion of production of the film, Investors A, B, C and D collect their proportionate exploitation rights (i.e. 25 percent) to revenue from subsequent film sales by X who is a registered distributor. Investor C sells all allocable exploitation rights to Investor Y for R180 000. The film generates income of R1.4 million after all disbursements are paid.

Result: Investors A, B, C and D obtain a full exemption in respect of their proportionate income of R350 000 since their income is earned pursuant to their exploitation rights held as of the date of completion. C also obtains a full exemption in respect of R180 000 of the exploitation rights sold to Investor Y. Y’s income of R350 000 is fully taxable after production since Y acquired the exploitation right from C after completion date.

4. Exploitation rights

The rights at issue (giving rise to exemption) must relate to exploitation (sales and licensing) rights associated with underlying film. More specifically, the profits must be wholly dependent on the production of a viable film. Therefore, the exemption does not apply to the extent any payments are subject to any guaranteed minimums. These rules effectively seek to exclude income from set salaries and loan repayments. However, it should be noted that parties taking salary compensation in the form of exploitation rights need not sacrifice the exemption. The exemption fully applies to the extent that these rights are fully dependent on film profits (i.e. film participants can take contingent film rights in lieu of salary).

Example:

Facts: A is a film producer that owns the production rights to produce a local film which is completed in 2014. Upon completion of the film, A has exploitation rights that entitles A to receive 10% of the proceeds from film sales with a minimum of R100 000. The film generates a total of R3 million of income after all disbursements are paid.

Result: A’s allocable income pursuant to his exploitation rights from film sales is R300 000. A will obtain a full exemption on the income of R200 000 but not on the income of R100 000 because this latter amount is guaranteed (i.e. probably linked to A’s salary).

5. Losses

As a general matter, expenditures and losses cannot be deducted if the associated income is exempt (i.e. lacks production of income under the general deduction formula). Limited protection will nonetheless be granted to taxpayers to protect their downside risk. Taxpayers may therefore claim a deduction for expenditures incurred if those expenditures exceed the total receipts and accruals in respect of the exploitation rights. To this end, taxpayers may claim this net loss during any year of assessment commencing only on or after two years following the date of completion of the film. All income pursuant to a taxpayer’s allocable exploitation rights will be taxable from the beginning of the year following the claimed deduction (i.e. the exemption permanently falls away from that point onwards). Despite the above, Taxpayers will not be allowed to claim a deduction for losses if the investor funds are obtained on loan, credit or similar financing. This prohibition ensures that only funds at risk qualify for the proposed relief.


Example 1

Facts: A is a film producer that owns the production rights to produce a local film which is completed in 2014. A’s expenditure incurred in respect of the exploitation rights held is R4 million. A has exploitation rights that entitles A to receive 40% of the film proceeds. The film generates income after all disbursements are paid of which R2.4 million is allocated to A. A has a loss of R1.6 million that A claims as a deduction in 2016.

Result: A will obtain a full exemption in respect of its proportionate income of R2.4 million since A earns this income pursuant to A’s allocable exploitation rights held as of the date of completion. A may potentially deduct the loss R1.6 million. However, any income from the qualifying film that A earns pursuant to A’s allocable exploitation rights from 2017 onwards will be taxable.

Example 2

Facts: B is a film producer that owns the production rights to produce a local film which is completed in 2012. B’s expenditure incurred in respect of the exploitation rights held is R1.5 million. B has exploitation rights that entitle B to receive 10% of the proceeds from subsequent film sales. B also receives funding from the DTI for R100 000. The film generates income of which R300 000 is allocated to B. B has a loss of R1.1 million that B claims as a deduction for in 2017.

Result: B will obtain a full exemption in respect of its proportionate income of R300 000 since B earns this income pursuant to Bs allocable exploitation rights held as of the date of completion. B’s income of R100 000 will also be fully exempt because the funds stem from the DTI grant (see below). A may potentially deduct the net loss of R700000- (R1.1 million minus R300 000 minus R100 000). Any income from the qualifying film that A earns pursuant to A’s allocable exploitation rights will be taxable from 2018 onwards.

6. Ten-year period

As stated above, exempt film income lasts only for a ten-year period (and to the extent that the taxpayer does not claim a net loss - see above). The ten-year period begins on the date that the film production is completed (i.e. roughly the date that the film is ready for distribution). As stated previously, the exemption covers all receipts and accruals (i.e. in respect of all sale and licensing rights) associated with the film (e.g. cinema, DVD and television).

Procedural requirements

Like all newer incentives, a policy stance is taken that on-going reporting is required to measure the economic success of the incentive and to guard against tax avoidance. The NFVF will act as the key point for collecting information. Reporting must be done via the SPCV or by a CAM approved via regulation. Taxpayers will be given a choice so as to reduce their administration costs depending on their circumstances. The reporting requirement will last for the same period as the potential exemption (i.e. up to 10 years).

DTI incentive

The DTI incentive will remain exempt in the hands of the SPCV. The DTI exemption will continue to apply to amounts paid over by the SPCV to the initial investors and will remain limited to the extent of the amount loaned or invested by the applicable investors in the film.

Change to the legislation to give effect to the above

Section 10(1)(zG) has been deleted

Prior to its deletion it exempted from normal tax any amount received by or accrued to a person by way of a subsidy payable by the State under any scheme designed to promote the production of films (as defined in section 24F): Provided that where that person has agreed to pay the whole or any portion of that amount to any film owner (as defined in section 24F) that is the owner of the film in respect of which the subsidy is payable, the exemption under this paragraph must also apply to the whole or that portion of the amount received by or accrued to that film owner.

Effective date

The deletion of section 10(1)(zG) comes into operation on 1 January 2012 and applies to all receipts and accruals in respect of films of which principal photography commences on or after that date.

Section 12O titled ‘Exemption in respect of films’ has been inserted

12O(1) For the purposes of this section-

‘completion date’ means the date on which a qualifying film is for the first time in a form in which it can be regarded as ready for copies of it to be made and distributed, for presentation to the general public;

‘exploitation rights’ means the right to any receipts and accruals in respect of—

(a) the use of;

(b) the right of use of; or

(c) the granting of permission to use,


any film to the extent that those receipts and accruals are wholly dependent on profits and losses in respect of the film;

‘film’ means—

(a) a feature film;

(b) a documentary or documentary series; or

(c) an animation,

conforming to the requirements stipulated by the Department of Trade and Industry in the Programme Guidelines for the South African Film and Television Production and Co-production Incentive;

‘National Film and Video Foundation’ means the National Film and Video Foundation established by the National Film and Video Foundation Act, 1997 (Act No. 73 of 1997); and

‘special purpose corporate vehicle’ means a company responsible for the production of a film as required by the Department of Trade and Industry in terms of the Programme Guidelines for the South African Film and Television Production and Co-production Incentive.

(2) There must be exempt from normal tax the receipts and accruals in respect of income derived from the exploitation rights of a film—

(a) if the National Film and Video Foundation has approved the film in terms of section 3(c) read with section 4(1) of the National Film and Video Foundation Act, 1997 (Act No. 73 of 1997), as a local production or co-production whereby a film is co-produced in terms of an international co-production agreement between the government of the Republic and the government of another country, which agreement must be subject to the Constitution;

(b) if income is derived from the exploitation rights of the film—

(i) by a person who acquired the exploitation rights in respect of that film prior to the date that the principal photography of that film commenced; or

(ii) by a person who acquired the exploitation rights in respect of that film after the date that principal photography of that film commenced but before the completion date of that film if consideration for those exploitation rights was not directly or indirectly paid or applied for the benefit of a person contemplated in subparagraph (i); and

(c) to the extent that the income is received or accrues within a period of 10 years after the completion date of that film.

(3) No exemption shall be allowed under this section to a person that is a broadcaster as defined in section 1 of the Broadcasting Act, 1999 (Act No. 4 of 1999), or any person that is a connected person in relation to that broadcaster.

(4)(a) A special purpose corporate vehicle or collection account manager—

(i) that manages exploitation rights under a collection account management agreement; and

(ii) that is approved by the Minister for the purpose of this section by notice in the Gazette, must provide a report to the National Film and Video Foundation containing such information, within such time and in such manner as is prescribed by the Minister when income arising from exploitation rights of a film is distributed to a person within a period of 10 years commencing from the completion date of the film.

(b) The National Film and Video Foundation must provide a report annually to the Minister in respect of all films approved in terms of subsection (2)(a) containing such information, within such time and in such manner as is prescribed by the Minister for a period of 10 years commencing from the completion date of a film if—

(i) any income is received or accrues in respect of the film; and

(ii) the income is eligible for the exemption under subsection (2).

(5)(a) A taxpayer may deduct from the income of the taxpayer an amount in respect of any expenditure incurred to acquire exploitation rights in respect of a film in accordance with paragraph (b).

(b) The amount of the deduction contemplated in paragraph (a) is equal to the amount of any expenditure incurred as contemplated in that paragraph less any amount received or accrued during any year of assessment in respect of that film.

(c) No deduction may be made under this subsection to the extent that the expenditure was funded from a loan, credit or similar financing.

(d) The deduction contemplated in paragraph (a) may only be made in any year of assessment commencing at least two years after the completion date of the film to the extent that the amount of expenditure incurred exceeds the total amount received by or accrued to that taxpayer in respect of the exploitation rights.

(e) Subsection (2) and paragraph (a) of this subsection cease to apply to any income derived from a film in any year of assessment subsequent to the date of a deduction made under paragraph (a) in respect of that film.

(6) (a) In addition to the exemption under subsection (2), any amount received by or accrued to a special purpose corporate vehicle by way of a grant payable by the State under the South African Film and Television Production and Co-production Incentive administered by the Department of Trade and Industry shall be exempt from normal tax subject to section 8(4).


(b) Where a special purpose corporate vehicle that received a grant contemplated in paragraph (a), or to whom such grant has accrued, pays the whole or any portion of the amount of the grant to another person pursuant to any exploitation rights in respect of that film, the exemption under this paragraph must also apply to the amount received by or accrued to that other person to the extent that the amount does not exceed any amount that the other person contributed to the production of the film.

Effective date

Section 12O comes into operation on 1 January 2012 and applies in respect of all receipts and accruals in respect of films of which principal photography commences on or after that date but before 1 January 2022.

Section 24F which deals with Film Allowances has been amended

Section 24F of the Income Tax Act, 1962, is hereby amended by the addition in subsection (2) the following paragraph:

(d) No deduction shall be allowed under this section in respect of any expenditure incurred in respect of—

(i) any film of which principal photography commences on or after 1 January 2012; or

(ii) any film after 31 December 2012.

Effective date

The amendment to section 24F comes into operation on 1 January 2012.

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CAPITAL ALLOWANCES ON FOUNDATIONS

Amendment to sections 12C of the Income Tax Act.

The addition of a further proviso to section 12C(1) makes provision for foundations and supporting structures on which a plant is mounted (or to which it is fixed) to be deemed part of that plant and to be eligible for the same deductions as the plant. This situation is set out in Practice Note 16, dated 12 March 1993. SARS has embarked on a process of repealing all practice notes. This position has instead been codified in the Income Tax Act. A similar provision already exists in paragraph (iiA) of the proviso to section 11(e).

The further proviso to section 12C(1) reads as follows:

Provided further that where any machinery, plant, implement, utensil, article or improvement qualifying for an allowance under this section is mounted on or affixed to any concrete or other foundation or supporting structure and the Commissioner is satisfied that—

(a) the foundation or supporting structure is designed for such machinery, plant, implement, utensil, article or improvement and constructed in such manner that it is or should be regarded as being integrated with the machinery, plant, implement, utensil, article or improvement; and

(b) the useful life of the foundation or supporting structure is or will be limited to the useful life of the machinery, plant, implement, utensil, article or improvement mounted thereon or affixed thereto, the foundation or supporting structure shall be deemed to be a part of the machinery, implement, utensil, article or improvement mounted thereon or affixed thereto.

Effective date

The further proviso to section 12C(1) is effective from 10 January 2012.

____________________________________

RESEARCH AND DEVELOPMENT

Amendment to sections 11D, 12C and 23B of the Income Tax Act.

Background

A. Overview

The income tax system contains an incentive for R&D in order to promote increased private sector R&D investment in South Africa, to enhance its role as an R&D innovation hub and to promote R&D innovation led industrial development and job opportunities. The incentive has two main aspects:

a 150% deduction for R&D non-capital expenditure, and

an accelerated 50:30:20% write off over three years for R&D buildings, plant, machinery, utensils, articles and improvements.


B. R&D non-capital expenditure (150%)

In order for R&D non-capital expenditure to be entitled to a 150%, this expenditure must be directly attributable to R&D undertaken in South Africa. R&D can either be:

the discovery of novel, practical and non-obvious information, or

the devising, developing or creation of inventions, designs, computer programs or knowledge essential to their use.

R&D must additionally be of a scientific or technological nature, and must either be:

used for production of the taxpayer’s income, or

discovered, devised, developed or created for purposes of deriving the taxpayer’s income.

The legislation contains certain ‘exclusions’ such as the following:

exploration and prospecting relating to minerals or oil and gas,

management or internal business processes,

trademarks, social sciences or humanities, or market research or sales or marketing promotion.

Banking, financial services and insurance businesses are excluded per se from the relief.

C. Accelerated (50:30:20) write offs

Buildings, plant, machinery, implements, utensils and articles obtain a 50:30:20 write off over three years if dedicated to R&D. The definition of R&D for this purpose (as well as the ‘exclusions’ noted above) is the same as the definition for non-capital expenditure. The rules for this write-off are consistent with other accelerated write-offs (including potential recoupment upon disposal that effectively recaptures prior write offs).

D. R&D third-party funding arrangements

Parties undertaking R&D activities often do so on behalf of others (those funding the activities). To the extent these circumstances exist, the parties funding the R&D obtain the 150% deduction as opposed to the parties undertaking the R&D activities. However, the 150% deduction shifts to the party undertaking the activity if the funder cannot deduct the amount funded (e.g. because the funder is tax-exempt or outside the tax system).

Reason for change

As is common place internationally, the lack of a concrete and precise definition of R&D has given rise to the following problems:

Firstly, concerns exist that while the definition has been broadened to cover as many industrial R&D activities as possible, specific areas remain unclear. This uncertainty gives rise to a need to clarify activities and expenditure related to R&D that are eligible to qualify.

Secondly, legitimate value-added R&D is often subject to unnecessary uncertainty and audit scrutiny due to lack of R&D expertise among auditors who naturally specialise in law and accounting.

On the technical side, the incentive continues to give rise to certain anomalies. One recurring issue is how to ensure that the incentive is properly applied when the R&D is funded by outside parties. In this circumstance, funder payment for R&D services undertaken by another is unnecessarily giving rise to an audit claim that the funding mechanism amounts to a recoupment, thereby neutralising the incentive when R&D services are performed on behalf of another.

The changes

A. Overview

The deduction relating to R&D expenditures have been simplified and streamlined for ease of use. Under the revised regime, all R&D expenditures will be separated into one of three categories.

Firstly, all expenditures incurred in respect of eligible R&D activities will qualify for the automatic deduction even if these expenditures are capital in nature.

Secondly, the additional 50% uplift will only apply to R&D expenditures that have been approved by the Department of Science and Technology (DST). The purpose of this DST intervention is to ensure that additional allowances are initiated like Government grants with taxpayer’s being provided well upfront certainty that the originating cause (in the nature of R&D) of the additional allowance will be respected by SARS upon audit.

Lastly, all R&D expenditures that do not qualify for the automatic deduction will remain eligible for deductions if the R&D satisfies the section 11(a) basic deduction formula.


B. R&D definitions

The definition of R&D has been wholly revised to better reflect Government’s intention to incentivise activities that constitute technical and scientific R&D in a commercial sense (as opposed to routine upgrades or applications). Additionally, revisions to the definition have been driven by the objective to allow for novel adjustments to pre-existing products or processes. As existed under the previous regime, the proposed relief will apply if the taxpayer carries out R&D activities in the production of income. (as opposed to R&D activities conducted by taxpayers merely as a hobby). More specifically, R&D must consist of:

Systematic investigative or systematic experimental activities involving ‘appreciable elements of novelty’, or

‘high levels of technical risk’ that are carried on: to discover non-obvious scientific or technological knowledge; or to create, develop or significantly improve inventions, designs, computer programs or knowledge (as statutorily defined) to enhance a new or improved function or an improvement of performance, an improvement of reliability or an improvement of quality.

C. R & D expenditure

1. Automatic deduction

As under current law, the definition of R&D contains explicit exclusions to eliminate deadweight loss and dubious arguments to the contrary. Expenditures incurred by a taxpayer in respect of R&D activities (undertaken by or for the benefit of the taxpayer) will be fully deductible for the basic 100% deduction without pre-approval as long as these expenditures:

are incurred solely and directly in respect of separately identifiable R&D activities (thereby eliminating general physical and administrative overheads);

are undertaken solely within South Africa;

are incurred in the production of income and in carrying on any trade R&D activities will remain deductible even if the activities culminate in an intangible asset (i.e. the expenditure incurred is of a capital nature because the expenditures culminate in a capitalised asset).

Example:

Facts: Company X regularly engages in R&D activities associated with manufacturing. Company Y hires Company X to perform manufacturing R&D to create certain products on Company Y’s behalf. Company X incurs R80 000 expenses and charges Company Y R115 000 (i.e. cost plus a profit mark-up).

Result: Company X can potentially deduct R80 000 and Company Y can potentially deduct up to R115 000. The result is the same regardless of whether the R&D potentially results in an identifiable intangible asset.

2. 50% uplift

Taxpayers will receive an additional uplift in respect of expenditures incurred for R&D activities. More specifically, to qualify under the proposed relief, expenditures must satisfy the following criteria:

the expenditures must be approved by the adjudication committee led by the DST.

the expenditures must be incurred in respect of R&D activities undertaken from the date that a successful application for approval of the R&D expenditures is submitted to the DST.

Additionally, where expenditures have been incurred by taxpayers who undertake R&D activities (funded by others), the party responsible for determining or altering the research methodology will be the only party eligible for the 50% uplift.

Example:

Facts: Company Y often engages in R&D activities associated with medical development. Company Y hires Subcontracting Company to perform R&D for clinical trials by creating certain products on Company Y’s behalf. Although Company Y delegates some of the R&D activities, Company Y is solely responsible for determining the research methodology applied. Subcontracting Company incurs R100 000 expenses and charges Company Y R130 000 (i.e. cost plus a profit mark-up).

Result: Company Y may potentially deduct R130 000, and Subcontracting Company may potentially deduct up to R100 000. However, only Company Y qualifies for the 50% uplift since Company Y is responsible for determining the research methodology.

3. Basic deduction (under section 11(a))

As a general matter, all expenditures listed below do not qualify for the basic 100% deduction or the additional 50% uplift. However, these expenditures will remain eligible for a general deduction if it satisfies all its requirements. More specifically, these expenditures include the following:

Market research, market testing, or sales promotions;


R&D expenditures associated with human resources management, payroll, legal, finance and audit;

Routine testing, analysis, the collection of information and quality control in the normal course of business (unrelated to a significant R&D project);

Research and development to enhance internal business processes (e.g. typical computer software) except where that research and development is conducted for external exploitation for sale or license to customers;

Social sciences, including the arts and humanities;

Oil and gas exploration or mineral prospecting, except R&D carried out to develop technology used for oil and gas or mineral exploration;

Expenditures to create or develop financial instruments or financial products (e.g. development of financial derivatives);

Expenditures to create or enhance trademarks or goodwill;

Expenditures incurred or allowances granted for the acquisition of pre-existing inventions, designs or computer programs (i.e. the acquisition of assets eligible for allowances under sections 11(gB) and (gC)).

Example:

Facts: Company X is engaged in a South African bottling distribution business. Company X frequently engages in R&D activities that are solely undertaken in order to improve the efficiency of the bottling plant. Company X incurs R300 000 expenses for R&D in respect of the creation of bottling processes.

Result: The R300 000 expenditure falls outside the revised regime. This expenditure merely constitutes enhances to Company X’s internal business processes. However, Company X can potentially deduct R300 000 under the general deduction formula.

Example:

Facts: Company Y frequently engages in R&D activities for the development of a software system for use by small businesses. Company Y incurs R200 000 expenses for R&D in respect of the software development. Company Y then licenses the software for recurring use by small business owners.

Result: Company Y will qualify for the basic R&D regime and possibly for 50% uplift on the R200 000 expenditure incurred for R&D. Despite the R&Ds relationship to internal business process, the software development is dedicated to external exploitation (i.e. licence to customers).

D. R&D funding

As discussed above, current law provides special rules when one party undertakes R&D activities on behalf of another (i.e. the funder). In most cases, the funding party obtains the uplift as opposed to the party undertaking the activity. Under the new relief, only the party who is responsible for determining the research methodology will be eligible to qualify for the 50% uplift.

Only this party has full knowledge and information associated with the R&D process to properly interact with government as to the facts relating to the R&D activity. Under the revised regime, special rules exist when R&D is indirectly supported by Government.

More specifically, the 50% additional allowance applies to private funders when funding R&D that is undertaken by exempt Government-owned entities (e.g. universities and the Council for Scientific and Industrial Research). This form of funding is important to enhance pre-existing centres of R&D activity. On the other hand, if taxpayers receive an exempt Government grant to undertake R&D, the 50% additional allowance does not apply to the extent of the grant (to prevent double dipping). In wholly private settings, a choice for use of the 50% additional allowance exists in the case of domestic groups of companies. The domestic company that determines or applies the methodology for the R&D activity can seek approval for the uplift or the funding group member can seek approval. If the funding party obtains approval for the 50% additional allowance, the allowance is available only to the extent of the expenditure incurred by the other company directly and solely for the R&D activities undertaken (thereby eliminating the 50% uplift for the profit charged). This rule for company groups is roughly the same as the previous R&D regime. Lastly, the law has been clarified in respect of recoupments. Parties undertaking R&D on behalf of another should not be viewed as having recouped the expenditure merely because these parties are undertaking R&D on behalf of another (by charging a corresponding service fee). Implications in current law suggesting otherwise will be removed; only the general rule of recoupment will apply.


E. Approval committee processes

The approvals committee for R&D projects will operate in much the same way as the adjudication committee relating to the Industrial Policy Project incentive. The committee must not only review the initial approval for recommendation to the appropriate Minister (DST in this case) but also engage in monitoring and reporting on an annual basis. The approvals committee will consist of three members appointed by the Minister of Science and Technology and four members appointed by the Minister of Finance. The respective committee appointees must be ‘persons full-time employed by the Department of Science and Technology’ and ‘persons full-time employed by the National Treasury or the South African Revenue Services’.

F. Applications procedure

As an initial matter, R&D activities will require DST approval in order for taxpayers to qualify for the 50% uplift. In this vein, new and pre-existing R&D projects will qualify for the 50% uplift from the date that a successful application (for approval of the expenditures) is submitted by the taxpayer to the DST. To this end, approval need

not precede project inception.

Example:

Facts: Company regularly engages in R&D activities associated with agricultural development. Company starts an R&D project in 2012 and incurs R120 000 as expenditures for R&D. Company incurs additional R&D expenditure of R40 000 for the project in 2013. Company submits its application for approval to the adjudication committee in 2013.

Result: The R40 000 expenditure eligible for the R&D 50% uplift depends on when the application is submitted in 2013. None of the R120 000 is eligible for the uplift.

The approvals committee will evaluate all applications and make a determination to approve any application of R&D activities that is innovative in nature and which requires specialised skills. Additional requirements may be added by regulation.

Although no DST approval is required in order for taxpayers to qualify for the basic R&D deduction, it is envisioned that the DST will play an increased role for interpretative purposes.

More specifically, SARS will be empowered to share information with the DST. This collaboration will enable SARS to gain access to DST expertise when interpreting the definition of R&D.

G. Accelerated write off for R&D assets

New and unused R&D machinery or plant (or improvements thereto) owned by the taxpayer will be eligible to obtain an accelerated write off over four years. The net effect is a four-year accelerated write-off at a 40:20:20:20 rate. On the other hand, R&D buildings owned by the taxpayer will be eligible for a 5% write-off over 20 years. This write-off again applies without resort to pre-approval.


Deductions for research and development

Section 11D deals with deductions in respect of science and technology research and development. It has been amended by the substitution of subsections (1) to (10) which now read as follows:

(1) For the purposes of this section ‘research and development’ means-

(a) systematic investigative or systematic experimental activities of which the result is uncertain for the purpose of-

(i) discovering non-obvious scientific or technological knowledge; or

(ii) creating-

(aa) an invention as defined in section 2 of the Patents Act, 1978 (Act No. 57 of 1978);

(bb) a design as defined in section 1 of the Designs Act, 1993 (Act No. 195 of 1993), that qualifies for registration under section 14 of that Act;

(cc) a computer program as defined in section 1 of the Copyright Act, 1978 (Act No. 98 of 1978); or

(dd) knowledge essential to the use of such invention, design or computer program; or

(b) developing or significantly improving any invention, design, computer program or knowledge contemplated in paragraph (a) if that development or improvement relates to any-

(i) new or improved function;

(ii) improvement of performance;

(iii) improvement of reliability; or

(iv) improvement of quality,

of that invention, design, computer program or knowledge.


(2) For the purposes of determining the taxable income of a taxpayer in respect of any year of assessment there shall be allowed as a deduction from the income of that taxpayer an amount equal to so much of any expenditure actually incurred by that taxpayer directly and solely in respect of research and development undertaken in the Republic if that expenditure is incurred-

(a) in the production of income; and

(b) in the carrying on of any trade.

(3) In addition to the deduction allowable in terms of subsection (2), a taxpayer that is a company may deduct an amount equal to 50% of the expenditure contemplated in subsection (2) if-

(a) that research and development is approved by the Minister of Science and Technology in terms of subsection (9);

(b) that expenditure is incurred in respect of research and development carried on by that taxpayer; and

(c) that expenditure is incurred on or after the date of receipt of the application by the Department of Science and Technology for approval of that research and development in terms of subsection (9).

(4) In addition to the deduction allowable in terms of subsection (2), where any amount of expenditure is incurred by a taxpayer to fund expenditure of another person carrying on research and development on behalf of that taxpayer, the taxpayer may deduct an amount equal to 50% of the expenditure contemplated in subsection (2)-

(a) if that research and development is approved by the Minister of Science and Technology in terms of subsection (9);

(b) if that expenditure is incurred in respect of research and development carried on by that taxpayer;

(c) to the extent that the other person carrying on the research and development is-

(i) (aa) an institution, board or body that is exempt from normal tax under section 10(1)(cA); or

(bb) the Council for Scientific and Industrial Research; or

(ii) a company forming part of the same group of companies, as defined in section 41, if the company that carries on the research and development does not claim a deduction under subsection (3); and

(d) if that expenditure is incurred on or after the date of receipt of the application by the Department of Science and Technology for approval of that research and development in terms of subsection (9).

(5) Where a company funds expenditure incurred by another company as contemplated in subsection (4)(c)(ii), any deduction under that subsection by the company that funds the expenditure must be limited to an amount of 50% of the actual expenditure incurred directly and solely in respect of that research and development carried on by the other company that is being funded.

(6) For the purposes of subsections (3) and (4), a person carries on research and development if that person may determine or alter the methodology of the research.

(7) Where any government grant is received by or accrues to a taxpayer to fund expenditure in respect of any research and development, an amount equal to the amount that is funded must not be taken into account for purposes of the deduction under subsection (3) or (4).

(8) No deduction shall be allowed under this section for expenditure incurred in respect of-

(a) market research, market testing or sales promotion;

(b) administration, financing, compliance or similar expenditure;

(c) routine testing, analysis, collection of information or quality control in the normal course of business;

(d) development of internal business processes unless those internal business processes are mainly intended for sale or for granting the use or right of use or the grant of permission to use thereof;

(e) social science research, including the arts and humanities;

(f) oil and gas or mineral exploration or prospecting, except research and development carried on to develop technology used for that exploration or prospecting;

(g) the creation or development of financial instruments or financial products;

(h) the creation or enhancement of trademarks or goodwill; and

(i) any expenditure contemplated in section 11(gB) or (gC).

(9) The Minister of Science and Technology must approve any research and development being carried on or funded for the purposes of subsections (3) and (4) having regard to-

(a) the innovative nature of the research and development;

(b) the extent to which carrying on that research and development requires specialised skills; and

(c) such other criteria as the Minister of Science and Technology in consultation with the Minister of Finance may prescribe by regulation.

(10) If research and development is approved under subsection (9) and-


(a) any material fact changes which would have had the effect that approval under subsection (9) would not have been granted had that fact been known to the Minister of Science and Technology at the time of granting approval; or

(b) the taxpayer carrying on that research and development fails to submit a report to the committee as required by subsection (13), the Minister of Science and Technology may, after taking into account the recommendations of the committee, withdraw the approval granted in respect of that research and development with effect from a date specified by that Minister.

Effective date

The amended section 11D comes into operation on 1 April 2012 unless a later date is determined by the Minister by notice in the Gazette and applies in respect of expenditure incurred in respect of research and development on or after 1 April 2012 or such later date determined by the Minister by notice in the Gazette but before 1 April 2022.

A further amendment was made to section 11D by way of the Taxation Laws Second Amendment Act No 25 of 2011

Section 11D has been amended by the substitution of subsections (11) to (18) which now read as follows:

(11)(a) A committee must be appointed for the purposes of approving research and development under subsection (9) consisting of—

(i) three persons employed by the Department of Science and Technology, appointed by the Minister of Science and Technology;

(ii) one person employed by the National Treasury, appointed by the Minister of Finance; and

(iii) three persons from the South African Revenue Service, appointed by the Minister of Finance.

(b) The Minister of Science and Technology or the Minister of Finance may appoint alternative persons to the committee if a person appointed in terms of paragraph (a) is not available to perform any function as a member of the committee.

(12)(a) The committee appointed in terms of subsection (11) must perform its functions impartially and without fear, favour or prejudice.

(b) The committee may—

(i) appoint its own chairperson and determine the procedures for its meetings;

(ii) evaluate any application and make recommendations to the Minister of Science and Technology for purposes of the approval of research and development in terms of subsection (9);

(iii) investigate or cause to be investigated research and development approved under subsection (9);

(iv) monitor all research and development approved under subsection (9)—

(aa) to determine whether the objectives of this section are being achieved; and

(bb) to advise the Minister of Finance and the Minister of Science and

Technology on any future proposed amendment or adjustment of this section;

(v) for a specific purpose and on the conditions and for the period as it may determine, obtain the assistance of any person to advise the committee relating to any function assigned to that committee in terms of this

section; and

(vi) require any taxpayer applying for approval of research and development in terms of subsection (9), to furnish any information or documents necessary for the Minister of Science and Technology and the committee to perform their functions in terms of this section.

(13) A taxpayer carrying on research and development approved under subsection (9) must report to the committee annually with respect to the progress of that research and development within 12 months after the close of each year of assessment, starting with the year following the year in which approval is granted under subsection (9) in the form and in the manner that the Minister of Science and Technology may prescribe.

(14) Notwithstanding section 4, the Commissioner may disclose to the Minister of Science and Technology information in relation to research and development as may be required by that Minister for the purposes of submitting a report to Parliament in terms of subsection (17).

(15) The members of the committee appointed in terms of subsection (11) and any person whose assistance has been obtained by that committee may not—

(a) act in any way that is inconsistent with the provisions of subsection (12)(a) or expose themselves to any situation involving the risk of a conflict between their responsibilities and private interests; or

(b) use their position or any information entrusted to them to enrich themselves or improperly benefit any other person.

(16) The Minister of Science and Technology must—

(a) provide written reasons for any decision to grant or deny any application for approval of any research and development under subsection (9), or for any withdrawal of approval contemplated in subsection (10);


(b) inform the Commissioner of the approval of any research and development under subsection (9), setting out such particulars as are required by the Commissioner to determine the amount of the additional deduction in terms of subsection (3) or (4); and

(c) inform the Commissioner of any withdrawal of approval in terms of subsection (10) and of the date on which that withdrawal takes effect.

(17) The Minister of Science and Technology must annually submit a report to Parliament advising Parliament of the direct benefits of the research and development in terms of economic growth, employment and other broader

government objectives and the aggregate expenditure in respect of such activities without disclosing the identity of any person.

(18) Every employee of the Department of Science and Technology, every member of the committee appointed in terms of subsection (11) and any person whose assistance has been obtained by that committee—

(a) must preserve and aid in preserving secrecy with regard to all matters that may come to their knowledge in the performance of their functions in terms of this section; and

(b) and may not communicate any such matter to any person whatsoever other than to the taxpayer concerned or its legal representative, nor allow any such person to have access to any records in the possession or custody of the Department of Science and Technology or committee, except in terms of the law or an order of court.

Effective date

The amended section 11D(11) to (18) comes into operation on 1 April 2012 unless a later date is determined by the Minister by notice in the Gazette and applies in respect of expenditure incurred in respect of research and development on or after 1 April 2012 or such later date determined by the Minister by notice in the Gazette but before 1 April 2022.

Section 23B prohibition has been relaxed

Section 23B(4) has been added which states that the provisions of subsection (3) shall not apply to the deduction of expenditure incurred on research and development contemplated in section 11D(8).

This opens the door to a section 11(a) deduction for expenditure contemplated in section 11D(8).

Effective date

Section 23B(4) comes into operation on 1 April 2012 unless a later date is determined by the Minister by notice in the Gazette and applies in respect of expenditure incurred in respect of research and development on or after 1 April 2012 or such later date determined by the Minister by notice in the Gazette but before 1 April 2022.

Plant and machinery used for research and development

Section 12C(1)(gA) has been in inserted into the Income Tax Act. It recognises new or unused machinery or plant, that is owned by a taxpayer, or acquired by a taxpayer as purchaser in terms of an agreement contemplated in paragraph (a) of the definition of ‘instalment credit agreement’ in section 1 of the Value-Added Tax Act, and is first brought into use by that taxpayer for purposes of research and development as defined in section 11D as qualifying for the section 12C capital allowance.

Section 12C(1)(h) has been extended to make the 12C allowance available on certain improvements to machinery and plant used for R&D purposes. The amended paragraph (h) reads as follows:

(h) improvement (other than repairs) to any machinery, plant, implement, utensil or article referred to in paragraph (a), (b), (c), (d), (e) or (gA), which is during the year of assessment used as contemplated in that paragraph.

The proviso to section 12C(1) grants the accelerated allowance at the rate of 40:20:20:20. This accelerated allowance is now available on new and unused machinery or plant referred to in section 12C(gA) or an improvement to it referred to in section 12C(1)(h) if it is or was-

(i) acquired by the taxpayer under an agreement formally and finally signed by every party to the agreement on or after 1 January 2012; and

(ii) brought into use by the taxpayer on or after that date for the purpose of research and development as defined in section 11D.

Effective date

Section 12C(1)(gA), amended section 12C(1)(h) and extended first proviso to section 12C(1) come into operation on 1 April 2012 unless a later date is determined by the Minister by notice in the Gazette and apply in respect of expenditure incurred in respect of research and development on or after 1 April 2012 or such later date determined by the Minister by notice in the Gazette but before 1 April 2022.


Buildings used for R&D purposes

The building allowance has been moved from section 11D to section 13 of the Income Tax Act. Refer to notes dealing with Industrial Buildings for details of the changes to section 13.

It seems that the new section 13(1) allowance is not available when the building, which would otherwise qualify, is let by the taxpayer and the tenant or subtenant uses it for R&D purposes.

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INDUSTRIAL POLICY PROJECTS

Amendment to sections 12I(2) and (9) of the Income Tax Act.

Background

An additional tax allowance (on top of the normal allowances available) for industrial policy projects was introduced in 2008 to benefit all manufacturing projects. The purpose of the incentive is to promote international competitiveness with other countries that similarly utilise the tax system to attract large industrial projects. The incentive offers special tax benefits to greenfield investments (i.e. new industrial projects) and brownfield investments (i.e. expansions or upgrades of existing industrial projects) with enhanced emphasis on the former. In order to receive this allowance, approval from an adjudication committee is required, which makes its determination based on pre-determined criteria with the committee approvals restricted to R20 billion of deductions for all industrial projects in total.

The main focus of the incentive is to promote capital expenditure. Greenfield projects receive an additional 55% allowance, and brownfield projects receive a 35% additional allowance. The allowances, however, are subject to certain limitations. A ceiling on the allowance of R900 or R550 million per project is imposed for greenfield projects (depending on whether the project is preferred or merely qualifying). A ceiling on the allowance of R500

or R350 million per project is imposed for brownfield projects (depending on whether project is preferred or merely qualifying).

A secondary focus of the incentive is skills training. Training effectively receives a double deduction for a six-year period. The additional training deduction is subject to two ceilings –

a ceiling of R36 000 per employee and a R30 million, or

R20 million ceiling per project (depending on whether the project is preferred or merely qualifying).

Reasons for change

Government is seeking to renew its efforts to enhance the Industrial Development Zone (IDZ) regime initiated by the Department of Trade and Industry. The purpose of the IDZ regime is to encourage industrial development within certain geographical areas in order to effectively facilitate the policy of the Department of Trade and Industry. Yet, the additional allowance for industrial projects barely takes the IDZ into account (awarding only one point for an IDZ location when the adjudicating committee reviews applications via the regulatory criteria).

Early Government experience with the incentive also reveals some small shortcomings. These shortcomings exist in both the legislation and in the accompanying regulations.

The change

A. Promotion of IDZ’s

In view of the above, the industrial project allowance has been enhanced in respect of IDZs. Instead of a 55% additional allowance for greenfield projects, the additional allowance for greenfield projects has been increased to 100%. Instead of a 35% additional allowance for brownfield projects, the additional allowance for brownfield projects will be increased to 75%. The regulatory point scoring criteria will also be shifted to enhance approval (and preferred status) within IDZ areas.

B. Minor anomalies

Under the previous law, additional capital incentives for industrial projects were subject to an overall R20 billion ceiling as stated above. However, the training allowance lacked any comparable aggregate ceiling. Training allowances have accordingly become part of the same aggregate ceiling to ensure the costs of the incentive are better controlled by Government.

The incentive also fails to contain deadweight losses for the fiscus as intended. The incentive is for projects that would not otherwise occur. In that vein, it was always intended that possible approval be given only toward project assets that are acquired and contracted after the approval date (not for projects already under way). The wording suggested otherwise and has accordingly been corrected.



Additional investment allowance

Section 12I(2) has been amended and now reads as follows:

In addition to any other deductions allowable in terms of this Act, a company may, subject to subsection (3), deduct an amount (hereinafter referred to as an additional investment allowance) equal to-

(a) (i) 55% cent of the cost of any new and unused manufacturing asset used in an industrial policy project with preferred status; or

(ii) 100% of the cost of any new and unused manufacturing asset used in an industrial policy project with preferred status that is located within an industrial development zone; or

(b) (i) 35% of the cost of any new and unused manufacturing asset used in any [other] industrial policy project other than an industrial policy project with preferred status; or

(ii) 75% of the cost of any new and unused manufacturing asset used in any industrial policy project other than an industrial policy project with preferred status that is located within an industrial development zone,

in the year of assessment during which that asset is first brought into use by the company as owner thereof for the furtherance of the industrial policy project carried on by that company, if that asset was acquired and contracted for on or after the date of approval and was brought into use within four years from the date of approval.

It is important to note that both conditions ‘acquired and contracted’ must now be satisfied:

○ The asset must be acquired on or after the date of approval,

○ The asset must be contracted for on or after the date of approval.

Effective dates

The amendment to section 12I(2)(a) and (b) come into operation on 1 January 2012 and apply in respect of projects approved on or before that date.

The amendment to the paragraph following section 12I(2)(b)(ii) is deemed to come into operation on 5 January 2009.

The Minister of Trade and Industry may not approve

In section 12I(9) the term ‘potential additional investment allowances’ has been replaced by the term ‘potential additional investment and training allowances’. Section 12I(9) now reads as follows:

Notwithstanding subsection (8), the Minister of Trade and Industry may not approve any industrial project where the potential additional investment and training allowances in respect of that project and all other approved industrial projects (other than those projects where the approval thereof has been withdrawn under subsection (12)), will in the aggregate exceed R20 billion.

Effective dates

The amendment to the paragraph following section 12I(9) is deemed to come into operation on 5 January 2009.

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VENTURE CAPITAL COMPANIES

Amendment to sections 12J and 9C(2A) of the Income Tax Act.

Background

Government enacted the venture capital company (VCC) tax regime in 2008. The purpose of the VCC is to create a pooling mechanism for investors to channel funds into small businesses and junior mining operations. The VCC itself (based on the private equity model) is intended to act as an ‘angel investor’ for these small businesses and junior mining companies by providing equity and supportive management services. The VCC is expected to typically acquire a major stake in these entities until these entities reach a certain level of growth with the VCC selling these entities for profits upon the entity’s maturity. The VCC model requires this incubation period to last between 5 and 10 years. Most of the small businesses and junior mining operations involved are high risk, with a few large ‘winners’ generating profits that should exceed the lack of profit in respect of the remainder.

Taxpayers investing in a VCC generate an upfront deduction for the investment (whereas most equity investments are non-deductible) with a recoupment upon withdrawal. The VCC has three sets of requirements: (i) investor-level requirements for the deduction,

(ii) criteria for determining whether the investor-pooling entity qualifies as a VCC,

(iii) criteria for determining whether the VCC is investing in a qualifying small business company or a junior mining company. The VCC itself requires pre-approval from SARS to initiate operations.


Reasons for change

To date, the VCC regime has not been successful. Applications have been few and no VCC has been successfully initiated to date. It is contended that the investment benefits are too small. It is also contended that the VCC, small business and junior mining criteria are too restrictive. The restrictive criteria mean that the VCC cannot operate in accordance with the private equity model upon which the regime is founded. The lengthy restrictive criteria have also rendered the regime far too complex, making operation of the VCC unsustainable.

The change

A. Overview

Given the above concerns, a general relaxation of requirements has been introduced so that investor pooling of equity funds through VCC can be achieved as intended. The general relaxation will also be balanced with minimal anti-avoidance requirements to ensure that the regime does not give rise to tax deductions that provide little or no assistance to the target group intended.

B. Investor criteria

The general ceilings and prohibitions associated with investors seeking a deduction have been completely removed. The current ‘natural person’ limitation has been removed, meaning that all taxpayers (e.g. legal entities) can now freely obtain deductions for investing in a VCC. The R750 000 investment and other ceilings have been similarly removed.

In lieu of the above criteria, three anti-avoidance criteria are added.

Firstly, the deduction will not be available to investors who become connected persons to the VCC as a result of, or upon completion, of the investment. As a practical matter, the connected person test is generally triggered at a more than 50% level or 20% level depending upon the facts. These rules ensure that taxpayers cannot obtain a deduction merely by cycling funds among closely connected parties (as opposed to obtaining a new independent investment).

Secondly, the deduction will only be allowed if the investments in the VCC are pure equity investments (investments with debt-like features will be completely disallowed). In essence, the channelled funds must bear the economic risk and loss associated with the profit model of the VCC.

Thirdly, the investment must place the investor genuinely ‘at-risk’. No issue arises if the investor funds the investment from the investor’s own resources. However, if the investment stems from a loan or a credit facility, the investor must bear the risk of the loan or the credit facility (i.e. the loan or credit facility must be a full recourse loan that must be repaid even if the VCC does not reach the investment objectives intended). Moreover, a loan or credit facility will not be deemed to satisfy the ‘at-risk’ criteria if the loan or credit facility is directly or indirectly provided by the VCC. Loans or credit facilities must also be repayable within 5-years to avoid ‘time-value of money’ schemes (schemes where the repayment is delayed for so long that the repayment is meaningless after inflation is taken into account).

C. Venture Capital Company Criteria

The VCC criteria have been significantly relaxed. The goal again is to simplify the regime by eliminating overly burdensome requirements. More specifically, the following amendments are proposed:

Firstly, VCCs will not be disqualified merely because the VCC lists on the JSE. The goal is to pool private investments; no reason exists to prohibit this form of pooling.

Secondly, the VCC can now form part of a group (either as a controlled group company or a controlling group company). However, note that deductions for investors are limited to persons who are not connected persons (see above) and that some ownership limitations still exist in respect of qualifying (small business or junior mining) investments (see below).

Thirdly, the prohibition against having more than 20% passive income in a single year has been dropped so that temporary cash build-ups do not undermine the regime. However, the VCC must still spend at least 80% of its expenditure for qualifying (small business and junior mining) companies from date of the VCC’s approval from SARS. The 80% requirement should be sufficient by itself to ensure (by applying objective principles) that the VCC is directed to its objective.

Fourthly, the minimum investment requirements have been dropped as contradictory to the regime. The VCC will no longer be required to invest a minimum of R30 million to acquire a (small business) qualifying company or a minimum of R150 million to acquire a (junior mining) qualifying company.

Fifthly, the diversification requirements are now slightly eased. Under the old law, the VCC could invest no more than 15% of its total expenditure in any one qualifying (small business or junior mining) company. The percentage has been increased to 20%. Hence, a VCC can satisfy the minimum criteria by investing in a minimum of five qualifying companies.

D. Qualifying (investee) companies

The rules associated with qualifying (investee) companies have been relaxed. In the main, a VCC must invest at least 80% of its expenditure in qualifying (investee companies). Previously, qualifying (small business) companies could not have a book value exceeding R10 million and qualifying (junior mining) companies could not have a book value exceeding R100 million. These maximum thresholds are unrealistically low and have accordingly been increased.


The maximum book value threshold for qualifying (small business) companies cannot exceed R20 million and qualifying (junior mining) companies cannot exceed R300 million.

The qualifying company ownership restrictions have also been relaxed. Under the old law, qualifying investee companies could not be more than 50% owned by the VCC. This requirement ran counter to the VCC (private equity) model because private equity funds often maintain temporary control of qualifying companies during the incubation period for enhanced management. The ownership prohibition has accordingly been relaxed so the VCC can own up to 70%. The 30% limitation ensures that the small business attracts independent players.

As a final matter, the prohibition against franchisees has been dropped. VCCs can now freely invest in qualifying (small business) companies operating as franchisees. Small businesses of this nature often need outside equity support to initiate or expand operations.


Definitions

Section 12J(1) contains the definitions of an ‘impermissible trade’, a ‘junior mining company’, a ‘qualifying company’, a ‘qualifying share’, and a ‘venture capital company’.

Impermissible trade

An „impermissible trade, means a trade carried on in immovable property, other than a trade carried on as a hotel keeper, by a bank as defined in the Banks Act 94 of 1990, a long-term insurer as defined in the Long-Term Insurance Act 52 of 1998, a short-term insurer as defined in the Short-Term Insurance Act 53 of 1998, and a trade carried on for money-lending or hire-purchase financing, in financial or advisory services, including a trade for legal services, tax advisory services, stock broking services, management consulting services, auditing or accounting services, in gambling, in liquor, tobacco, arms or ammunition, mainly outside South Africa.

The word ‘trade’ is widely defined in section 1 of the Act. It includes every profession, trade, business, employment, calling, occupation or venture, including the letting of property and the use of or the grant of permission to use certain intellectual property.

Junior mining company

A ‘junior mining company’ means a company that is solely carrying on a trade of mining exploration or production that is either an unlisted company as defined in section 41, or listed on the alternative exchange division of the JSE Limited (AltX).

An ‘unlisted company’ is defined in section 41 as a company that is not a listed company as defined in section 41. A ‘listed company’ as defined in section 41 is a company contemplated in paragraph (a) of the definition of a ‘listed company’ in section 1. A ‘listed company’ under paragraph (a) of the definition of a ‘listed company’ in section 1 means a company when its shares (or depository receipts for its share) are listed on an exchange defined in section 1 and licensed under section 10 of the Securities Services Act 2004.

Qualifying company

A ‘qualifying company’ means a company:

○ if it is a resident. A company will be a resident if it is incorporated, established or formed in South Africa or has its place of effective management in South Africa,

○ it is not a controlled group company in relation to a group of companies,

○ its tax affairs are in order and it has complied with all the relevant provisions of the laws administered by the Commissioner,

○ it is an unlisted company as defined in section 41 (see above) or a junior mining company (see above),

○ it is not carrying on an impermissible trade (see above), and

○ the sum of the investment income, as defined in section 12E(4)(c), derived by it during a year of assessment does not exceed 20% of its gross income for that year. Investment income as defined in section 12E(4)(c) includes:

income in the form of dividends, foreign dividends, royalties, rentals derived from immovable property, annuities and income of a similar nature,

interest as contemplated in section 24J (other than interest received by or accrued to a co-operative bank as contemplated in section 12E(4)(a)(ii)(ff), amounts contemplated in section 24K (interest-rate agreements) and other income that is subject to the same treatment as income from money lent under the laws of South Africa administered by the Commissioner, and


the proceeds (not profits or gains) derived from investment or trading in financial instruments (including futures, options and other derivatives), marketable securities and immovable property.

Qualifying share

A ‘qualifying share’ means an equity share held by a venture capital company that is issued to it by a qualifying company (see above), and does not include a share which

- it has an option to dispose of, or the qualifying company has an obligation to redeem for an amount other than its market value at the time of its disposal or redemption, or

- would have constituted a hybrid equity instrument, as defined in section 8E(1), but for the three-year period requirement contemplated in paragraph (a) of the definition of ‘hybrid equity instrument’ in section 8E.

Qualifying share from 1 October 2012

A ‘qualifying share’ means an equity share held by a venture capital company that is issued to it by a qualifying company (see above), and does not include a share which:

○ would have constituted a hybrid equity instrument, as defined in section 8E(1), but for the three-year period requirement contemplated in paragraph (a) of the definition of ‘hybrid equity instrument’ in section 8E, or

○ constitutes a ‘third-party backed share’ as defined in section 8EA(1).

Effective date

The above definition of a ‘qualifying share’ comes into operation on 1 October 2012.

Venture capital company

A ‘venture capital company’ means a company that has been approved by the Commissioner under section 12J(5) and for which this approval has not been withdrawn under section 12J(6) or section 12J(6A) (see below).

Venture capital share

A ‘venture capital share’ means an equity share held by a taxpayer in a venture capital company which is issued to him by a venture capital company, and does not include a share that:

○ he has an option to dispose of, or the venture capital company has an obligation to redeem, for an amount other than its market value at the time of the disposal or redemption, or

○ would have constituted a hybrid equity instrument, as defined in section 8E(1), but for the three-year period requirement contemplated in paragraph (a) of the definition of ‘hybrid equity instrument’ in section 8E.

Venture capital share from 1 October 2012

A ‘venture capital share’ means an equity share held by a taxpayer in a venture capital company which is issued to him by a venture capital company, and does not include a share that would have constituted a hybrid equity instrument, as defined in section 8E(1), but for the three-year period requirement contemplated in paragraph (a) of the definition of ‘hybrid equity instrument’ in section 8E, constitutes a ‘third-party backed share’ as defined in section 8EA(1).

Effective date

The above definition of a ‘venture capital share’ comes into operation on 1 October 2012.

Deduction

Section 12J(2) which is subject to section 12J(3), section 12J(3A) and section 12J(4) has been amended. It now provides for a deduction from the income of a taxpayer expenditure actually incurred by him in acquiring venture capital shares issued to him by a venture capital company.

The recoupment provisions of section 8(4)(a) apply to a section 12J(2) deduction. It therefore follows that if a person sells a ’qualifying share’ an amount will be included in his gross income.

Amount

Section 12J(3)(a) has been amended. In its amended form it provides that when during a year of assessment, a loan or credit has been used by a taxpayer for the payment or financing of the whole or a portion of expenditure contemplated in section 12J(2), and portion of that loan or credit is owed by him on the last day of the year of assessment, the amount which may be taken into account as expenditure that qualifies for a deduction under section 12J(2) must be limited to the amount for which he is under section 12J(3)(b) deemed to be at risk on the last day of the year of assessment.


Section 12J(3)(b) has also been amended. It now provides that for the purposes of section 12J(3)(a), a taxpayer must be deemed to be at risk to the extent that the incurral of the expenditure contemplated in section 12J(2), or the repayment of a loan or credit (other than the loan or credit contemplated in paragraph (ii) of the proviso to section 12J(3)(b) (see below) used by him for the payment or financing of expenditure contemplated in section 12J(2), would (having regard to a transaction, agreement, arrangement, understanding or scheme entered into before or after the expenditure is incurred) result in an economic loss to him if no income is to be received by or accrue to him in future years from the disposal of a venture capital share issued to him as a result of the incurral of that expenditure.

There is a proviso to section 12J(3)(b). It provides that the taxpayer will not be deemed to be at risk to the extent that the loan or credit is not repayable within a period of five years from the date on which it was advanced to him (proviso (aa)), and the loan or credit used by him for the payment or financing of the whole or a portion of the expenditure contemplated in section 12J(2) is (having regard to a transaction, agreement, arrangement, understanding or scheme entered into before or after the expenditure is incurred) granted directly or indirectly to him by the venture capital company by which the qualifying shares are issued as a result of the incurral of that expenditure (proviso (bb)).

Section 12J(3A) has been inserted. It provides that if during a year of assessment a taxpayer incurs expenditure as contemplated in section 12J(2), and as a result of, or immediately after, the acquisition of a venture capital share in a venture capital company he is a connected person in relation to it, no deduction is allowed under section 12J(2) during that year of assessment for expenditure incurred by him in acquiring a venture capital share issued to him by it.

Supporting certificate

Section 12J(4) states that a claim for a deduction under section 12J(2) (see above) must be supported by a certificate issued by the venture capital company stating the amounts invested in it, and that the Commissioner has approved it as contemplated in section 12J(5) (see below).

Approval

Under section 12J(5), which has been amended, the Commissioner must approve a venture capital company if it has applied for approval and he is satisfied that it is a resident, its sole object is the management of investments in qualifying companies, its tax affairs are in order and it has complied with all the relevant provisions of the laws administered by the Commissioner, and it is licensed under section 7 of the Financial Advisory and Intermediary Services Act 37 of 2002.

Withdraw approval

Section 12J(6) has also been amended. It now states that if the Commissioner is satisfied that a venture capital company approved under section 12J(5) (see above) has during a year of assessment failed to comply with the required provisions (see above) he must after due notice to it, withdraw its approval from the commencement of that year if corrective steps acceptable to him are not taken by it within a period stated in that notice.

Three-year period requirements withdrawal

Section 12J(6A) has also been amended. It now provides that if after the expiry of a period of 36 months commencing on the date of approval by the Commissioner of a company as a venture capital company under section 12J(5) (see above), he is dissatisfied that at least 80% of the expenditure incurred by it in that period to acquire assets held by it was incurred to acquire qualifying shares issued to it by qualifying companies, each of which, immediately after the issue, held assets with a book value not exceeding R300 million, when the qualifying company was a junior mining company, or R20 million, when the qualifying company was a company other than a junior mining company, or no more than 20% of the expenditure incurred by it to acquire qualifying shares held by it was incurred for qualifying shares issued to it by another qualifying company, he must after due notice to it withdraw that approval with effect from the date of his approval of it as a venture capital company if corrective steps acceptable to him are not taken by it within a period stated in the notice.

Re-approval

Under section 12J(7), a company may again apply for approval under section 12J(5), in the year of assessment following the year of assessment when its approval was withdrawn under section 12J(6) or section 12J(6A) (see above), if the non-compliance that resulted in the withdrawal has been rectified to the satisfaction of the Commissioner.

Deemed income

Section 12J(8) provides that if the Commissioner withdraws the approval of a company under section 12J(6) or section 12J(6A) (see above), 125% of the expenditure incurred by a person for the issue of shares held in it must be include in its income in the year of assessment that the approval is withdrawn by the Commissioner.

Annual return

Section 12J(9) provides that a venture capital company must submit to the Commissioner an annual return within the time and containing information that he may prescribe.


Report

Section 12J(10) states that a venture capital company must submit to the Minister a report providing him with information that he may prescribe.

Closing date

Under section 12J(11), no deduction is allowed under this provision for shares acquired after 30 June 2021. Unless indicated above, the amendments to section 12J are deemed to have come into operation on 1 January 2012 and apply to years of assessment commencing on or after that date.

Effective date

Unless other indicated above the amendments to section 12J are deemed to come into operation on 1 January 2012 and apply to years of assessment commencing on or after that date.

Shares deemed to be capital in nature - Venture capital company share

Section 9C(2A) provides that the provisions of section 9C(2) do not apply to so much of the amount received or accrued on the disposal of a qualifying share contemplated in section 9C as does not exceed the expenditure allowed for it under section 12J(2).

Section 12J provides a deduction for expenditure incurred on the issue of venture capital company shares. Section 12J(2) which is subject to the provisions of section 12J(3), (3A) and (4), states that there must be deductible from the income of a taxpayer expenditure actually incurred by him or it in acquiring venture capital shares issued to him or it by a venture capital company.

Effective date

Section 9C(2A) comes into operation on 1 January 2012 and applies to years of assessment commencing on or after that date.

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INDUSTRIAL BUILDINGS

Amendment to section 13 of the Income Tax Act.

As a result of the amendment to section 13 of the Income Tax Act, a building used wholly and mainly (more than 50%) by the taxpayer during the year of assessment for the purpose of carrying on in it in the course of his trade research and development will qualify for the section 13(1) capital allowance.

The amended subsections to section 13(1) read as follows—

(b) any building the erection of which was commenced by the taxpayer on or after 15 March, 1961, if such building was wholly or mainly used by the taxpayer during the year of assessment for the purpose of carrying on therein in the course of his trade (other than mining or farming) any process of manufacture, research and development or any other process which in the opinion of the Commissioner is of a similar nature, or such building was let by the taxpayer and was wholly or mainly used by a tenant or subtenant for the purpose of carrying on therein any process as aforesaid in the course of any trade (other than mining or farming).

(d) any building the erection of which was commenced on or after 15 March, 1961, if such building has been acquired by the taxpayer by purchase from any other person who was entitled to an allowance in respect thereof under paragraph (b) or this paragraph or the corresponding provisions of any previous Income Tax Act, and such building was wholly or mainly used during the year of assessment by the taxpayer for the purpose of carrying on therein in the course of his trade (other than mining or farming) a process of manufacture, research and development or any other process which in the opinion of the Commissioner is of a similar nature, or such building was let by the taxpayer and was wholly or mainly used by a tenant or subtenant for the purpose of carrying on therein in the course of any trade (other than mining or farming) any process as aforesaid.

(dA) any building that has never been used, if such building has been acquired by the taxpayer by purchase from any other person and such building was wholly or mainly used during the year of assessment by the taxpayer for the purpose of carrying on therein in the course of his trade (other than mining or farming) a process of manufacture, research and development or any other process which in the opinion of the Commissioner is of a similar nature, or such building was let by the taxpayer and was wholly or mainly used by a tenant or subtenant for the purpose of carrying on therein in the course of any trade (other than mining or farming) any process as aforesaid.

Effective date

The amended section 13(1) comes into operation on 1 April 2012 unless a later date is determined by the Minister by notice in the Gazette and applies in respect of buildings in which research and development is carried on or after 1 April 2012 or such later date determined by the Minister by notice in the Gazette but before 1 April 2022.


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URBAN DEVELOPMENT ZONES

Amendment to section 13quat of the Income Tax Act.

The deprecation allowance for urban development zones can generally be used either by developers or first-purchasers (the first party purchasing the property from the developer). The first-purchaser cannot claim the depreciation allowance if already claimed by the developer. At issue is another requirement that prevented the developer from claiming the depreciation allowance if the property is used for anything other than sale. This same requirement also prevented the purchaser from claiming the allowance even if the allowance was never claimed by the developer. With the advent of the global economic downturn, certain developers are temporarily renting their properties to maintain cash-flow due to a lack of sales. This temporary rental of property unfortunately prevented both the developer and first-purchaser from claiming the depreciation allowance. This result was overly punitive. The developer is now allowed to undertake temporary rentals for up to three years without jeopardizing the deprecation allowance. It should be noted that this relief roughly matches the three-year relief for temporarily rentals by developers registered for VAT.

Definition of a ‘developer’

The definition of ‘developer’ has been amended and now means a person who —

13quat(a) erects, extends, adds to or improves a building or part of a building—

(a) with the purpose of disposing of that building or part thereof immediately after completion of that

erection, extension, addition or improvement; and

(b) disposes of the building or part of a building within three years after completion of that erection, extension, addition or improvement.

Allocation of purchase price

Section 13quat(3B) has been amended and it now provides that when a taxpayer purchased a building or part of a building from a developer—

(a) 55% of the purchase price of that building or part of a building, in the case of a new building erected, extended or added to by that developer as contemplated in subsection (3)(a) or (3A)(a); and

(b) 30% of the purchase price of that building or part of a building, in the case of a building improved by that developer as contemplated in subsection (3)(b) or (3A)(b),

is deemed to be costs incurred by that taxpayer in respect of the erection, extension, addition to or improvement of that building or part of a building.

Effective date

The above amendments to section 13quat are deemed to have come into operation as from the commencement of years of assessment ending on or after 1 January 2012.

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GROUP RELIEF PROVISIONS

REORGANISATION TRANSACTIONS: LIMITATION OF DEDUCTIONS ON ACQUISITION DEBT ARISING FROM REORGANISATION ROLLOVERS

Insertion of section 10(1)(hA) of the Income Tax Act and new section 23K of the Income Tax Act.

Background

Taxpayers may not generally deduct interest incurred in respect of loan funding used to acquire shares because shares generally only produce exempt income. However, taxpayers can indirectly obtain a deduction for interest when acquiring shares of a target company when the acquisition is associated with certain rollover reorganisation, especially section 45. The most common technique for indirectly obtaining an interest deduction for share acquisitions is known as the section 45 debt push-down technique. In its simplest form, the debt push-down technique is used when acquiring all of the shares of a target company. The first step typically involves the purchase of the target company shares with cash from a bridging loan. In the second step, the acquiring company transfers the assets of the target company into a newly formed subsidiary pursuant to a section 45 rollover with the assets paid by the newly formed subsidy from external bank funding. The target company then liquidates with the bank funding used to pay off the bridging loan. The interest from the bank loan is seemingly viewed as deductible because the loan is linked to the direct acquisition of assets (see ITC 1625).


Reasons for change

The reorganisation rollover rules were merely intended to facilitate the transfer of assets in specified circumstances. The rollover rules were never intended to enable interest deductions when those deductions would not otherwise be available. However, the use of the reorganisation rollover rules as a means to allow for interest deductions when acquiring shares is said to be necessary when the seller refuses to sell underlying company assets as opposed to shares. It has also been said that this technique is necessary because the South

African tax system is an outlier in respect of global tax systems by disallowing interest when used for share acquisitions. In many settings, the above use of section 45 and other reorganisation rollover rules does not jeopardise the fiscus. Interest deductions for the borrower are often matched by taxable interest income for the creditor. However, the fiscus is at risk if the interest is paid to parties that are not subject to tax on the interest or that have on-going losses to absorb the interest income. Unfortunately, the use of section 45 and other reorganisation rollovers as a tool to achieve the mismatch of interest deductions vis-à-vis the exempt receipt of that interest has become a regular feature. The nature of the transactions of concern involves large amounts of debt with many aggressive transactions utilising debt with share-like features (including soft shareholder loans). In the most aggressive schemes, the interest paid is artificial, being rerouted back to the same economic group via tax-free preference share dividends. It also transpires that companies often use debt to facilitate or enable a liquidation transaction by borrowing money to acquire a target company and subsequently distributing all the assets of the target company followed by a liquidation of the target company.

The argument brought forward in deducting the interest expense associated with the acquisition of the shares of the target company is that the interest expense is related (indirectly) to the acquisition of the assets of the target company through a liquidation distribution. The use of section 47 in this manner poses the same risk to the fiscus as the above uses of section 45.

The change

Pre-Approval for Interest Deductions

In terms of the revised provisions, interest deductions in respect of debt used to procure, enable, facilitate or fund section 45 and 47 reorganisations will be controlled (as well as interest deductions for debt that refinances or otherwise substitutes the initial debt). More specifically, interest associated with this debt will no longer be automatically deductible (see approval process below).This denial of the deduction is limited to the interest incurred by the acquiring company.

If the interest is non-deductible by the payor, the holder of the debt instrument will be treated as receiving exempt income under certain circumstances, governed by the new section 10(1)(hA)). In particular, the exemption applies if the payor and the holder of the debt instrument are part of the same group of companies at the time that the debt is issued.

Example

Facts: Parent Co acquires all of the shares of Sub A mainly with a bridging loan. Sub A has assets with a value of R 1 billion. Parent Co sets up Sub B (newly formed) to acquire all of the assets of Sub A. Sub B then acquires all of the assets of Sub A in exchange for cash. Sub B obtains this cash via a long-term interest bearing loan from Bank. Sub a liquidates with the long-term cash used to repay the bridging loan.

Result: The transaction will qualify for intra-group transaction relief, but the interest deduction in respect of the loan to acquire the assets by Sub B will not be automatically allowed more specifically. The interest deduction may only be allowed if the Commissioner is satisfied that the incurral, receipt and accrual of the interest does not significantly erode the tax base (see below). In order for the acquiring company to obtain a deduction of the interest expenses, taxpayers will generally be required to apply for a directive in order to obtain approval from SARS for the deductibility of the interest expenses. At issue for obtaining this approval is whether the deduction of the interest expense will lead (or likely lead) to a significant reduction of taxable income (or likelihood thereof). In determining whether there will be a significant reduction to taxable income, all of the debt directly or indirectly associated with acquisition of assets in terms of a reorganisation transaction should be taken into account (over the lifespan of the debt). Indirect debt includes back-to-back loans, refinancing and other related financing. The criteria envisioned in determining whether approval should be granted by the Commissioner are:

(i) the level of debt in relation the level of equity of the acquiring company,

(ii) the estimated interest expense in relation to the estimated income of the acquiring company after the reorganisation transaction,

(iii) the debt terms and economic effects of the debt having regard to the debt versus equity features of the debt instrument,

(iv) the relationship between the acquiring company and the holder of the debt instrument (i.e. whether the lender is a direct or indirect shareholder), and

(v) any other further criteria that the Minister may prescribe. This criteria is subject to further elaboration in Ministerial legislation.


The Commissioner is also empowered to impose additional conditions in the directive concerning any changes to the facts presented in the application for approval. The Minister has also been given the power to exclude transactions from the preapproval process (by regulation). This exclusion is intended as a fast-track mechanism for transactions that represent little or no risk to the tax base (for example, pure intra-group transactions).

Change in facts and circumstances under which approval is granted

SARS approval will be made based on the facts in existence at the time of the approval request. The approval will cease to apply if there is a material change in the facts and circumstances on which the Commissioner relied in issuing the directive. This approval will also not apply (ab initio) if the approval was granted based on fraudulent or misrepresented facts or a material omission.

Timing of Directive

The directive issued by the Commissioner will be effective from the date of issue of the debt instrument or the date on which the application for the directive was made as described below. The directive will be effective from the date of debt issue if the application was made: on or before 31 December 2011 and the debt instrument is issued before 25 October 2011; or within 60 days of the date of issue of the debt instrument and the debt instrument was issued on or after 25 October 2011.

The directive will be effective from the date on which the application is made if the debt instrument was issued: before 25 October 2011 and the application was made after 31 December 2011, or on or after 25 October 2011 and the application was made later than 60 days after the issue of the debt instrument.

Amalgamations

Current law allows certain forms of debt to be assumed in a amalgamation without giving rise to Dividends Tax consequences. In particular, for the debt to be permissible, the debt assumed must have been incurred by the target company more 18 months before the amalgamation disposal of the asset or within 18 months if that debt was used to refinance old debt or arose in the normal course of the amalgamated business. It was never intended that the debt assumed by the acquiring company should be used to facilitate, procure, enable or fund an amalgamation transaction. In order to ensure unintended result does not arise, the amalgamation rules have accordingly been adjusted slightly to remove any arguable implications to the contrary (that is, any debt instrument used or issued to procure, enable, facilitate or fund the amalgamation transaction will be impermissible, even if the debt was incurred by the amalgamated company 18 months before the disposal).


Section 10(1)(hA)

Section 10(1)(hA) has been inserted and exempts from normal tax any amount received by or accrued to the holder of a debt instrument as defined in section 23K(1)-

(i) if the holder of that debt instrument is a company that forms part of the same group of companies, as defined in section 41, as the issuer of that debt instrument; and

(ii) to the extent that the amount is attributable to any amount of interest as defined in section 23K(1) that is not deductible as a result of the application of section 23K.

Effective date

Section 10(1)(hA) is deemed to come into operation on 3 June 2011 and applies to years of assessment ending on or after that date.

Limitation of deductions in respect of reorganisation transactions

Section 23K has been inserted into the Income Tax Act as an anti-avoidance measure to limit the deduction for interest incurred on certain reorganization transactions. It reads as follows:

23K(1) For the purposes of this section-

‘acquiring company’ means a transferee company contemplated in the definition of ‘intra-group transaction’ in section 45(1); (see below for expanded definition)

‘debt instrument’ means a debt instrument as defined in section 37I(1);

‘interest’ means interest as defined in section 24J;

‘reorganisation transaction’ means an intra-group transaction as defined in section 45(1) to which section 45 applies. (see below for expanded definition)

(2) Subject to subsections (3) and (9), no deduction is allowed in respect of any amount of interest incurred by an acquiring company in terms of a debt instrument if that debt instrument was issued or used directly or indirectly-

(a) for the purpose of procuring, enabling, facilitating or funding the acquisition by that acquiring company of any asset in terms of a reorganisation transaction; or


(b) in substitution for any debt instrument issued or used as contemplated in paragraph (a).

(3) Subject to subsection (5), the Commissioner may, on application by an acquiring company, issue a directive that subsection (2) does not apply in respect of an amount of interest incurred as contemplated in that subsection.

(4) In considering an application for a directive contemplated in subsection (3), the Commissioner-

(a) must take into account-

(i) the amount of interest incurred as contemplated in subsection (2) by an acquiring company in terms of a debt instrument contemplated in that subsection; and

(ii) all amounts of interest incurred, received or accrued in respect of all debt instruments issued or used directly or indirectly to fund a debt instrument in respect of which any amount of interest is incurred by an acquiring company as contemplated in subsection (2); and

(b) may only issue a directive contemplated in subsection (3) if and to the extent that the Commissioner is, having regard to the criteria prescribed by the Regulations contemplated in subsection (7), satisfied that the issuing of that directive will not lead nor be likely to lead to a significant reduction of the aggregate taxable income of all parties who incur, receive or accrue interest-

(i) in respect of; and

(ii) for all periods during which any amounts are outstanding in terms of,

any debt instrument contemplated in subparagraphs (i) and (ii) of paragraph (a):

Provided that in determining whether a reduction of taxable income is significant for the purpose of this subsection, the Commissioner must have regard to the criteria prescribed by the regulations contemplated in subsection (7).

(5) Any directive issued by the Commissioner in terms of subsection (3) may be made subject to such conditions and limitations as may be determined by the Commissioner.

(6) A directive issued by the Commissioner in terms of subsection (3) in respect of an amount of interest incurred in terms of a debt instrument must be effective from-

(a) the date on which that debt instrument was issued if the application for that directive is made-

(i) on or before 31 December 2011, where that debt instrument was issued before 25 October 2011; or

(ii) within 60 days of the date of issue of that debt instrument, where that debt instrument is issued on or after 25 October 2011; or

(b) the date on which the application for that directive is made if-

(i) that debt instrument was issued before 25 October 2011 and that application is made after 31 December 2011; or

(ii) that debt instrument is issued on or after 25 October 2011 and that application is made later than 60 days after the date of issue of that debt instrument.

(7) The Minister must make regulations that prescribe criteria that the Commissioner must, in terms of subsection (4)(b), have regard to in considering any application made in terms of subsection (3) by an acquiring company in respect of any amount of interest incurred by such an acquiring company in terms of any debt instrument, which criteria must relate to-

(a) amounts of debt in relation to equity of such an acquiring company;

(b) total amounts of interest to be incurred by such an acquiring company in relation to total income of such an acquiring company;

(c) terms of such a debt instrument, including the economic effect of such a debt instrument, having regard to any debt or equity features of such a debt instrument;

(d) the direct or indirect holding of shares in such an acquiring company by any holder (or any company that forms part of the same group of companies as the holder) of such a debt instrument; and

(e) any other factor prescribed by the Minister.

(8) (a) If, subsequent to the date on which a directive is issued by the Commissioner pursuant to an application made by an acquiring company in terms of subsection (3)-

(i) there is any material change in respect of any fact or circumstance which influenced any decision of the Commissioner relating to the issuing of that directive; and

(ii) that change would, had the change been anticipated by the Commissioner at the time of issuing the directive, have resulted in the Commissioner not issuing the directive or issuing the directive on terms that are less favourable to that acquiring company, the directive will cease to apply with effect from the date on which that change takes effect.

(b) Where any decision relating to the issuing of a directive by the Commissioner in terms of subsection (3) was made by the Commissioner as a direct or indirect result of fraud, misrepresentation or non-disclosure of material facts, that directive will cease to apply with effect from the date that the directive took effect.

(9) The Minister may make regulations prescribing circumstances in which subsection (2) does not apply.


Effective date

In respect of debt arising from a section 45 transaction, the proposed amendment will apply in respect of any asset acquired on or after 3 June 2011. In respect of debt arising from a section 47 transaction, the proposed amendment will apply in respect of any asset acquired on or after 3 August 2011. We were told that the proposed amendments are intended only to be of a temporary nature with an intended 1 January 2014 sunset clause, no such sunset clause has come through in the legislation.

Section 23K is deemed to have come into operation on 3 June 2011 and applies in respect of any amount of interest incurred in terms of a debt instrument where that debt instrument was issued or used for the purpose of procuring, enabling, facilitating or funding the acquisition by an acquiring company of an asset in terms of a reorganization transaction entered into on or after that date.

Acquiring company and reorganisation transaction definitions expanded from 3 August 2011

The following definitions contained in section 23K have been expanded:

‘acquiring company’ means-

(a) a transferee company contemplated in the definition of ‘intra-group transaction’ in section 45(1); or

(b) a holding company contemplated in the definition of ‘liquidation distribution’ in section 47(1).

‘reorganisation transaction’ means-

(a) an intra-group transaction as defined in section 45(1) to which section 45 applies; or

(b) a liquidation distribution as defined in section 47(1) to which section 47 applies.

Effective date

See further explanation in the effective date paragraph above.

The amended definitions are deemed to have come into operation on 3 August 2011 and apply in respect of any amount of interest incurred in terms of a debt instrument where that debt instrument was issued or used for the purpose of procuring, enabling, facilitating or funding the acquisition by an acquiring company of an asset in terms of a reorganisation transaction entered into on or after that date.

Notices issued by the Minister of Finance

Section 23K(3)

The Minister of Finance determined the criteria to be taken into account in the determination of the potential for a significant erosion of the tax base of South Africa. These criteria were set out in the following schedule:

1. The aggregate impact of the incurral, receipt or accrual of interest on tax payable by any person that is an issuer or holder of any debt instrument as defined in section 37I(1) that was issued or used as contemplated in section 23K(2).

2. The reorganisation transaction -

is financed at higher than a 1 to 1 debt to share ratio,

results in higher debt levels for the transferee subsequent to the reorganisation transaction than the debt levels of the transferor before the reorganisation transaction,

results in low projected coverage of interest expenses by earnings before interest, tax, depreciation and amortisation, or

was financed by debt bearing interest at rates exceeding market rates or interest.

3. The nature of the debt instrument as contemplated in section 23K(2) used by the acquiring company to finance the reorganisation transaction having regard to-

conditions associated with the rate and amounts of interest payable,

the terms of repayment of the debt,

whether any portion of the debt is subordinated by its creditors,

any security or guarantee provided by any person who is a connected person in relation to the acquiring company, and

alternative financing options which were considered for the reorganisation transaction.


4. The reorganisation transaction was entered into for the main or one of the main purposes of the reduction or delay of the payment of income tax by any party to the transaction, or the utilisation of the consideration received by the transferor in the reorganisation transaction to earn amounts other than income.

Section 23K(4)

Under section 23K(4) of the Income Tax Act, the Minister of Finance determined the circumstances under which section 23K(2) does not apply. The only circumstance listed in the schedule issued by the Minister of Finance was as follows:

Reorganisation transactions as defined in section 23K entered into by a taxpayer if the transaction was financed directly or indirectly only by a company forming part of the same group of companies, as defined in section 41, in relation to the taxpayer.

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SECTION 41 - GENERAL

Amendments to section 41 of the Income Tax Act.

The following amendments have been made to section 41 of the Income Tax Act.

The definition of ‘company’ has been amended and now reads as follows:

‘company’ does not include a headquarter company and, for the purposes of sections 42 and 44, includes any portfolio of a collective investment scheme in securities.

The definition of ‘resident’ has been deleted.

An obsolete reference in subsection (2) has been deleted and it now reads as follows:

(2) The provisions of this Part must, subject to subsection (3), apply in respect of an asset-for-share transaction, an amalgamation transaction, an intra-group transaction, an unbundling transaction and a liquidation distribution as contemplated in sections 42, 44, 45, 46 and 47, respectively, notwithstanding any provision to the contrary contained in the Act, other than sections 24B(2) and 103 and Part IIA of Chapter III.

Subsection (4) has been amended to update the company legislation references from the 1973 Companies Act to the 2008 Companies Act. Subsection (4)(d)(i) now reads as follows:

(i) that company has lodged a resolution authorising the voluntary winding-up of that company in terms of-

(aa) section 80(2) of the Companies Act, 2008 (Act No. 71 of 2008), in the case of a company to which that section applies;

(bb)Regulation 21 of the Regulations under the Co-operatives Act, 2005 (Act No. 14 of 2005), published under section 95 of that Act in Government Notice R. 366 of 30 April 2007, in the case of a co-operative; or

(cc) a similar provision contained in any foreign law relating to the liquidation of companies, in the case where that company is incorporated in a country other than the Republic, if such foreign law so requires; and.

Subsection 4(b) and (c) have been substituted and read as follows:

(b) in the case of a deregistration of a company, that company has lodged a request for the deregistration of that company in the prescribed manner and form-

(i) to the Companies and Intellectual Property Commission in terms of section 82(3)(b)(ii) of the Companies Act, 2008, in the case of a company to which that section applies; or

(ii) has been deleted.

(iii) in the case where that company is incorporated in a country other than the Republic, to a person who, in terms of any similar provision contained in any foreign law, exercises the powers and performs the duties assigned to the Commission contemplated in subparagraph (i), if such foreign law so requires;

(c) that company has submitted a copy of the resolution contemplated in paragraph (a)(i) or the request contemplated in paragraph (b) to the Commissioner; and.

Subsection 8(a) and (b) have been amended as follows:

(a) This subsection applies where a return of capital in respect of any share as contemplated in paragraph 76(1)(b) of the Eighth Schedule has been received by or has accrued to any person, and that person has disposed of that share, after that receipt or accrual, in terms of a disposal or distribution in respect of which the provisions of sections 42, 44, 45 or 47 apply; and

(b) Where paragraph (a) applies, that return of capital must for purposes of paragraph 76(1)(b) of the Eighth Schedule be deemed to have been received by or to have accrued to-

(i) the person to whom that share is so disposed of or distributed in respect of that share; and

(ii) the person so disposing of that share, in respect of any share acquired in consequence of that disposal (other than a transferor company contemplated in section 45(1)(a)).


Effective date

Amendments to the definition of ‘company’ and ‘resident’ come into operation on 1 January 2012.

The amendment to subsection (2) is deemed to have come into operation on 21 October 2008 and applies in respect of shares or debt instruments acquired, issued or disposed of on or after that date.

The amendment to subsection 4(a), (b) and (c) of subsection (1) are deemed to have come into operation on 1 January 2011.

The amendment to subsection 8(a) and (b) come into operation on 1 April 2012.

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ASSET – FOR – SHARE TRANSACTIONS


For a detailed explanation of the amendments affecting Controlled Foreign Company’s refer to the section of the notes dealing with CFC’s.

Section 42(1) of the Income Tax Act has been amended as follows:

‘asset-for-share transaction’ means any transaction-

(a)(i) in terms of which a person disposes of an asset (other than an asset which constitutes a restraint of trade or personal goodwill), the market value of which is equal to or exceeds-

(aa) in the case of an asset held as a capital asset, the base cost of that asset on the date of that disposal; or

(bb) in the case of an asset held as trading stock, the amount taken into account in respect of that asset in terms of section 11(a) or 22(1) or (2), to a company which is a resident, in exchange for an equity share or shares of that company and that person-

(A) at the close of the day on which that asset is disposed of, holds a qualifying interest in that company; or

(B) is a natural person who will be engaged on a full-time basis in the business of that company, or a controlled group company in relation to that company, of rendering a service; and

(a)(ii) as a result of which that company acquires that asset from that person-

(aa) as trading stock, where that person holds it as trading stock;

(bb) as a capital asset, where that person holds it as a capital asset; or

(cc) as trading stock, where that person holds it as a capital asset and that company and that person do not form part of the same group of companies:

Provided that this subparagraph does not apply in respect of any transaction which meets the requirements of subparagraph (i) in terms of which a person disposes of an equity share in a listed company or in a portfolio of a collective investment scheme in securities to any other company and after that disposal, together with any other transaction that is concluded-

(aa) on the same terms as that transaction; and

(bb) within a period of 90 days after that disposal, that other company holds-

(A) at least 35% of the equity shares of that listed company or portfolio; or

(B) at least 25% of the equity shares of that listed company or portfolio if no person other than that other company holds an equal or greater amount of equity shares in the listed company or portfolio; or

(b) in terms of which a person disposes of an asset that constitutes an equity share in a foreign company, the market value of which is equal to or exceeds-

(i) in the case of an equity share held as a capital asset, the base cost of that equity share on the date of that disposal; or

(ii) in the case of an equity share held as trading stock, the amount taken into account in respect of that equity share in terms of section 11(a) or 22(1) or (2), to another foreign company, in exchange for an equity share in that other foreign company and immediately before and at the close of the day on which the asset is disposed of in terms of that transaction-

(aa) that person holds a qualifying interest in the other foreign company; and

(bb) the other foreign company is a controlled foreign company in relation to any company that forms part of the same group of companies, as defined in section 1, as that person.

The definition of ‘qualifying interest’ in section 42(1) has been amended and reads as follows:

‘qualifying interest’ of a person-

(a) for the purposes of paragraph (a) of the definition of ‘asset-for-share transaction’, means-


(i) an equity share held by that person in a company which is a listed company or will become a listed company

within 12 months after the transaction as a result of which that person holds that share;

(ii) an equity share held by that person in a portfolio of a collective investment scheme in securities;

(iii) equity shares held by that person in a company that constitute at least 20% of the equity shares and that confer at least 20% of the voting rights of that company; or

(iv) an equity share held by that person in a company which forms part of the same group of companies as that person; or

(b) for the purposes of paragraph (b) of the definition of ‘asset-for-share transaction’, means equity shares held by that person in a foreign company that constitute at least 20% of the equity shares and that confer at least 20% of the voting rights of the foreign company.

Section 42(2)(a)(i) has been amended

Section 42(2) states that subject to subsections (4) and (8), where a person disposes of an asset to a company in terms of an asset-for-share transaction-

(a) that person must be deemed to have-

(i) disposed of that asset-

(aa) in the case of an asset-for-share transaction contemplated in paragraph (a) of the definition of ’asset-for-share transaction’, for an amount equal to the amount contemplated in item (aa) or (bb) of subparagraph (i) of that paragraph, as the case may be; or

(bb) in the case of an asset-for-share transaction contemplated in paragraph (b) of the definition of ‘asset-for-share transaction’, for an amount equal to the amount contemplated in subparagraph (i) or (ii) of that paragraph, as the case may be; and…

Section 42(3A) has been amended

Although assets received by a company in a section 42 ‘asset-for-share transaction’ generally have a carryover base cost, a fair market value tax cost applies in the case of listed shares transferred (and in the case of collective investment scheme interests transferred).

It is now proposed that this fair market deviation must be reflected when determining contributed tax capital (because contributed tax capital derived from an ‘asset-for-share transaction’ mirrors the tax cost of the shares received in a section 42 transfer).

Section 42(3A) now reads as follows:

For the purposes of the definition of ‘contributed tax capital’, if an asset is disposed of by a person to a company in terms of an asset-for-share transaction contemplated in paragraph (a) of the definition of ‘asset-for-share transaction’ and that person at the close of the day on which that asset is disposed of holds a qualifying interest in that company as contemplated in paragraph (a)(iii) of the definition of ‘qualifying interest’, or is a natural person who will be engaged on a full-time basis in the business of that company or a controlled group company in relation to that company of rendering a service, the amount received by or accrued to the company for the issue of the shares is deemed to be equal to-

(a) if the asset is trading stock, the amount taken into account by that person in respect of the asset in terms of section 11(a) or 22(1) or (2); or

(b) if the asset is an asset other than trading stock, the base cost of that asset determined at the time of that disposal in relation to the person disposing of that asset;

Provided that this subsection does not apply in respect of any asset-for-share transaction in terms of which a person disposes of an equity share in a listed company or in a portfolio of a collective investment scheme in securities to any other company and after that disposal, together with any other asset-for-share transaction that is concluded-

(i) on the same terms as that asset-for-share transaction; and

(ii) within a period of 90 days after that disposal,

that other company holds-

(aa) at least 35% of the equity shares of that listed company or portfolio; or

(bb) at least 25% of the equity shares of that listed company or portfolio if no person other than that other company holds an equal or greater amount of equity shares in the listed company or portfolio.


Section 42(6) has been amended

In its amended form it reads as follows:

(6) Where a person-

(a) disposed of an asset to a company in terms of an asset-for-share transaction contemplated in paragraph (a) of the definition of ‘asset-for-share transaction’ and, within a period of 18 months after the date of that disposal, that person ceases-

(i) to hold a qualifying interest in that company, as contemplated in paragraph (a)(iii) and (iv) of the definition of ‘qualifying interest’ (whether or not as a result of the disposal of shares in that company); or

(ii) to be engaged on a full-time basis in the business of the company, or controlled group company in relation to that company, of rendering the service contemplated in paragraph (a)(i)(B) of the definition of ‘asset-for-share transaction’; or

(b) disposed of an equity share to a foreign company in terms of an asset-for-share transaction contemplated in paragraph (b) of the definition of ‘asset-for-share transaction’ and, within a period of 18 months after the date of that disposal and whether or not as a result of the disposal of shares in that foreign company-

(i) that person ceases to hold a qualifying interest in the foreign company, as contemplated in paragraph (b) of the definition of ‘qualifying interest’; or

(ii) the foreign company-

(aa) ceases to be a controlled foreign company in relation to that person; or

(bb) ceases to form part of the same group of companies as that person (without regard to paragraph (i)(ee) of the proviso to the definition of ‘group of companies’ in section 41),

that person is for purposes of subsection (5), section 22 or the Eighth Schedule deemed to have—

(A) disposed of all the equity shares acquired in terms of that asset-for-share transaction that are still held immediately after that person ceased to hold such a qualifying interest, for an amount equal to the market value of those equity shares as at the beginning of that period of 18 months; and

(B) immediately reacquired all the equity shares contemplated in paragraph (a) at a cost equal to the amount contemplated in that paragraph:

Provided that the provisions of this subsection do not apply where that person ceases to hold a qualifying interest in that

company in terms of an intra-group transaction contemplated in section 45, an unbundling transaction contemplated in

section 46 or a liquidation distribution contemplated in section 47, an involuntary disposal as contemplated in paragraph 65

of the Eighth Schedule or a disposal that would have constituted an involuntary disposal as contemplated in that paragraph

had that asset not been a financial instrument, or as the result of the death of that person.


In its amended form it reads as follows:

Where a person disposes of-

(a) any asset which secures any debt to a company in terms of an asset-for-share transaction and that debt was incurred by that person-

i) more than 18 months before that disposal; or

ii) within a period of 18 months before that disposal-

(aa) and that debt was incurred at the same time as that asset was acquired by that person; or

(bb) to the extent that debt constitutes the refinancing of any debt in respect of that asset incurred as contemplated in subparagraph (i) or item (aa) of subparagraph (ii), and that company assumes that debt or an equivalent amount of debt that is secured by that asset; or

b) any business undertaking as a going concern to a company in terms of an asset-for-share transaction and that disposal includes any amount of any debt that is attributable to, and arose in the normal course of that business undertaking,

that person must, upon the disposal of any equity share acquired in terms of that asset-for-share transaction and notwithstanding the fact that that person may be liable as surety for the payment of the debt referred to in subparagraph (a) or (b), treat so much of the face value of that debt as relates to that equity share-

(aa) where that equity share is held as a capital asset, as a return of capital by way of a distribution of cash in respect of that equity share that accrues to that person immediately after the acquisition by that person of that equity share in terms of that asset-for-share transaction; or

(bb) where that equity share is held as trading stock, as income to be included in that person’s income for the year of assessment during which that equity share is acquired by that person in terms of that asset-for-share transaction.



Because most taxpayers prefer to fall within rollover treatment, taxpayers falling within the conditions of ‘asset-for-share transactions’ receive the benefit of rollover treatment unless the parties agree otherwise.

However, transferring parties falling completely outside of South African taxing jurisdiction generally prefer to avoid rollover

treatment because the assets transferred effectively receive a market value tax cost without any upfront taxation (regardless of the reorganisation rollover rules). It was accordingly intended that asset transfers from parties wholly outside South African taxing jurisdiction be excluded from rollover treatment. The exclusion, however, failed to account for potential taxation under the controlled foreign company regime. The exclusion from rollover treatment will accordingly apply only where the transferor lacks:

(i) taxable income (or assessed loss), and

(ii) section 9D net income.

In its amended form section 42(8) reads as follows:

This section does not apply to the disposal of an asset by a person to a company if-

a) the person and the company agree in writing that this section does not apply; or

b) the disposal would not be taken into account for purposes of determining-

(i) any taxable income or assessed loss of that person; or

(ii) any proportional amount of the net income of a controlled foreign company which is included in the income of that person in terms of section 9D.

Effective date

The amended sections 42(1), (2), (3A), (6) and (8A) come into operation on 1 January 2012 and apply in respect of transactions entered into on or after that date.

The new proviso to section 42(3A) comes into operation on the date on 1 April 2012.

The amended section 42(8) comes into operation on 1 April 2012 and applies in respect of transactions entered into on or after that date.

____________________________________

AMALGAMATION TRANSACTIONS

Amendments to section 44 of the Income Tax Act and section 50 of the Revenue Laws Amendment Act 60 of 2008.


For a detailed explanation of the amendments affecting Controlled Foreign Company’s refer to the section of the notes dealing with CFC’s.

Section 44(1) now reads as follows:

For the purpose of this section ‘amalgamation transaction’ means any transaction-

(a) (i) in terms of which any company (hereinafter referred to as the ‘amalgamated company’) disposes of all of its assets (other than assets it elects to use to settle any debts incurred by it in the ordinary course of its trade) to another company (hereinafter referred to as the ‘resultant company’) which is a resident, by means of an amalgamation, conversion or merger; and

(ii) as a result of which that amalgamated company’s existence will be terminated; or

(b) (i) in terms of which an amalgamated company which is a foreign company disposes of all of its assets (other than assets it elects to use to settle any debts incurred by it in the ordinary course of its trade) to a resultant company which is a foreign company, by means of an amalgamation, conversion or merger;

(ii) if-

(aa) that amalgamated company and that resultant company form part of the same group of companies (without regard to paragraph (i)(ee) of the proviso to the definition of ‘group of companies’ in section 41) immediately before that transaction:

Provided that for the purposes of this item an amalgamated company and a resultant company will only form part of the same group of companies if the expression ‘at least 70%’ in paragraphs (a) and (b) of the definition of ‘group of companies’ in section 1 were replaced by the expression ‘at least 95%’; and

(bb) that resultant company is a controlled foreign company in relation to any company that is a resident and that forms part of the group of companies contemplated in item (aa) immediately before and after that transaction; and

(iii) as a result of which that amalgamated company’s existence will be terminated.


The definition of a ‘qualifying interest’ in section 44(1) has been deleted.

Under the old law, target shareholders fell within amalgamation rollover treatment only if these shareholders have a qualifying interest (often requiring a 20% minimum equity stake). The qualifying interest requirement operates separately from other aspects of the amalgamation rollover rules. The net result may mean that rollover treatment applies at the entity level but not the shareholder level. This split treatment gives rise to technical anomalies and can be unfair to minority shareholders who may be ‘involuntary’ participants. The qualifying interest requirement for the target shareholders has accordingly been dropped.

The provisions of section 44(4) have been amended


The provisions of subsections (2) and (3) will not apply to a disposal of an asset by an amalgamated company to a resultant company as part of an amalgamation transaction to the extent that such asset is so disposed of in exchange for consideration other than-

(a) an equity share or shares in that resultant company; or

(b) the assumption by that resultant company of a debt of that amalgamated company, unless that debt-

(i) was incurred by that amalgamated company-

(aa) more than 18 months before that disposal; or

(bb) within a period of 18 months before that disposal,

to the extent that the debt-

(A) constitutes the refinancing of any debt incurred as contemplated in subparagraph (aa); or

(B) is attributable to and arose in the normal course of the disposal, as a going concern, of a business undertaking to that resultant company as part of that amalgamation transaction; and

(ii) was not incurred by that amalgamated company for the purpose of procuring, enabling, facilitating or funding the acquisition by that resultant company of any asset in terms of that amalgamation transaction.

The provisions of section 44(6)(a) have been amended

Section 44(6)(a) now reads as follows:

(a) Subject to subsection (7), this subsection applies where-

i) a person disposes of any equity shares in an amalgamated company as a result of the liquidation, winding up or deregistration of that amalgamated company and acquires equity shares in the resultant company as part of an amalgamation transaction in respect of which subsection (2) or (3) applied, which equity shares in the resultant company are acquired-

(aa) as either capital assets or trading stock, in the case where that share in the amalgamated company is disposed of as a capital asset; or

(bb) as trading stock in the case where that share in the amalgamated company is disposed of as trading stock.

Reorganisation mitigation – amendments to sections 44(9)(a) and 44(10)

As indicated elsewhere in these notes, the Secondary Tax on Companies (STC) will be converted into a Dividends Tax as of 1 April 2012. This change will have wide-ranging ramifications within the Income Tax Act.

The reorganisation rollover rules override or otherwise adjust many provisions within the Income Tax Act, including provisions relating to dividends. Some of these reorganization rollover rules eliminate or mitigate the impact of otherwise existing taxable dividends. These mitigation provisions will accordingly have to be modified in light of the pending conversion from the STC to the new Dividends Tax.

The reorganisation rollover rules contained two overrides in respect of the STC. The first override is contained in the amalgamation rules; the second is contained in the unbundling rules.

A. Non-share consideration in an amalgamation transaction

Under the old law, any non-share consideration received by the amalgamated company shareholders within an amalgamation potentially gave rise to a dividend. This dividend potentially triggered STC. The rules also provided a system for the CTC of the amalgamated company to be shifted to the resultant company. The non-share consideration received by the amalgamated company shareholders will now be treated as a distribution that qualifies as either a dividend or return of capital (depending on whether the CTC of the amalgamated company is transferred in the distribution). Any amalgamated company CTC shifted to the resultant company must be reduced by any CTC reduction in the amalgamated company caused by a non-share return of capital distribution within the amalgamation.


B. Amalgamation override

(1) Dividends Tax override

Under old law, where the resultant company shares acquired by an amalgamated company in terms of an amalgamated transaction are disposed of to the shareholders of the amalgamated company, the disposal of those shares did not attract STC. Under the amended rules the disposal of the resultant company shares by the amalgamated company to the latter’s shareholders does not give rise to the Dividends tax.

(2) Amalgamations with no consideration

The relief measures for amalgamation transactions were only available if the resultant company issues shares or assumes the amalgamated company’s debts as consideration for the disposal of assets by the amalgamated company. Under the new rules the resultant company will no longer be required to issue any consideration within the amalgamations. This lack of consideration typically arises in respect of amalgamations occurring within a wholly owned group because shareholders own all of the assets and entities before and after the amalgamation.

C. Unbundling override

Under the old law, the unbundling of a company was deemed not to be a dividend for STC purposes if part of an unbundling transaction. The net result was the elimination of the STC charge as well as any corresponding STC credits. The unbundling company was also freed from any tax charge associated with any built-in gain or loss in the unbundled shares. Under the new rules an unbundling transaction will not give rise to the Dividends Tax, ordinary revenue or a return of capital in the hands of the unbundling company shareholders. The unbundling company is also freed from any built-in tax charge associated with any built-in gain or loss in the unbundled shares.

The provisions of section 44(9)(a) have been amended

Section 44(9)(a) now reads as follows:

Where an amalgamated company disposes of any equity shares in a resultant company that were acquired by that amalgamated company in terms of an amalgamation transaction that was subject to subsection (2) or (3), to a shareholder of that amalgamated company as part of an amalgamation transaction –

(a) the disposal by that amalgamated company of those shares must be deemed not to be a dividend for purposes of Part

VIII of Chapter II; and

(b) any shares acquired by a company in terms of that disposal must be deemed not to be a dividend which accrued to that

company for the purposes of section 64B(3)



(10) So much of the amount of any other consideration to which a person becomes entitled as contemplated in subsection (7)(b) as does not exceed the market value of all the assets of the amalgamated company immediately before the amalgamation, conversion or merger less-

(a) the liabilities; and

(b) the sum of the contributed tax capital of all the classes of shares, of the amalgamated company immediately before the amalgamation, conversion or merger must, for the purposes of the definitions of ‘dividend’, ‘foreign dividend’, ‘foreign return of capital’ and ‘return of capital’ in section 1, be deemed to be an amount transferred by that amalgamated company for the benefit or on behalf of that person in respect of a share held by that person in the amalgamated company.

The provisions of section 44(11) have been deleted



The provisions of this section do not apply where the amalgamated company-

(a) has not, within a period of 18 months after the date of the amalgamation transaction, or such further period as the Commissioner may allow, taken the steps contemplated in section 41(4) to liquidate, wind up or deregister; or

(b) has at any stage withdrawn any step taken to liquidate, wind up or deregister that company, as contemplated in paragraph (a), or does anything to invalidate any step so taken, with the result that the company will not be liquidated, wound up or deregistered:

Provided that any tax which becomes payable as a result of the application of this subsection may be recovered from the resultant company.




The provisions of this section do not apply-

a) in respect of any transaction if the resultant company holds at least 70 per cent of the equity shares in the amalgamated company immediately before the amalgamation, conversion or merger;

b) in respect of any transaction if the resultant company is a company contemplated in paragraph (c) or (d) of the definition of 'company';

bA) in respect of any transaction if the resultant company is a portfolio of a collective investment scheme in securities and the amalgamated company is not a portfolio of a collective investment scheme in securities;

c) in respect of any transaction if the resultant company is a non-profit company as defined in section 1 of the Companies Act, 2008 (Act No. 71 of 2008);

d) in respect of any transaction in paragraph (a) of the definition of ‘amalgamated company’ if the resultant company is a company contemplated in paragraph (b) or (e)(i) of the definition of 'company' in section 1 and does not have its place of effective management in the Republic;

e) in respect of any transaction if any amount constituting gross income of whatever nature would be exempt from tax in terms of section 10 were it to be received by or to accrue to the resultant company; or

f) in respect of any transaction if the resultant company is a public benefit organisation or recreational club approved by the Commissioner in terms of section 30 or 30A; or

(g) to a disposal of an asset by an amalgamated company to a resultant company-

(i) in terms of an amalgamation transaction contemplated in paragraph (a) of the definition of ‘amalgamation transaction’ where that resultant company and the person contemplated in subsection (6) form part of the same group of companies immediately before and after that disposal; or

(ii) in terms of an amalgamation transaction contemplated in paragraph (b) of the definition of ‘amalgamation transaction’ where that resultant company and the person contemplated in subsection (6) form part of the same group of companies (without regard to paragraph (i)(ee) of the proviso to the definition of ‘group of companies’ in section 41) immediately before and after that disposal,

if that amalgamated company, resultant company and person jointly so elect.

Effective date

The amendment deleting part of section 44(14)(bA) and replacing the deleted part with the words ‘portfolio of a collective investment scheme in securities’ is deemed to have come into operation as from the commencement of years of assessment commencing on or after 1 January 2010.

The amendment to section 44(1), (4), (6) (11) (13) and all other amendments to section 44(14) come into operation on 1 January 2012 and apply in respect of transactions entered into on or after that date.

The amendments to section 44(9) and (10) come into operation on 1 April 2012and apply in respect of disposals made on or after that date.

____________________________________

INTRA- GROUP TRANSACTIONS


Background

Section 45 provides rollover treatment for the transfer of assets from one company to another as long as both companies are part of the same group of companies. This transfer can be in exchange for cash or in exchange for a note issued by the transferee, but not in exchange for shares issued by the transferee. If the transferor receives a note issued by the transferee, the tax cost equals the fair market value of the note at the time of issue.

Reasons for change

The fair market value tax cost of the note can give rise to avoidance in the case of appreciated assets because a fair market value tax cost exists for the note, even though the transferor receives rollover treatment for the appreciated assets. This treatment differs from section 42 rollovers, which also allows for deferral of transferred assets. However, unlike section 45, any consideration issued (i.e. preference shares) in exchange under section 42 have a rollover base cost (as opposed to a fair market value base cost).


In 2007, the tax-free increase in tax cost of section 45 considerations was identified as problematic, but an interim solution was proposed. This interim solution required reexamination given the on-going problems associated with section 45. The exclusion of any shares as consideration in a section 45 transaction is also problematic, especially since preference shares may pose less of a risk to the fiscus than debt.

The change

A. Permissible use of preference shares

The use of preference shares as consideration for section 45 transferred assets will now be permitted. This use of preference shares does not overlap with section 42, the latter of which excludes preference shares. Preference shares are a useful tool in section 45, especially if the section 45 transfer is part of a shift to owners outside the group (up to 30%).

Preference shares are often preferred in this instance because a newly formed entity with partial non-group shareholders often lacks the income to absorb the interest expenses associated with debt.

B. Revised tax cost for notes or preference share consideration

The tax cost for notes and preference share consideration within the context of section 45 raises two sets of issues.

Rollover tax cost is the most appropriate result (like section 42) if this consideration is transferred to parties outside the group because an elevated tax cost can act as a indirect form of exemption.

On the other hand, repayment of a note or preference shares within a group should not give rise to taxable gain or income because the repayment represents a mere internal shift.

As a result under the new provisions notes and preference shares issued as consideration under section 45 have a split impact.

These notes and preference shares will have a tax cost of nil if the holder (i.e. Target Company) thereof forms part of the same group of companies as the issuer (i.e. acquirer). However, any gain or income from the repayment of notes or preference shares will be exempt if the notes or preference shares are repaid whilst both parties to the notes or preference shares remain together within the same group of companies.

Example

Facts: Parent Co owns all the shares of Sub A and Sub B. Sub A and Sub B are part of the same group of companies. Sub B wants to acquire some of the assets of Sub A with a market value of R80 million, a book value of R50 million and a tax value of R35 million. Sub A transfers the assets to Sub B. Sub B issues an interest-free loan of R50 million (equal to book value) to Sub A in consideration for the acquisition of the assets.

Result: The transaction will qualify for the intra-group transaction relief. Sub A will be deemed to have a tax cost of zero in respect of the loan. To the extent that Sub A and Sub B are still members of the same group of companies, any gain or income realised by Sub A as repayment of the loan principle will be disregarded for the purposes of determining Sub A’s gain and income.


Section 45(3A) has been inserted and reads as follows:

(3A) (a) This subsection applies where an asset is acquired by a transferee company from a transferor company in terms of an intra-group transaction and-

(i) any amount incurred by that transferee company as consideration for the acquisition of that asset from that transferor company is funded directly or indirectly by the issue of any-

(aa) debt instrument as defined in section 37I(1); or

(bb) share other than an equity share; and

(ii) that debt instrument or share-

(aa) is issued by a company that forms part of the same group of companies as the transferee company or the transferor company; and

(bb) is issued or used for the purposes of directly or indirectly facilitating or funding that intra-group transaction.

(b) The holder of any debt instrument or share contemplated in paragraph (a) who is part of the same group of companies as the issuer of that debt instrument or share must, for the purposes of-

(i) paragraph 20 of the Eighth Schedule, be deemed to have acquired that debt instrument or share for an amount of expenditure of nil; and

(ii) section 11(a) or 22(1) or (2), be deemed to have acquired that debt instrument or share for an amount of expenditure or cost of nil.


(c) Where an amount, other than an amount of interest, is received by or accrued to a holder in respect of a debt instrument contemplated in paragraph (a) from any company that forms part of the same group of companies as that holder and that amount is applied by the holder in settlement of the amount outstanding in respect of that debt instrument, that amount must be disregarded in determining the aggregate capital gain or the taxable income of that holder.

(d) Where an amount, other than an amount that constitutes a dividend, is received by or accrued to a holder in respect of a share contemplated in paragraph (a) from any company that forms part of the same group of companies as that holder and that amount is applied in reduction of the capital subscribed for that share, that amount must be disregarded in determining the aggregate capital gain or the taxable income of that holder.

Section 45(5)(a)(i) has been amended

A superfluous word has been deleted and it now reads as follows:

45(5)(a)(i) ….so much of any capital gain determined in respect of the disposal of that asset as does not exceed the amount that would have been determined had that asset been disposed of at the beginning of that period of 18 months for proceeds equal to the market value of that asset as at that date, may not be taken into account in determining any net capital gain or assessed capital loss of that transferee company but is subject to paragraph 10 of the Eighth Schedule for from that gain, which taxable capital gain may not be set off against any assessed loss or balance of assessed loss of that transferee company; or….

Section 45(6)(c) has been amended by the addition of the word ‘equity’


This section does not apply in respect of the disposal of an asset if-

(a) deleted by Act No 35 of 2007

(b) all the receipts and accruals of the transferee company are exempt from tax in terms of section 10(1)(cA), (cN), (cO),

(cP), (d) or (t);

(c) the asset was disposed of by the transferor company in exchange for equity shares issued by the transferee company;

(d) the asset constitutes a share that is distributed by the transferor company to the transferee company;

(e) the asset was disposed of by the transferor company to the transferee company in terms of a liquidation distribution

referred to in section 47 regardless of whether or not an election has been made for the provisions of that section to apply

and regardless of whether or not that transferee company acquired that asset as a capital asset or as trading stock;

(f) the asset constitutes a share in the transferee company; or

(g) at the time of the disposal of the asset, the transferor company and the transferee company agree in writing that this

section does not apply to that disposal.

Effective date

Section 45(3A) comes into operation on 1 January 2012 and applies in respect of years of assessment commencing on or after that date.

The amendments to section 45(5) and (6) come into operation on 30 August 2010 and apply in respect of transactions entered into-

(a) on or after that date; and

(b) on or before 31 December 2012.

____________________________________

UNBUNDLING TRANSACTIONS


Refer to the detailed notes on CFC restructuring for an explanation and background to the CFC changes set out below.


The amended section 46(1) reads as follows:

(1) For purposes of this section, ‘unbundling transaction’ means any transaction-


(a) (i) in terms of which all the equity shares of a company (hereinafter referred to as the ‘unbundled company’) which is a resident that are held by a company (hereinafter referred to as the ‘unbundling company’) which is a resident, are distributed by that unbundling company to the shareholder or shareholders of that unbundling company in accordance with the effective interest of that shareholder or those shareholders, as the case may be, in the shares of that unbundling company, but only to the extent to which those shares are so distributed-

(aa) where that unbundling company is a listed company and the shares of the unbundled company are listed shares or will become listed shares within 12 months after that distribution, to the shareholders of that unbundling company;

(bb) where that unbundling company is an unlisted company, to any shareholder of that unbundling company that forms part of the same group of companies as that unbundling company; or

(cc) pursuant to an order in terms of the Competition Act, 1998 (Act No. 89 of 1998), made by the Competition Tribunal or the Competition Appeal Court, to the shareholders of that unbundling company; and

(ii) if the shares distributed as contemplated in subparagraph (i) constitute-

(aa) where that unbundled company is a listed company immediately before that distribution-

(A) and no shareholder in the unbundled company other than the unbundling company holds the same number of equity shares as or more equity shares than the unbundling company in that unbundled company, more than 25% of the equity shares of the unbundled company; or

(B) and any shareholder in the unbundled company other than the unbundling company holds the same number of equity shares as or more equity shares than the unbundling company in that unbundled company, at least 35% of the equity shares of that unbundled company; or

(bb) where that unbundled company is an unlisted company immediately before that distribution, more than 50% of the equity shares of that unbundled company; or

(b) (i) in terms of which all the equity shares of an unbundled company which is a controlled foreign company that are held by an unbundling company which is a resident or a controlled foreign company are distributed by that unbundling company to the shareholder or shareholders of that unbundling company in accordance with the effective interest of that shareholder or those shareholders, as the case may be, in the shares of that unbundling company, but only to the extent to which those shares are so distributed to shareholders of that unbundling company that form part of the same group of companies as that unbundling company (without regard to paragraph (i)(ee) of the proviso to the definition of ‘group of companies’ in section 41) immediately after that distribution; and

(ii) if, immediately before the distribution contemplated in subparagraph (i), the unbundling company holds more than 50% of the equity shares of the unbundled company.

Both proviso’s to section 46(6)(1) have been deleted

Section 46(5) has been substituted


(5)(a) Where shares are distributed by an unbundling company to a shareholder in terms of an unbundling transaction, the distribution by that unbundling company of the shares must, for the purposes of the definition of ‘dividend’ and the definition of ‘return of capital’ in section 1, be deemed not to be an amount transferred by that unbundling company for the purposes of Part VIII of Chapter II.

(5)(b) has been deleted

Section 46(7)(b)(i) has been amended


(a) This section does not apply if, immediately after any distribution of shares in terms of an unbundling transaction, 20% or more of the shares in the unbundled company are held by a disqualified person either alone or together with any connected person (who is a disqualified person) in relation to that disqualified person.

(b) For the purposes of paragraph (a), a ‘disqualified person’ means-

(i) a person that is not a resident; unless that person is a controlled foreign company;

(ii) the government of the Republic in the national, provincial or local sphere, contemplated in section 10(1)(a);

(iii) a public benefit organisation as defined in section 30 that has been approved by the Commissioner in terms of that section;

(iv) a recreational club as defined in section 30A that has been approved by the Commissioner in terms of that section;

(v) a company or trust contemplated in section 37A;

(vi) a fund contemplated in section 10(1)(d)(i) or (ii); or

(vii) a person contemplated in section 10(1)(cA) or (t).




Where an unlisted unbundling company disposes of shares in an unlisted unbundled company in terms of an unbundling transaction to a shareholder and that unbundled company is a controlled group company in relation to that shareholder immediately before and after that disposal, the provisions of this section will not apply to that disposal if that shareholder and that unbundling company agree in writing that this section does not apply to that disposal.

Effective date

The amendments to section 46(1), (7) and (8) come into operation on 1 January 2013 and apply in respect of transactions entered into on or after that date.

The amendment to section 46(5) comes into operation on 1 April 2012 and applies in respect of distributions made on or after that date.

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LIQUIDATION, WINDING- UP AND DEREGISTRATION


Refer to the detailed notes on CFC restructuring and dividends tax – collateral definitions, for an explanation and background to the changes set out below.



For the purposes of this section ‘liquidation distribution’ means-

(a) in terms of which any company (hereinafter referred to as the ‘liquidating company’) distributes all its assets (other than assets it elects to use to settle any debts incurred by it in the ordinary course of its trade) to its shareholders in anticipation of or in the course of the liquidation, winding up or deregistration of that company, but only to the extent to which those assets are so disposed of to another company (hereinafter referred to as the ‘holding company’) which is a resident and which-

i) is not-

aa) has been deleted;

bb) a public benefit organisation as defined in section 30 that has been approved by the Commissioner in terms of that section;

cc) a recreational club as defined in section 30A that has been approved by the Commissioner in terms of that section; or

dd) a person contemplated in section 10(1)(cA), (cP), (d), (e) or (t); and

ii) on the date of that disposal forms part of the same group of companies as the liquidating company; or

(b) in terms of which a liquidating company distributes all its assets (other than assets it elects to use to settle any debts incurred by it in the ordinary course of its trade) to its shareholders in anticipation of or in the course of the liquidation, winding up or deregistration of that company, if those assets are so disposed of to a holding company which-

(i) forms part of the same group of companies as the liquidating company (without regard to paragraph (i)(ee) of the proviso to the definition of ‘group of companies’ in section 41) immediately before that distribution; and

(ii) is a controlled foreign company in relation to any resident that forms part of the group of companies contemplated in subparagraph (i) immediately before and after that distribution.



Where-

a) a holding company disposes of any equity share in a liquidating company as a result of the liquidation, winding up or deregistration of that liquidating company; or

b) in anticipation of or in the course of the liquidation, winding up or deregistration of a liquidating company, a return of capital by way of a distribution of cash or an asset in specie by that company is received by or accrues to a holding company,

the holding company must disregard that disposal or return of capital for purposes of determining its taxable income, assessed loss, aggregate capital gain or aggregate capital loss.




The provisions of this section do not apply where –

a) [deleted by the Revenue Laws Amendment Act No. 60 of 2008]

b) the holding company and the liquidating company agree in writing that this section does not apply;

bA) the distribution would not be taken into account-

(i) for purposes of determining any taxable income or assessed loss of the liquidating company; or

(ii) where the liquidating company is a controlled foreign company, for purposes of determining the net income, as contemplated in section 9D(2A), of the liquidating company; or

(c) the liquidating company-

i) has not, within a period of 18 months after the date of the liquidation distribution, or such further period as the Commissioner may allow, taken the steps contemplated in section 41(4) to liquidate, wind up or deregister; or

ii) has at any stage withdrawn any step taken to liquidate, wind up or deregister that company, as contemplated in paragraph (i), or does anything to invalidate any step so taken, with the result that the company will not be liquidated, wound up or deregistered:

Provided that any tax which becomes payable as a result of the application of this paragraph shall be recoverable from the holding company or, where the holding company is a controlled foreign company, from any resident who directly or indirectly holds any participation rights in that controlled foreign company as contemplated in section 9D(2).

Effective date

The amendments to section 47(1) and (6) come into operation on 1 January 2012 and apply in respect of transactions entered into on or after that date.

The amendments to section 47(5) come into operation on 1 April 2012 and apply in respect of transactions entered into on or after that date.

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SECONDARY TAX ON COMPANIES

Amendments to section 64C of the Income Tax Act.

Various amendments have been made to section 64C

Updated Companies Act terminology

The definition of ‘share incentive scheme’ in section 64C(1) has been amended

It now reads as follows:

For the purposes of this section-

‘share incentive scheme’ means a scheme in terms of which not more than 20% of the equity share capital of a company is -

a) held by the directors and full-time employees of –

i) such company; or

ii) an associated institution, as defined in paragraph 1 of the Seventh Schedule, in relation to such company, in terms of a share incentive scheme carried on for their own benefit;

b) held by a trustee for the benefit of such directors and employees under an employee share scheme as defined in section 95(1)(c) of the Companies Act, 2008 (Act No. 71 of 2008); or

c) collectively held by such directors and full-time employees, and such a trustee.

Section 64C(4)(a) has been amended

The amendment eliminates the potential overlap between actual and deemed dividends when applying the Secondary Tax on Companies. More specifically, a deemed dividend cannot arise if an actual dividend exists.

The amended section 64C(4) (a) reads as follows:

The provisions of subsection (2) shall not apply--

(a) where the amount constitutes a dividend; and…


Section 64C(4)(i) has been amended

An exemption from deemed dividend treatment exists in the case of loans to trusts so that these trusts can acquire shares for the benefit of employees. However, in practical terms, this exemption was slightly too narrow. The exemption has been accordingly expanded to cover 7th Schedule associated institutions (not just the company or a controlling company).

The amended section 64C(4)(i) provides that the provisions of section 64C(2) will not apply-

(i) to any loan or credit granted to a trust by a company to enable that trust to purchase shares in-

(i) that company;

(ii) the controlling company in relation to that company; or

(iii) an associated institution, as defined in paragraph 1 of the Seventh Schedule, in relation to that company, with a view to the resale of those shares by that trust to employees of that company or that associated institution, under a share incentive scheme operated by the company or the associated institution for the benefit of those employees.

Effective date

The above amendments to section 64C are deemed to have come into operation on 1 January 2011.

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DEBT WITHOUT A SET MATURITY DATE – ANTI AVOIDANCE

Amendments to 24J of the Income Tax Act.

Background

Interest is commonly payable or receivable in respect of debt instruments (or interest is implied through various mechanisms, such as a redemption feature). Specific rules exist that are used to calculate the incurral and accrual of interest per specific period. In essence, these rules require an interest calculation that is based on the present value all future income streams payable or receivable by transacting parties (technically referred to as the ‘yield to maturity’ calculation). The duration of the ‘term’ of the interest forms an important part of the ‘yield to maturity’ calculation formula with the maturity date (i.e. date of redemption) acting as a key marker.

Reasons for change

A concern exists that taxpayers are distorting the interest calculation rules by manipulating the maturity date. Some debt instruments arguably fall outside the interest calculation when they simply lack a maturity date. Payments on some instruments contain a final maturity date with early contingency dates. These instruments distort the calculation because the tax system focuses on the final maturity date when in fact the contingencies will most probably be triggered before. Other instruments are payable on demand so that the maturity date can technically fall anywhere between initial issue and the date demand is actually made. The nature of all these instruments creates difficulties even when created primarily for commercial reasons.

The change

Overview

In view of the above, a specific set of rules will be added to cover all three instruments outlined:

(i) debt without a maturity date (known as perpetual debt),

(ii) debt instruments with uncertain maturity dates, and

(iii) demand instruments.

Perpetual debt will be incorporated into the rules dealing with uncertain maturity dates and special maturity date rules will be added for all the above instruments.

Perpetual debt

The explanatory memorandum tells us that perpetual debt (i.e. a debt instrument lacking a maturity date) is essentially equivalent to shares (and indeed financial accounting fully takes this form into debt as such). Payments in respect of perpetual debt will accordingly be treated as dividends for both the payor and payee. As a result, payments in respect of perpetual debt will no longer be deductible with the payment instead being potentially subject to the new Dividends Tax. We do not feel that the above can be applied and the amendment to section 24J incorporates perpetual debt instruments under the provisions governing debt with uncertain maturity dates (see below).


Debt instruments with uncertain maturity dates

As stated above, a debt instrument may have a final maturity date with one or more maturity dates that may trigger termination before the final maturity date. In these circumstances, the yield to maturity calculation for these debt instruments will be based on the date that the termination will most likely occur based on the balance of probabilities. In addition, rights to renew or extend will be taken into account to extent these rights will more likely than not be exercised based on the balance of probabilities. It should be noted that all of these dates may change over time as facts and circumstances deviate from initial premises (thereby requiring annual adjustments).

Demand instruments

Instruments payable on demand create total uncertainty because the final maturity date is essentially unknown. Therefore, for the sake of simplicity, the term of the instrument is deemed to last for a one year period (i.e. 365 days). Therefore, the ‘yield to maturity’ calculation will be automatically determined solely with reference to the present value of the amounts payable and receivable for that one year period.


The provisions of section 24J of the Income Tax Act have been extended to deal with interest accrued and incurred on a demand instrument. The amendment are as follows:

The following definition has been added after the definition of ‘alternative method’:

‘date of redemption’, in relation to an instrument other than a demand instrument, means-

(a) where-

(i) the terms of that instrument specify a date on which all liability to pay all amounts in terms of that instrument

will be discharged; and

(ii) the date so specified is not, in terms of the instrument, subject to change, whether as a result of any right, fixed or contingent, of the holder of that instrument or otherwise,

that date; or

(b) where-

(i) the terms of that instrument do not specify a date as contemplated in paragraph (a)(i); or

(ii) that date, if so specified, is subject to change as contemplated in paragraph (a)(ii),

the date on which, on a balance of probabilities, all liability to pay all amounts in terms of that instrument is likely to be discharged.

The following definition has been added after the definition of ‘deferred interest’:

‘demand instrument’ means any instrument where the holder of that instrument has, at any time during a year of assessment, a right to require the redemption of that instrument at any time before the date specified in terms of that instrument as the date of redemption of that instrument.

Paragraph (a) of the definition of ‘instrument’ has been amended and now reads as follows:

(a) any bond, debenture, bill, promissory note, certificate or similar arrangement.

The definition of ‘term’ has been amended as follows:

‘term’, in relation to-

(a) a demand instrument, means a period of 365 days commencing on the date of issue or transfer of that instrument; or

(b) an instrument other than a demand instrument, means the period commencing on the date of issue or transfer of that instrument and ending on the date of redemption of that instrument.

Effective date

Other than the amendment to the definition of ‘instrument’ all other amendments to section 24J come into operation on 1 April 2012 and apply in respect of amounts received by or accrued to or incurred by any person during years of assessment commencing on or after that date.

The amendment to the definition of ‘instrument’ is deemed to come into operation as from the commencement of years of assessment ending on or after 1 January 2012.

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DIVIDENDS TAX AND ANTI-AVOIDANCE PROVISIONS

ACCRUAL VERSUS CASH ACCOUNTING

Section 64E(2) of the Income Tax Act

Background

The Secondary Tax on Companies (“STC”) falls on the company declaring the dividend. On 1 April 2012, the STC will be replaced with the Dividends Tax. The Dividends Tax applies at the shareholder-level. Tax liability for the Dividends Tax will be triggered when the dividend is paid to the shareholder. The dividend would have been deemed to be paid on the date on which the dividend accrues to the shareholder. Case law defines accrual as an unconditional entitlement to an amount.

Reasons for change

In many cases (especially in the case of closely-held companies), the date of dividend declaration and the date of dividend payment are the same. However, a delay may exist between declaration and payment. This delay is most prominent in the case of listed companies with these companies using a “last date to register” as an interim date for settling dividend accrual. This issue can also arise in closely-held situations. For example, a closely-held company may declare a dividend far in advance of cash available to clear profits before the entry of new shareholders. The difference in accrual versus payment often causes unique difficulties when applying tax withholding. Withholding agents (especially regulated intermediaries) cannot practically be expected to withhold cash on dividends without timely physical control over the cash. If foreign dividends from foreign shares listed on the JSE are involved, there is the added problem of foreign currency conversion. If the accrual date precedes the cash payment date, the Rand-to-foreign currency value might fluctuate so that the shareholder receives a different Rand value than the Rand value accrued.

The change

Because the concept of accrual often cannot be practically applied in the context of withholding, the timing rules will be changed in favour of actual or constructive payment. Under this revised concept, the Dividends Tax will be triggered when an actual payment of the dividend is made (“actual payment”) or when the dividend becomes payable to the shareholder. The explanatory memorandum states that this is on the last date of registration of the dividend in respect of listed shares. We should point out that the term payable is not defined in the Income Tax Act and is open to interpretation with guidance from past case law.

Example 1:

Facts: Listed Company declares a dividend on 1 March. The last date to register in respect of the dividend is 13 March. The date of payment of the dividend is 20 March.

Result: The explanatory memorandum gives the date of payment (withholding) date as the date on which the dividend is payable by the company payor, which it says is 13 March. We submit that this could be 20 March.

Example 2:

Facts: Company (an unlisted company) announces a declaration of a dividend on 1 March with the date of payment to be announced in the future (i.e. date of payment unspecified). On 15 August, a board decision is made for payment to occur on 1 November with the actual payment made accordingly.

Result: The applicable date is 1 November (i.e. the date that the dividend is payable).

Example 3:

Facts: The facts are the same as Example 2, except that the dividend is ultimately cancelled in October (i.e. before actual payment).

Result: The Dividends Tax never arises because the dividend is never actually paid or payable.

Amendments to the legislation to give effect to the above

Section 64E(2) has been amended and now provides as follows:

For the purposes of this Part, a dividend is deemed to be paid on the earlier of the date on which the dividend is paid or becomes payable by the company that declared the dividend.

Effective date

The amended section 64E(2) comes into operation on 1 April 2012.


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CONTRIBUTED TAX CAPITAL (CTC)

Section 1 of the Income Tax Act definition of CTC and para 19 of the 8th Schedule to the Income Tax Act.

Background

A. Dividends versus return of capital distributions

Company distributions (including buyouts and liquidations) can be classified as dividends or a return of capital. As a general matter, the default position is dividend treatment. However, the transfer of contributed tax capital (“CTC”) translates this treatment into a return of capital distribution.

Under the new dividends tax, dividends paid to individual and foreign persons are subject to a 10% charge (with the latter potentially reduced by virtue of tax treaty). Dividends paid to domestic companies are tax-free. The Dividends Tax is largely enforced through a system of withholding imposed on the paying company (or regulated intermediary). Return of capital creates different results. Gain from return of capital payments to individuals are generally subject to a maximum 10% charge, payments to domestic companies are subject to a 14% charge, and payments to foreign persons are largely exempt. Companies making return of capital distributions will be required to inform recipient shareholders so that these shareholders can properly account for the gain in respect of their annual returns.

B. Allocation of CTC

CTC is a company-level account (not a per share account). The decision to distribute CTC and allocate that CTC is made by the distributing company. However, return of capital distributions in respect of a class of shareholders must be allocated pro rata.

Reason for change

Questions exist about the nature of the rule requiring a pro rata allocation of CTC. More specifically, a forced allocation of CTC may represent an over-declaration for certain shareholders within a class.

The change

As the old law, no requirement existed to allocate CTC to a particular distribution. However, if the paying company decided to transfer CTC pursuant to the distribution, the allocation of the CTC available in relation to that class will be clarified. Under the law as revised (and as initially intended), the distributing company will be limited in transferring CTC. In particular, the CTC allocable must “not exceed” the proportion of the shares generating the distribution in relation to the total shares in that class.

Example

Facts: Company Shareholder owns 50 ordinary shares in Company X with a base cost of R38 000. Company X has a total 250 ordinary shares outstanding. The CTC allocable to the class is equal to R400 000. Pursuant to a buyback, Company Shareholder surrenders all 50 of its ordinary shares in exchange for R100 000.

Result: Of the R100 000 distributed to Company Shareholder, no more than R80 000 of CTC can be allocated to the retiring shares (1/5th of R400 000). The net result is an R80 000 capital distribution and a R20 000 dividend.


Amendment to the definition of ‘CTC’ in section 1 of the Income Tax Act

The amended definition of CTC reads as follows:

‘contributed tax capital’, in relation to a class of shares issued by a company, means—

(a) in the case of a company that is not a resident and that becomes a resident on or after 1 January 2011, an amount equal to the sum of—

(i) the market value of all the shares in that company of that class immediately before the date on which that company becomes a resident; and

(ii) the consideration received by or accrued to that company for the issue of shares of that class on or after the date on which that company becomes a resident, reduced by so much of that amount as—

(aa) the company has transferred on or after the date on which the company becomes a resident for the benefit of any person holding a share in that company of that class in respect of that share; and

(bb) has by the date of the transfer been determined by the directors of the company or by some other person or body of persons with comparable authority to be an amount so transferred; or

(b) in the case of any other company, an amount equal to the sum of—


(i) the stated capital or share capital and share premium of that company immediately before 1 January 2011 in relation to shares in that company of that class issued by that company before that date, less so much of that stated capital or share capital and share premium as would have constituted a dividend, as defined before that date, had the stated capital or share capital and share premium been distributed by that company immediately before that date; and

(ii) the consideration received by or accrued to that company for the issue of shares of that class on or after 1 January 2011, reduced by so much of that amount as—

(aa) the company has transferred on or after 1 January 2011 for the benefit of any person holding a share in that company of that class in respect of that share; and

(bb) has by the date of the transfer been determined by the directors of the company or by some other person or body of persons with comparable authority to be an amount so transferred:

Provided that the amount transferred by a company as contemplated in paragraph (a) or (b) for the benefit of a person holding shares of any class of shares of that company must not exceed an amount that bears to the total of the amount of contributed tax capital attributable to that class of shares immediately before the transfer the same ratio as the number of shares of that class held by that person bears to the total number of shares of that class.

Effective date

The definition of CTC was amended in two stages:

The first is deemed to have come into operation on 1 January 2011.

The second comes comes into operation on 1 April 2012.

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REBATE FOR DIVIDENDS TAX ON INCOME OF FOREIGN COMPANIES

Insertion of section 6sex of the Income Tax Act.

The provisions of section 10(1)(k)(i) proviso (ee) (which does not allow the normal tax exemption for a dividend received by or accrued to a person as a result of a cession – see detailed notes on dividend cessions) could result in a local dividend being taxed twice in South Africa first, it is liable for the dividends tax, and secondly, due to the local dividend exemption being unavailable, it is also liable for normal tax.

This double taxation will result when the shareholder is a non-resident (since the beneficial owner is not a resident company). To provide relief from this double taxation section 6sex has been enacted.

Definitions

Dividend

A ‘dividend’ and a ‘foreign dividend’ are both defined in section 6sex(1) and both definitions are for the purposes of section 6sex.

A ‘dividend’ means any dividend as defined in section 1, but it does not include a dividend paid or declared by a headquarter company.

Refer notes for the amended definition of a ‘dividend’ in section 1.

A ‘foreign dividend’ means any ‘foreign dividend’ as defined in section 10B(1).

Refer notes for the definition of a ‘foreign dividend’ in section 10B(1).

Qualifying circumstance

Paragraph 6sex(2)(a) provides that if, during any year of assessment-

(a)(i) any dividend, foreign dividend or amount of any foreign dividend is, by virtue of section 10(1)(k)(i) or section 22B, included in the income of a foreign company, and

(a)(ii) it is the beneficial owner, as defined in section 64D, of the share to which that dividend, foreign dividend or amount relates at the time of the above inclusion, and

(a)(iii) the dividend, foreign dividend or amount would, but for-

(aa) para (ee) or (ff ) of the proviso to section 10(1)(k)(i), or

(bb) section 22B (the shares in respect of which the dividend has been distributed must have been held by the foreign

company as trading stock),

have been exempt from tax under section 10(1)(k)(i) or section 10B, or


(b)(i) the proceeds from the disposal by a foreign company of shares in another company are, by virtue of paragraph 43A of the Eighth Schedule, increased by an amount equal to any dividend received by or accrued to that foreign company in respect of any share held by it in that other company, and

(b)(ii) that foreign company is the beneficial owner, as defined in section 64D, of the above share at the time of the above

disposal, and

(b)(iii) there would have been no increase in proceeds as contemplated above but for paragraph 43A of the Eighth Schedule,

a rebate determined in accordance with section 6sex(3) must be deducted from the normal tax payable by that foreign company.

Please note that for the provisions of paragraph 43A of the Eighth Schedule to apply, the shares in respect of which the dividend has been distributed must have been held by the foreign company as an investment (capital asset).

Amount of the rebate

Section 6sex(3) provides that for the purposes of section 6sex(2), the rebate is an amount equal to the dividends tax borne by the foreign company during the year of assessment or the following year of assessment which-

(a) in the case of any dividend, foreign dividend or amount contemplated in section 6sex(2)(a)(i), is attributable to that dividend, foreign dividend or amount, or

(b) in the case of any amount contemplated in section 6sex(2)(b)(i), is attributable to that amount.

Determination

Under section 6sex(4), the determination of the rebate as contemplated in section 6sex(3) must be made-

(a) after taking into account an applicable agreement for the prevention of double taxation, and

(b) irrespective of whether a declaration contemplated in section 64G(3) or section 64H(3) has been submitted as contemplated in those provisions for the relevant dividend or foreign dividend.

Effective date

Section 6sex comes into operation on the date when Part VIII of Chapter II of the Income Tax Act comes into operation and applies in respect of-

(a) any dividend, foreign dividend or amount of foreign dividend included in income, or

(b) any dividend received by or accrued to a foreign company, during any year of assessment commencing on or after that date.

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DIVIDENDS TAX – COLLATERAL DEFINITION ISSUES

Amendments to section 1, 7, 8B, 8C, 12E, 64D of the Income Tax Act, paragraph 18 of the fourth Schedule to the Income Tax Act and paragraph 74 of the Eight Schedule to the Income Tax Act.

Background

South African and foreign companies may distribute cash or in specie assets to their shareholders. These distributions may constitute a dividend or a return of capital. Dividends distributed by resident companies generally attract Secondary Tax on Companies (STC) at company level at a flat rate of 10%. On 1 April 2012 the STC system is to be replaced with a Dividends Tax at shareholder level. Dividend distributions made by non-resident companies are referred to as ‘foreign dividends’ and are included in gross income, subject to certain exemptions.

Return of capital payments fall under different tax provisions than dividends. Return of capital payments are subject to Capital Gains Tax. The same capital gain rules apply to both domestic and foreign return of capital payments. As a result of changes made in 2010, the main distinction between a dividend versus a return of capital distribution is based on whether the distribution comes from ‘contributed tax capital’. Distributions drawn from ‘contributed tax capital’ qualify as a return of capital while distributions from other sources qualify as dividends.

Reasons for change

The new Dividends Tax and comprehensive changes to the Companies Act legislation have forced core definitions in the Income Tax Act to be revisited. In 2010, new definitions for domestic and foreign dividends were enacted along with a new definition of equity shares.

While these recent changes are fundamentally correct, the piecemeal nature of these changes creates incongruities and potential anomalies. The relationship of domestic and foreign distributions was also somewhat unclear. A streamlined set of definitions is accordingly required for a cleaner landscape.


The changes

Overview

Three sets of definitions have been introduced. Under the first set, payments from domestic companies by virtue of their shares will be treated either as dividends or return of capital.

Under the second set, payments from foreign companies by virtue of their shares will be treated either as foreign dividends or foreign return of capital.

The third set clarifies the share and equity share definitions.

(Domestic) dividends and return of capital

Core aspects of the (domestic) dividend and return of capital definitions provide roughly the same trigger. Both sets of transactions arise from amounts transferred by a domestic company by virtue of the company’s issued shares or similar interests, regardless of whether the transfer arises by way distribution or repurchase of the company’s own shares. Both sets of transactions exclude the issue by a company of its own shares and general buybacks of a company’s own shares (i.e. where the seller on the open market cannot readily identify the purchaser).

The one distinction between (domestic) dividends and that of a return of capital payment relates to contributed tax capital. Return of capital payments must be drawn from the paying company’s contributed tax capital (i.e. a tax account stemming from shareholder investments measured in tax terms).

Foreign dividends and foreign return of capital

The new foreign dividend definition essentially relies on the foreign income tax law characterisation of the payment of the country in which the company payor is effectively managed. If the country of the company payor does not have any applicable laws in relation to the tax on income, the foreign company law characterisation will prevail. Nonetheless, regardless of any foreign law characterisation, excluded from this definition is the redemption of participatory interests in a foreign collective investment scheme (effectively matching the exclusion of current law).

This definition also takes into account the existence of certain foreign entities that are not recognised as companies for South African company law purposes (e.g. Dutch co-operatives). Certain amounts paid by these entities will lose their status as a foreign dividend to the extent that these amounts are not deductible by that entity under foreign income tax principles that determine the taxes on income in the country in which that entity is effectively managed.

The definition of a foreign return of capital definition has also been added. This definition roughly mirrors the foreign dividend definition but only includes the residual (that is, non-dividend distributions in respect of shares or similar equity instruments made by the foreign company). Like the foreign dividend definition, the status of a foreign payment depends upon foreign income tax provisions (or foreign company law characterisation if the country in which the payor resides lacks an income tax).

Share and equity share definitions

The terms ‘shares’ and ‘equity shares’ are frequently used throughout the Income Tax Act. In 2010, the term ‘equity shares’ was defined as ‘any share or similar interest that does not carry any right to participate beyond a specified amount in a distribution’. The equity share definition was fundamentally correct but has been further changed to include ‘similar equity interest’ as opposed to ‘similar interests’ to clarify that the definition cannot exclude debt.

Reference to ‘similar equity interest’ is meant to cover interests in entities that are similar to companies, such as a member’s interest in a close corporation or a co-operative.

In addition, a ‘share’ definition has been added. This definition mirrors the ‘equity share’ definition with one caveat. The ‘share’ definition applies regardless of whether the share or similar interest ‘carries any right to participate beyond a specified amount in a distribution’.

Removal of the shareholder definition

The shareholder definition focused on both the share register and beneficial ownership. This duality creates confusion because the person named in the share register is not necessarily the beneficial owner of the share (for example, a regulated intermediary). Consistent with the overall philosophy of the Income Tax Act, the focus should solely be on the beneficial owner of the shares. The shareholder definition has been deleted to avoid treating both the registered and beneficial owners of shares as ‘shareholders’. The focus should always be on the beneficial owner of the share (that is, ‘the holder’ or ‘the person who holds the shares’), not the registered owner.

Collateral changes

The above terms are frequently used throughout the Income Tax Act. As a result, the use of the term ‘dividend’ has been clarified as to whether the term is intended to cover domestic versus foreign dividends or a combination of both. The term ‘distribution’ has similarly been clarified as to whether the term includes both dividends and return of capital or simply one kind of distribution. The terms ‘equity shares’ and ‘shares’ have also been reviewed throughout the Income Tax Act to ensure appropriate use. Due to the deletion of the term ‘shareholder’, the concept will instead be denoted by the use of the words ‘holder’ or ‘hold’ to denote beneficial ownership.


Effective date

The amendments in respect of dividends and return of capital are generally effective from 1 January 2012. However, the revised foreign dividend definition is effective from 1 January 2011.

Amended definition of ‘dividend’

“dividend” means any amount transferred or applied by a company that is a resident for the benefit or on behalf of any person in respect of any share in that company, whether that amount is transferred or applied—

(a) by way of a distribution made by; or

(b) as consideration for the acquisition of any share in,

that company, but does not include any amount so transferred or applied to the extent that the amount so transferred or applied—

(i) results in a reduction of contributed tax capital of the company;

(ii) constitutes shares in the company; or

(iii) constitutes an acquisition by the company of its own securities by way of a general repurchase of securities as contemplated in subparagraph (b) of paragraph 5.67(B) of section 5 of the JSE Limited Listings Requirements, where that acquisition complies with any applicable requirements prescribed by paragraphs 5.68 and 5.72 to 5.84 of section 5 of the JSE Limited Listings Requirements.

Amended definition of ‘foreign dividend’

“foreign dividend” means any amount that is paid or payable by a foreign company in respect of a share in that foreign company where that amount is treated as a dividend or similar payment by that foreign company for the purposes of the laws relating to—

(a) tax on income on companies of the country in which that foreign company has its place of effective management; or

(b) companies of the country in which that foreign company is incorporated, formed or established, where the country in which that foreign company has its place of effective management does not have any applicable laws relating to tax on income,

but does not include any amount so paid or payable that—

(i) constitutes a redemption of a participatory interest in an arrangement or scheme contemplated in paragraph (e) (ii) of the definition of “company”; or

(ii) is deductible by that foreign company in the determination of any tax on income on companies of the country in which that foreign company has its place of effective management.

New definition of ‘foreign return of capital’

“foreign return of capital” means any amount that is paid or payable by a foreign company in respect of any share in that foreign company where that amount is treated as a distribution or similar payment (other than an amount that constitutes a foreign dividend) by that foreign company for the purposes of the laws relating to—

(a) tax on income on companies of the country in which that foreign company has its place of effective management; or

(b) companies of the country in which that foreign company is incorporated, formed or established, where that country in which that foreign company has its place of effective management does not have any applicable laws relating to tax on income,

but does not include any amount so paid or payable to the extent that the amount so paid or payable is deductible by that foreign company in the determination of any tax on income of companies of the country in which that foreign company has its place of effective management.

New definition of ‘return of capital’

“return of capital” means any amount transferred by a company that is a resident for the benefit or on behalf of any person in respect of any share in that company to the extent that that transfer results in a reduction of contributed tax capital of the company, whether that amount is transferred—

(a) by way of a distribution made by; or

(b) as consideration for the acquisition of any share in,

that company, but does not include any amount so transferred to the extent that the amount so transferred constitutes—

(i) shares in the company; or

(ii) an acquisition by the company of its own securities by way of a general repurchase of securities as contemplated in subparagraph (b) of paragraph 5.67(B) of section 5 of the JSE Limited Listings Requirements, where that acquisition complies with any applicable requirements prescribed by paragraphs 5.68 and 5.72 to 5.84 of section 5 of the JSE Limited Listings Requirements;

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FOREIGN DIVIDENDS Refer to the section above for amended definitions and refer to the section of the notes dealing with International provisions and more specifically the section on Foreign dividends – a new dispensation.

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DIVIDENDS TAX – IN SPECIE DIVIDENDS Amendment to section 64D, E, EA, F, FA, G, H, I and K of the Income Tax Act and paragraph 74 and 75 of the 8th Schedule to the Income Tax Act.

Background

Companies pay dividends in cash or in kind (i.e. the latter being referred to as dividends in specie). The Secondary Tax on Companies generally imposes tax on companies when declaring dividends. The Dividends Tax will replace the Secondary Tax on Companies. As part of this change, the Dividends Tax will shift technical liability onto the shareholder, but the Dividend Tax will include a withholding tax collection mechanism that is imposed on the payor.

Reason for change

The taxation of in specie dividends poses administrative problems when the method of collection involves withholding. While a company paying the dividend can possibly plan so as to set aside the cash needed to pay the tax for in specie dividends, withholding intermediaries will often not be in this position. Cash availability will be especially problematic for regulated intermediaries (e.g. central securities depository participants). Most regulated intermediaries are merely collection agents that are not otherwise required to hold substantial cash reserves.

Another set of issues relates to the valuation of in specie dividends. Values may be volatile even over short periods (especially if the in specie dividends consist of listed shares). Funds set aside to pay the Dividend Tax may be sufficient at one point in time, but insufficient if the in specie asset subsequently increases in value. It should be noted that valuation is also important in the case of determining company-level gain or loss in respect of the assets distributed and for determining the impact of in specie return of capital distributions.

The change

A. Domestic companies making in specie dividends

A set of special rules have been added for in specie dividends in view of the practical cash problems described above. In particular, the shift of liability to a shareholder-level will not apply in the case of in specie dividends distributed by domestic companies. Under the new system, the company distributing the in specie dividend remains liable for paying the tax. The withholding mechanism for in specie dividends of this nature will be rendered irrelevant.

Despite the shift in liability, in specie dividends will be eligible for the same exemptions as cash dividends. For instance, in specie dividends paid by domestic companies to domestic companies will be exempt like cash dividends. In order for the company payor to receive this exemption, the company must generally receive a declaration of exemption from the beneficial owner by the date that the dividend is paid. The only deviation from the declaration rule involves dividends paid to a domestic group company member or for certain residential property company distributions; in these latter instances, the exemption applies automatically. Tax treaty relief is also available for in specie dividends with declarations from beneficial owners similarly required. Lastly, credits stemming from the Secondary Tax on Companies will be available to the same extent as those credits are available for cash dividends.

Administration of in specie dividends by domestic companies will operate under roughly the same administration as cash dividends. For instance, the tax payment due date will remain the same (i.e. the last day of the month following the month in which the dividend was paid). However, no refunds are envisioned for late declarations.

B. Foreign in specie dividends

Unlike domestic in specie dividends (see above), South Africa (like all countries) does not have the authority to tax foreign residents in respect of foreign-related payments (i.e. foreign companies paying in specie foreign dividends). Therefore, in specie dividends declared by foreign companies will not trigger tax for that foreign company. These dividends will instead be subject to the normal tax (at the maximum effective rate of 10%) without regard to the Dividends Tax, even if the foreign dividend is paid in respect of JSE shares.


Section 64D of the Income Tax Act has been amended

The amended definition of ‘dividend’ reads as follows:

‘dividend’ means any dividend or foreign dividend as defined in section 1 that is-


(a) paid by a company that is a resident; or

(b) paid by a company that is not a resident-

(i) if the share in respect of which that foreign dividend is paid is a listed share; and

(ii) to the extent that that foreign dividend does not consist of a distribution of an asset in specie.

Section 64E of the Income Tax Act has been amended

See CGT section of the notes on company distributions for a detailed explanation of cash versus accrual basis of accounting for dividends.


For the purposes of this Part, a dividend is deemed to be paid on the earlier of the date on which the dividend is paid or becomes payable by the company that declared the dividend.


Where a company declares and pays a dividend and that dividend consists of a distribution of an asset in specie, the amount of the dividend must, for the purposes of subsection (1), be deemed to be equal to the market value of the asset on the date that the dividend is, in terms of subsection (2), deemed to be paid.

Section 64E(4)(a) has been added and provides as follows:

Where, during any year of assessment, any amount is owing to a company in respect of a loan or advance provided by the company to-

(i) a person that is-

(aa) not a company;

(bb) a resident; and

(cc) a connected person in relation to that company; or

(ii) a person that is-

(aa) not a company;

(bb) a resident; and

(cc) a connected person in relation to a person contemplated in subparagraph (i),

that company must, for the purposes of this Part, be deemed to have paid a dividend if that loan or advance is provided by the company by virtue of any share held in that company by a person contemplated in subparagraph (i).

(b) The amount of the dividend that is deemed to have been paid in terms of paragraph (a) must, for the purposes of subsection (1), be deemed to be equal to the greater of-

(i) the market-related interest in respect of that loan or advance, less the amount of interest that is payable to that company in respect of that loan or advance for that year of assessment; or

(ii) nil.

(c) Where during any year of assessment a company is deemed to have paid a dividend in terms of paragraph (a), that dividend must be deemed to have been paid on the last day of that year of assessment.

(d) For the purposes of this subsection, ‘market-related interest’, in relation to any loan or advance provided by a company means the amount of interest that would be payable to that company on the amount owing to that company in respect of that loan or advance for a period during a year of assessment if the loan or advance had been provided for that period at the official rate of interest as defined in paragraph (1) of the Seventh Schedule.

(5) For the purposes of subsection (1), where any amount of any dividend is denominated in any currency other than the currency of the Republic, that amount must be translated to the currency of the Republic by applying the spot rate applicable at the time that the dividend is paid.

Section 64EA titled ‘Liability for tax’ has been inserted

The new section 64EA reads as follows:

Any-

(a) beneficial owner of a dividend, to the extent that the dividend does not consist of a distribution of an asset in specie; or

(b) company that is a resident that declares and pays a dividend to the extent that the dividend consists of a distribution of an asset in specie, is liable for the dividends tax in respect of that dividend.


Section 64F of the Income Tax Act has been amended

Amended section 64F has an amended title together with other amendments and now reads as follows:

Exemption from tax in respect of dividends other than dividends in specie

Any dividend is exempt from the dividends tax to the extent that it does not consist of a dividend in specie if the beneficial owner is-

a) a company which is a resident;

b) the Government, a provincial administration or a municipality;

c) a public benefit organisation approved by the Commissioner in terms of section 30(3);

d) a trust contemplated in section 37A; or

e) an institution, board or body contemplated in section 10(1)(cA);

f) a fund contemplated in section 10(1)(d)(i) or (ii);

g) a person contemplated in section 10(1)(t);

h) a shareholder in a registered micro business, as defined in the Sixth Schedule, paying that dividend, to the extent that the aggregate amount of dividends paid by that registered micro business to its shareholders during the year of assessment in which that dividend is paid does not exceed the amount of R200 000;

i) [deleted];

j) a person that is not a resident and the dividend is a dividend contemplated in paragraph (b) of the definition of ‘dividend’ in section 64D.

Section 64FA has been inserted

The new section 64FA provides as follows:

Exemption from and reduction of tax in respect of dividends in specie

(1) Where a company declares and pays a dividend that consists of a distribution of an asset in specie, that dividend is exempt from the dividends tax to the extent that it constitutes a distribution of an asset in specie if-

(a) the person to whom the payment is made has, by the date of payment of the dividend, submitted to the company-

(i) a declaration by the beneficial owner in such form as may be prescribed by the Commissioner that the portion of the dividend that constitutes a distribution of an asset in specie would, if that portion had not constituted a distribution of an asset in specie, have been exempt from the dividends tax in terms of section 64F; and

(ii) a written undertaking in such form as may be prescribed by the Commissioner to forthwith inform the company in writing should the beneficial owner cease to be a beneficial owner;

(b) the beneficial owner forms part of the same group of companies, as defined in section 41, as that company; or

(c) the dividend constitutes a disposal as contemplated in paragraph 51A of the Eighth Schedule.

(2) A company that declares and pays a dividend that consists of a distribution of an asset in specie is liable for the dividends tax at a reduced rate in respect of the portion of the dividend that constitutes the distribution of an asset in specie if the person to whom the payment is made has, by the date of payment of the dividend, submitted to the company-

(a) a declaration by the beneficial owner in such form as may be prescribed by the Commissioner that the portion of the dividend that constitutes a distribution of an asset in specie would, if that portion had not constituted a distribution of an asset in specie, have been subject to that reduced rate as a result of the application of an agreement for the avoidance of double taxation; and

(b) a written undertaking in such form as may be prescribed by the Commissioner to forthwith inform the company in writing should the beneficial owner cease to be the beneficial owner.

Section 64G(1) of the Income Tax Act has been amended

Amended section 64G(1) reads as follows:

(1) Subject to subsections (2) and (3), a company that declares and pays a dividend, to the extent that the dividend does not consist of a distribution of an asset in specie, must withhold dividends tax from that payment at a rate of 10% the amount of that dividend.

Section 64H(1) of the Income Tax Act has been amended

Amended section 64H(1) reads as follows:

(1) Subject to subsections (2) and (3), a regulated intermediary that pays a dividend, to the extent that the dividend does not consist of a distribution of an asset in specie, that was declared by any other person must withhold dividends tax from that payment at a rate of 10% of the amount of that dividend.


Section 64I of the Income Tax Act has been amended

Amended section 64I reads as follows:

Withholding of dividends tax by insurers

If a dividend, to the extent that the dividend does not consist of a distribution of an asset in specie, is paid to an insurer as defined in section 29A, the insurer must be deemed to be a regulated intermediary and the dividend must, to the extent that the dividend is allocated to a fund contemplated in section 29A(4)(b), be deemed to be paid to a natural person that is a resident by the regulated intermediary on the date that the dividend is paid to the insurer.

Section 64J(2)(b) of the Income Tax Act has been amended

Amended section 64J(2)(b) reads as follows:

(b) the dividends accrued to that company on or after the effective date, to the extent that the person paying the dividend submits a written notice to the company prior to paying the dividend of the amount by which the dividend reduces the STC credit of the company paying the dividend.

Section 64J(3) of the Income Tax Act has been amended

Amended section 64J(3) reads as follows:

For purposes of subsections (1)(b) and (2)(b), the amount by which the STC credit of a company is reduced is deemed to be equal to an amount which bears to the dividend paid by that company to the person or company contemplated in those subsections the same ratio as the amount by which the STC credit of that company is reduced as a result of the payment of that dividend to all shareholders bears to the total dividend paid to all shareholders.

Section 64K(1) of the Income Tax Act has been amended

Amended section 64K(1) reads as follows:

(1) (a) If, in terms of section 64EA(a), a beneficial owner is liable for any amount of dividends tax in respect of a

dividend, that beneficial owner must pay that amount to the Commissioner by the last day of the month following the month during which that dividend is paid by the company that declared the dividend, unless the tax has been paid by any other person.

(b) If, in terms of section 64EA(b), a company is liable for any amount of dividends tax in respect of a dividend, that company must pay that amount to the Commissioner by the last day of the month following the month during which that dividend is paid by the company.

(c) If, in terms of this Part, a person is required to withhold any amount of dividends tax in respect of a dividend, that person must pay that amount, less any amount refundable in terms of section 64L or 64M, to the Commissioner by the last day of the month following the month during which that dividend is paid by that person as contemplated in section 64G or 64H.

(d) If, in terms of this Part, a person is required to make payment of any amount of dividends tax, that person must, together with that payment, submit a return to the Commissioner.

Section 64K(2) of the Income Tax Act has been deleted

Section 64K(4) of the Income Tax Act has been amended

Amended section 64K(4) reads as follows:

Where a person-

(a) has, in terms of section 64G(3) or 64H(3), withheld dividends tax in accordance with a reduced rate in respect of the payment of any dividend; or

(b) that is a company which was, in terms of section 64FA(2), liable for dividends tax at a reduced rate in respect of the declaration and payment of any dividend,

that person must submit to the Commissioner any declaration-

(i) submitted to the person by or on behalf of a beneficial owner; and

(ii) relied upon by the person in determining the amount of dividends tax so withheld, at the time and in the manner prescribed by the Commissioner.

Effective date

The amended sections 64D, E, EA, F, FA, G, H, I, J and K come into operation on 1 April 2012.


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ANTI-AVOIDANCE – HYBRID EQUITY INSTRUMENTS AND INDEPENDENTLY SECURED OR THIRD-PARTY BACKED SHARES

Amendments to section 8E and 8EA of the Income Tax Act.

Background

Debt versus shares

Debt and share instruments have a number of differences in their features and their consequences. In commercial terms, debt represents a claim on a specified stream of cash flows. In its purest form, this claim (and the interest yield thereon) is payable despite the financial performance of the debtor. Shares, on the other hand, represent a contingent claim by shareholders directly or indirectly based on company profits. In tax terms, interest payments on debt are typically deductible by the payer with the same interest payments being included in gross income by the payee. Under the new Dividends Tax, dividend payments in respect of shares are not deductible by the payer but are potentially subject to a 10% charge falling on the payee. Depending on the circumstances, a tax incentive may exist for a taxpayer to attach a label to a debt or share instrument that differs from the underlying substance.

Legislative anti-avoidance rules

Setting aside the potential impact of commercial law, two sets of legislative tax rules exist that seek to address the differences in respect of debt or share instruments when the label of those instruments differs from the substance. Stated dividends in respect of shares (informally known as hybrid shares) will be deemed to be interest if instruments labeled as shares contain certain debt features. Conversely, stated interest in respect of debt (informally known as hybrid debt) will not be deductible if instruments labeled as debt contain certain share features.

Reasons for change

Hybrid shares secured by debt

The tax rules preventing the mismatch between the commercial versus tax nature of hybrid shares has been largely ineffective. Commercial law principles are rarely (if ever) asserted in respect of hybrid shares as a means to recharacterise the label in favour of substance. Moreover, in the case of the current legislative anti-avoidance rules, key impermissible debt features (e.g. required redemptions and optional redemptions by holders) can be avoided by extending the utility of these features beyond a three-year period. These weaknesses within the tax law have led to a set of avoidance schemes that have become costly to the fiscus. The purpose of these schemes is to convert an interest yield into a dividend yield through the use of a series of entities. At some stage within the chain, deductible interest is paid by a domestic taxable entity and roughly the same yield is returned to the same economic group via tax-free preference share dividends from another entity. Within the chain is a tax-free entity (typically a foreign entity wholly outside South African taxing jurisdiction) that holds interest-bearing notes that operates as security for the arrangement. The net effect of the chain is to generate a tax/economic mismatch on the same flow of income.

Hybrid shares backed by third parties

Parties involved in funding often have the freedom to choose debt funding versus preference share funding. While debt funding operates differently than preference share funding in their purest forms, the impact of the two mechanisms can easily be merged by modifying particular funding features. This merging of features allows for preference share funding to replicate most (if not all) of the features of debt while still retaining the tax treatment applicable to preference shares. One of the most common forms of preference share funding operating like debt involves preferences shares that are guaranteed by third parties. These third party guarantees come in a variety of forms, such as put and call options triggered upon dividend short-falls as well as direct guarantees. Many of these third-party backed hybrid arrangements are mainly designed with tax in mind (i.e. the arrangement would have been debt but for undesirable tax consequences). In some of these arrangements, the entity in need of funding has ongoing net losses or is wholly exempt from tax, thereby having no practical need for deductions arising from the incurral of interest. These deductions are accordingly foregone via preference share funding so that the funder (e.g. bank) is exempt upon the receipt of the corresponding yield. In these scenarios, the entity in need of funding is effectively exporting the tax benefits associated with the entity’s net losses or exempt position. Taxpayers should not be allowed to mix-and-match their separate tax bases to the detriment of the fiscus.

The changes

Overview

The anti-avoidance hybrid share rules have been divided into two types. The first type focuses on debt features between the issuer and the holder. The second type focuses on debt features held by outside (i.e. third) parties.


Type one: Independently secured hybrid shares

The anti-avoidance rules pertaining to hybrid shares (triggering ordinary revenue) will be expanded slightly to fully cover preferences shares whose yield is tied to underlying interest bearing notes. More specifically, hybrid shares within the anti-avoidance rules are expanded to include instances where (i) a rate of interest or capital amount subscribed is used in calculating the dividend, and (ii) the hybrid share is secured by a financial instrument, which does not qualify as an equity share. These rules apply without regard to any three-year period (unlike other pre-existing hybrid share rules).

Example

Facts: Company A holds preference shares (that are redeemable in five years) issued by Company B. Company B directly or indirectly holds ordinary shares in Company C with Company C holding interest-bearing notes. Company C is partly owned by an independent financial institution. The dividends payable in respect of the Company A preference shares provide a yield of JIBAR plus 3%. The interest-bearing bonds provide a yield of JIBAR plus 4%. The notes exist as collateral for the preference shares with Company A having a right to acquire the notes if the yield falls below the JIBAR plus 3% level.

Results: The preference shares are linked to an interest-bearing yield, and the preference shares are secured by financial instruments other than equity shares. The preference shares held by Company A are accordingly viewed as hybrid shares subject to the anti-avoidance rule (i.e. the yield on the shares generates ordinary revenue).

Type two: Third-party backed shares

The general rule seeks to eliminate special purpose vehicles and other outside guarantee mechanisms that allow the holder of preference shares to rely on parties other than the issuer of the preference shares. These mechanisms make the conversion of debt into hybrid shares for tax avoidance all-too-common. If a preference share is to be respected as such, the holder should be mainly looking to the risk of the issuer – not some other person. In view of the above concerns, stated dividends in respect of shares backed by third parties will be treated as ordinary revenue. This ordinary revenue treatment will cover various forms of third party backing, all of which will apply without regard to any three-year rule or other timing requirements. More specifically, third-party backing will be deemed to exist if:

1. The holder of the share has a fixed or contingent right to require any party (other than the issuer) to acquire the share, or an obligation exists so that any of those parties is obligated to acquire the share;

2. The holder can rely on a fixed or contingent guarantee, indemnity or similar arrangement from a party other than the issuer; or

3. The holder has a fixed or contingent right to procure, facilitate or assist with the acquisition of the share or repayment of the value associated with the share (or the issuer is subject to a corresponding obligation).

Example

Facts: Collective Investment Scheme holds preference shares issued by a Preference Share Company. The preference shares provide a prime plus one yield. To secure the performance of the preference shares, a third-party bank grants a put option to Collective Investment Scheme that is exercisable on the occurrence of certain credit events (e.g. failure of the preference shares to generate the specified yield of prime plus one).

Results: The dividends received by Collective Investment Scheme from the preference shares are to be treated as fully taxable ordinary income. This treatment exists because Collective Investment Scheme does not bear the risk of the Preference Share Company due to the put option granted by the third-party bank.

Exemption for operating company share acquisitions

One of the unique features of the South African tax system is the system’s general disallowance of interest deductions in respect of funds borrowed to acquire shares because the yield on the shares (i.e. dividends) is not generally includible as income. As a result, a company borrowing funds enjoys no tax deduction for the interest incurred if the funds are used to acquire shares while the same interest generates includible income for the creditor. This mismatch places both parties to the borrowed funds in a harsh position, thereby raising the cost of capital to an unsustainable level. In order to eliminate this mismatch, parties borrowing funds to acquire shares (including parties seeking to facilitate black economic empowerment) often use preference share funding. Preference share funding effectively eliminates the includible income for the funder, thereby leaving the overall funding in a net neutral position (no deduction for the yield with no corresponding income). This form of preference share funding often entails third-party backed guarantees in order to be commercially viable.

The new anti-avoidance regime relating to third-party backed shares accordingly contains a special exemption that recognises the need for third-party backed shares when funding is directly or indirectly related to the acquisition of shares of an operating company. Under this exemption, certain forms of third-party backed funding can be disregarded if the funding is used for one of the following four applications:

1. To acquire equity shares in an operating company;


2. To indirectly acquire equity shares in an operating company by acquiring shares in another company with the funds ultimately used or applied solely to acquire equity shares in an operating company (e.g. back-to-back preference share funding);

3. To settle any debt (and interest thereon) if the debt was previously incurred for the purpose of acquiring equity shares in an operating company (e.g. to replace bridging loans incurred to acquire shares in an operating company); or

4. To acquire (by way redemption or otherwise) any preference shares (and accumulated dividends thereon) if the preference share funding was previously incurred for the purpose of acquiring equity shares in an operating company.

For purposes of this exception, an operating company (i.e. the object of the funding) must carry on business continuously and that business must entail the provision of goods or services. Alternatively, the company to be acquired (i.e. the object of the funding) must be a holding company that directly or indirectly controls an active company (i.e. a company that carries on business continuously with a business entailing the provision of goods and services).

Transactions falling within this exception for the acquisition of operating company shares can disregard two types of third-party backed shares:

1. Third-party backed guarantees from the issuer (i.e. the party issuing the preference shares), or

2. Third-party backed guarantees from the target company whose shares are acquired (i.e. the object of the funding).

These guarantees can come from shareholders that directly or indirectly hold more than 20% of the issuing company or the target company. Alternatively, these guarantees can come from companies that are directly or indirectly controlled by the issuing company or the target company.

Example 1

Facts: Holding Company holds all the shares of Acquiring Company that acquires all of the ordinary shares in Operating Company with funding from Bank. Acquiring Company issues preference shares to Bank as a funding mechanism. As security for the preference share funding, Holding Company of the Acquiring Company issues a guarantee in favour of Bank that is exercisable if Acquiring Company defaults on the obligation to provide the required yield on the preference shares issued.

Results: The exception to third-party backed funding applies. The guarantee by Holding Company will not taint the preference shares.

Example 2

Facts: Black Economic Empowerment Company acquires all of the ordinary shares of Holding Company with funding from Bank. Black Economic Empowerment Company issues preference shares to Bank as a funding mechanism. Holding Company holds all of the shares of Subsidiary, a company that actively and continuously engages in the provision of goods. As security for the preference share funding, Subsidiary issues a guarantee in favour of the Bank that is exercisable if Black Economic Empowerment Company defaults on the obligation to provide the required yield on the preference shares issued.

Result: The exception to third-party backed funding applies. The guarantee by Subsidiary will not taint the preference shares.

Amended legislation to give effect the above

Hybrid Equity Instruments

Amendments have been made to section 8E. It deals with hybrid equity instruments. In its amended form section 8E(2) provides that a dividend or foreign dividend received by or accrued to a person from a share that is received or accrues during a year of assessment when it at any time during that year constitutes a hybrid equity instrument is deemed, in relation to him only, to be interest accrued to him.

Definitions

Section 8E(1) defines a ‘hybrid equity instrument’. In terms of paragraph (a) of the definition of a ‘hybrid equity instrument’, it means any share other than an equity share if:

its issuer is obliged to redeem it in whole or in part, or

it may at the option of the holder be redeemed in whole or in part,

within a period of three years from the date when it is issued.

In terms of paragraph (b) of the definition of a ‘hybrid equity instrument’, it means any other share if:

its issuer is obliged to redeem it in whole or in part within a period of three years from the date when it is issued,


it may at the option of the holder be redeemed in whole or in part within a period of three years from the date when it is issued, or

at the time of its issue, the existence of the company issuing it:

(A) is to be terminated within a period of three years, or

(B) is likely to be terminated within a period of three years upon a reasonable consideration of all the facts at that time.

There is a further requirement for a share to be a ‘hybrid equity instrument’, under paragraph (b) of the definition of a ‘hybrid equity instrument’. It is contained in paragraph (b)(ii) of the definition of a ‘hybrid equity instrument’. This further requirement is that:

the share must not rank pari passu as regards its participation in dividends or foreign dividends with all other ordinary shares in the capital of the relevant company, or

when the ordinary shares in the company are divided into two or more classes, with the shares of at least one of these classes, or

a dividend or foreign dividend payable on such share is to be calculated directly or indirectly with reference to-

(aa) a specified rate of interest,

(bb) the amount of capital subscribed for it, or

(cc) the amount of a loan or advance made directly or indirectly by the shareholder or his connected person.

Paragraph (c) of the definition of a ‘hybrid equity instrument’ provides that it means a share if:

a dividend or foreign dividend payable on it is to be calculated directly or indirectly with reference to a specified rate of interest or the amount of capital subscribed for it, and

it is directly or indirectly secured by a financial instrument other than an equity share.

It is important to note that under paragraph (c) of the definition of a ‘hybrid equity instrument’, the requirement of a less than

three-year holding period is not present.

Date of issue

The definition of ‘date of issue’ has been amended. In its ‘amended form’ in relation to a share it means the date on which

it is issued by that company,

the company at any time after it is issued undertakes the obligation to redeem it in whole or in part, and

its holder at any time after it is issued obtains the right to require it to be redeemed in whole or in part, otherwise than as a result of its acquisition by him.

The above are attempting to deal with situations of disguised debt and focus on the redemption features added after the initial date of issue of the share.

Right of disposal

The definition of a ‘right of disposal’ has been deleted.

Effective date

The amended section 8E comes into operation on 1 April 2012 and applies to dividends or foreign dividends received or accrued on or after that date.

Dividends on third-party backed shares deemed to be income in relation to recipients thereof

Section 8EA has been inserted

Section 8EA(2) provides that a dividend or foreign dividend received by or accrued to a person on a share that is received or accrued during a year of assessment when that share at any time during that year constitutes a third-party backed share is deemed, in relation to him only, to be income received by or accrued to him.


Definitions

The following definitions apply for the purposes of section 8EA:

Enforcement obligation

An ‘enforcement obligation’ in relation to a share means an obligation, whether fixed or contingent, of a person other than its issuer to:

acquire it from its holder,

make a payment for it under a guarantee, indemnity or similar arrangement or

procure, facilitate or assist with its acquisition as contemplated above or the making of a payment for it as contemplated above.

Enforcement right

An ‘enforcement right’ in relation to a share means a right, whether fixed or contingent, of its holder or his connected person

to require a person other than its issuer to

acquire it from its holder,

make a payment for it under a guarantee, indemnity or similar arrangement or

procure, facilitate or assist with its acquisition as contemplated above or the making of a payment contemplated above.

Equity share

An ‘equity share’ means an equity share as defined in section 1, other than an equity share that would have constituted a

‘hybrid equity instrument’, as defined in section 8E(1), but for the three-year period requirement contemplated in

paragraph (a) of the definition of a ‘hybrid equity instrument’, in that provision.

An ‘equity share’ as defined in section 1 means a share in a company, excluding a share that,

neither for dividends, nor

for capital,

carries a right to participate beyond a specified amount in a distribution.

Operating company

An ‘operating company’ means

a company that carries on business continuously, and in the course or furtherance of that business provides goods or services for consideration, or

a company that is a controlling group company in relation to a company.

The term ‘controlling group company’ is defined in section 1. It means a controlling group company contemplated in the

definition of a ‘group of companies’.

Third-party backed shares

A ‘third-party backed share’ means a share on which an enforcement right is exercisable, or an enforcement obligation is enforceable, as a result of a specified dividend or foreign dividend attributable to it not being received by or accruing to the person holding it.

There is a proviso to the definition of ‘third-party backed share’ which states that when the consideration received by or accrued to the issuer of a share which, but for this proviso, would have constituted a third-party backed share was used by that issuer to-

acquire an equity share in an operating company,

indirectly acquire an equity share in an operating company by means of the acquisition of another share in another company, if that consideration is used or applied directly or indirectly for the purpose of acquiring an equity share in an operating company,

settle a

debt incurred by it for the purpose of acquiring an equity share in an operating company, or


interest accrued on the above debt, or

acquire another share issued by it if:

○ that other share, but for this proviso, would have constituted a third-party backed share, and

○ that consideration does not exceed the amount outstanding for that share, being the capital subscribed for the acquisition of, and an amount of dividends or interest accrued for, that other share,

○ in the determination of whether

an enforcement right is exercisable for that share, no regard must be had to an arrangement under which the holder of that share has an enforcement right for that share and that right is exercisable only against

○ that operating company or a person that directly or indirectly holds more than 20% of the equity shares in that operating company,

○ a person that directly or indirectly holds more than 20% of the equity shares in it, or

○ a company that is a controlled group company in relation to that operating company or it, and

an enforcement obligation is enforceable for that share, no regard must be had to an arrangement under which

○ that operating company or a person that directly or indirectly holds more than 20% of the equity shares in that operating company,

○ a person that directly or indirectly holds more than 20% of the equity shares in it, or

○ a company that is a controlled group company in relation to that operating company or it,

○ has an enforcement obligation for that share and that obligation is enforceable by the holder of that share.

Effective date

Section 8EA comes into operation on 1 October 2012 and applies to dividends or foreign dividends received or accrued on or after that date.

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ANTI-AVOIDANCE – DIVIDEND STRIPPING ADJUSTMENTS

Amendments to section 10(1)(k))(i)(cc) and 22B of the Income Tax Act and paragraph 19 and 43A of the Eighth Schedule to the Income Tax Act.

The explanatory memorandum, reproduced below, was prepared based on the amendments proposed in the Bill, on release of the final Act these had been changed and the provisions were expanded somewhat. The final version of both section 22B and paragraph 43A of the Eighth Schedule contain similar subparagraphs (2)(b). We are not certain whether the ‘and’ between subparagraph (2)(a) and (b) in section 22B is intentional or whether it should read ‘or’. The ‘and’ weakens the provision considerably whereas an ‘or’ would make the provisions very onerous. In addition neither ‘and’ nor ‘or’ has been inserted between paragraph 43A(2)(a) and (b) which is clearly a mistake. Please read the amendments to the legislation carefully to determine what is provided for in the Act. We hope this uncertainty will be resolved in the 2012 amendments.

Background

Pre-sale purchaser-funded dividends

New anti-avoidance rules have been introduced that deem certain pre-sale dividends as ordinary revenue or capital gain proceeds when those dividends are associated with the disposal of target controlled (i.e. more than 50% owned) company shares. These anti-avoidance rules apply only in respect of resident shareholders and resident target companies. The anti-avoidance rules are aimed at situations where pre-sale dividends stem from purchaser funding. In these instances, the target controlled company to be disposed of typically borrows funds guaranteed or backed by the purchaser and uses the funds to distribute dividends to the selling shareholder (with the purchaser group ultimately repaying the loan). The effect of these pre-sale dividends is to reduce the explicit selling price of the target company shares. In tax terms, the result is a potentially tax-free dividend if the selling shareholder is a company with the tax-free dividend acting as an economic substitute for taxable sale proceeds. The anti-avoidance rules accordingly convert the tax-free dividends into ordinary revenue or capital gain proceeds (depending on whether the shares are capital or revenue in nature).


Extra-ordinary dividends

An older set of anti-avoidance rules exist to prevent extra-ordinary dividend stripping that significantly devalues underlying shares before disposal. The concern in this circumstance is the distribution of extra-ordinary tax-free dividends in respect of shares (held as capital) followed by a capital loss upon disposal of the shares (with the loss stemming from the devaluation of the shares caused by the dividend). The anti-avoidance rules essentially eliminate the capital loss.

Reasons for change

The landscape for both domestic and foreign dividends has changed dramatically in 2012 with both domestic and foreign dividends generally taxable at an effective rate of 10%. Both domestic and foreign dividends will also have a revised set of exemptions. With these changes, the anti-avoidance dividend stripping rules needed to account for the revised landscape. More specifically, the rules have been changed to account for cross-border dividends (dividends coming in and out of South Africa) in addition to the previous limitations imposed solely on dividends between domestic companies. The anti-avoidance rules for extraordinary dividends additionally have been re-aligned for the revised set of dividend exemptions.

The change

New coverage for cross-border dividends

As stated above, the old anti-avoidance dividend stripping rules apply only in respect of domestic dividends distributed to domestic companies. The anti-avoidance provisions have been extended to additionally cover

(i) foreign company dividends to South African shareholders, and

(ii) domestic company dividends to foreign company shareholders.

Revised tainted dividends involved in extra-ordinary dividends

The goal of the extra-ordinary dividend stripping rules is to target extra-ordinary exempt dividends followed by artificial losses on share disposals. The new rules clarify the law regarding the (exempt) dividend triggering event and update definitions to fully reflect the current landscape. (Note: This provision has little practical impact on foreign shareholders because foreign shareholders generally fall outside the capital gains system unless the shares relate to an immovable property company).

Note on tax rebates (credits) to prevent double taxation

If a taxpayer receives dividends already subject to the Dividends Tax, a rebate is available to reduce normal taxes or capital gains otherwise due (i.e. the same rebate as for the ordinary revenue treatment arising from non-at risk dividends and manufactured dividends).


Deletion of section 10(1)(k)(i)(cc) of the Income Tax Act

Automatic ordinary revenue treatment for taxpayers disposing of ‘trading stock’ shares in a buyback is inconsistent with the new dividend definition, which treats specific buybacks as dividends. This dividend treatment should equally apply regardless of whether the shares are held as trading stock or capital. This automatic ordinary revenue treatment is also unnecessary as an anti-avoidance mechanism given the addition of the minimum holding period rules for the dividend exemption. Section 10(1)(k)(i)(cc) has therefore been deleted.

Effective date

The deletion of section 10(1)(k)(i)(cc) comes into effect on 1 April 2012.

Dividends treated as income on disposal of certain shares

Section 22B of the Income Tax Act has been substituted and now reads as follows:

22B(1) For the purposes of this section, ‘exempt dividend’ means any dividend or foreign dividend to the extent that the dividend or foreign dividend is-

(a) not subject to tax under Part VIII of Chapter II; and

(b) exempt from normal tax in terms of section 10(1)(k)(i) or section 10B(2)(a) or (b).

(2) Where a taxpayer that is a company disposes of shares in another company, the amount of any exempt dividend received by or accrued to the taxpayer in respect of any share held by the taxpayer in that other company must be included in the income of the taxpayer-

(a) (i) to the extent that the exempt dividend is received by or accrues to the taxpayer within a period of 18 months prior to or as part of the disposal;

(ii) if the taxpayer immediately before the disposal-

(aa) held the shares disposed of as trading stock; and

(bb) held more than 50% of the equity shares in the other company; and


(iii) if the other company (or any company in which that other company directly or indirectly holds more than 50% of the equity shares) has, within a period of 18 months prior to that disposal, obtained any loan or advance or incurred any debt by reason of or in consequence of the disposal-

(aa) owing to the person acquiring the shares or any connected person in relation to that person; or

(bb) that is guaranteed or otherwise secured by the person acquiring the shares or any connected person in relation to that person; and

(b) if the share in respect of which the exempt dividend is so received or accrues is disposed of by that company within a period of 45 days after the date of accrual in respect of that exempt dividend.

(3) For the purposes of subsection (2)(a), the amount that must be included in the income of the taxpayer is limited to the amount of the loan, advance or debt contemplated in subparagraph (iii) of that subsection.

Effective date

The amendment to section 22(B) comes into operation on 1 April 2012.

Limitation of losses on the disposal of certain shares – Paragraph 19 of the Eighth Schedule to the Income Tax Act

Paragraph 19(1) and (3)(b) and (c) have been amended. The amended paragraph 19 reads as follows:

(1) Where a person disposes of a share in a company—

(a) as a result of the acquisition by the company from that person of that share or as part of the liquidation, winding-up or deregistration of that company, that person must disregard so much of any capital loss resulting from the disposal as does not exceed any exempt dividends; or

(b) in circumstances other than those contemplated in item (a), that person must disregard so much of any capital loss resulting from the disposal as does not exceed any extraordinary exempt dividends, received by or accrued to that person in respect of that share within a period of 18 months prior to or as part of the disposal.

(2) [deleted by the Revenue Laws Amendment Act, 2007 (Act No. 35 of 2007)].

(3) For the purposes of this paragraph—

(a) the period of 18 months does not include any days during which the person disposing of a share—

(i) has an option to sell, is under a contractual obligation to sell, or has made (and not closed) a short sale of, substantially similar financial instruments;

(ii) is the grantor of an option to buy substantially similar financial instruments; or

(iii) has otherwise diminished risk of loss with respect to that share by holding one or more contrary positions with respect to substantially similar financial instruments;

(b) ‘exempt dividend’ means any dividend or foreign dividend to the extent that the dividend or foreign dividend is-

(i) not subject to any tax under Part VIII of Chapter II; and

(ii) exempt from normal tax in terms of section 10(1)(k)(i) or section 10B(2)(a) or (b);

(c) ‘extraordinary exempt dividends’ means so much of the amount of the aggregate of any exempt dividends received or accrued within the period of 18 months contemplated in subparagraph (1) as exceeds 15% of the proceeds received or accrued from the disposal contemplated in that subparagraph.

(d) ‘holding company’ and ‘intermediary company’ means a ‘holding company’ and ‘intermediary company’ as defined in section 64B of this Act.

Effective date

The amendments to paragraph 19 come into operation on 1 April 2012.

Dividends treated as proceeds on disposal of certain shares – Paragraph 43A of the Eighth Schedule to the Income Tax Act

Paragraph 43A has been substituted. The new paragraph 43A reads as follows:

(1) For the purposes of this section, ‘exempt dividend’ means any dividend or foreign dividend to the extent that the dividend or foreign dividend is-

(a) not subject to any tax under Part VIII of Chapter II; and

(b) exempt from normal tax in terms of section 10(1)(k)(i) or section 10B(2)(a) or (b).

(2) The proceeds from the disposal by a taxpayer that is a company of shares in another company must be increased by an amount equal to the amount of any dividend or foreign dividend that is exempt in terms of section 10B(2)(a) received by or accrued to that taxpayer in respect of any share held by the taxpayer in that other company-

(a) (i) to the extent that that dividend is received by or accrues to the taxpayer within a period of 18 months prior to or as part of the disposal;


(ii) if the taxpayer immediately before the disposal-

(aa) held the shares disposed of as a capital asset (as defined in section 41); and

(bb) held more than 50% of the equity shares in the other company; and

(iii) if the other company (or any company in which that other company directly or indirectly holds more than 50% of the equity shares) has, within a period of 18 months prior to that disposal, by reason of or in consequence of the disposal obtained any loan or advance or incurred any debt-

(aa) owing to the person acquiring the shares or any connected person in relation to that person; or

(bb) that is guaranteed or otherwise secured by the person acquiring the shares or any connected person in relation to that person;

(b) if the share in which the dividend or foreign dividend is so received or accrues is disposed of by that company within a period of 45 days after the date of accrual in respect of that dividend or foreign dividend.

(3) For the purposes of subparagraph (2)(a), the amount by which the proceeds must be increased is limited to the amount of the loan, advance or debt contemplated in subitem (iii) of that subparagraph.

Effective date

The substitution of paragraph 43A comes into operation on 1 April 2012.

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ANTI-AVOIDANCE – DIVIDEND CESSIONS

Amendments to section 6sex, section 10(1)(k)(i) and section 103 of the Income Tax Act.

Background

Domestic companies are subject to secondary tax on companies (STC) at 10% when distributing dividends; these dividends are exempt from tax when received or accrued by shareholders. Once the new Dividends Tax is in place, the 10% tax on dividends will no longer be borne by the company paying the dividend but by the eventual recipient. This new tax on dividends contains a number of exemptions (such as the exemption for dividends paid to domestic companies). Parties often enter into cession contracts whereby a cedent transfers rights to a cessionary. These cessions include the cession of dividends otherwise associated with underlying shares. Cessions may occur when dividend rights are ceded before or after the declaration of dividends. Cessions of this nature are typically undertaken in exchange for consideration. These cessions are generally effective and the amounts ceded typically retain their character as dividends.

Reasons for change

As a general matter, taxpayers treat dividend cessions as a mere assignment of dividends from a cedent (e.g. the holder of shares initially entitled to the dividend) to a cessionary (i.e. the assignee). However, in many circumstances, the character of a ceded dividend is effectively transformed once the dividend is separated from any meaningful stake in the underlying shares. Stated differently, the cessionary is merely purchasing an income stream – an event that makes the receipt of the income distinct from the distribution of the underlying dividend. At a theoretical level, two differing policies are at stake. Domestic companies receiving dividends are exempt to prevent multi-tier taxation.

Distributed profits going through a chain of domestic companies should generally be taxed only once (under the STC, the charge typically arose at the beginning; under the new Dividends Tax, the charge will typically arise at the end). On the other hand, the progressivity principle demands that each taxpayer

(including companies) be fully subject to tax at ordinary rates. While the progressivity principle should give way to the principle against multiple-level taxation as a general matter, this compromise becomes questionable when the company beneficiary of a dividend lacks any meaningful interest in the underlying shares giving rise to the dividend. In the case of a dividend cession, the cessionary receiving the dividend has no interest in the underlying shares and should accordingly be fully taxed under the progressivity principle. The lack of balance outlined above has given rise to a host of avoidance schemes. Many companies regularly purchase dividends via cessions solely due to their tax-free nature so as to undermine the tax system. These purchases would simply not exist but for tax arbitrage. Dividend cessions occuring after dividend declaration especially lack any non-tax commercial rationale. Still worse, these cessions are often accompanied by seemingly deductible finance schemes, whereby the link between the tax-free income and the deductible finance is artificially broken. The net effect is a book tax disparity with taxpayers achieving neutrality on their financial books along with a net tax deduction.


The change

Overall concept

The policy around dividend exemptions is not at stake. Domestic and foreign companies (and trusts) receiving dividends will remain exempt (or subject to tax at a reduced rate) if these companies have a meaningful underlying stake in the company paying dividends. To be meaningful, the company (or trust) receiving the dividend must be exposed to the risk of profit and loss associated with the underlying share. Failure to achieve this meaningful interest will result in tax at ordinary rates. The proposal will mainly eliminate the tax-free nature of dividends obtained by way of cession and for dividends in respect of shares held only momentarily. Dividends received shortly before the disposal of trading stock will also be subject to tax as ordinary revenue. These presale dividends are effectively part of the sales trading stock proceeds,

Technical trigger

Proposed taxation of certain dividends at ordinary rates applies solely to domestic and foreign companies (or trusts) receiving (domestic or foreign) dividends. Natural persons fall outside this ordinary treatment because the disconnect between dividends received by natural persons and the underlying shares may be driven by other non-tax factors (e.g. testamentary trusts offering dividend streams to heirs without the heirs having any underlying interest in the underlying distributing shares). Ordinary treatment under the proposal will arise under either one of two triggering events.

The first trigger is an automatic trigger for dividends from all shares; the second trigger arises only if the underlying shares are held as trading stock.

Automatic Trigger: Ordinary revenue treatment (i.e. the loss of exemption) for dividends arises whenever a company benefiting from dividends fails to hold the underlying shares from the beginning of the date that the dividend was declared until the close of the date when the dividend is received and accrued. This rule applies without regard to whether the underlying shares are held as trading stock or as capital.

Trading Stock: Under this second trigger, ordinary revenue treatment additionally applies whenever a company benefiting from those dividends holds the underlying shares as trading stock and the dividend is received or accrued within 45 days before disposal of the share.

Note on offsetting positions: For purposes of the above timing calculation, taxpayers benefiting from dividends cannot take into account days whereby the taxpayer has offsetting positions in respect of the underlying distributing shares. For instance, if a taxpayer holds distributing shares in the long position and at the same time has in place a short position to hedge the risk in respect of those long shares, the holding in the long position will be disregarded for the duration of the hedge.

Example 1

Facts: Distributing Domestic Company declares dividends on 10 March 2012 in respect of the Distributing Domestic Company shares. On 11 March 2012, Domestic Company X acquires R5 million of Distributing Domestic Company ordinary dividends by way of cession. Distributing Domestic Company pays the declared dividends on 2 April 2012.

Result: The dividends ceded to Domestic Company X are taxed as ordinary revenue. No exemption applies because the shares are never held by Domestic Company X on the relevant dates.

Example 2

Facts: Distributing Domestic Company declares dividends on 12 June 2012 in respect of its ordinary shares and pays those dividends on 10 July. Domestic Company Shareholder owns the ordinary shares from 5 July 2012 until 15 July 2012 and accordingly receives the 10 July dividends. Domestic Company Shareholder holds the shares as trading stock until disposal on 15 July 2012.

Result: The dividends received by Domestic Company Shareholder are taxed as ordinary revenue. No exemption applies because the underlying trading stock shares are not held for the requisite 45 day period before disposal.

Example 3

Facts: On 20 March 2012, Domestic Company Shareholder acquires Distributing Domestic Company ordinary shares for investment capital purposes. On 15 September 2014, Domestic Company Shareholder changes the investment intent in respect of the ordinary shares to trading stock. Dividends are declared in respect of the ordinary shares on 20 September and paid on 1 October 2012. On the 10 October 2012, Domestic Company Shareholder sells the ordinary shares.

Result: The dividends paid to Distributed Company Shareholder are treated as ordinary revenue. The dividends are not exempt because the dividends are received or accrued within 45 days before disposal (the fact that shares are held for over two years before is irrelevant).

Shares held via trusts

Dividends receives through trusts require special considerations because two levels are involved. The ultimate beneficiary has an interest in the trust, and the trust has an interest in the underlying distributing shares.


In these circumstances, the company beneficiary must have a vested interest in the underlying shares through the trust that satisfies both anti-avoidance rules.

Example

Facts: Discretionary Trust acquired Domestic Distributing Company ordinary shares in 2010 for investment purposes. On 15 January 2014, Domestic Distributing Company pays dividends in respect of its ordinary shares. The Discretionary Trust allocates these dividends to Domestic Company Beneficiary.

Result: The dividends received by Domestic Company Beneficiary are taxed as ordinary revenue. No exemption applies because Domestic Company Beneficiary never holds a vested interest in the underlying ordinary shares.

Tax rebates (i.e. credits)

As outlined above, the new rules apply to three sets of dividends:

(i) dividends between domestic companies,

(ii) foreign dividends received or accrued by domestic companies, and

(iii) domestic dividends received or accrued by foreign companies.

The latter two scenarios require tax rebates (i.e. credits) to offset double taxation. In the second scenario (foreign dividends received domestic companies), foreign tax rebates are already available under section 6 quat against any South African taxes otherwise due. At stake is the third scenario (domestic dividends received by foreign companies). In the third scenario, the dividends at issue may be subject to the Dividends Tax in addition to being taxed at ordinary rates under the normal tax. To the extent this situation arises, the foreign shareholder is eligible to receive rebates (credits) against the normal tax for Dividends Tax already paid.

Example

Facts: Distributing Domestic Company declares dividends on 10 October 2012 in respect of its ordinary shares. On 11 October 2012, Foreign Company Shareholder acquires R4 million of Distributing Domestic Company dividends by way of cession. Distributing Domestic Company pays the declared dividends on 2 April 2012. These dividends are fully subject to the Dividends Tax (without any tax treaty reduction).

Result: The dividends ceded to Foreign Company Shareholder are taxed as ordinary revenue. No exemption applies because the shares are never held on the relevant dates. However, the normal tax on the dividends can be reduced for the Dividends Tax paid.

Section 6 sex has been introduced for this purpose, see detailed notes on rebate for dividends tax on income of foreign companies.


Three paragraphs have been added to the proviso to section 10(1)(k()(i).

The section 10 dividend exemption shall not apply:

(ee) to any dividend received by or accrued to or in favour of a company in consequence of—

(A) any cession; or

(B) any right of that company acquired in consequence of any cession;

(ff) to any dividends received by or accrued to or in favour of a company in respect of a share held by that company to the extent that the aggregate of those dividends does not exceed the aggregate of any amounts incurred by that company by way of direct or indirect compensation for any distributions in respect of any share borrowed by the company where that share so borrowed constitutes an identical asset as defined in paragraph 32(2) of the Eighth Schedule in relation to the share so held; or

(gg) to any dividends received by or accrued to or in favour of a company in respect of a share borrowed by that company.

Effective date


Section 103 of the Income Tax Act has been amended

Section 103(5) has been substituted and now reads as follows:

(a) any taxpayer has ceded the right to receive any amount in exchange for the right to receive any amount of dividends; and

(b) in consequence of that cession the liability for normal tax of the taxpayer or any other party to the transaction, operation or scheme, as determined before applying the provisions of this subsection, has been reduced or extinguished,

the Commissioner shall determine the liability for normal tax of the taxpayer and any other party to the transaction, operation or scheme as if that cession had not been effected.


Effective date

The amended section 103(5) comes into operation on 1 April 2012 and applies in respect of amounts received or accrued on or after that date.

Section 6sex of the Income Tax Act has been inserted

Refer to detailed notes dealing with Rebate for dividends tax on income of foreign companies.

____________________________________

VALUE EXTRACTION TAX – REMOVAL THEREOF

Amendments to section 1 definition of ‘gross income’, section 57 and the repeal of part IX (sections 64O to R) of the Income Tax Act.

Background

The proposed Dividends Tax regime shifts the tax liability in respect of dividends from the distributing company to the beneficial owner of the dividend. As part of this change, the ‘dividend’ definition has undergone significant amendments. The new dividend definition encompasses any amount that has been transferred or applied by virtue of any share held in that company. This definition accordingly seeks to move beyond pure dividends declared so as to cover disguised dividends.

In addition, the Value Extraction Tax is intended to replace the current deemed dividend rules associated with the soon-to-be replaced Secondary Tax Companies. The objective of the VET is to trigger a tax when any form of value is extracted from a company for the benefit of connected persons in relation to the paying company.

The VET covers several forms of disguised dividends, including disguised dividends resulting from the granting of financial assistance (i.e. discounted loans or advances).

Reasons for change

The determination of whether a payment by a company to its shareholders constitutes a disguised dividend is essentially a question that entirely depends on the facts and circumstances. The shifting of value from a company without a dividend declaration could alternatively stem from some other originating link, such as salary to shareholder-employees, payment for an asset or use thereof, or as an indirect gift by a controlling shareholder.

The VET (like the former deemed dividend regime associated with the soon-to-be-replaced Secondary Tax on Companies) assumes certain forms of value extraction automatically result in a deemed dividend without regard to the facts and circumstances. For instance, when a company pays or settles debts of a third party creditor owed by an indebted shareholder, the automatic result is deemed dividend treatment when the value shift could, in fact, stem from some other cause. This automatic deemed dividend stands in contrast to certain aspects of the ‘dividend’ definition, which assumes that the term ‘dividend’ includes disguised dividends (i.e. by covering payments to shareholders ‘by virtue of’ the underlying shares).

The change

A. General facts and circumstances linkage

The VET regime has been completely deleted. The determination of whether value extracted from a company amounts to a dividend or stems from some other cause must be resolved solely by reliance on the facts and circumstances. Consistent with this change, some of the technical ‘linkage’ language associated with the gross income definition will be adjusted to ensure consistency. Whether a value extraction from a company qualifies as a dividend, salary, payment for the purchase of an asset or use of an asset (amongst others) must be determined through reliance on the same legal connection (e.g. ‘in respect of’ or ‘as consideration for’).

Example:

Facts: Company is owned 100% by Individual. At the instance of Individual, Company purchases a car for the benefit of Individual.

Result: The zero-rated loan is possible because Individual owns all the shares of Company, thereby being ‘in respect of’ the shares held by Individual. The ‘in respect of’ language goes beyond the ‘by virtue of’ test (which would focus on the technical legal rights associated with separate shares as opposed to a focus on the shares as held by one party in an aggregate). As part of this change, the impact of value extraction to a person in the form of a donation will be clarified. More specifically, if value is extracted from a company at the instance of a person as a donation to a third party, two transactions have effectively occurred. The value extraction from the company represents some form of constructive dividend to that person, followed by a donation by that person to the third party.

Example:

Facts: Company X is owned 60% by Individual A and 40% by Individual B. At the instance of Individual A, Company X makes a cash payment of R10 000 to Son (of Individual A) that is received by Son as a donation.


Result: The R10 000 cash is being applied to Son by virtue of Individual A’s shares in Company X and should accordingly be viewed as a dividend to Individual A. The R10 000 amount should then be viewed as a donation received by Son from Individual A.

B. Discounted loans or advances

Despite the elimination of VET, loans or advances from a company to a shareholder (or any person connected to the shareholders) will still automatically to be a deemed dividend in certain circumstances. This deeming rule will be triggered when a loan or advance has been made to a resident person that is not a company.

This rule is retained for the sake of providing certainty in respect of a common practice. The amount of the dividend that is deemed to have arisen from the loan or advance will be equal to the deemed market-related amount of interest in respect of the loan or advance less the amount of interest that is actually paid. The market-related interest rule is similar to the rules for a interest-free or discounted loans contained in the Seventh Schedule. Moreover, even with regard to the proposed deeming rules, a dividend could still be deemed to occur under the general facts-and-circumstances analysis if a borrower has no intention to repay the capital amount borrowed.

Example:

Facts: Individual A owns 100% of the equity shares in Company X. Company X provides a loan of R 100 000 to Individual A at an interest rate of 6%. The corresponding current ‘official interest rate’ at the time of the loan as fixed by the Minister is 8%.

Result: Individual A intends to repay the loan over a period of 5 years. The amount to be treated as a dividend will be equal to R 2 000 [R 100 000 x (8% - 6%)]. However if, based on the facts and circumstances, Individual A does not have any intention to repay the loan, the loan capital can be treated as a dividend upfront (that is, when the R 100 000 is made available to Individual A).

The new rule accordingly creates an annual charge that is comparable to the discount loan rules involving disguised employee fringe benefits. The exemptions applicable in respect of the Dividends Tax will also be applicable to the rules for discounted loans or advances (for example, inter-company shareholder loans).


Disposals by companies under donations at the instance of any person

Section 57 of the Income Tax Act has been amended

The amended section 57 reads as follows:

If-

(a) any property is disposed of by any company at the instance of any person; and

(b) that disposal would have been treated as a donation had that disposal been made by that person, that property must for the purposes of this Part be deemed to be disposed of under a donation by that person.

Effective date

The amended section 57 of the Income Tax Act comes into operation on 1 April 2012.

Chapter II of the Income Tax Act is amended by the repeal of Part IX.

Effective date

The repeal of Part IX comes into operation on 1 April 2012 (the date on which Part VIII of Chapter II of the Income Tax Act, 1962, comes into operation).

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PASSIVE HOLDING COMPANIES

Amendments to section 14 of the Revenue Laws Amendment Act No 60 of 2008.

Delay in the implementation of section 9E

Section 14 of the Revenue Laws Amendment Act No 60 of 2008 has been amended.

The amendment postpones the effective date of section 9E (dealing with passive holding companies) to 1 April 2013.

Effective date

The amendment to section 14 of the Revenue Laws Amendment Act No 60 of 2008 is deemed to have come into operation on 21 October 2008.

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INTERNATIONAL PROVISIONS

TIMING OF REBATES FOR FOREIGN TAXES ON INCOME

Amendment to section 6quat of the Income Tax Act.

Background

Residents with taxable income attributable to income from foreign sources are eligible for tax rebates (commonly referred to as tax credits) against South African taxes otherwise due and payable. These foreign taxes must be ‘proved to be payable’. Section 6quat contains special rules to prevent timing mismatches between the South African income tax systems and the applicable foreign tax system. More specifically, situations may arise in which the foreign tax ultimately due may differ from the foreign tax initially claimed (with the ultimate amount either falling short or exceeding the initial amount). Under these circumstances, section 6quat(5) allows the Commissioner to re-open assessments (to the benefit or detriment of taxpayers) for a period of six years from date of assessment.

Reasons for change

Section 6quat(5) recognises some mismatches between South African taxes due versus foreign taxes due, this recognition is incomplete. The mismatch focused on foreign tax deviations relating to disputes (e.g. audit challenges, refund claims and litigation). However, this form of mismatch is only part of the picture. Many other timing mismatches arise from differences as to when the South African tax system recognises taxable income versus the timing recognition of the applicable foreign tax system. One common timing mismatch arises from cross-border debt. In the case of cross-border debt lent by a South African company, South Africa generally recognises income on an accrual basis while many countries impose withholding taxes on a cash basis. As a result, the South African tax system recognises the underlying income before the income is recognised by the foreign country imposing the withholding tax. Although the South African lender still receives a tax rebate at a later date but the timing of the rebate often undercuts its value as a tax offset.

Changes

Foreign tax rebates have been adjusted to ensure that these rebates are better matched against the time when the South African tax system recognises the underlying taxable income. More specifically, foreign tax rebates will be matched against the year in which the South African tax system recognises the underlying foreign taxable income. This matching will ensure that rebates will apply when these rebates are of the greatest practical use for the South African taxpayer.

Example

Facts: A South African Holding Company owns all the shares of a Foreign Subsidiary (located in Foreign Country). A cross-border R5 million loan exists between the two entities with the South African Holding Company being the creditor and the Foreign Subsidiary being the debtor. In 2013, R750 000 interest accrues on the loan. The interest is paid in 2014 with Foreign Country X imposing withholding in 2014.

Result: The South African Holding Company can re-open the 2013 year of assessment due to the withholding tax imposed by Foreign Country X in 2014. This foreign withholding tax can then be applied as a foreign rebate against South African taxes otherwise due for its 2013 year of assessment.


The introduction of section 6quin and section 6sex and amendment to section 9D (CFCs), have resulted in the deletion of the following provisions in section 6quat:

Section 6quat(1)(d).

Section 6quat(1A)(a)(ii).

Section 6quat(1B)(iA)(aa).

The pre-tax amounts of foreign receipts and accruals are included in South African gross income of a resident. With the exception of the foreign tax paid on ‘foreign dividends’, taxes paid to these foreign countries, including various withholding taxes, are not deductible in the determination of taxable income.

To give relief to the resident who has been taxed twice on the same receipt or accrual, a deduction or credit is given against his South African normal tax liability. It is section 6quat that provides both the deduction and the credit (rebate) relief. The section 6quat provisions can be summarised as follows:

(1) identifies the receipts and accruals that give rise to the rebate.

(1A) determines the amount of the rebate.

(1B) limits the amount that may be set off in the current year of assessment and allows the excess to be carried forward to

the next year of assessment.


(1C) and (1D) allows a deduction (as opposed to a rebate) of certain foreign taxes.

(2) ensures that double relief does not result through relief under a double tax agreement and section 6quat.

(3) defines the term ‘taxes on income’.

(4) and (4A) provide the method to be used to convert the foreign taxes paid into Rand.

(5) allows for the reassessment of the rebate in certain circumstances.

Effective date

The amendments to section 6quat(IB)(iA) come into operation on 1 April 2012 and apply in respect of years of assessment commencing on or after that date.

All the other amendments to section 6quat come into operation on 1 January 2012 and apply to years of assessment commencing on or after that date.

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SPECIAL FOREIGN TAX CREDIT FOR MANAGEMENT FEES

Insertion of section 6quin of the Income Tax Act.

Background

A South African resident with taxable income attributable to income from a foreign source is eligible for a tax rebate (often referred to as a tax credit) against his South African taxes which would otherwise be due and payable. Amongst other requirements, these credits are conditioned on the foreign taxes being applied to foreign sourced income and no foreign tax credits are available in respect of South African sourced income.

Reasons for change

A number of African jurisdictions impose withholding taxes in respect of services (especially management services) rendered abroad if funded by payments from their home jurisdictions.

These withholding taxes are sometimes imposed even when tax treaties suggest that the practice should be otherwise. African imposition of these withholding taxes in respect of South African sourced services is no exception. The net result of these African withholding taxes was double taxation with little relief. The South African tax system did not provide for credits in respect of these foreign withholding taxes because these taxes lacked a proper foreign source nexus. Only partial relief was afforded through the allowance of a deduction. While the South African position is theoretically correct, the practical implication of this position was adverse to South Africa’s objective of becoming a regional financial centre. As long as this theoretically correct position was maintained, the only viable solution for regional operations was to shift their management location to a low-taxed or no-taxed location so as to avoid double taxation.

Changes

In view of the above, a new limited foreign tax credit has been introduced. The scope of this foreign tax credit is limited solely to foreign withholding taxes imposed in respect of services rendered in South Africa. These tax credits will be limited solely to South African taxes otherwise imposed on the same service income after taking applicable deductions into account. Foreign withholding taxes in excess of the South African tax cannot be carried over (i.e. the excess is lost). However, this limited foreign tax credit will, not be available if the taxpayer is claiming deductions in respect of the same foreign taxes. To claim this limited foreign tax credit, a resident taxpayer must submit a declaration to SARS within 60 days from the date on which the amount is withheld. SARS will use this information to reduce or eliminate the foreign tax if that tax operates in violation of tax treaty commitments. To the extent the foreign tax remains despite this effort, the new foreign tax credit can be claimed. If the matter regarding the imposition of the foreign tax is then resolved and the undue foreign tax is ultimately refunded to the taxpayer, the credit will be reversed.


Section 6quin(1) is subject to section 6quin(3) and provides that when a portion of the taxable income of a resident is

attributable to an amount that is from a source within South Africa and is received by or accrued to him for services rendered

within South Africa, and an amount of tax on that amount is-

(a)(i) levied by a sphere of government of any country-

(aa) other than South Africa; and

(cc) with which South Africa has concluded an agreement for the avoidance of double taxation, and

(a)(ii) withheld when the amount is paid to him by the person making the payment; or


(b) imposed by a sphere of government of a country other than South Africa in terms of the laws of that country,

a rebate determined in accordance with section 6quin(2) must be deducted from his normal tax payable.

Under section 6quin(2)(a) and for the purposes of section 6quin(1)(a), the rebate is an amount equal to the lesser of-

(i) the amount of normal tax that is attributable to the amount received or accrued as contemplated in section 6quin(1)(a), or

(ii) the amount of tax levied and withheld as contemplated in section 6quin(1)(a).

Under section 6quin(2)(b) and for the purposes of section 6quin(1)(b), the rebate is an amount equal to the lesser of-

(i) the amount of normal tax which is attributable to the amount received or accrued as contemplated in section 6quin(1)(b),

or

(ii) the amount of tax imposed as contemplated in section 6quin(1)(b).

Section 6quin(3) provides that no rebate may be deducted under this section if-

(a) the amount of tax levied and withheld as contemplated in section 6quin(1)(a);

(b) the amount of tax imposed as contemplated in section 6quin(1)(b); or

(c) any portion of an amount contemplated in (a) and (b) above,

is deducted from the income of that resident in terms of section 6quat(1C).

Under section 6quin(4) and for the purposes of section 6quin(2)(a)(ii) and section 6quin(2)(b)(ii), the amount of any tax-

(a) levied and withheld as contemplated in section 6quin(1)(a); or

(b) imposed as contemplated in section 6quin(1)(b),

must be translated to the currency of South Africa on the last day of the year of assessment in which that tax is so levied

and withheld or imposed, by applying the average exchange rate for that year of assessment.

Effective date

Section 6quin comes into operation on 1 January 2012 and applies to amounts of tax withheld or imposed by any sphere of

government of any country other than South Africa during years of assessment commencing on or after that date.

Further amendment to section 6quin which requires a declaration

Section 6quin(1) has been amended to makes its provisions subject to section 6quin(3A) in addition to section 6quin(3). At the same time section 6quin(3A) has been added.

Section 6quin(3A) provides that where an amount of tax is levied and withheld as contemplated in section 6quin(1)(a), no rebate may be deducted in terms of this section if the resident contemplated in section 6quin(1) does not, within 60 days from the date on which that amount of tax is withheld, submit to the Commissioner a declaration in such form as may be required by the Commissioner that the amount of tax was levied and withheld as contemplated in section 6quin(1)(a).

Effective date

The amended section 6quin(1) and section 6quin(3A) come into operation on a date determined by the Minister by notice in the Gazette, which date must be later than 1 January 2012 and apply to amounts of tax withheld or imposed by a sphere of government of any country other than South Africa during years of assessment commencing on or after the date so determined.

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UNIFICATION OF SOURCE RULES

Amendment to sections 1, 6quat, 9, 10(1)(k)(ii), 35(1), 37J, 41(1) of the Income Tax Act, paragraph 1 of the Seventh Schedule to the Income Tax Act and paragraph 64B of the Eight Schedule to the Income Tax Act.

Background

South African residents are taxed on the basis of their world-wide income with foreign sourced income eligible for tax rebates (credits) in respect of foreign tax proven to be payable. Non-residents are only subject to tax on the basis of income derived from sources within (or deemed to be within) South Africa. The Income Tax Act does not define the term ‘source’. The source of income is instead initially determined with reference to case law. In terms of the case law (see CIR v Lever Brothers & Unilever Ltd (1946 AD), the determination of source generally involves the doctrine of originating cause involving the following two levels of analysis:


What is the originating cause of the income; and

What is the location of that originating cause?

In respect of some categories of income, the Income Tax Act contains deeming rules. These deeming rules create deemed South African source income in addition to South African source income under the case law. These deemed source rules cover interest, royalties and capital gains (amongst others). Foreign source income exists only once it is determined that the income is neither actual South African source under case law principles nor deemed South African source in terms of the provisions of the Income Tax Act.

Reasons for change

The previous source rules give rise to uncertainty, thereby imposing additional costs in respect of cross-border activities with little or no benefit for the fiscus. Part of this uncertainty stems from differing interpretations about the application of case law.

The statutory regime relating to source is also somewhat scattered throughout the Income Tax Act. All of these technical source issues make South Africa a less attractive regional holding company destination from a tax perspective. The old source rules also added unnecessary costs for South African companies operating abroad (especially into Africa). On a policy level, the source rules had to be revisited in light of the paradigm shift in regards to the South African tax system that occurred ten years ago. More specifically, the core of the source principles were formulated when South Africa operated on a source-plus basis with little change occurring once South Africa moved to a residency-minus system. The growing South African tax treaty network also raises the need for re-examination of how the domestic source rules should apply to the residual list of countries lying outside the treaty network.

The changes

Overview

In order to remedy the above uncertainties and anomalies, a new uniform system of source has been introduced. The new system represents a combination of the case law, pre-existing statutory law and tax treaty principles. The starting point for these uniform source rules loosely reflect implicit tax treaty principles (with a few added built-in protections) so that the South African system is globally aligned. The case law remains as a residual method for certain categories of income. In terms of format, the new uniform set of source rules eliminate the concept of deemed source. As under the previous law, foreign residents are subject to South African tax only in respect of South African source income. South African residents remain subject to worldwide tax but may be eligible for foreign tax credits in respect of foreign source income.

Source Categories

Dividends

Old law

Under the old provisions, two sets of definitions were recently added in respect of dividends – the definition of “dividend” (which mainly covers domestic dividends), and the definition of “foreign dividend” (which covers dividends from non-resident companies). The explicit source rules for dividends depended on the case law, which mainly focuses on the share register.

OECD model treaty principles

The source determination under OECD model treaty principles focuses on tax residence of the company declaring the dividend. Therefore, a dividend will be locally sourced (subject to the ‘tie-breaker’ rules) if the distributing company is a resident. Residence is based on the country where that company was formed or established or where that company’s effective management resides.

The change

Source has been designed to reach roughly the same outcome as the OECD principles. The South African source rules of dividends have been clarified so that dividends from domestic resident companies will be South African sourced with ‘foreign dividends’ being foreign sourced. The ‘share register’ concept from case law is no longer relevant.

Interest

Old law

The current source rules for interest are determined through a combination of case law and deeming legislation. The case law rules follow the doctrine of originating cause.

The originating cause for interest is viewed as the supply of credit and the location of the originating cause is the place where that credit is supplied. Therefore, interest is sourced in South Africa if credit is provided in South Africa (typically by a South African credit provider). In addition, the legislative rules deem interest to be sourced in South Africa if the interest is derived from the utilisation or application of funds within South Africa. South African residents paying interest are presumed to be utilizing or applying funds within South Africa.


OECD model tax treaty principles

OECD model tax treaty principles focus on the tax residence of the payor (i.e. the debtor incurring the interest). However, if payment arises from (i.e. has an economic connection to) a permanent establishment located in the source country, the focus shifts to the source country.

The change

The source of interest will largely be determined using implicit OECD principles. The determination of source of interest is now based on a two-part test:

(i) the residence of the debtor paying/incurring the interest, or

(ii) the place in which the loan funds are utilised or applied.

Therefore, interest will be sourced in South Africa if:

(i) paid by a South African resident, or

(ii) if the interest is derived from use or application in South Africa (e.g. from a South African permanent establishment).

The change removes the case law focus on the credit provider.

Moreover, the pending 10% interest withholding regime to be applied in respect of payments to certain non-resident persons has been clarified. Under this clarification, the withholding regime will apply only to South African sourced interest paid or payable to non-resident persons.

Royalties

Old Law

The old source rules for royalties were determined through a combination of case law and deeming provisions in the Income Tax Act. The case law doctrine of originating cause for determining the source of royalties focuses on where the intellectual property producing the royalty was created, devised or developed. In addition, the income tax provisions deem royalties to be South African sourced if the royalties relate to the use, right of use or the grant of permission to use the intellectual property within South Africa. For purposes of 12% royalty withholding, South African source royalties include closely-related imparting of knowledge, assistance or services.

OECD model tax treaty principles

The OECD model tax treaty principles follow the principles used for interest. Once again, source will be based on the tax residence of the party paying the royalties or on royalties having an economic link with a permanent establishment.

The change

The determination of source in respect of royalties will again largely follow OECD tax treaty principles. Firstly, source will be based on the residence of the party paying the royalties. In addition, South African source royalties will exist if the royalties relate to the use, right of use or grant of permission to use intellectual property within South Africa. The change removes any focus on the party creating, devising or developing intellectual property (thereby removing the previous disincentive to generate intellectual property within South Africa).

Ancillary services

The determination of source in respect of know-how will also be based on a two-part test:

(i) the residence of the payor except where the payment for the know-how is attributable to a permanent establishment of the payor located outside South Africa; or

(ii) where the know-how will be used or applied in South Africa.

Services, pensions/annuities

The source determination for services was based solely on case law. This source determination largely focuses on the place where the services are rendered (with some minority arguments in favour of the dominant activity giving rise to those services). If services are rendered partly within and partly outside South Africa, the allocation of source is based entirely on the facts and circumstances (e.g. time and value addition). The basic case law source rules for services will remain unchanged.

The new rules for determining the source of private pensions or annuities derived from services follow exactly the same principles as the source determination for service income. More specifically, the source for these annuity and pension payments will be based on the source of the underlying services giving rise to those payments. Therefore, if the underlying services are rendered within South Africa, the associated annuities and pensions will be viewed as South African source. If the annuities and pensions relate to mixed services (i.e. services rendered within and without South Africa), the allocation will be based on time spent. These rules are essentially the same as pre-existing law, except for the two-out-of-ten year election.


Government services and associated annuities/pensions

Much like the old law, the source of services for (or on behalf of) the various tiers of government will be deemed to be South African sourced without regard to where those services were rendered. Government pensions and annuities will be treated similarly. This rule will cover Government in a broad sense (the national, provincial and municipal spheres, the holding of any public office as well as any entity falling within the PFMA or the MFMA).

Gains from the disposal of assets

Gains in respect of immovable property are sourced in South Africa if the immovable property is situated in South Africa. Special look-through rules apply if ownership exists through company shares and 80% or more of the market value of the company shares stems from the immovable property. The source determination for gains in respect of movable property is based on the residence of the person disposing of the movable property (i.e. if the party disposing of the property is a South African resident, the disposal will be deemed to be South African sourced). The notion of deemed source has been eliminated.

Exchange differences rules

A new special source rule for currency gains has been introduced and it mirrors the disposal of asset source rules. Under this approach, exchange differences are sourced in South Africa if these differences arise from exchange items attributable to a South African resident or attributable to a South African permanent establishment of a non–resident. In view of their alignment with OECD model tax treaty principles, the old legislative source rules have essentially remained. However, the notion of deemed source has been eliminated, leaving the legislative determination as the sole determination.

Residual doctrine of originating cause – Other receipt and accruals

In the case of dividends, interest, royalties, and gains from the disposal of assets and exchange gains, the doctrine of originating cause will no longer apply. Therefore, items of income of this kind that fall outside the South African sourced categories listed above are explicitly treated as foreign source income. Otherwise, the doctrine of originating cause (initiated in CIR v Lever Brothers & Unilever Ltd (1946 AD)) implicitly remains as a residual category. In other words, this doctrine remains in respect of any residual item of income falling outside the main categories described above (e.g. rental income and insurance premiums).


A new section 9 has been introduced and reads as follows:

9. (1) For the purposes of this section, ‘royalty’ means any amount that is received or accrues in respect of the use, right of use or permission to use any intellectual property as defined in section 23I.

(2) An amount is received by or accrues to a person from a source within the Republic if that amount—

(a) constitutes a dividend received by or accrued to that person;

(b) constitutes interest as defined in section 24J or deemed interest as contemplated in section 8E(2) where that interest—

(i) is attributable to an amount incurred by a person that is a resident, unless the interest is attributable to a permanent establishment which is situated outside the Republic; or

(ii) is received or accrues in respect of the utilisation or application in the Republic by any person of any funds or credit obtained in terms of any form of interest-bearing arrangement;

(c) constitutes a royalty that is attributable to an amount incurred by a person that is a resident, unless that royalty is attributable to a permanent establishment which is situated outside the Republic;

(d) constitutes a royalty that is received or accrues in respect of the use or right of use of or permission to use in the Republic any intellectual property as defined in section 23I;

(e) is attributable to an amount incurred by a person that is a resident and is received or accrues in respect of the imparting of or the undertaking to impart any scientific, technical, industrial or commercial knowledge or information, or the rendering of or the undertaking to render, any assistance or service in connection with the application or utilization of such knowledge or information, unless the amount so received or accrued is attributable to a permanent establishment which is situated outside the Republic;

(f) is received or accrues in respect of the imparting of or the undertaking to impart any scientific, technical, industrial or commercial knowledge or information for use in the Republic, or the rendering of or the undertaking to render, any assistance or service in connection with the application or utilisation of such knowledge or information;

(g) is received or accrues in respect of the holding of a public office to which that person has been appointed or is deemed to have been appointed in terms of an Act of Parliament;

(h) is received or accrues in respect of services rendered to or work or labour performed for or on behalf of any employer—

(i) in the national, provincial or local sphere of government of the Republic;

(ii) that is a constitutional institution listed in Schedule 1 to the Public Finance Management Act, 1999 (Act No. 1 of 1999);


(iii) that is a public entity listed in Schedule 2 or 3 to that Act; or

(iv) that is a municipal entity as defined in section 1 of the Local Government: Municipal Systems Act, 2000 (Act No. 32 of 2000);

(i) constitutes a pension or an annuity and the services in respect of which that amount is so received or accrues were rendered within the Republic:

Provided that if the amount is received or accrues in respect of services which were rendered partly within and partly outside the Republic, only so much of that amount as bears to the total of that amount the same ratio as the period during which the services were rendered in the Republic bears to the total period during which the services were rendered must be regarded as having been received by or accrued to the person from a source within the Republic;

(j) constitutes an amount received or accrued in respect of the disposal of an asset that constitutes immovable property held by that person or any interest or right of whatever nature of that person to or in immovable property and that property is situated in the Republic;

(k) constitutes an amount received or accrued in respect of the disposal of an asset other than an asset contemplated in paragraph (j) if—

(i) that person is a resident and—

(aa) that asset is not attributable to a permanent establishment of that person which is situated outside the Republic; and

(bb) the proceeds from the disposal of that asset are not subject to any taxes on income payable to any sphere of government of any country other than the Republic; or

(ii) that person is not a resident and that asset is attributable to a permanent establishment of that person which is situated in the Republic; or

(l) is attributable to any exchange difference determined in terms of section 24I in respect of any exchange item as defined in that section to which that person is a party if—

(i) that person is a resident and—

(aa) that exchange item is not attributable to a permanent establishment of that person which is situated outside the Republic; and

(bb) that amount is not subject to any taxes on income payable to any sphere of government of any country other than the Republic; or

(ii) that person is not a resident and that exchange item is attributable to a permanent establishment of that person which is situated in the Republic.

(3) For the purposes of—

(a) paragraph (i) of subsection (2), any amount granted to a person by way of pension or annuity must be deemed to have been received by or to have accrued to that person in respect of services rendered by that

person; and

(b) paragraph (j) of subsection (2), an interest in immovable property held by a person includes any equity shares in a company or ownership or the right to ownership of any other entity or a vested interest in any assets of any trust, if—

(i) 80 per cent or more of the market value of those equity shares, ownership or right to ownership or vested interest, as the case may be, at the time of disposal thereof, is attributable directly or indirectly to immovable property held otherwise than as trading stock; and

(ii) in the case of a company or other entity, that person (whether alone or together with any connected person in relation to that person) directly or indirectly holds at least 20 per cent of the equity shares in that company or ownership or right to ownership of that other entity.

(4)An amount is received by or accrues to a person from a source outside the Republic if that amount—

(a) constitutes a foreign dividend received by or accrued to that person; constitutes interest as defined in section 24J(1) or deemed interest as contemplated in section 8E(2) received by or accrued to that person that is not from a source within the Republic in terms of subsection (2)(b);

(c) constitutes a royalty received by or accrued to that person that is not from a source within the Republic in terms of subsection (2)(c) or (d);

(d) constitutes an amount received or accrued to that person in respect of the disposal of an asset that is not from a source within the Republic in terms of subsection (2)(j) or (k); or

(e) is attributable to any exchange difference determined in terms of section 24I in respect of any exchange item as defined in that section to which that person is a party and is not from a source within the

Republic in terms of subsection (2)(l).


Effective date

The new section 9 comes into operation on 1 January 2012 and applies to receipts and accruals in respect of years of assessment commencing on or after that date.

Royalties to non-residents

Section 35 of the Income Tax Act has been substituted and reads as follows:

(1) (a) Subject to paragraph (b), there must be levied for the benefit of the National Revenue Fund a tax, to be known as the withholding tax on royalties, calculated at the rate of 12% of any amount contemplated in section 9(2)(c), (d), (e) or (f) that is received by or accrues to a person (other than a resident or a controlled foreign company).

(b) Paragraph (a) does not apply in respect of any amount which is received by or accrues to any person who is not a resident, if such amount is effectively connected with a permanent establishment of that person in the Republic.

Effective date

The amended section 35 of the Income Tax Act comes into operation on 1 January 2012 and applies in respect of amounts received or accrued during years of assessment commencing on or after that date.

Withholding tax on interest

Section 37J of the Income Tax Act has been amended.

Section 37J(1) now reads as follows:

There must be levied for the benefit of the National Revenue Fund a tax, to be known as the withholding tax on interest, calculated at the rate of 10% of the amount of any interest that is regarded as having been received or accrued from a source within the Republic in terms of section 9(2)(b) received by or accrued to any foreign person that is not a controlled foreign company.

Section 37J(2) has been deleted.

Effective date

The amended section 37J(1) comes into operation on 1 January 2013 and applies in respect of any interest that accrues on or after that date.

Paragraph 1 of the Seventh Schedule to the Income Tax Act

The paragraph (d) of the definition of ‘taxable benefit’ contained in paragraph 1 of the Seventh Schedule has been amended and paragraph (e) has been added.

A ‘taxable benefit’ is now defined as follows:

‘taxable benefit’ means a taxable benefit contemplated in paragraph 2, whether the grant of such benefit is voluntary or

otherwise, but excluding-

a) any benefit the amount or value of which is exempt from normal tax under the provisions of section 10 of this Act; or

b) any benefit provided by any benefit fund in respect of medical, dental and similar services, hospital services, nursing

services and medicines; or

c) any lump sum benefit payable by a benefit fund, pension fund, pension preservation fund, provident fund or provident

preservation fund being a benefit referred to in the definition of "benefit fund" in section 1 of this Act or in paragraph (i) of the

proviso to paragraph (c) of the definition of "pension fund" in that section or in paragraph (a) of the definition of "provident

fund" in that section.

d) any benefit or privilege received by or accrued to a person contemplated in section 9(2)(g) or (h) stationed outside the

Republic which is attributable to that person’s services rendered outside the Republic; or

(e) any severance benefit.

Effective date

The amendment to paragraph (d) of the definition of ‘taxable benefit’ comes into operation on 1 January 2012 and applies in respect of amounts received or accrued during years of assessment commencing on or after that date.

The addition of paragraph (e) to the definition of ‘taxable income’ is deemed to have come into effect on 1 March

2011.

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BLOCKED FOREIGN FUNDS

Amendment to section 9A of the Income Tax Act

A controlled foreign company does not technically have a ‘year of assessment’ or ‘income’ - only South African residents holding participating rights in that controlled foreign company have these items. The proposed changes accordingly adjust the language to replace the term ‘year of assessment’ with ‘foreign tax year’ and the word ‘income’ with the term ‘net income’. These are the terms used in section 9D.

The amended section 9A(3) now provides that when an amount, or a portion of an amount, of the net income of a CFC for its foreign tax year may not be remitted to South Africa for the reasons contemplated in section 9A(1), there is allowed to be deducted from its net income for that foreign tax year an amount equal to so much of the amount or portion that may not be remitted. In terms of the amended section 9A(4), the amount or portion that may not be remitted as contemplated in section 9A(3) is deemed to be an amount received by or accrued to the CFC contemplated in section 9A(3) in its following foreign year tax.

Effective date

The amended section 9A(3) and (4) comes into operation on 1 January 2012 and applies to a foreign tax year of a CFC ending during years of assessment commencing on or after that date.

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OFFSHORE CELL COMPANIES

Amendment to section 9D and 10(1)(k)(ii)(dd) of the Income Tax Act and Paragraph 64B of the Eighth Schedule to the Income Tax Act.

Background

Taxation of offshore operations

South African residents are subject to tax on a worldwide basis (i.e. foreign activities of a South African resident are fully within the South African tax net). In addition, South African tax indirectly applies to tainted activities conducted by controlled foreign companies (CFCs). Control of a foreign company generally exists if South African residents own more than 50% of the participation and voting rights of the foreign company. CFC activities subject to indirect taxation mainly include passive income (e.g. interest and royalties) and diversionary income (i.e. income readily susceptible to transfer pricing manipulation). CFCs engaged in business as an insurer may or may not be subject to indirect taxation. If a CFC generates most of its revenue from independent customers, no indirect taxation applies. On the other hand, captive foreign insurers (i.e. foreign subsidiaries largely earning premiums from fellow group companies) are fully subject to indirect taxation because their accumulated profits essentially represent passive reserves for the group. As a result, the tax law places CFC captive insurers on par with domestic captives – full taxation with a deduction for premiums set aside for reserves to be paid in short order.

Roll of foreign statutory cell companies

Foreign statutory cell companies (technically, often referred to as ‘protected cell companies’ or ‘segregated account companies’) effectively operate as multiple limited liability companies, separated into legally distinct cells. These cell companies are often found in the jurisdictions of Bermuda, Guernsey, Gibraltar, Isle of Man, Jersey, Vermont, Mauritius and Seychelles. The cell company is a single legal entity that operates in two distinct parts. These parts are the core and the other cells. There is only one core, but there may be an infinite number of

other cells. The core is owned by the founding members of the company who are the service providers and central managers of the company as a whole. The other cells are designed to isolate risk for their ‘customer’ users. Cell companies often issue two classes of shares namely:

(i) ordinary voting shares issued to the practical owners of the core, and

(ii) non-voting preference shares issued to the ‘customers’ using the other cells (with a separate class of preference shares issued to each set of owners of each separate cell).

In the case of cell company insurers, each of the other (non-core) cells is funded by the insured’s own capital contributions and premiums collected. The insured cell participant can only collect payouts via the insurance agreement and typically can only receive distributions upon termination of the cell’s functions. Cells operate under a limited liability principle with each cell having full limited liability protection against the other cells (i.e. the creditors of the other cells cannot make claims against the cell). However, the core can be subject to the claims of other cells in limited circumstances.

Reasons for change

While it is undisputed that offshore cell captives often have legitimate non-tax commercial uses, these cells essentially operate as offshore captive insurers.


Offshore captive insurers are generally subject to indirect tax under the CFC regime because the excess build-up of reserves is essentially passive income. No reason exists to allow offshore cell companies to be treated differently. Hence, as a matter of parity, offshore cells should fall within the South African CFC regime. The other issue of parity is between domestic cell companies (governed by contract) and foreign cell companies. Both cell companies essentially provide the same functions and almost the same level of limited liability. Yet, lack of CFC treatment for each offshore cell provides these cells with significant tax advantages over domestic cells.

The changes

CFC imputation

In view of the above the CFC rules have been adjusted so that each cell of a foreign statutory cell company will be treated as a separate stand-alone foreign company for all section 9D purposes. Therefore, if one or more South African residents hold more than 50% of the participation rights in an offshore cell, the cell will be deemed to be a CFC without regard to ownership in the other cells. CFC treatment for the cell typically triggers income tax for the participant cell owners to the extent that the cell generates tainted income. For purposes of the above rule, a cell exists if the cell is part of a legal entity formed, established (or converted) under foreign law, whereby the foreign law forming, establishing (or creating the entity by way of conversion): segregates the assets of the entity into cells that are structurally independent; links or attributes specified assets and liabilities to those cells; or does not allow for claims to be made against the legal entity as a whole unrelated to cellular assets to be made against the cell merely because the legal entity as a whole is liable or obligated to satisfy those liabilities or obligations.

This amendment is not intended to apply to standard-investment type unit trusts. The amendment’s application is limited to protected cell companies engaged in the insurance business.

Example 1

Facts: Protected cell company (PCC) is located in Foreign Country X with the core managed and controlled by Country X’s residents. The PCC has 100 cells; one cell (Cell 1) is owned by South African Company. The PCC is engaged in the business of insurance with each cell offering a different insurance package to each cell participant. Cell 1 provides insurance solely to South African Company (and some of its group members).

Result: The CFC status of Cell 1 will be tested separately. Because South African Company economically controls the cell, the cell qualifies as a CFC. The proportionate tainted amount of the net income of the cell will be attributed to the South African Company. All passive income of the cell will be tainted because the cell qualifies as a captive insurer when standing alone. However, Cell 1 may be entitled to the section 28 deductions as a short term insurer.

Effective Date

The proposed amendment will apply to the net income of a CFC relating to a shareholder-taxpayer year of assessment beginning on or after 1 April 2012.

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REFORM OF THE CONTROLLED FOREIGN COMPANY (CFC) REGIME

Amendment to section 9D of the Income Tax Act.

Background

The CFC regime taxes certain income generated by South African controlled foreign companies on an accrual basis. More specifically, the CFC rules impose tax on South African residents in respect of their proportionate share of CFC tainted income. A CFC is any foreign company in which South African residents own more than a 50% interest in the profits or capital of the company or by means of voting rights. Tainted income consists of passive (or highly mobile) income as well as diversionary income. Passive income includes interest, dividends, royalties, rentals, annuities, exchange differences, insurance premiums, similar income and associated capital gains. Diversionary income generally includes income derived from suspect transactions between a CFC and a resident that will likely lead to transfer pricing concerns. Tainted (passive or diversionary) income is fully taxable in South Africa because CFC ownership of this income poses a high risk to the tax base. The CFC attribution rules are subject to various exemptions, such as the foreign business establishment exemption, a de minimis exemption, a high-foreign tax exemption and related party exemptions.

From a policy perspective, all of these exemptions are part of a framework that seeks to strike a fair balance between protecting the tax base and the need for South African multinationals to be internationally competitive.


Reasons for change

The CFC regime is in its tenth year anniversary. While the regime closed many obvious loopholes, the ten-year mark creates a useful opportunity for reflection based on practical experience. In the main, the CFC regime has largely closed the straight forward movement of passive income offshore and the comparable use of shell companies to divert income offshore through unsustainable transfer pricing. Nonetheless, problems remained. The tainted income calculation was overly complex and created uncertainties. For instance, the overly rigid nature of the regime triggered tainted income for non-tax driven commercial income and often allowed taxpayers to artificially manipulate problematic income so as to avoid tainted treatment, especially in the case of diversionary-type transactions. Certain interpretations also emerged that seemingly allowed taxpayers to create a marginal nexus in respect of employment or activity to tax havens so as to claim exemption when the ‘supposedly’ exempt income lacked any meaningful economic substance. Lastly, the CFC regime additionally contained certain elections and ruling mechanisms that add complexity with little benefit for the tax system.

The change

Overview

In view of the above, the core calculations associated with the tainted income determination have been simplified. Certain tests are now more closely integrated with transfer pricing without current reliance on overly objective (and misdirected) criteria. Tainted income treatment of mobile income has also be segregated into discrete elements so as to be more closely aligned with the relevant issues of concern. Overall, the current changes provide simplicity, certainty and strengthen the rules to guard against the possible erosion of the South African tax base. It was intended that these changes close structural deficiencies in the system and make the rules more targeted in line with the regime’s underlying purpose without undermining the country’s international competitiveness.

Income attributable to a foreign business establishment (FBE)

The previous FBE exemption assumed that only the income relating to a substantive business could be ‘attributable to’ a FBE. The amendment has highlighted this assumption by expressly providing that income will only be attributable to a FBE once arm’s length transfer pricing principles are taken into account. In line with this change, attribution to a FBE must account for the functions performed, assets used and the various risks of the foreign business establishment. Mere connection of income to a FBE via legal agreements and similar artifices will not be sufficient. Indeed, this arm’s length connection has always been the stated intention behind the ‘attributable to’ standard.

Simplification of the diversionary income rules

Under the old law, three sets of diversionary rules existed. The first set of rules sought to prevent the use of CFCs to shift income offshore when the import of goods is involved. The second set sought to prevent the use of CFCs to shift income offshore when the export of goods is involved. The third set sought to prevent the use of CFCs when the import of services is involved. Diversionary income is viewed as tainted CFC income even if attributable to a FBE. The overly mechanical nature of the diversionary rules has caused problems for both legitimate commercial activities and for the meaningful protection of the fiscus. Non-tax motivated commercial activities often became trapped by the mechanical rules while the overly rigid nature of the rules allowed for tax avoidance in the case of more flexible non-tax motivated activities. While the unintended commercial impact of these rules has been substantially mitigated with the introduction of the high-foreign tax exemption, the underlying concerns remain. In view of these concerns, the following changes have been made:

Imported goods

The rigid mechanical nature of the diversionary rules in respect of imported goods from CFCs has been entirely removed. Instead, the imported goods diversionary rules will be triggered only if three (simplified) conditions exist:

1. As envisioned under the old law, a CFC must be disposing of goods directly to a connected South African resident. In addition, the new regime will alternatively cover disposals indirectly made to these same connected South African residents. The indirect rule essentially seeks to capture a CFC’s disposal of goods ultimately destined for import to a connected South African resident (thereby ending the practice of interposing shell companies so as to break the import link).

2. The sales income of a CFC must be subject to a foreign rate of tax that falls below 50% of the South African company rate (i.e. 14%) after taking tax credits into account. In other words, the CFC must be located in a low-tax jurisdiction.

3. The sales income must not be attributable to the activities of a permanent establishment (as defined in the O.E.C.D. Model Tax Treaty Convention) located in the CFC’s country of residence. In other words, the CFC sale destined for South African import are now triggered if sales income is simply associated with various forms of ‘preparatory and auxiliary activities’ or with activities outside the CFC’s country of residence. Like the revised FBE test, the test of ‘attribution’ requires a transfer pricing analysis.

Exported goods

The diversionary rules associated with South African exports to a CFC have been completely removed. Additional protection is not required because the value-adding activities largely occur on-shore – all of which make the task of enforcing arm’s length transfer pricing principles more manageable.


Imported services

The old diversionary rules associated with services imported from a CFC have been retained in their old form. Under these rules, CFC income relating to services rendered by a CFC to a South African connected party are taxable, unless the CFC meets a higher business activity test as measured by objective criterion.

Removal of the transfer pricing penalty

Under old law, transfer pricing violations involving a CFC triggered tainted treatment for all amounts derived from the suspect transaction, not just the reallocation of misallocated income. This ‘all-or-nothing’ rule is misdirected and has accordingly been deleted.

Mobile income

As a general rule (and consistent with current law), mobile income accruing to a CFC will be automatically taxable unless specific exemptions relevant to that income stream apply. As under the previous law, the FBE exemption will not apply even though the mobile income may be attributable to FBE activities. Unlike old law which mixed mobile income into one set of rules, targeted mobile income is now covered under four broad but distinct categories:–

1. Financial instruments

2. Insurance premiums

3. Royalties and disposals of intellectual property

4. Rentals and sales of tangible movable property

1. Financial instrument income

Income from financial instruments includes income from debts, shares, derivatives instruments and financial leases. The concept of ‘financial instrument’ is defined broadly in section 1. Income from financial instruments also consists of capital gains derived from the disposal of these instruments. Lastly, income from financial instruments includes exchange differences determined in respect of those financial instruments. Income from financial instruments derived by a CFC is taxable unless:

(i) the CFC is a bank, financial services provider or insurer, or

(ii) the income is subject to the working capital exemption. However, for the exemption to apply, the income must not result in a tax deduction for a South African connected person. These exemptions already existed under the old law but have been streamlined in line with initially intended principles.

Bank, financial service provider or insurer exemption

Financial instrument income is now not tainted if the income arises from the principal trading activities of a bank, financial services provider or insurer (other than a treasury operation or captive insurer). More specifically, in order to qualify for the exemption:

(i) the CFC must carry on principal trading activities of a bank, financial services provider or insurer through a FBE,

(ii) the financial instrument must be attributable to that FBE, and

(iii) the activities of the CFC should not constitute activities of a treasury operation or captive insurer. A determination of whether a CFC is a treasury operation or captive insurer is based on facts and circumstances analysis. However, notwithstanding this facts and circumstances analysis, financial instrument CFC this income will additionally be denied relief as a treasury operation if:

a. The CFC fails to conduct more of its principal trading activities in the country in which the FBE is located than any other country;

b. the CFC does not regularly accept deposits or make loans to clients who are unconnected persons; or

c. the amounts derived from the principal trading activities of the CFC with unconnected persons are less than 50% of the total amounts attributable to the activities of the foreign business establishment of that CFC.

Similarly, notwithstanding the facts and circumstances test used to determine whether a CFC is a captive insurer, the financial instrument CFC income is now additionally denied relief as a captive insurer if:

a. The CFC fails to conduct more of its principal trading activities in the country in which the FBE is located than any other country;

b. the principal trading activities of the CFC do not involve the regular transaction of the business of an insurer with clients who are not connected persons; or

c. the amounts derived from the principal trading activities of the CFC with unconnected persons are less than 50% of the total amounts attributable to the activities of the foreign business establishment of that CFC.


As a side point, it should further be noted that the new financial instrument income dispensation provides a special exemption pertaining to section 24I exchange differences relating to financial instruments. In order to qualify for this additional exemption, the exchange differences must arise in the ordinary course of the core business of the CFC. This dispensation will not apply if the exchange difference is attributable to the activities of a treasury operation or captive insurer (as set out above).

Working capital exemption

The working capital exemption has replaced the current 10% de minimis exemption. The working capital exemption applies only if tainted financial instrument income is associated with financial instrument receipts and accruals that do not exceed 5% of total CFC receipts and accruals. It should be noted that the working capital de minimis exemption does not apply to other forms of mobile income because working capital is typically only held in the form of financial instruments.

South African deductible payment override

The above exemptions do not apply in respect of financial instrument income associated with a deduction from the same or an interdependent financial instrument. This anti-avoidance rule applies because of the high tax avoidance risk posed by this mobile income.

The purpose of the rule is to prevent the round-tripping of amounts to undercut the tax system (as an additional mechanism on top of the general anti-avoidance rule, the latter of which takes into account alleged business purposes). Deductible payments relating to financial instruments (especially debt) often go offshore tax-free and return to South Africa in the form of an exempt dividend income, (while effectively remaining within the same corporate group).

Example:

Facts: SA Company 1 owns all the shares of SA Company 2 and CFC, the latter of which is an active banking company located in Country X. CFC has a loan book of R100 million comprising of loans advanced mainly to unconnected persons located in Country X. CFC is also owed R2 million on loan account from SA Company 2 at a 12% interest rate. SA Company 2 uses the R2 million to finance its trading operations.

Result: The 12% interest received by CFC is not eligible for the principal banking activity exception. The exception does not apply even though the loan is part of CFC’s commercial banking activities and not attributable to treasury operations. The reason for this exclusion is that SA Company 2 will claim a deduction in respect of that interest and SA Company 2 is a connected person in relation to the CFC.

2. Insurance premiums

Insurance premiums derived by a CFC will generally be taxable. However, an exception exists if the income is derived from the CFC’s principal trading activities of an insurer unless the insurer is a captive. These tests are largely based on the facts and circumstances, but an insurer will always be deemed to be a captive if:

i. The CFC fails to conduct more of its principal trading activities in its country in which the FBE is located than any other country; or

ii. The principal trading activities of the CFC do not involve the regular transaction of the business of an insurer with clients who are not connected persons; or

iii. The amounts derived from the principal trading activities of the CFC with unconnected persons are less than 50% of the total amounts attributable to the activities of the foreign business establishment of that CFC.

3. Intellectual property (royalties and sales)

The old rules applicable to royalties and capital gains from the disposal of intellectual property have been largely retained in their old form. In the main, royalties and intellectual property gains derived by a CFC will be taxable unless the CFC actively develops the underlying intellectual property. These relief mechanisms will not apply if the intellectual property is tainted. Tainted intellectual property largely involves intellectual property that was once within the South African tax net.

4.1 Immovable (rentals and sales)

Rentals derived by a CFC from the leasing of immovable property are exempt from tainted mobile income treatment. The disposal of immovable property is similarly eligible for the FBE exemption without deviation. Despite their passive nature, these forms of passive income fall outside the mobility issues of concern.

4.2 Tangible movables (rentals and sales)

Rentals derived by a CFC from the leasing of movables are fully taxable unless the lease is an operating lease or a financial instrument. The exemption of operating leases covers genuine leasing operations where the lessor substantially bears the economic risk of the assets involved. More specifically, the expression ‘operating lease’ has been defined as a lease of movable property concluded by a lessor if:

1. The property can be hired by members of the general public for a period of no more than 5 years;

2. The costs or activities of maintenance and repairs occasioned by normal wear and tear are borne by the lessor; and

3. The lessee does not assume liability for the loss or destruction of the property, except if the lessee has failed to take proper care.


Relief under this dispensation excludes financial instruments such as finance leases. Typical finance leases effectively transfer the economic life of those assets; or somehow, the lessee bears the ultimate risk and rewards associated with ownership of an asset. These leases will instead be tested under the financial instrument provisions.

Capital gains from the disposal of the tangible movable property will be entitled to the FBE exemption without deviation

Miscellaneous

As part of the simplification, a number of miscellaneous provisions have been deleted and streamlined. These provisions entailed complexity that outweighed their potential benefits.

Shift to a 10% threshold

The ownership thresholds in respect of the dividend and capital gain participation exemptions in relation to foreign shares will be reduced from 20% down to 10%. This lower threshold is consistent with the global economic concept of direct foreign investment. In view of this reduction, the election to be treated as a CFC for foreign companies between the 10 and 20% range has been deleted.

High tax exemption and elections

Previously, a person that held 10-to-20% of a foreign company could elect to treat that foreign company as a CFC and further elect out of the CFC exemptions. As a result, the CFC income was taxable on a accrual basis, with the CFC income carrying foreign tax credits.

The introduction of the high tax exemption meant that a person who elected to treat a 10- 20% held foreign company as a CFC and further elected out of the CFC exemptions could no longer claim foreign tax credits. This result was never intended. A special temporary dispensation has thus been provided during the phase-out period of the elections. In a nutshell, any person who elects to treat a foreign company as a CFC without the foreign business establishment exemption may also elect out of the high tax exemption so as to be eligible for foreign tax credits.

Removal of rulings option

The old CFC rules provided SARS with the authority to waive the potential taint caused by certain of the current diversionary rules. In light of the current changes, the CFC ruling system has been deleted as superfluous.


Section 9D has been amended and in its amended form provides as follows:

Definitions

Added to the definitions in section 9D(1) are the definitions of a ‘foreign company’ and a ‘protected cell company’.

Foreign company

A ‘foreign company’ means any-

(a) cell or segregated account contemplated in the definition of a ‘protected cell company’;

(b) protected cell company to the extent that-

(i) its specified assets are not segregated into structurally independent cells or segregated accounts as contemplated in

paragraph (a) of the definition of a ‘protected cell company’; or

(ii) its specified assets and liabilities are not linked or attributed to cells or segregated accounts as contemplated in

paragraph (b) of the definition of a ‘protected cell company’; or

(a) foreign company, as defined in section 1, other than a protected cell company.

Section 1 defines a ‘foreign company’ as a company that is not a resident.

A ‘resident’ is also defined in section 1. Under paragraph (b) of the definition of a ‘resident’, a resident person other than a natural person will be a resident if it is, incorporated, established or formed, or has its place of effective management, in South Africa.

Effective date

The definition of a ‘foreign company’ in section 9D(1) comes into operation on 1 January 2012 and applies to a foreign tax year of a CFC ending during years of assessment commencing on or after that date.

Protected cell company

A ‘protected cell company’ means an entity incorporated, established or formed, whether by way of conversion or otherwise, under a law of a country other than South Africa;

(a) if its principal trading activities constitute the business of an insurer, and

(b) when that law makes provision for-


(i) the segregation of specified assets into structurally independent cells or segregated accounts;

(ii) the linking or attribution of specified assets and liabilities to those cells or segregated accounts, or

(iii) separate participation rights for each such cell or segregated account,

irrespective of whether or not that law provides that the establishment or formation of a cell or segregated account

creates a legal person distinct from that entity.

Effective date

The definition of a ‘protected cell company’ in section 9D(1) comes into operation on 1 January 2012 and applies to a foreign tax year of a CFC ending during years of assessment commencing on or after that date.

Net income

In the determination of the net income of a CFC certain adjustments are made to its taxable income.

Passive amounts incurred between CFCs

The adjustment in section 9D(2A) proviso (c) has been substituted. It now provides that no deduction is allowed for-

(i) interest, royalties, rental or income of a similar nature that is paid or payable or deemed to be paid or payable by that

company to another CFC (including a similar amount adjusted under section 31 (so-called transfer pricing or thin

capitalisation)),

(ii) an exchange difference determined under section 24I for an exchange item to which it and another CFC are parties,

(iii) an exchange difference for a forward exchange contract or foreign currency option contract entered into to hedge the

above exchange item, or

(iv) a reduction or discharge by it of a debt owed to it by another CFC for no consideration or for consideration less than the

amount by which the face value of the debt has been so reduced or discharged,

when it and that other CFC form part of the same group of companies, unless that interest, rental, royalty, other income, adjusted amount, exchange difference, reduction or discharge is taken into account in the determination of the net income of that other CFC.

Effective date

Proviso (c) to section 9D(2) in its ‘amended’ form comes into operation on 1 April 2012 and applies to foreign tax years of a CFC ending during years of assessment commencing on or after that date.

Section 31

The ‘adjustment’ in section 9D(2A) proviso (i) has been deleted.

Effective date

The deletion of proviso (i) to section 9D(2A) comes into operation on 1 April 2012 and applies to foreign tax years of a CFC ending during years of assessment commencing on or after that date.

Translation

Section 9D(6) has been substituted with the correction of the incorrect reference to the CFC’s ‘year of assessment’ which has been replaced by a correct reference to its ‘foreign tax year’.

Effective date

The above amendment to section 9D(6) comes into operation on 1 January 2012 and applies to a foreign tax year of a CFC ending during years of assessment commencing on or after that date.

Foreign business establishment

Section 9D(9)(b) has been substituted and now provides that in the determination of the net income of a CFC under section 9D(2A), there must not be taken into account an amount that is attributable to a foreign business establishment of that CFC (whether or not as a result of the disposal or deemed disposal of an assets forming part of that foreign business establishment) and, in determining that amount and whether that amount is attributable to a foreign business establishment-

(i) that foreign business establishment must be treated as if that foreign business establishment were a distinct and separate enterprise engaged in the same or similar activities under the same or similar conditions and dealing wholly independently with the CFC of which the foreign business establishment is a foreign business establishment; and


(ii) that determination must be made as if the amount arose in the context of a transaction, operation, scheme, agreement or understanding that was entered into on the terms and conditions that would have existed had the parties to that transaction, operation, scheme, agreement or understanding been independent persons dealing at arm’s length.

Effective date

Section 9D(9)(b) in its ‘amended’ form comes into operation on 1 April 2012 and applies to foreign tax years of a CFC ending during years of assessment commencing on or after that date.

Foreign dividends accruing from another CFC

The reference in section 9D(9)( f ) to section 10(1)(k)(ii)(dd) has been replaced by a reference to section 10B(2)(a), (b) or (c).

The effect of the amended section 9D(9)(f) is that a resident holding participation rights in a CFC that derives a foreign dividend from another CFC in relation to him will not be taxed on his proportional amount of that foreign dividend.

Effective date

Section 9D(9)( f ) in its ‘amended’ form comes into operation on 1 April 2012 and applies to foreign tax years of a CFC ending during years of assessment commencing on or after that date.

Interest, royalties, rentals and similar amounts

The proviso to section 9D(9)( fA) has been deleted.

Section 9D(9)( fA) now exempts from the application of section 9D the net income of a CFC attributable to

(i) interest, royalties, rental or income of a similar nature that is paid or payable or deemed to be paid or payable to it by

another CFC (including a similar amount adjusted under section 31),

(ii) an exchange difference determined under section 24I for an exchange item to which it and another CFC are parties,

(iii) an exchange difference on a forward exchange contract or foreign currency option contract entered into to hedge the

exchange item referred to above, or

(iv) the reduction or discharge by another CFC of a debt owed by it to that other CFC for no consideration or for a consideration less than the amount by which its face value has been so reduced or discharged,

when it and that other CFC form part of the same group of companies.

Effective date

The deletion of the proviso to section 9D(9)( fA) comes into operation on 1 April 2012 and applies to foreign tax years of a cfc ending during years of assessment commencing on or after that date.

Further inclusions in net income

Section 9D(9A) has been inserted into the Income Tax Act. It provides for the inclusion in a CFC’s net income, certain amounts that are attributable to its foreign business establishment, It reads as follows:

Section 9D(9A)(a) provides that any amount which is attributable to a foreign business establishment of a controlled foreign company as contemplated in subsection (9)(b) must, notwithstanding that subsection, be taken into account in determining the net income of that controlled foreign company if that amount—

(i) is derived from the disposal of goods by that controlled foreign company where those goods will be acquired directly or indirectly by a connected person (in relation to that controlled foreign company) who is a resident, unless—

(aa) the aggregate amount of tax payable to all spheres of government of any country other than the Republic by the controlled foreign company in respect of the foreign tax year of that controlled foreign company is more than 50% of the amount of normal tax that would have been payable in respect of any taxable income of the controlled foreign company had the controlled foreign company been a resident for that foreign tax year; or

(bb) that amount is attributable to a permanent establishment of the controlled foreign company;

(ii) is derived from any service performed by that controlled foreign company to a connected person (in relation to that controlled foreign company) who is a resident, unless that service is performed outside the Republic and—

(aa) the service relates directly to the creation, extraction, production, assembly, repair or improvement of goods utilised within one or more countries other than the Republic;

(bb) the service relates directly to the sale or marketing of goods of a connected person (in relation to that controlled foreign company) who is a resident and those goods are sold to persons who are not connected persons in relation to that controlled foreign company for physical delivery to customers’ premises situated within the country of residence of that controlled foreign company;


(cc) the service is rendered mainly in the country of residence of that controlled foreign company for the benefit of customers that have premises situated in that country; or

(dd) to the extent that no deduction is allowed of any amount paid by that connected person to that controlled foreign company in respect of the service;

(iii) arises in respect of a financial instrument—

(aa) unless that financial instrument is attributable to the principal trading activities of the foreign business establishment and those principal trading activities—

(A) constitute the activities of a bank, financial service provider or insurer; and

(B) do not constitute the activities of a treasury operation or captive insurer;

(bb) unless—

(A) that amount is attributable to any exchange difference determined in terms of section 24I in respect of that financial instrument;

(B) the exchange difference contemplated in subitem (A) arises in the ordinary course of business of the principal trading activities of that foreign business establishment; and

(C) the principal trading activities contemplated in subitem (B) do not constitute the activities of a treasury operation or captive insurer; or

(cc) to the extent that the total of—

(A) those amounts arising in respect of financial instruments attributable to activities of that foreign business establishment; and

(B) amounts arising from exchange gains determined in terms of section 24I attributable to activities of that foreign business establishment, other than amounts in respect of which paragraphs (e) to (fB) of subsection (9) apply, does not exceed 5% of the total of all amounts received by or accrued to the controlled foreign company that are attributable to that foreign business establishment;

(iv) arises by way of rental in respect of any movable property, unless that movable property is leased by the controlled foreign company in terms of—

(aa) an operating lease; and

(bb) a lease that constitutes a financial instrument;

(v) arises in respect of the use or right of use of or permission to use any intellectual property as defined in section 23I, unless that controlled foreign company directly and regularly creates, develops or substantially upgrades any intellectual property as defined in section 23I which gives rise to that amount;

(vi) is a capital gain determined in respect of the disposal or deemed disposal of any intellectual property as defined in section 23I unless—

(aa) that controlled foreign company directly and regularly creates, develops or substantially upgrades any intellectual property as defined in section 23I which gives rise to that amount; and

(bb) that intellectual property does not constitute property which, if that controlled foreign company were a resident, would constitute tainted intellectual property as defined in section 23I in relation to that controlled foreign company; or

(vii) is in the form of an insurance premium, unless that amount is attributable to the principal trading activities of the foreign business establishment and those principal trading activities—

(aa) constitute the activities of an insurer; and

(bb) do not consititute the activities of a captive insurer:

Provided that if any amount which is attributable to a foreign business establishment of a controlled foreign company as contemplated in subsection (9)(b) is, solely as a result of the application of subparagraph (iii) of this paragraph, not taken into account in determining the net income of that controlled foreign company, that amount must be so taken into account—

(A) to the extent that a deduction is allowed in respect of any other amount incurred by a connected person (in relation to that controlled foreign company) who is a resident; and

(B) where that amount is attributable to that other amount.

Section9D(9A)(b) further provides that for the purposes of—

(i) item (aa) of paragraph (a)(i), the aggregate amount of tax payable contemplated in that item must be determined—

(aa) after taking into account any applicable agreement for the prevention of double taxation and any credit, rebate or other right of recovery of tax from any sphere of government of any country other than the Republic; and

(bb) after disregarding any loss in respect of a year other than a year contemplated in that item or from a company other than a controlled foreign company contemplated in that item;


(ii) item (bb) of paragraph (a)(i), in determining whether an amount is attributable to a permanent establishment of a controlled foreign company—

(aa) that permanent establishment must be treated as if that permanent establishment were a distinct and separate enterprise engaged in the same or similar activities under the same or similar conditions and dealing wholly independently with the controlled foreign company of which it is a permanent establishment; and

(bb) that determination must be made as if the amount arose in the context of a transaction, operation, scheme, agreement or understanding that was entered into on the terms and conditions that would have existed had the parties to that transaction been independent persons dealing at arm’s length;

(iii) items (aa) and (bb) of paragraph (a)(iii), where the principal trading activities of a foreign business establishment do not constitute the activities of a treasury operation, the principal trading activities of that foreign business establishment must be deemed to constitute the activities of a treasury operation where—

(aa) less of those principal trading activities are conducted in the country in which the foreign business establishment is located than in any other single country;

(bb) those principal trading activities do not involve the regular and continuous acceptance of deposits from or the provision of credit to clients who are not connected persons in relation to that controlled foreign company; or

(cc) less than 50% of the amounts attributable to the activities of the foreign business establishment are derived from those principal trading activities with respect to clients who are not connected persons in relation to that controlled foreign company;

(iv) items (aa) and (bb) of paragraph (a)(iii) and paragraph (a)(vii), where the principal trading activities of a foreign business establishment do not constitute the activities of a captive insurer, the principal trading activities of that foreign business establishment must be deemed to constitute the activities of a captive insurer where—

(aa) less of those principal trading activities are conducted in the country in which that foreign business establishment is located than in any other single country;

(bb) those principal trading activities do not involve the regular transaction of business as an insurer with clients who are not connected persons in relation to that controlled foreign company; or

(cc) less than 50% of the amounts attributable to activities of that foreign business establishment are derived from those principal trading activities with respect to clients who are not connected persons in relation to that controlled foreign company; and

(v) paragraph (a)(iv), ‘operating lease’ means a lease of movable property concluded by a lessor in the ordinary course of business of letting such property if—

(aa) such property may be hired by members of the general public directly from that lessor in terms of such a lease, for a period of no more than five years;

(bb) either—

(A) the cost of maintaining such property and of carrying out repairs thereto required in consequence of normal wear and tear is ultimately borne by the lessor; or

(B) the activities of maintaining and repairing such property that are required in consequence of normal wear and tear are performed by the lessor; and

(cc) subject to any claim that the lessor may have against the lessee by reason of the lessee’s failure to take proper care of the property, the risk of destruction or loss of or other disadvantage to such property is not assumed by the lessee.

Effective date

The insertion of section 9D(9A) comes into operation on 1 April 2012 and applies to foreign tax years of a CFC ending during years of assessment commencing on or after that date.

Rulings

Section 9D(10) has been deleted. Prior to its deletion it provided together with certain conditions that the Commissioner may issue a ruling that disregards the application of section 9D(9)(b)(ii) for the sale of goods or performance of services by a CFC when its foreign business establishment situated in its country of residence mainly serves as a central location for the sale or performance of identical or similar goods or services in at least two countries that are contiguous to its country of residence.

Effective date

The deletion of section 9D(10) comes into operation on 1 April 2012 and applies to foreign tax years of a CFC ending during years of assessment commencing on or after that date.


Election to disregard exceptions

Section 9D(12) has been deleted. Prior to its deletion it provided that a resident who, together with any other resident who is his connected person, held at least 10% but not 20% or more of the participation rights and voting rights of a CFC could elect that all the provisions of section 9D(9) (the exclusions or exemptions) would not apply to the net income determined for a relevant foreign tax year of a CFC in which he held participation rights.

This election allowed a resident shareholder to be taxed on foreign income under the provisions of section 9D so as to receive the benefit of the section 6quat rebate.

Effective date

The deletion of section 9D(12) comes into operation on 1 April 2012 and applies to foreign tax year of a CFC ending during years of assessment commencing on or after that date.

Election to be a CFC

Section 9D(13) has been deleted. Prior to its deletion it provided that a resident who, together with any other resident who is his connected person, held at least 10% but not 20% or more of the participation rights and voting rights of a foreign company could elect that it be deemed to be a CFC in relation to him for any of its foreign tax years.

This election allowed a resident shareholder to be taxed on foreign income under section 9D so as to receive the benefit of the section 6quat rebate and not to be taxed on the distribution of the profits of the foreign company by way of a ‘foreign dividend’. This enabled the resident to avoid the economic double taxation of profits distributed and taxed as a ‘foreign dividend’ when no underlying foreign tax credits may be claimed.

Effective date

The deletion of section 9D(13) comes into operation on 1 April 2012 and applies to foreign tax year of a CFC ending during years of assessment commencing on or after that date.

Addition of section 9D(14) being a further proviso to section 9D(2A)

Section 9D(14) has been added. It provides that a resident who made an election contemplated in section 9D(12) or (13) may also elect that the further proviso to section 9D(2A) must not apply to the foreign tax year for which the election contemplated in section 9D(12) or (13) was made.

The further proviso to section 9D(2A) provides as follows:

Paragraph (i) of this further proviso states that the net income of a CFC for a foreign tax year is deemed to be nil when the aggregate amount of tax payable to all spheres of government of a country other than South Africa by it for its foreign tax year is at least 75% of the normal tax that would have been payable on its taxable income had it been a resident for that foreign tax year.

There is an additional requirement for this further proviso to apply. In terms of paragraph (ii) of the further proviso, the aggregate amount of tax payable contemplated in paragraph (i) of this further proviso must be determined-

(i) after taking into account an applicable agreement for the prevention of double taxation and any credit, rebate or other

right of recovery of tax from a sphere of government of a country other than South Africa, and

(ii) after disregarding a loss for a year other than a year contemplated in paragraph (i) of this further proviso or from a

company other than a company contemplated in paragraph (i) of this further proviso.

The effect of this further proviso is that a resident shareholder of a cfc will not be required to include in his income his proportionate share of its net income when it has paid tax to another country and this tax paid is at least 75% of the normal tax that would have been paid in South Africa on its taxable income had it been a resident. A taxpayer would seek to use the election when the foreign income is subject to a high level of tax, but the high-tax exception indirectly prohibits use of the election in these circumstances. The election will accordingly be allowed to override the high-tax exception.

Effective date

Section 9D(14) is deemed to have come into operation on 1 January 2011 and applies to a foreign tax year of a CFC ending during years of assessment-

(a) ending on or after that date, and

(b) for which a return for the assessment of tax is furnished to the Commissioner on or after that date.

It is important to note that this change is short lived. The election has been removed in 2012 as part of the overall CFC reform (see below).


Section 9D(14) is then deleted.

Effective date

The deletion of section 9(14) comes into operation on 1 April 2012 and applies to foreign tax year of a CFC ending during years of assessment commencing on or after that date.

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SINGLE CHARGE FOR COMPANY EMIGRATION

Insertion of section 9H of the Income Tax Act, amendment to section 64P.of the Income Tax Act and amendment to paragraph 12 of the Eighth Schedule to the Income Tax Act

Background

A company can be said to have migrated when that company ceases to be a tax resident in South Africa. One method for effecting this migration entails a company shift of its place of effective management to another tax jurisdiction (even if the company continues some or all of its operations in South Africa). This re-domiciling from South Africa to a foreign jurisdiction triggers certain tax consequences. At the company-level, the company migration of effective management was deemed to be a disposal for capital gains tax purposes. In particular, the migrating company was deemed to have generally disposed of its assets at market value on the day before ceasing to be a resident and repurchasing those same assets at the same market value. However, assets that remained within the capital gains tax net were excluded from this deemed disposal (and market value repurchase). A company migration additionally triggered a deemed dividend for purposes of the Secondary Tax on Companies. This deemed dividend treatment was limited to company profits and reserves immediately before the company ceased to be a resident. Many aspects of this deemed dividend treatment were initially to be carried over into the Value Extraction Tax (to be imposed when the new Dividends tax comes into effect).

Reason for change

When a company migrates, the event could theoretically be viewed in one of two ways – firstly as a sale and repurchase of assets by the entity, or secondly as a liquidation followed by a reincorporation. However, the old policy regarding the migration of companies was an inconsistent combination of both concepts. The imposition of a tax on dividends was also problematic at the shareholder-level because these shareholders do not receive any cash at any point during the migration (and any actual dividend under the new Dividend Tax falling within similar circumstances may be exempt). A simplified regime was therefore required that is both more theoretically defensible and more administratively viable.

The change

A single set of company-level tax has been imposed when a company ceases to be a South African tax resident by virtue of a change in effective management. This event will trigger either capital gain or ordinary revenue. No deemed dividend treatment will result. The disposal will be deemed to take place on the date immediately before the date of the change of residence. More specifically, assets held by the existing company on the day before cessation as a resident will be deemed to be disposed at an arm’s length value. These entities are subject to the charge because these entities are already exiting the tax net. All of these assets will then be deemed repurchased at the same market value. Appreciating assets held as trading stock will trigger ordinary revenue; appreciating assets of a capital nature will trigger capital gains (and possibly recoupment). As under the old provisions, exceptions will exist for assets remaining within the South African taxing jurisdiction and for certain share incentive schemes. Further, as indicated under the discussion pertaining to headquarter company adjustments, a similar exit charge has been levied at the headquarter company level for any resident company that enters the headquarter company regime.


Section 9H of the Income Tax Act has been inserted

9H(1) For the purposes of this section—

‘asset’ means an asset as defined in paragraph 1 of the Eighth Schedule;

‘market value’ in relation to an asset means the price which could be obtained upon a sale of that asset between a willing buyer and a willing seller dealing at arm’s length in an open market.

(2) Subject to subsection (3), where a person ceases to be a resident or becomes a headquarter company, that person must be treated as having—

(a) disposed of each of that person’s assets on the date immediately before the day on which that person so ceases to be a resident or becomes a headquarter company for an amount received or accrued equal to the market value of the asset on that date; and

(b) reacquired each of those assets immediately after the time of the disposal contemplated in paragraph (a) and at an expenditure equal to the market value contemplated in that paragraph.


(3) Subsection (2) does not apply in respect of an asset of a person where that asset constitutes—

(a) immovable property, any interest in immovable property or any right to or in immovable property situated in the Republic as contemplated in paragraph 2(2) of the Eighth Schedule and held by that person;

(b) any asset which will, after the person ceases to be a resident or becomes a headquarter company as contemplated in subsection (2), be attributable to a permanent establishment of that person in the Republic;

(c) any qualifying equity share contemplated in section 8B that was granted to that person less than five years before the date on which that person ceases to be a resident or becomes a headquarter company as contemplated in subsection (2);

(d) any equity instrument contemplated in section 8C, which had not yet vested as contemplated in that section at the time that the person ceases to be a resident or becomes a headquarter company as contemplated in subsection (2); or

(e) any right of that person to acquire any marketable security contemplated in section 8A.

Effective date

The insertion of section 9H comes into operation on the date on which Part VIII of Chapter II of the Income Tax Act, 1962, comes into operation (i.e on or after 1 April 2012).

Paragraph 12 of the Eighth Schedule to the Income Tax Act has been amended

Paragraph 12 provides for events treated as disposals and acquisitions. Paragraph 12(2) deals with persons commencing or ceasing to be resident. Paragraph 12(2)(a) has been amended as a consequence of the insertion of section 9H that deals with ‘change of residence’.

Paragraph 12(1) and amended paragraph (2)(a) now read as follows:

(1) Unless subparagraph (4) applies, where an event described in subparagraph (2) occurs, a person must,

subject to paragraph 24, be treated for the purposes of this Schedule as having disposed of an asset described

in subparagraph (2) for an amount received or accrued equal to the market value of the asset at the time of the

event and to have immediately reacquired the asset at an expenditure equal to that market value, which

expenditure must be treated as an amount of expenditure actually incurred and paid for the purposes of

paragraph 20(1)(a).

(2) Subparagraph (1) applies, in the case of—

a) a person that commences to be a resident, or a controlled foreign company, in respect of all assets of that person other than-

i) assets in the Republic listed in paragraph 2(1)(b)(i) and (ii);

ii) [deleted]

iii) [deleted]

iv) any right to acquire any marketable security contemplated in section 8A;

Effective date

The amendments to paragraph 12(2)(a) of the Eighth Schedule to the Income Tax Act comes into operation on 1 April 2012.

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CONTROLLED FOREIGN COMPANY RESTRUCTURING

Amendment to sections 42, 44, 46 and 47 of the Income Tax Act and Paragraph 64B(2)(b) of the Eighth Schedule to the Income Tax Act.

Background

Resident companies can restructure their affairs through various transactions falling within the reorganisation rollover rules. Rollover relief means that the transactions themselves are exempt, but any gain is deferred until a later disposal. These rollover transactions can take the form of asset-for-share transactions, amalgamations, intra-group transfers, unbundlings and liquidations. This relief is premised on the fact that the parties at issue have merely transformed their interests in the underlying assets as opposed to a cash-out of underlying risks. These relief measures are not available to the restructuring of foreign operations (except in very limited circumstances). A simpler and narrower set of parallel relief provisions exist for offshore restructurings, known as the capital gains participation exemption. Under this exemption, a gain is wholly exempt (not simply deferred) when residents and CFCs dispose of equity shares in a 20% held foreign company. However, this exemption is generally available only if the foreign shares are transferred to a totally independent foreign resident or to a CFC under the same South African group of companies (without any intention of resale to South African residents). The restructuring of CFC assets can also qualify for tax relief if disposed of within the confines of the foreign business establishment exemption or if the disposal occurs within a high-taxed country.


Reasons for change

Many South African multinationals seek to restructure their offshore operations. These restructurings often occur when multinationals acquire foreign companies with inconveniently located subsidiaries and seek to move these foreign subsidiaries into more efficient locations within the group. In light of the current economic downturn, these restructurings have accelerated in order to realise economies of scale and to increase internal efficiency, thereby keeping South African multinationals globally competitive. The current participation exemption applicable to offshore restructurings has a number of shortcomings. On the one hand, the regime is too narrow – allowing some restructurings while inadvertently excluding others (e.g. certain transactions lacking an actual disposal of shares or certain transfers to South African companies within the same group). On the other hand, the breadth of the exemption poses a risk to the tax base with some taxpayers seeking an internal restructuring solely to elevate the base cost of their shares, followed by a taxable sale with artificially reduced gain (due to the elevated base cost). A balance must therefore be struck between facilitating restructurings and preventing tax avoidance.

The change

Overview

In view of the above, the domestic corporate restructuring rollover rules have been extended to include the restructuring of offshore companies that remain under the control of the same South African group of companies. More specifically, the asset-for-share, amalgamation, unbundling and liquidation rules will be revised to cover offshore restructurings within this framework. It should be noted that the extension of the reorganisation rollover rules to cover foreign restructurings was always intended, but this extension was delayed until many issues involving offshore CFCs could be resolved and simplified. For instance, the initial system of indirect credits has been dropped and a simplified exclusion exists for high-taxed foreign country income.

Extension of the reorganisation rollover regime

Asset- for-share transactions

Asset-for-share relief is mainly limited to the transfer of assets between residents. This relief has now been extended to cover the transfer of foreign company equity shares to CFCs (thereby allowing intra-group foreign share-for-share transactions). This extended asset-for-share relief is premised on the fact that reorganisation rollovers should not result in the tax-free externalisation of corporate value outside the South African group. In particular, this extended rollover relief allows the transfer of foreign equity shares (in addition to other pre-existing requirements for asset-for-share transfers) if:

(i) the transferor holds a qualifying interest (i.e. 20% equity shares and voting rights) in the transferee; and

(ii) the transferee constitutes a controlled foreign company in relation to the transferee or any group company.

Foreign asset-for-share rollovers will also be subject to a charge if the qualifying criteria is not maintained for a period of 18 months after the transaction. More specifically, the transferee must remain a CFC, remain within the group, and the transferor must maintain a qualifying interest in the transferee for at least 18 months. Failure to comply with these requirements will trigger a gain for the transferor.

Example

Facts: Foreign Parent owns all the shares of South African Holding Company. South African Holding Company owns all the shares of CFC and 45% of the shares of Foreign Company (FC). CFC owns the other 55% of the shares of CFC. South African Holding Company transfers all of its shares in FC to CFC.

Result:

The foreign share-for-share rollover relief will apply because FC became a controlled foreign company immediately after the disposal, and FC remains part of the same group. However, gain will be triggered if CFC

status or group status is lost within 18 months (or qualifying interest status is lost).

Amalgamation transactions

Previous amalgamation rollover relief was only available if the resultant company was a resident. Thus, a resident company could be merged into another resident company or a foreign company could be merged inbound into a resident company. This rule has been extended to cover the amalgamation, merger or conversion of a foreign company into certain resultant foreign companies. As in the previous rules, the amalgamated foreign company must transfer all of its assets (other than assets used to settle debts incurred in the ordinary course of business). This extended rollover relief for foreign amalgamations applies (in addition to other preexisting requirements for asset-for-share transfers) if:

(i) the amalgamated company and the resultant company form part of the same group of companies,

(ii) the resultant company constitutes a CFC in relation to resident group company, and

As discussed elsewhere in this explanatory memorandum, the resultant company need not issue shares in exchange for the assets of the amalgamated company (note: many connected party foreign amalgamations do not involve any transfer of shares).


Example

Facts: South African Parent company owns all the shares of CFC 1, which in turn owns all the shares of CFC 2 and CFC 3. CFC 2 transfers all its assets to CFC 3. Following the transfer, CFC2’s existence is terminated in terms of foreign law. CFC 3 does not issue any shares to CFC 2 (because CFC 1 already owns all of the CFC 3 shares).

Result: The amalgamation of CFC2 into CFC3 will qualify for rollover relief.

Unbundling transactions

The old unbundling rules already allowed for the unbundling of foreign companies. This relief, however, was limited to situations involving 95% ownership. The unbundling of foreign companies has been aligned to the newly revised rules. More specifically, this extended rollover relief allows for the unbundling of foreign holding companies to other foreign companies if:

(i) the unbundled company constitutes a controlled foreign company, and

(ii) the unbundling company and its shareholders form part of the same group of companies (with foreign companies viewed as part of the group for this purpose despite their foreign status).

(iii) the unbundling company must hold at least 50% of the equity shares of the unbundled company before the transaction.

Example:

Facts: South Africa Company owns all the equity shares of CFC1. CFC1 owns 80% of the shares of CFC 2. A foreign company owns the remaining 20% of the equity shares of CFC 2. In turn, CFC 2 owns all the shares of CFC3. In order to create a flatter structure, CFC 2 distributes all the equity shares held in CFC 3 to CFC1 and the Foreign Company in accordance with their effective shareholding in CFC2. CFC 1 and CFC2 do not elect out of the unbundling provisions.

Results: The distribution of the CFC3 shares to CFC 1 (and Foreign Company) will qualify for rollover relief as an unbundling transaction.

Liquidation transaction

Previous liquidation rollover relief covered the liquidation of companies into domestic holding companies. The liquidation rollover rules now additionally allow for liquidation into group CFCs revised rules. More specifically, this extended rollover relief allows for the liquidation into foreign holding companies if:

(i) the liquidating company and the holding company form part of the same group of companies (with foreign companies viewed as part of the group for this purpose despite their foreign status), and

(ii) the holding company constitutes a controlled foreign company in relation to group company that is a resident.

Note on participation exemption

The capital gains tax participation exemption for the transfer of equity shares to totally independent foreign residents will temporarily remain. The participation exemption will be re-examined in 2012 when the offshore reoganisation rules are refined.

Effective date

The amendments will generally apply in respect of transactions entered into on or after 1 January 2012.


Refer section of notes dealing with unbundling transactions.

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HEADQUARTERS COMPANIES

Amendment to section 1, 9D, 9I, 10(1)(k)(ii), 31(3) and 41(1) of the Income Tax Act and paragraph 64B of the Eighth Schedule to the Income Tax Act.

Background

In 2010, a new tax regime was enacted to ensure that the tax system did not act as a barrier to the use of South Africa as base to establish regional headquarter companies (mainly for Sub-Sahara). The new regime cleared three hurdles –

1. Relief from tax on dividends (to and from the headquarter company),

2. Relief from the controlled foreign company deemed income rules, and

3. Relief from transfer pricing (including thin capitalisation) in respect of back-to-back loans.

In order to qualify as a headquarter company, a South African company had to satisfy three criteria:

1. Minimum participation by shareholders: Each shareholder of the headquarter company must hold at least 20% of the headquarter company’s equity.


2. 80-20 tax value: 80% of the tax cost of the assets held by the headquarter company (in the form of equity shares held, amounts loaned or intellectual property) should represent investments in foreign subsidiaries in which the headquarter company beneficially holds at least 20% of the equity.

3. 80–20 receipts and accruals: 80% of the total receipts and accruals of the headquarter company must be derived from foreign subsidiaries in which the headquarter company holds at least 20% of the equity. These receipts and accruals include management fees, interest, royalties and dividends.

In respect of the first two requirements, the headquarter company must have always complied with these requirements in respect of each year of assessment since the company’s inception. These requirements equally applied;

(i) to existing companies that wish to enter the regime, and

(ii) to new companies going forward.

Reasons for change

Early experience with the headquarter company regime suggested that certain anomalies need to be removed that render the regime partially impractical. Early information suggested that certain parties are seeking to utilise the regime to undermine certain aspects of the pre-existing tax base. Lastly, many companies inadvertently fall into the regime with no desire to remain.

The change

Election and annual reporting

National Treasury has increasingly taken the position that incentives require annual reporting in order to measure their success and to protect against risks. Reporting is also necessary from a fiscal management point of view in order to measure the tax expenditure of the concession granted. No reason existed for the headquarter company regime to fall outside this paradigm. In the main, the entry into the headquarter company regime is voluntary and not automatic. A resident company that meets the qualifying criteria can simply elect into the regime by submitting a prescribed form to notify SARS of the election. This election will be annual and will be valid from the beginning of the year of assessment for which the election is made. Taxpayers within this relief must further submit annual information to National Treasury as required (in the form and manner prescribed). It is envisioned that the required reporting in this area will be fairly minimal.

Qualifying criteria

1. Reduced minimum participation by shareholders

Under the old law, each shareholder of a headquarter company must hold at least 20% of the total equity shares and voting rights. The participation threshold has been reduced to 10% in line with the reduced participation exemption threshold applicable to all residents holding foreign shares.

2. Relaxation of the 80-20 asset test

The revised 10% participation requirement has also been incorporated into the asset test. Thus, 80% of the total costs of the assets of the headquarter company (in the form of debt, equity or licensed intellectual property) must represent investments in subsidiaries in which the headquarter company holds a minimum 10% participation interest. The 80% asset test has been further relaxed in some respects. More specifically, the 80% asset requirement will no longer be determined with reference to cash or bank deposits payable on demand. These assets are being removed from the calculation because funds of this nature may inadvertently arise and be held for extended periods without any intention of tax avoidance (when simple planning could avoid this problem without any additional tax charge).

3. Relaxation of the 80-20 receipts and accruals test

The requirement that 80% of the total receipts and accruals of a headquarter company must be derived from foreign subsidiaries in which the headquarter company holds a minimum 10% participation interest has been significantly relaxed. The 80% income test operates as a backstop to the 80% asset requirement so that foreign subsidiary income bears some relationship to the foreign assets. As a backstop, this test has been relaxed.

Firstly, receipts and accruals no longer have to be used as a benchmark for the income test due to the broad nature and uncertainty created by this benchmark. Instead, gross income will be used in line with the legislature’s initial conceptual intention. Receipts and accruals falling outside the tax net will accordingly be ignored (e.g. receipts of share dividends).

Secondly, the 80% threshold has been dropped to 50%. The new 50% threshold will continue to apply to specified items of passive income (interest, royalty, dividends, service fees and rental) that form part of the gross income of the headquarter company with preferences for transactions with 10% foreign subsidiaries. The list of specified items (and preferences) to which the 50% threshold applies now includes lease payments. Specified passive income (and preferences) also excludes currency exchange differences. This exclusion for foreign exchange gains applies if the gains are attributable to exchange items to which the headquarter company is a party.

In addition, a safe haven now exists for small headquarter operations with total gross income of less than R5 million. This safe haven will provide flexibility during start up phases of headquarter operations.


Change of participation exemption

The capital gains tax participation exemption has been retained with the qualifying participation threshold reduced to 10%. The holding period of the foreign equity shares has remained 18 months, but restrictions as to whom the headquarter company can dispose of its foreign interest has been lifted. Headquarter companies can therefore dispose of their foreign interests to any person tax-free. Because of this advantageous tax position for the headquarter company, the shares held in the headquarter company by South African residents will no longer be eligible for the participation exemption. However, foreign residents holding shares in a headquarter company will continue to be exempt if the shares are not attributable to a permanent establishment in South Africa.

Deemed tax migration

A headquarter company effectively operates partially outside of South African taxing jurisdiction. Under old law, this partial outside status was recognised in the reorganisation rules, which treat headquarter companies as non-resident (i.e. generally ineligible to participate in rollover treatment). The new legislation maintains this reorganisation exclusion by not treating a headquarter company as a company for reorganisation purposes. Consistent with this treatment, a shift to South African headquarter status will trigger a deemed sale by the headquarter company of all its assets held before becoming a headquarter company. This charge will reduce the opportunity for taxpayers to utilise the headquarter company regime solely to undermine the pre-existing tax base (i.e. as an escape hatch for taxable gain).


Section 9I titled ‘Headquarter companies’ has been inserted

9I(1) provides that any company that—

(a) is a resident; and

(b) complies with the requirements prescribed by subsection (2),

may elect in the form and manner determined by the Commissioner to be a headquarter company for a year of assessment of that company.

(2) A company complies with the requirements contemplated in subsection (1)(b) for a year of assessment of that company if—

(a) for the duration of that year of assessment and of all previous years of assessment of the company, each shareholder in the company (whether alone or together with any other company forming part of the same group of companies as that shareholder) held 10% or more of the equity shares and voting rights in that company;

(b) at the end of that year of assessment and of all previous years of assessment of that company, 80% or more of the cost of the total assets of the company was attributable to one or more of the following:

(i) any interest in equity shares in;

(ii) any amount loaned or advanced to; or

(iii) any intellectual property as defined in section 23I(1) that is

licensed by that company to, any foreign company in which that company (whether alone or together with any other company forming part of the same group of companies as that company) held at least 10% of the equity shares and voting rights: Provided that in determining the total assets of the company, there must not be taken into account any amount in cash or in the form of a bank deposit payable on demand; and

(c) where the gross income of that company for that year of assessment exceeds R5 million, 50% or more of that gross income consisted of amounts in the form of one or both of the following:

(i) any rental, dividend, interest, royalty or service fee paid or payable by any foreign company contemplated in paragraph (b); or

(ii) any proceeds from the disposal of any interest contemplated in paragraph (b)(i) or of any intellectual property contemplated in paragraph (b)(iii):

Provided that in determining the gross income of the company, there must not be taken into account any exchange difference determined in terms of section 24I in respect of any exchange item as defined in that section to which that company is a party.

(3) An election made by a company in terms of subsection (1) is effective from the commencement of the year of assessment in respect of which that election is made.

(4) A headquarter company must submit to the Minister an annual report providing the Minister with the information that the Minister may prescribe within such time and containing such information as the Minister may prescribe.

Effective date

Section 9I is deemed to have come into operation on 1 January 2011 and applies in respect of years of assessment commencing on or after that date.


Section 10(1)(k)(ii) has been deleted

Section 10(1)(k)(ii) provided certain exemptions from normal tax for certain foreign dividends.

Effective date

The deletion of section 10(1)(k)(ii) comes into operation:

(a) insofar as it applies to any person that is a natural person, deceased estate, insolvent estate or special trust, on 1 March 2012 and applies in respect of years of assessment commencing on or after that date; and

(b) insofar as it applies to any person that is a person other than a natural person, deceased estate, insolvent estate or special trust, on 1 April 2012 and applies in respect of years of assessment commencing on or after that date.

Corporate restructure provisions

The definition of ‘company’ in section 41 of the Income Tax Act has been amended to exclude a headquarter company.

The definition of ‘resident’ in section 41 of the Income Tax Act has been deleted.

Effective date

The amendment to the definition of ‘company’ in section 41 comes into operation on 1 April 2012.

The deletion of the definition of ‘resident’ in section 41 comes into operation on 1 April 2012.

Disposal of equity shares in foreign companies – Paragraph 64B of the Eighth Schedule

Refer to the CGT section of these notes for further details

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FOREIGN DIVIDENDS – A NEW DISPENSATION

Section 10B has been inserted into the Income Tax Act. Section 10(1)(i) has been amended and section 10(1)(k)(ii) of the Income Tax Act have been deleted and section 11C of the Income Tax Act has been repealed. In addition section 23(q) has been added to the Income Tax Act.

Background

A. Taxation of dividends paid by domestic companies

Under current law, the Secondary Tax on Companies generally imposes tax at a rate of 10% on companies declaring dividends. This system is to be replaced with the Dividends tax system. The Dividends Tax will be levied at the shareholder-level at a rate of 10%, with certain exemptions. The liability to withhold the Dividends Tax falls on the company paying the dividend, whereas, the primary liability for the Dividend Tax falls on the beneficial owner of the dividend.

B. Taxation of dividends paid by foreign companies

Foreign dividends are not subject to the current Secondary Tax on Companies nor will foreign dividends be subject to the new Dividends Tax. Foreign dividends mainly fall outside these regimes (except for foreign cash dividends paid in respect of JSE listed shares). South Africa lacks the ability to directly tax the foreign company paying these dividends, even if paid to a South African resident.

As a general rule, foreign dividends are included in the recipient’s gross income and taxed at marginal rates (that is, 28% for companies and up to 40% for individuals). This form of taxation is subject to several exemptions, as follows:

(i) the participation exemption,

(ii) the previously-taxed income exemption, and

(iii) the dual-listed companies’ exemption (the last of which will be deleted once the new Dividends Tax comes into effect).

In addition, natural persons are entitled to a de minimis exemption of R3 700 on the aggregate of foreign dividends received or accrued during any year of assessment.

A rebate (i.e. a credit) for direct foreign taxes paid in respect of foreign dividends is available as a measure to relieve double taxation. Interest expenditure that is incurred in earning foreign dividends is deductible in determining the taxable income of the taxpayer, but these deductions are ring-fenced against ordinary revenue associated with these foreign dividends.

Reasons for change

At issue is the lack of parity between domestic and foreign dividends. As stated above, taxpayers face a maximum rate of 10% when receiving domestic dividends; whereas, taxpayers face a maximum 28 or 40% rate when receiving foreign dividends. This disparity is particularly apparent in the case of dual listed companies. Dividends from JSE listed shares in respect of a dual listed company will be subject to the maximum 10% rate; whereas, dividends from shares listed on a foreign exchange in respect of the same company are subject to a maximum 28% or 40% rate.


The change

A. General rule

The disparity of maximum rates between domestic and foreign dividends will be eliminated. However, foreign dividends cannot become part of the new Dividends Tax because South Africa does not have the ability to generally impose a withholding tax on foreign companies paying a dividend. Therefore, foreign dividends (except foreign dividends in respect of JSE listed shares) will remain within normal income tax system (including the provisional tax and final year of assessment payments). However, the marginal rate system will be adjusted so that the maximum rate does not exceed the 10% imposed on domestic dividends. This 10% effective rate will be determined using certain formula rates (e.g. the 30 / 40 exemption for natural persons and the 18 / 28 exemption for companies).

Foreign dividends are subject to four exemptions as listed below:

(i) Participation exemption exists as under prior law. Under this exemption, foreign dividends will be exempt if received by or accrued to a person who holds more than 10% of the equity share and voting rights in the company declaring the foreign dividend.

(ii) A new country-to-country participation exemption is now being added. In terms of the country-to-country exemption, a CFC will be allowed to claim the participation exemption without regard to the 10% participation requirement if the foreign dividends are paid by a foreign company which is situated within the same country as the CFC to which the foreign dividend is paid. The country-to-country exemption is being introduced because foreign dividends between companies in the same country are typically exempt (similar to the new Dividend Tax).

(iii) The previously taxed income exemption.

(iv) An exemption for cash foreign dividends will be added in respect of JSE listed shares (because these are taxed under the Dividends Tax).

The participation and country-to-country exemptions are subject to an override that mimics the current rule contained in section 10(1)(k)(ii)(dd). In particular the participation exemption and the country-to-country exemptions will not apply if the amount of the foreign dividend:

is determined directly or indirectly with reference to (or arises from) from any amount payable by any person to any other person; and

the amount paid or payable is deductible by the payor and not subject to tax in the hands of the recipient taxpayer (or in respect of a recipient CFC, if not taken into account in determining the net income of that CFC).

Example

Facts: SA Company 1 pays interest on a loan provided by Foreign Company. Another company (SA Company 2) owns preference shares in Foreign Company.

The dividend paid in respect of the preference shares held by SA Company 2 is determined with reference to the interest payable by SA Company 1 in respect of the interest bearing loan from Foreign Company.

Result: The foreign dividend paid to SA Company 2 is not subject to the participation exemption because this dividend is determined with reference to a deductible amount of interest payable by SA Company 1.

The participation and the country-to-country exemptions will also not be applicable if the foreign dividend is received by or accrued to any person from a foreign Collective Investment Scheme. Redemptions and buybacks by a foreign CIS are instead subject to the capital gains regime. In addition, no exemption is available if the foreign dividend is in the form of an annuity. This latter anti-avoidance already applies to local dividends (section 10(2)(b)).

D. Rebates and deductions

The rebate (i.e. credit) for direct foreign taxes paid in respect of foreign dividends will remain. While these rebates only take into account taxable income (thereby excluding foreign dividends exempt by virtue of the participation and previously taxed income exemptions), these rebates will not be directly reduced by the partial income (30 / 40 or 18 / 28) exemption. However, these rebates will be subject to the worldwide foreign source-to-total income ratio, just like any other foreign rebates. The worldwide foreign source-total income ratio will achieve this result by excluding all exempt income, even the partially (30 / 40 or 18 / 28) exempt income, from the numerator with the denominator not being reduced for the partial (30 / 40 or 18 / 28) exempt income.

However, the current deduction system for expenses associated with foreign shares has been dropped. Henceforth, no deductions will be allowed for expenses incurred in relation to the acquisition of the foreign shares because no comparable deduction is allowed for expenses associated with domestic shares.


Example

Facts: Mr. M, a South African resident, pays taxes at a marginal rate of 40%. Mr. M holds 2% of the total equity shares and voting rights in Foreign Company (a company that does not qualify as a controlled foreign company). Foreign Company pays a dividend of R1.2 million to Mr. M, which is subject to foreign withholding taxes of 8% (i.e. R96 000).

Result: The R1.2m dividend will be included in Mr. M’s gross income. The participation and previously taxed income exemptions do not apply. However, the dividend is exempt to a ratio of 30 / 40. Therefore, the amount included in Mr. M’s taxable income in relation to the dividend is R300 000 (1/4th of R1.2 million). Assuming no other income, the South African tax on the foreign dividend is R120 000 (i.e. R300 000 x 40%) less the R96 000 of foreign tax rebates, thereby amounting to R24 000.

Amendments to the legislation to give effect to the above

Amended definitions in section 1 of the Income Tax Act

Refer section of notes dealing with Dividends tax – Collateral definition issues

Section 10(1)(i of the Income Tax Act has been amended

The amendment serves to remove the R3 700 exemption that applied to foreign dividends and interest received by or accrued to a natural person. Section 10(1)(i) now reads as follows:

An exemption applies in the case of any taxpayer who is a natural person, to so much of the aggregate of any interest received by or accrued to him or her from a source in the Republic as does not during the year of assessment exceed—

(i) in the case of any person who was or, had he or she lived, would have been at least 65 years of age on the last day of the year of assessment, the amount of R33 000; or

(ii) in any other case, the amount of R22 800.

Effective date

The amended section 10(1)(i) comes into operation on 1 April 2012.

Section 10(1)(k)(ii) of the Income Tax Act has been deleted

Prior to its deletion section 10(1)(k)(ii) provided exemptions from normal tax for certain foreign dividends.

Effective date

The deletion of section 10(1)(k)(ii) comes into operation insofar as it applies to a person that is a natural person, deceased estate, insolvent estate or special trust, on 1 March 2012 and applies to years of assessment commencing on or after that date, and person other than a natural person, deceased estate, insolvent estate or special trust, on 1 April 2012 and applies to years of assessment commencing on or after that date.

Section 11C of the Income Tax Act has been repealed

The provisions of section 11C have been repealed. Section 11C provided a limited deduction for interest incurred on funds borrowed to purchase foreign-dividend yielding shares.

Effective date

The repealing of section 11C comes into operation on 1 April 2012.

The Income Tax Act, 1962, is hereby amended by the insertion after section 10A of the following section:

Section 10B of the Income Tax Act has been inserted titled - Exemption of foreign dividends and dividends paid or declared by headquarter companies

Section 10B reads as follows:

(1) For the purposes of this section, ‘foreign dividend’ means any-

(a) foreign dividend as defined in section 1; or

(b) dividend paid or declared by a headquarter company.

(2) Subject to subsection (4), there must be exempt from normal tax any foreign dividend received by or accrued to a person-

(a) if that person (whether alone or together with any other company forming part of the same group of companies as that person) holds at least 10% of the total equity shares and voting rights in the company declaring the foreign dividend;

(b) if that person is a company and the foreign dividend is paid or declared by another foreign company that is resident in the same country as that company;

(c) who is a resident to the extent that the foreign dividend does not exceed the aggregate of all amounts which are included in the income of that resident in terms of section 9D in any year of assessment, which relate to the net income of-

(i) the company declaring the foreign dividend; or


(ii) any other company which has been included in the income of that resident in terms of section 9D by virtue of that resident’s participation rights in that other company held indirectly through the company declaring the foreign dividend, reduced by-

(aa) the amount of any foreign tax payable in respect of the amounts so included in that resident’s income; and

(bb) so much of all foreign dividends received by or accrued to that resident at any time from any company contemplated in subparagraph (i) or (ii), as was-

(A) exempt from tax in terms of paragraph (a), (b) or (d); or

(B) previously not included in the income of that resident by virtue of any prior inclusion in terms of section 9D; or

(d) to the extent that the foreign dividend is received by or accrues to that person in respect of a listed share and does not consist of a distribution of an asset in specie.

(3) In addition to the exemption provided for in subsection (2), there must be exempt from normal tax so much of the amount of the aggregate of any foreign dividends received by or accrued to a person during a year of assessment as-

(a) is not exempt from normal tax in terms of subsection (2) for that year of assessment; and

(b) does not during the year of assessment exceed an amount determined in accordance with the following formula:

A = B × C

in which formula:

(i) ‘A’ represents the amount to be exempted for a year of assessment in terms of this paragraph;

(ii) ‘B’ represents-

(aa) where the person is a natural person, deceased estate, insolvent estate or special trust, the ratio of the number 30 to the number 40; or

(bb) where the person is a person other than a natural person, deceased estate, insolvent estate or special trust, the ratio of the number 18 to the number 28; and

(iii) ‘C’ represents the aggregate of any foreign dividends received by or accrued to the person during a year of assessment that is not exempt from normal tax in terms of subsection (2).

(4) Subsections (2)(a) and (2)(b) do not apply in respect of any foreign dividend received by or accrued to any person-

(a) if-

(i) (aa) any amount of that foreign dividend is determined directly or indirectly with reference to; or

(bb) that foreign dividend arises directly or indirectly from, any amount payable by any person to any other person; and

(ii) the amount so paid or payable is deductible by the person and-

(aa) is not subject to normal tax in the hands of that other person; or

(bb) where that other person is a controlled foreign company, is not taken into account in determining the net income, contemplated in section 9D(2A), of that controlled foreign company; or

(b) from any portfolio contemplated in paragraph (e)(ii) of the definition of ‘company’ in section 1.

(5) The exemptions from tax provided by this section do not extend to any payments out of any foreign dividend received by or accrued to any person.

Effective date

Section 10B comes into operation-

(a) insofar as it applies to any person that is a natural person, deceased estate, insolvent estate or special trust, on 1 March 2012 and applies in respect of dividends received or accrued on or after that date; and

(b) insofar as it applies to any person that is a person other than a natural person, deceased estate, insolvent estate or special trust, on 1 April 2012 and applies in respect of dividends received or accrued on or after that date.

Prohibition of deductions

Taxpayers cannot deduct interest incurred for domestic shares due to the exemption of domestic dividends from normal tax (even though dividends trigger a separate 10% charge under both the Secondary Tax on Companies and under the new withholding tax). The new provisions essentially place foreign dividends on par with domestic dividends, being subject to an overall maximum effective tax rate of 10%. Deductions are now similarly disallowed in respect of expenditures incurred to acquire foreign shares.

Section 23(q) of the Income Tax Act has been introduced for this purpose and reads as follows:

23(q) No deduction will be allowed for any expenditure incurred in the production of income in the form of foreign dividends.


Effective date

Section 23(q) comes into operation-

(a) insofar as it applies to any person that is a natural person, deceased estate, insolvent estate or special trust, on 1 March 2012 and applies in respect of years of assessment commencing on or after that date; and

(b) insofar as it applies to any person that is a person other than a natural person, deceased estate, insolvent estate or special trust, on 1 April 2012 and applies in respect of years of assessment commencing on or after that date.

Paragraph 20 of the Eighth Schedule to the Income Tax Act – Base cost of assets

Amounts subject to normal tax

Paragraph 20(1)(h)(iii) has been substituted as a consequence of the amendments that have been introduced that deal with the dividends tax and the new dispensation for foreign dividends. The references to section 10(1)(k)(ii)(cc) have been replaced with a reference to section 10B(2)(a).

The amended paragraph 20(1)(h)(iii) provides as follows:

(aa) a right in a controlled foreign company held directly by a resident, an amount equal to the proportional amount of the net income (without having regard to the percentage adjustments contemplated in paragraph 10) of that company and of any other controlled foreign company in which that controlled foreign company and that resident directly or indirectly have an interest, which was included in the income of that resident in terms of section 9D during any year of assessment, less the amount of any foreign dividend distributed by that company to that resident during any year of assessment which was exempt from tax in terms of section 10B(2)(a) or (b); or

(bb) a right in a controlled foreign company held directly by another controlled foreign company, an amount equal to the proportional amount of the net income (without having regard to the percentage adjustments contemplated

in paragraph 10) of that first-mentioned controlled foreign company and of any other controlled foreign company in which both the first- and second-mentioned controlled foreign companies directly or indirectly have an interest, which during any year of assessment would have been included in the income of that second-mentioned controlled foreign company in terms of section 9D had it been a resident, less the amount of any foreign dividend distributed by that first-mentioned controlled foreign company to the second-mentioned controlled foreign company if that dividend would have been exempt from tax in terms of section 10B(2)(a) or (b) had that second-mentioned controlled foreign company been a resident.

Effective date

The amendments to paragraph 20(1)(h)(iii) of the Eighth Schedule come into operation on 1 April 2012 and apply to disposals made on or after that date.

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FOREIGN EXCHANGE GAINS AND LOSSES – FOREIGN SHARE ACQUISITION HEDGES

Amendment to section 24I(11A) of the Income Tax Act.

Background

Section 24I recognises exchange differences for tax purposes on an annual basis irrespective of realisation. However, if the exchange difference relates to the acquisition of foreign equity shares, the currency recognition is waived largely in line with accounting principles. The purpose of this waiver is to ensure matching – the hedge in this case is being matched against a substantial equity stake in a foreign company (the latter of which does not trigger recognition of currency exchange differences on an annual basis).

In terms of formal requirements, the hedge must be associated with a 20% acquisition of a foreign company by South African residents and is only applicable if the foreign company becomes a controlled foreign company (CFC) after the acquisition. The hedge currency gain or loss must also not be reflected in applicable accounting statements. On the disposal of the hedged equity shares, the currency gain or loss will be taken into account for capital gains purposes through a corresponding adjustment to the base cost of the equity shares. Thus, the relief operates similar to a rollover with the added benefit of converting ordinary revenue into capital gain (that may ultimately be exempt by virtue of the participation exemption).

Reasons for change

The currency recognition waiver requirements for Income Tax purposes are much tighter than necessary – going beyond the requirements for accounting non-recognition. The tax rules require a 20% acquisition; whereas, accounting would not discriminate against smaller acquisitions that are part of a creeping acquisition that leave a substantial equity stake.

The CFC requirement is also excessive – accounting does not require more than 50% control. In addition, the CFC requirement often creates problems when the target foreign company is subject to foreign ownership restrictions in the foreign country concerned (i.e. a foreign ownership restriction preventing South African control).


Lastly, because of the resident requirement, the waiver will not apply if the foreign share acquisition is indirectly performed through a CFC. No reason appears to exist for excluding CFC acquisitions.

The change

In view of the above, the currency waiver requirements in respect of hedges associated with foreign share acquisitions have been liberalised. The foreign target must simply be at least 20% owned upon completion of the acquisition. The CFC requirement will be deleted. In addition, non-resident acquiring persons (e.g. CFCs) can participate in the relief.


Section 24I(11A) has been amended as follows:

(11A) No amount shall be included in or deducted from the income of a person in terms of this section in respect of any exchange difference arising from any forward exchange contract or foreign currency option contract or premium in respect of any foreign currency option contract entered into by that person to hedge the purchase price in respect of the acquisition of the equity shares of a company by that person, or by any other person forming part of the same group of companies as that person, to the extent that-

(a) no less than 20% of the equity shares of that company will, after that acquisition, be held by that person or that other person, as the case may be; and

(b) has been deleted

(c)(i) in the case of an acquisition by that person, that amount is not included in the income statement of that person utilised for financial reporting purposes pursuant to International Financial Reporting Standards; or

(ii) in the case of an acquisition by another person forming part of the same group of companies as that person, that amount is not included in the consolidated income statement forming part of the annual financial statements of a group for purposes of financial reporting pursuant to International Financial Reporting Standards or South African Statements of Generally Accepted Accounting Practice in terms of which the aforementioned persons are viewed as part of that group for purposes of those Standards or Statements.

Effective date

The amended section 24(11A) comes into operation on 1 January 2012 and applies in respect of years of assessment commencing on or after that date.

_____________________________________

TRANSFER PRICING

Amendment to section 31 of the Income Tax Act.

Section 31 was amended by the Taxation Laws Amendment Act No 7 of 2010. That amendment has now been deleted with the effect being that the 2010 amendment never came into operation. A new version of section 31 has now been enacted and is set out after the extract from the explanatory memorandum below.

Background

A. Transfer pricing rules

South Africa’s transfer pricing rules apply arm’s length principles to transactions, operations or schemes that have been entered into between connected persons with such terms and conditions that would not have been entered into between independent persons. The 2010 legislative amendments introduced certain modernisation changes to these transfer pricing rules in accordance with the OECD guidelines. The new wording of the section also removes certain previous uncertainties.

B. Deemed dividends

Deemed dividend rules exist as a measure targeted at minimising the avoidance of the Secondary Tax on Companies through the transfer of certain benefits to a non-resident company without a formal declaration of a dividend. These deemed dividend rules contained a provision relating to transfer pricing adjustments. More specifically, a deemed dividend arises from any additional income (or reduced loss) of a South African company stemming from the adjustment. The purpose of this deemed dividend provision is to account for the removal of value from a South African company due to the company transacting with connected persons on a non-arm’s length basis. In transfer pricing terms, this removal of value would constitute a ‘secondary adjustment’. Advanced tax systems make secondary adjustments in one form or another.


Reason for change

Transfer pricing adjustments (generally referred to as ‘primary adjustments’) aim to ensure an arm’s length allocation of the taxable profits. However, the primary adjustment under current rules do not place the financial position of the parties to the transaction onto an arm’s length basis because this primary adjustment only accounts for taxable income, not actual income. In order to address this non-arm’s length financial position of the parties, some countries require secondary adjustments. The deemed dividend rules under current law essentially seek to replicate this concept of secondary adjustments.

The change

A. Power to make secondary adjustments

The automatic deemed dividend rules stemming from a transfer pricing adjustment will not continue in the new Dividends Tax regime. Instead, the law will be modified to directly cater for secondary adjustments arising from transfer pricing primary adjustments. The OECD refers to a secondary adjustment within the following context:

‘To make the actual allocation of profits consistent with the primary transfer pricing adjustment, some countries having proposed a transfer pricing adjustment will assert under their domestic legislation a constructive transaction (a secondary transaction), whereby the excess profits resulting from a primary adjustment are treated as having been transferred in some other form and taxed accordingly.’

In view of the above, the amount of the primary adjustment will be deemed to be a loan by the South African taxpayer to the non-resident. This deemed loan will thus constitute an affected transaction, which will require the taxpayer to calculate an arm’s length rate of interest on the deemed loan. The rate of interest should be calculated under the arm’s length principle and will be deemed to be payable until the deemed loan is repaid to the South African taxpayer that has been subject to a primary adjustment.

However, it is intended that the primary adjustment will not be treated as loan to the extent that adjustment is repaid to the South African taxpayer by the end of the year of assessment in which the primary adjustment is made.

Example

Facts: Foreign Parent pays R1 million for goods provided by South African Subsidiary. South African Subsidiary records taxable income based on the receipt of R1 million for the goods sold to Foreign Parent. The arm’s length price for the goods is R1.2 million.

Result: A primary adjustment to the transaction in terms of section 31, whereby the taxable income of the South African Subsidiary will be increased to reflect the arm’s length price of R1.2 million. The differential of R200 000 will constitute a deemed loan (for the purposes of section 31) by South African Subsidiary to Foreign Parent in respect of which an arm’s length interest rate must be attached. It is intended that a secondary adjustment will not be triggered if the deemed loan is repaid by the end of the year of assessment in which the primary adjustment under section 31 is made. If the loan remains unpaid, interest of R12 000 (R200 000 x 6%) (assuming an arm’s length interest rate of 6% per annum) will accrue to the South African Subsidiary. Interest will continue to accrue every year of assessment thereafter until the deemed loan is repaid.

B. Expansion of the transfer pricing rules

The revised transfer pricing rules technically allow only for the recalculation of ‘taxable income’, thereby limiting transfer pricing adjustments solely to the normal tax. It is proposed that this recalculation cover all taxes within the Income Tax Act (including the new Dividends Tax).


Tax payable in respect of international transactions to be based on arm’s length principle

For purposes of this section-

‘affected transaction’ means any transaction, operation, scheme, agreement or understanding where-

(a) that transaction, operation, scheme, agreement or understanding has been directly or indirectly entered into or effected between or for the benefit of either or both-

(i) (aa) a person that is a resident; and

(bb) any other person that is not a resident;

(ii) (aa) a person that is not a resident; and

(bb) any other person that is not a resident that has a permanent establishment in the Republic to which the transaction, operation, scheme, agreement or understanding relates;

(iii) (aa) a person that is a resident; and

(bb) any other person that is a resident that has a permanent establishment outside the Republic to which the transaction, operation, scheme, agreement or understanding relates; or


(iv) (aa) a person that is not a resident; and

(bb) any other person that is a controlled foreign company in relation to any resident, and those persons are connected persons in relation to one another; and

(b) any term or condition of that transaction, operation, scheme, agreement or understanding is different from any term or condition that would have existed had those persons been independent persons dealing at arm’s length;

‘financial assistance’ includes the provision of any-

(a) loan, advance or debt; or

(b) security or guarantee.

(2) Where-

(a) any transaction, operation, scheme, agreement or understanding constitutes an affected transaction; and

(b) any term or condition of that transaction, operation, scheme, agreement or understanding-

(i) is a term or condition contemplated in paragraph (b) of the definition of ‘affected transaction’; and

(ii) results or will result in any tax benefit being derived by a person that is a party to that transaction, operation, scheme, agreement or understanding, the taxable income or tax payable by any person contemplated in paragraph (b)(ii) that derives a tax benefit contemplated in that paragraph must be calculated as if that transaction, operation, scheme, agreement or understanding had been entered into on the terms and conditions that would have existed had those persons been independent persons dealing at arm’s length.

(3) To the extent that there is a difference between-

(a) any amount that is, after taking subsection (2) into account, applied in the calculation of the taxable income of any resident that is a party to an affected transaction; and

(b) any amount that would, but for subsection (2), have been applied in the calculation of the taxable income of the resident contemplated in paragraph (a), the amount of that difference must, for purposes of subsection (2), be deemed to be a loan that constitutes an affected transaction.

(4) For the purposes of subsection (2), where any transaction, operation, scheme, agreement or understanding has been directly or indirectly entered into or effected as contemplated in that subsection in respect of-

(a) the granting of any financial assistance; or

(b) intellectual property as contemplated in the definition of ‘intellectual property’ in section 23I(1) or knowledge,

‘connected person’ means a connected person as defined in section 1:

Provided that the expression ‘and no shareholder holds the majority voting rights in the company’ in paragraph (d)(v) of that definition must be disregarded.

(5) Where any transaction, operation, scheme, agreement or understanding has been entered into between a headquarter company and-

(a) any other person that is not a resident and that transaction, operation, scheme, agreement or understanding is in respect of the granting of financial assistance by that other person to that headquarter company, this section does not apply to so much of that financial assistance that is directly applied as financial assistance to any foreign company in which the headquarter company directly or indirectly (whether alone or together with any other company forming part of the same group of companies as that headquarter company) holds at least 10% of the equity shares and voting rights; or

(b) any foreign company in which the headquarter company directly or indirectly (whether alone or together with any other company forming part of the same group of companies as that headquarter company) holds at least 10% of the equity shares and voting rights and that transaction, operation, scheme, agreement or understanding comprises the granting of financial assistance by that headquarter company to that foreign company, this section does not apply to that financial assistance.

Effective date

The amended section 31 comes into operation on 1 April 2012 and applies in respect of years of assessment commencing on or after that date.

________________________________


WITHHOLDING TAX ON INTEREST

Part 1A of Chapter II of the Income Tax Act. Part 1A contains sections 37I to N.

Background as provided in the 2010 explanatory memorandum

The tax system currently provides a blanket normal income tax exemption in respect of interest payable to non-residents. This exemption is subject to two exceptions applicable to non-residents participating in the domestic economy. The first applies to non-residents who conduct business in South Africa and the second to non-residents.

Most developed and emerging economies currently exempt cross-border interest relating to mobile portfolio debt and incidental trade finance. Other forms of cross-border debt are normally subject to a flat rate of withholding tax. More generous forms of exemption typically exist only through tax treaties. The current blanket exemption appears to be overly generous from a competitive point of view. The exemption arguably also provides foreign debt with a tax advantage over local debt, the latter of which is taxable.

The exemption has created cycle schemes designed to undermine the tax base. These create tax deductible interest costs without taxable income. The funds then flow back to South Africa as dividends and are exempt from tax by way of the participation exemption.

The exemption also creates an incentive for foreigners to fund businesses with higher amounts of debt compared to equity. Although the thin-capitalization provisions attempt to limit some of this excess debt, these rules only act as a partial remedy.

In view of these concerns, the cross-border interest exemption has been narrowed in line with global tax practice.

Part 1A has been inserted into the Income Tax Act and it contains sections 37I to section 37M. It is not yet operative and only comes into operation on 1 January 2013. It reintroduces provisions applicable to the withholding tax on interest. Until 16 March 1988, South Africa levied a 10% non-resident tax on interest (NRTI) on interest that accrued to its offshore lenders.

Amendments have been made to sections 37K, 37L and 37M and sections 37JA and 37N have been added, these are explained in the 2011 explanatory memorandum

Background

In 2010, Government announced its intention to narrow the cross-border interest exemption in line with international global tax practice.

The effect of this narrowing is that interest paid to a non-resident will generally be subject to a withholding tax at the rate of 10%. The charge will take effect from 1 January 2013 (to provide time for Government to renegotiate certain tax treaties). However, this withholding tax will be subject to a list of exemptions, such as the exemption for interest from bonds issued by any sphere of Government or in respect of listed debt instruments. Under the initial withholding mechanisms, the person making payment of cross-border interest must withhold. This withheld amount had to be paid over to SARS within 14 days after the end of the month during which the amount is withheld.

Reasons for change

Although most substantive issues relating to the new withholding tax on interest have been resolved during the 2010 legislative cycle, a few issues relating to the administrative mechanisms remain. Some of these issues include:

the nature of the liability,

payment due dates, and

the provision for refunds.

The change

In view of the above, the following administrative refinements have been made.

The law clarifies that the beneficial owner is primarily liable unless the tax is paid by another (typically the withholding agent).

The due date has been moved in line with the dividends withholding tax (i.e. the close of the month following the month).

The revised rules set a three year time limit for refunds from SARS for amounts wrongfully withheld (with only the beneficial owner being entitled to claim). All of these rules have been aligned in accordance with the new Dividends Tax.


The amended sections 37I to N are set out below:

Definitions

Section 37I contain the definitions.

Bank

A ‘bank’ means a,

a) bank as defined in section 1 of the Banks Act 94 of 1990,

b) mutual bank as defined in section 1 of the Mutual Banks Act 94 of 1993,or

c) co-operative bank as defined in section 1 of the Co-operative Banks Act 40 of 2007.

Debt instrument

A ‘debt instrument’ means a loan, advance, debt, bond, debenture, bill, promissory note, banker’s acceptance, negotiable certificate of deposit or similar instrument.

Foreign person

A ‘foreign person’ means a person that is not a resident.

Goods

‘Goods’ means a corporeal movable thing.

Government debt instrument

A ‘government debt instrument’ means a debt instrument issued by the government of the Republic in the national, provincial or local sphere.

Interest

‘Interest’ means interest as defined in section 24J(1) or deemed interest as contemplated in section 8E(2).

Section 24J(1) defines ‘interest’ as including the,

i) gross income of interest or related finance charges, discount or premium payable or receivable in terms of a financial

arrangement,

ii) amount or portion thereof payable by a borrower to a lender in terms of a lending arrangement as represents

compensation for an amount that the lender would, but for this lending arrangement, have been entitled to, and

iii) difference between the amounts receivable and payable in terms of a sale and leaseback arrangement as contemplated

in section 23G,

it does not matter whether the interest is,

i) calculated with reference to a fixed or variable rate of interest, or

ii) payable or receivable as a lump sum or in unequal instalments during the terms of the financial arrangement.

Section 8E(2) provides that a dividend declared by a company on a hybrid equity instrument that is declared on or after the date that the share becomes a hybrid equity instrument is for the purposes of this Act deemed, in relation to its recipient only, to be interest received by him from a source within the Republic.

Listed debt instrument

A ‘listed debt instrument’ means a debt instrument that is listed on a recognised exchange as defined in paragraph 1 of the Eighth Schedule.


South African Reserve Bank

The ‘South African Reserve Bank’ means the central bank of the Republic regulated in terms of the South African Reserve Bank Act 90 of 1989.

Levy of tax

Section 37J(1) provides that there must be levied for the benefit of the National Revenue Fund a tax, to be known as the withholding tax on interest, calculated at the rate of 10% of the amount of interest that is regarded as having been received by or accrued from a source within the Republic in terms of section 9(2)(b) received by or accrued to any foreign person that is not a controlled foreign company (CFC).

Section 37J(2) has been deleted.

Liability for tax

Section 37JA provides that a foreign person to which an amount of interest is paid or accrues is liable for the withholding tax on interest.

Exemptions on certain instruments

Subject to the provisions of section 37K(2), section 37K(1) provides that there must be exempt from the withholding tax on interest any amount of interest,

(a) received by or accrued to a foreign person during a year of assessment,

i) on a government debt instrument,

ii) on a listed debt instrument,

iii) on a debt owed by (aa) a bank, or (bb) the South African Reserve Bank, and

iv) on a bill of exchange, letter of credit or similar instrument

(aa) to the extent that the interest is payable for the purchase price of goods imported into the Republic, and

(bb) if an authorised dealer as defined in the Exchange Control Regulation 1961 (as promulgated by GN No.

R.1111 of 1 December 1961 and amended up to GN No. R.885 in Government Gazette No. 20299 of 23 July

1999), has certified on the instrument that a bill of lading or other document covering the importation of the goods

has been exhibited to it

v) has been deleted.

vi) if the interest is paid or payable,

(aa) by a headquarter company, and

(bb) for financial assistance that is not subject to section 31 as a result of the application of section 31(4).

The exemption for interest that is paid or payable by a headquarter company and for financial assistance that is

not subject to section 31 as a result of the application of section 31(4) is because a headquarter company is

treated as a non-resident company for many provisions in the Income Tax Act.

b) payable as contemplated in section 27(6) of the Securities Services Act 36 of 2004, to a foreign person that is a client as

defined in section 1 of that Act.

A client is defined in section 1 of the Securities Service Act as a person who uses the services of an authorised user or

participant.


c) that is deemed to have accrued to a foreign person in terms of section 25BA(a). In terms of section 25BA(a), an amount,

other than an amount of a capital nature, received or accrued to a portfolio of a collective investment scheme in

securities (equity unit trust) is to the extent that the amount is distributed by it,

i) to a person who is entitled to the distribution by virtue of him being a holder of a participatory interest in that

portfolio (a unit-holder), and

ii) within 12 months of its receipt by that portfolio,

is deemed to have directly accrued to him on the date of the distribution.

Section 37K(2) provides that interest received by or accrued to a foreign person during a year of assessment for an amount advanced, whether directly or indirectly, by him to a bank will not be exempt from the withholding tax on interest if the amount is advanced in the course of an arrangement, transaction, operation or scheme to which he and another person are parties and in terms of which the bank advances an amount to that other person on the strength directly or indirectly of the amount advanced by the foreign person to it.

Section 37K(3) provides that a foreign person will be exempt from the withholding tax on interest if he,

a) is a natural person who was physically present in the Republic for a period exceeding 183 days in aggregate during that

year,

b) at any time during that year carried on business through a permanent establishment in the Republic, and

c) is a controlled foreign company as defined in section 9D.

The above exemption (section 37K(3)) has been introduced because in both situations interest will not be exempt in terms of section 10(1)(h) and so the interest earned will be subject to normal tax in South Africa.

Withholding and payment

Section 37L(1) provides that a person who makes payment of interest for the benefit of a foreign person that is not a CFC must withhold an amount equal to 10% of the interest from that payment.

(2) Has been deleted.

(3) A person must not withhold an amount from a payment contemplated in subsection (1),

a) to the extent that the interest is exempt from the withholding tax on interest in terms of section 37K(1), or

b) if the person to which it is to be paid has, by the date of its payment submitted to him a declaration in such form as

may be prescribed by the Commissioner that he is exempt from the withholding tax on interest in terms of

section 37K(3).

(4) The rate referred to in subsection (1) must, for its purposes, be reduced if the person to which the amount of interest is to

be paid has, by the date of its payment submitted to the person paying that amount of interest a declaration in such form as

may be prescribed by the Commissioner that he is subject to a reduced rate of tax as a result of the application of an

agreement for the avoidance of double taxation.

Payment and recovery of tax

Section 37M(1) provides that if, in terms of section 37JA, a foreign person is liable for any amount of withholding tax on interest in respect of any amount of interest that is paid or that accrues to the foreign person, that foreign person must pay that amount of withholding tax by the last day of the month following the month during which the interest is paid, unless the tax has been paid by any other person.

(2) Any person that withholds any withholding tax on interest in terms of section 37L must pay the tax to the Commissioner by the last day of the month following the month during which the interest is paid.

Refund of withholding tax on interest

Section 37N(1) provides that notwithstanding section 102, if-


(a) an amount is withheld from the payment of interest in terms of section 37L(1);

(b) a declaration contemplated in section 37L(3)(b) or (4) in respect of that interest is not submitted to the person paying that interest by the date of the payment of that interest; and

(c) a declaration contemplated in section 37L(3)(b) or (4) is submitted to the person paying that interest within three years after the payment of the interest in respect of which the declaration is made, so much of that amount as would not have been withheld had that declaration been submitted by the date contemplated in the relevant

subsection is refundable to the person to whom the interest was paid.

(2) Subject to subsection (3), if any amount is refundable to any person in terms of subsection (1), the person to whom the interest was paid as contemplated in subsection (1) may recover the refundable amount from the Commissioner.

Effective date

The amended sections 37I to N come into operation on 1 January 2013 and apply to interest that accrues on or after that date.

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CAPITAL GAINS TAX

ANNUAL EXCLUSION

Amendments to paragraph 5 of the Eighth Schedule to the Income Tax Act.

Paragraph 5(1) and (2) have been amended to increase the annual exclusion

(1) Subject to subparagraph (2), the annual exclusion of a natural person and a special trust in respect of a year of assessment is R20 000.

(2) Where a person dies during a year of assessment, that person’s annual exclusion for that year is R200 000.

Effective date

The amendment to paragraph 5(1) and (2) of the Eighth Schedule to the Income Tax Act is deemed to have come into operation on 1 March 2011 and applies in respect of years of assessment commencing on or after that date.

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FOREIGN CURRENCY – REPEAL OF CAPITAL GAIN RULES

Repeal of part XIII of the Eighth Schedule to the Income Tax Act (paragraphs 84 to 96).

Background

Gains and losses in respect of foreign exchange items (i.e. currency, debt, currency forward contracts and currency option contracts) are generally governed by section 24I. Section 24I annually accounts for unrealised gains and losses with these unrealised amounts taken into account as ordinary revenue or loss.

Currency units and debt of natural persons (and certain trusts) generally fall outside of the section 24I paradigm and are instead subject to capital gains tax on a realisation basis. Realisation for this purpose generally means the conversion of foreign currency (or debt) into a different currency or into a non-monetary asset. This form of gain or loss is based on the pooling method. To determine gain or loss under the pooling method, one must first establish a base cost for the pool of foreign currency. Proceeds from disposals of foreign currency are then measured against a proportionate share of this pooled base cost.

Reasons for change

While taxation of foreign currency gains and losses is theoretically sound, this form of taxation is extremely complicated. Taxpayers are often required to spend significant time and resources to review ordinary day-to-day currency movements solely for purposes of the tax computation. These costs often far outweigh the actual tax at stake.

The change

For the reasons outlined above, the capital gain or loss rules (Part XIII of the Schedule) relating to currency monetary items have been repealed. As a result, gain or loss from foreign currency units (and foreign debt) held by natural persons will no longer be taken into account.


A secondary amendment has been introduced which covers the capital gain or loss provisions mainly associated with non-monetary assets denominated in foreign currency. These rules have been revised to ensure that a creditor’s disposal of foreign debt does not give rise to currency capital gain or loss with other gain or loss aspects remaining within the tax system. Going forward, a gain or loss for natural persons (and certain trusts) will be solely measured based on differences calculated utilising the foreign currency denomination with the gain or loss translated into Rands after the differences are determined.

For instance, if a taxpayer holds a zero-coupon bond worth 100 pounds and sells the bond for 110 Pounds, the gain will be calculated at 10 Pounds with the 10 Pound gain converted into Rands based on the currency during the year of assessment. The Rand-Pound currency differentials between purchase and sale will not be taken into account.


Part XIII of the Eighth Schedule to the Income Tax Act (paragraphs 84 to 96) has been repealed

Effective date

The repeal of part XIII of the Eighth Schedule is deemed to come into operation on 1 March 2011 and applies in respect of years of assessment commencing on or after that date.

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ASSETS DISPOSED OF IN A FOREIGN CURRENCY

Amendment to paragraph 43 of the Eighth Schedule to the Income Tax Act.

Republic source assets

Paragraph 43(4)(b) has been amended as a consequence of the repealing of the foreign currency provisions contained in Part XIII of the Eighth Schedule. In its ‘amended’ form paragraph 43(4)(b) provides for the situation when a person during a year of assessment disposes of an asset (other than an amount in foreign currency owing to him for a loan, advance or debt payable to him), the capital gain or capital loss from the disposal of which is derived or deemed to have been derived from a source in South Africa, as contemplated in section 9(2) that was acquired or disposed of in a currency other than the currency of South Africa. He must for purposes of the determination of the capital gain or capital loss on its disposal translate-

(i) its proceeds into the currency of South Africa at the average exchange rate for the year of assessment in which it was disposed of, or at the spot rate on the date of its disposal, and

(ii) the expenditure incurred for it into the currency of South Africa at the average exchange rate for the year of assessment when that expenditure was incurred, or spot rate on the date when that expenditure was incurred.

Before its amendment paragraph 43(4)(b) excluded from its provisions an asset contemplated in paragraph (b) of the definition of a ‘foreign currency asset’ in paragraph 84 of Part XIII.

Effective date

The amendment to paragraph 43(4)(b) is deemed to have come into operation on 1 March 2011 and applies to years of assessment commencing on or after that date.

Unification of source provisions

Paragraph 43(4)(b) has been further amended as a consequence of the amendments introduced that deal with the unification of the source provisions.

Paragraph 43(4)(b) now provides for the situation when a person during a year of assessment disposes of an asset (other than an amount in foreign currency owing to him for a loan, advance or debt payable to him) the capital gain or capital loss from the disposal of which is from a source in South Africa, that was acquired or disposed of in a currency other than the currency of South Africa. He must for purposes of the determination of the capital gain or capital loss on its disposal translate-

(i) its proceeds into the currency of South Africa at the average exchange rate for that year of assessment in which it was disposed of, or spot rate on the date of its disposal, and

(ii) the expenditure incurred for it into the currency of South Africa at the average exchange rate for the year of assessment when that expenditure was incurred, or spot rate on the date when that expenditure was incurred.

The proviso to paragraph 43(4) states that its provisions do not apply to an exchange item that is subject to the provisions of

section 24I.


Effective date

The further amendment to paragraph 43(4)(b) comes into operation on 1 January 2012.

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DISPOSAL OF SMALL BUSINESS ASSETS

Amendment to paragraph 57 of the Eighth Schedule to the Income Tax Act.

Paragraph 57 provides relief to a ‘small business’ person who instead of providing for his retirement has reinvested his resources into his business. A ‘small business’ is defined in paragraph 57(1) as a business of which the market value of all its assets at the date of disposal of the asset or interest in the business does not exceed R5 million.

In ascertaining whether the business qualifies, the market value of all its assets must be taken into account, regardless of their nature and also regardless of the liabilities of the business. Paragraph 57(2) provides that a natural person must disregard a capital gain under the relief provided, and only for the disposal of an ‘active business asset’,

if it has been held for a continuous period of at least five years prior to the disposal contemplated,

he had been substantially involved in the operations of the business of that small business, during that period, and

he had attained the age of 55 years or the disposal was in consequence of his ill-health, other infirmity, superannuation of death.

Paragraph 57(3) limited the amount of the capital gain that may be excluded to R750 000. With effect from 1 March 2011 this amount was increased to R900 000.

It further provides that the exclusion may not exceed R900 000 during that natural person’s lifetime. The exclusion is therefore cumulative and is not for each business or asset disposed of.

Effective date

The amendment to paragraph 57 is deemed to have come into operation on 1 March 2011 and applies to years of assessment commencing on or after that date.

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DISPOSAL OF EQUITY SHARES IN FOREIGN COMPANIES

Amendments to paragraph 64B of the Eighth Schedule to the Income Tax Act.

A number of provisions in paragraph 64B have been substituted as part of the-

controlled foreign company (CFC) reform,

headquarter company regime, and

dividends tax.

Refer to detailed notes in the relevant section dealing with the above topics.

Paragraph 64B is now titled ‘Disposal of equity shares in foreign companies’. Paragraph 64B(1) contains the definitions of a ‘foreign company’ and a ‘foreign financial instrument holding company’.

The definition of a ‘foreign company’ has been deleted.

Paragraph 64B(2) has been substituted. It now provides that a person must disregard a capital gain or capital loss determined on the disposal of an equity share in a ‘foreign company’, other that a ‘foreign financial instrument holding company’, if he, either alone or together with another person forming part of the same group of companies immediately before that disposal held at least 10% of its equity shares and voting rights.

For this provision to apply, the 10% interest must have been held for a period of at least 18 months prior to being disposed of, unless the person concerned is a company and the interest was acquired by it from another company that forms part of the same group of companies and the companies concerned in aggregate held that interest for more than 18 months. (In the determination of the total equity shares in a foreign company, a share that would have constituted a hybrid equity instrument, as contemplated in section 8E, but for the three-year period requirement contained in that provision, must be ignored).

Paragraph 64B(2)(b) has been amended and paragraph 64B(2)(a) now applies when the equity share is disposed of:

to a person other than a resident or a CFC,


in the circumstances contemplated in paragraph 12(2)(a), that is, when a person is deemed to dispose of certain assets on ceasing to be a resident and the application of paragraph 12(2)(a) arises directly or indirectly as a result of the disposal of shares to a person other than a resident or a CFC, or

by a person to his CFC, or to a CFC that forms part of the same group of companies as him,

by a person that is a headquarter company.

Paragraph 8(b) (a net capital gain) applies in certain circumstances to a capital gain disregarded under paragraph 64B(2) in a year of assessment. Under paragraph 8(b), when paragraph 64B(3) becomes applicable during a year of assessment, the amount of the capital gain that was disregarded by a person under paragraph 64B(2) or paragraph 64B(5) (see below) during that or a previous year of assessment must be added to his net capital gain for that year.

Paragraph 64B(3) has also been amended. It makes paragraph 8(b) applicable when the person concerned disposes of the equity share in a foreign company to a person who is, or will be, his connected person before or after the disposal and the foreign company is a CFC in relation to him, or to another company in the same group of companies as him. In addition, one of the following factors must also be present for paragraph 8(b) to apply:

The equity share must have been disposed of for no consideration or for a consideration that does not reflect an arm’s length price. (Excluded is a distribution described in the next bullet.)

The equity share in that foreign company must have been disposed of by means of a distribution unless the full amount of that distribution was or is subject to STC (but for the application of the intra-group exemption from STC provided by section 64B(5)( f )) or the distribution was included in the income of a shareholder of the distributing company or would have been so included but for the so-called participation exemption granted under section 10B(2)(a) or section 10(2)(b).

The person disposed of any consideration received or accrued from the disposal of the equity share (or any amount received in exchange for it) under a transaction, operation or scheme of which its disposal formed a part for no consideration or for consideration that does not reflect an arm’s length price (excluding a distribution described below).

The person must have disposed of any consideration received or accrued from the disposal of the equity share (or any amount received in exchange for it) under a transaction, operation or scheme of which its disposal formed a part by means of a distribution by a company, unless the full amount of that distribution was or is subject to STC (but for the application of the intra-group exemption from STC provided by section 64B(5)( f ) or the distribution was included in the income of a shareholder of the distributing company or is not taxed due to the so-called participation exemption granted under section 10B(2)(a) or section 10B(2)(b).

In addition, the foreign company must under the transaction , operation or scheme have ceased to be a CFC in relation to the person or another company in the same group of companies as him, regard being had solely to the rights conferred by paragraph (a) of the definition of ‘participation rights’ in section 9D, that is, the right to participate in all or part of the benefits of the rights (other than voting rights) attracting to a share, or an interest of a similar nature.

Paragraph 64B(4) has also been substituted. It now states that when paragraph 64B(3) does not apply because the distribution was or is subject to STC (but for the application of the intra-group exemption from STC provided by section 64B(5)( f )) or the distribution was included in the income of a shareholder of the distributing company (or would have been but for the so-called participation exemption granted under section 10B(2)(a) and section 10B(2)(b)) and the company to which the distribution was made disposes of an amount of the distribution in certain circumstances, it must be treated as having disposed of the equity share in that foreign company by means of a disposal that is or was disregarded under paragraph 64B(2). The circumstances are those set out in the bulleted items above.

Paragraph 64B(5) has also been substituted. It now provides that a person must disregard a capital gain determined for a foreign return of capital received by or accrued to him from a ‘foreign company’ (other than a foreign financial instrument holding company or an interest contemplated in paragraph 2(2)) when he (whether alone or together with another person forming part of the same group of companies as him) holds at least 10% of its total equity shares and voting rights.

The proviso to paragraph 64B(5) states that:

in the determination of the total equity shares in a company, there must not be taken into account a share that would have constituted a hybrid equity instrument, as contemplated in section 8E, but for the three-year period requirement contained in section 8E, and

this proviso does not apply to a distribution that forms part of a transaction, operation or scheme under which a capital gain is regarded while a corresponding expenditure is taken into account by that person or his connected person in the determination of his connected person’s liability for tax.


Paragraph 64B(6) remains unchanged. It provides that the provisions of paragraph 64B do not apply to a capital gain or capital loss determined for:

the disposal of an equity share in a portfolio contemplated in paragraph (e) of the definition of ‘company’ in section 1 (a so-called equity unit trust), and

a distribution contemplated in paragraph 64B(5) by a portfolio contemplated above.

Effective date

The amendments to paragraph 64B(1) and 64B(2)(b) come into operation on 1 April 2012 and apply to disposals made on or after that date.

The amendments to paragraph 64B(2)(a), 64B(3), 64B(4) and 64B(5) come into operation on 1 April 2012 and apply to disposals made on or after that date.

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COMPANY DISTRIBUTIONS

Amendments to paragraph 74, 75, 76, 76A, 76B, 77 and 78 of the Eighth Schedule to the Income Tax Act.

Paragraph 74 has been amended as part of the new dividend tax regime.

Refer notes on collateral changes resulting from the new dividends tax for a detailed explanation of some of the paragraph 74 amendments.

Dividends tax: Accrual versus cash accounting

See also the changes to section 64E(2) of the Income Tax Act

Background

The Secondary Tax on Companies (‘STC’) falls on the company declaring the dividend. On 1 April 2012, the STC will be replaced with the Dividends Tax. The Dividends Tax applies at the shareholder-level. Tax liability for the Dividends Tax will be triggered when the dividend is paid to the shareholder. The dividend will be deemed to be paid on the date on which the dividend accrues to the shareholder. Case law defines accrual as an unconditional entitlement to an amount.

Reasons for change

In many cases (especially in the case of closely-held companies), the date of dividend declaration and the date of dividend payment are the same. However, a delay may exist between declaration and payment. This delay is most prominent in the case of listed companies with these companies using a ‘last date to register’ as an interim date for settling dividend accrual. This issue can also arise in closely-held situations. For example, a closely-held company may declare a dividend far in advance of cash available to clear profits before the entry of new shareholders. The difference in accrual versus payment often causes unique difficulties when applying tax withholding. Withholding agents (especially regulated intermediaries) cannot practically be expected to withhold cash on dividends without timely physical control over the cash. If foreign dividends from foreign shares listed on the JSE are involved, there is the added problem of foreign currency conversion. If the accrual date precedes the cash payment date, the Rand-to-foreign currency value might fluctuate so that the shareholder receives a different Rand value than the Rand value accrued.

The change

Because the concept of accrual often cannot be practically applied in the context of withholding, the timing rules have been changed in favour of actual or constructive payment. Under this revised concept, the Dividends Tax will be triggered when an actual payment of the dividend is made (“actual payment”) or when the dividend becomes payable to the shareholder (that is, on the last date of registration of the dividend in respect of listed shares).

Example 1

Facts: Listed Company declares a dividend on 1 March. The last date to register in respect of the dividend is 13 March. The date of payment of the dividend is 20 March.

Result: The payment (withholding) date is the date on which the dividend is payable by the company payor (i.e. 13 March).

Example 2:

Facts: Company (an unlisted company) announces a declaration of a dividend on 1 March with the date of payment to be announced in the future (i.e. date of payment unspecified). On 15 August, a board decision is made for payment to occur on 1 November with the actual payment made accordingly.

Result: The applicable date is 1 November (i.e. the date that the dividend is payable).


Example 3:

Facts: The facts are the same as Example 2, except that the dividend is ultimately cancelled in October (i.e. before actual payment).

Result: The Dividends Tax never arises because the dividend is never actually paid or payable.

Amendment to paragraph 74 of the Eighth Schedule as a result of the above changes

Definitions

The definition of ‘capital distribution’ has been deleted.

The definition of ‘date of distribution’ has been substituted and now reads as follows:

‘date of distribution’ in relation to any distribution, means the date of payment of the distribution-

a) by a company subject to the condition that it be payable to a shareholder of the company registered in that company’s share register on a specified date, in which case it must be that date;

b) by a company to a shareholder of that company otherwise than by way of a formal declaration of a dividend, in which case it must be the date on which the shareholder became entitled to that distribution; or

c) by the liquidator of a company to a shareholder of that company in the course of the winding up or liquidation of that company, in which case it must be the date on which the shareholder became entitled to that distribution.

The definition of ‘distribution’ has been deleted.

The definition of ‘share’ has been deleted.

Effective date

The amendment to paragraph 74 comes into operation on 1 April 2012.

Amendment to paragraph 75 of the Eighth Schedule as a result of the above changes

Distributions in specie by company

Paragraph 75 of the Eighth Schedule has been amended and now reads as follows:

Where a company makes a distribution of an asset in specie to a person holding a share in that company, that company must be treated as having disposed of that asset to that shareholder on the date of distribution for an amount received or accrued equal to the market value of that asset on that date.

Effective date

The amendment to paragraph 75 comes into operation on 1 April 2012.

Revised treatment of capital distributions

Background

A. Dividends versus capital distributions

Dividends and capital distributions can be in the form of either cash or assets. A company declaring a dividend is liable to Secondary Tax on Companies (STC) at a rate of 10%.

The STC will be replaced with a Dividends Tax at shareholder level at a rate of 10% as from 1 April 2012. Under the Dividends Tax system, amounts distributed are treated as a dividend except to the extent that the distribution reduces contributed tax capital. Capital distributions are subject to Capital Gains Tax (CGT) at the rate of 10, 14 or 20% depending on whether the shareholder is an individual, company or trust. A gain subject to CGT is generally determined by comparing the capital distribution received or accrued against the applicable base cost of the shares.

B. Calculation of capital distribution gains

Under the old law, in the shareholder’s hands, a capital distribution can either result in:

(i) a reduction of pre-CGT base cost,

(ii) an addition to proceeds, or

(iii) proceeds from the part-disposal of the shares.

This treatment largely depends on the date on which the capital distribution is received or accrued to a shareholder. A capital distribution occurring after 1 October 2007 triggers a part-disposal of the share with the distribution treated as proceeds. Part-disposal treatment effectively means that only part of the base cost can be applied against the capital distribution proceeds. If the capital distribution occurs before 1 October 2007 with the full disposal of the shares occurring after that date, part-disposal treatment will generally be deemed to arise on 1 July 2011.


C. Pre-CGT shares

Special rules are required for determining the base cost of pre-CGT effective date assets (i.e. assets held before 1 October 2001), including pre-effective date shares. The purpose of these effective date rules is to exclude capital gain arising before CGT was implemented. The value of these pre-CGT effective date assets is determined based on one of three methods (as determined by the taxpayer):

The market value method;

The time-apportionment method; and

The 20% of proceeds method.

Determination of which method applies (and how each method applies) can only be made upon disposal of the relevant asset.

In the case of capital distributions involving pre-effective date shares, application of the valuation method applies only in respect of the part-disposal; application of the valuation method for disposal of the remainder is only determined upon disposal of the remainder.

Reasons for change

Conceptually, dividends should encompass realised and unrealised undistributed profits. Capital distributions should merely represent a return of the capital (i.e. the return of capital contributions made by the shareholders). However, part-disposal treatment as currently formulated triggers capital gain on amounts that effectively include both realised and unrealised undistributed profits. The net effect is to over-tax capital distributions by only allocating a portion of base cost as an offset when the full base cost associated with the underlying share should be available.

While Government has always understood that return of capital treatment should allow for a full base cost offset, the calculations for pre-CGT effective date shares have always been problematic. Delayed calculation of base cost until disposal has meant that the entire base cost of pre-CGT shares is unknown when a capital distribution is involved.

The change

A. Revised treatment for capital distributions

The capital gain calculation for capital distributions has been re-aligned in accordance with the intended concept. Capital distribution proceeds will be allocated against the full base cost of the underlying share involved in the distribution. These capital distribution proceeds will be applied to reduce the base cost of the underlying shares with capital gain arising to the extent these proceeds exceed base cost. This rule will apply for capital distributions occurring on or after the effective date of this proposal.

Example

Facts: Shareholder A holds all the shares in Company X. The base cost of the shares held by Shareholder A is 150. Company X makes a capital distribution of 400 to Shareholder A.

Result: The amount distributed to Shareholder A must first be applied in reduction of the base cost. Therefore, amounts in excess of the base cost (i.e. 400 less 150) will trigger a capital gain in the hands of Shareholder A.

B. Capital distributions in respect of pre-CGT assets

If a capital distribution involves a share acquired before 1 October 2001, the valuation date rules have been slightly revised. For purposes of these valuation rules, the share will be deemed to be fully acquired as of the capital distribution date. Hence, if the taxpayer elects a valuation date method in respect of a capital distribution, the resulting base cost after the capital distribution will fully apply in respect of the share going forward. No subsequent change of method will be allowed.

C. Special 1 July 2011 deeming rule

Under the old law, capital distributions occurring before 1 October 2007 triggered a part disposal on 1 July 2011 if the underlying share is not disposed of before the 1 July 2011 date. If the share is disposed of before 1 July 2011, the capital distribution amount is added to the proceeds of the share disposal. The 1 July 2011 date was utilised when the part disposal capital distribution rules were initially adopted to provide pre-existing shareholders with time to adjust their affairs. As a further relief measure, shareholders in these circumstances will now have the deemed capital distribution deferred until 1 April 2012.

This extended deferral will allow these capital distributions to enjoy the adopted to provide benefits of the new regime (as opposed to part-disposal treatment).


Changes to the Eighth Schedule to give effect to the above


Definitions

Capital distribution

The definition of a ‘capital distribution’ in paragraph 74 was substituted in 2009 to mean a distribution (or portion of it) by a company that does not constitute a dividend. This definition has now been deleted.

Date of distribution

The definition of the ‘date of distribution’ in paragraph 74 has been substituted. In relation to a distribution, it now means the date of payment of the distribution

by a company subject to the condition that it be payable to its shareholder registered in its share register on a specified date, in which instance it must be that date,

by a company to its shareholder otherwise than by way of a formal declaration of a dividend, in which instance it must be the date when the shareholder became entitled to that distribution, or

by the liquidator of a company to a shareholder of it in the course of its winding up or liquidation, in which instance it must be the date when the shareholder became entitled to that distribution.

Distribution

The definition of a ‘distribution’ in paragraph 74 was substituted in 2009. This definition has now also been deleted.

Share

The definition of a ‘share’ in paragraph 74 was substituted in 2010 to mean a share or member’s interest in that company whether or not it carries a right to participate beyond a specified amount in the distribution. This definition has now also been deleted.

Effective date



Paragraph 75(1) has been substituted. In now provides that when a company make a distribution of an asset in specie to a person holding a share in it, it must be treated as having disposed of that asset to that shareholder on the date of distribution for an amount received or accrued equal to the market value of that asset on that date. The amendment to paragraph 75 comes into operation on the date when Part VIII of Chapter II of the Income Tax Act (the dividends tax provisions) comes into operation.

Paragraph 75(1) provided that when a company made a distribution of an asset in specie to a shareholder, it must be treated as having disposed of that asset to that shareholder on the date of distribution for an amount received or accrued equal to the market value of that asset on that date. The wording in paragraph 75(1) specifically included an interim dividend. Since an interim dividend constitutes a distribution, and will still constitute a distribution when the new dividends tax comes into effect, the reference to an ‘interim dividend’ was deleted as being superfluous by section 79 of the Taxation Laws Amendment Act 17 of 2009. Section 79 of the Taxation Laws Amendment Act 17 of 2009 has now been repealed as a consequence of the revised treatment for capital distributions.

Effective date

The repealing of section 79 of the Taxation Laws Amendment Act 17 of 2009 comes into operation on 1 April 2012.

Paragraph 76 has been amended

The title of the paragraph has been amended to ‘Returns of capital by way of distributions of cash or assets in specie’.

The amended paragraph 76 reads as follows:

(1) Subject to subparagraph (2), where a return of capital by way of a distribution of cash or an asset in specie

(other than a distribution of a share in terms of an unbundling transaction contemplated in section 46(1)) is received by or accrues to a shareholder in respect of a share, that shareholder must where the date of distribution of that cash or asset occurs-

(a) before valuation date, reduce the expenditure contemplated in paragraph 20 actually incurred before valuation date in respect of that share by the amount of that cash or the market value of that asset;

(b) on or after valuation date but before 1 October 2007 and that share is disposed of by the shareholder on or before 31 December 2011, treat the amount of that cash or the market value of that asset as proceeds when that share is disposed of;


(c) on or after 1 October 2007 but before 1 April 2012, treat the amount of that cash or the market value of that asset as proceeds when that share is partly disposed of in terms of paragraph 76A.

(2) Where a shareholder uses the weighted average method in respect of shares that are identical assets as contemplated in paragraph 32(3A)(a) and a return of capital by way of a distribution of cash or an asset in specie (other than a distribution of a share in terms of an unbundling transaction contemplated in section 46(1)) is received by or accrues to that shareholder in respect of those shares on or after valuation date but before 1 October 2007, the weighted average base cost of those shares must be determined by-

(a) deducting the amount of that cash or the market value of that asset from the base cost of those shares held when that return of capital was received or accrued; and

(b) dividing the result by the number of those shares held when that return of capital was received or accrued.

(3) Where a return of capital is effected by way of a distribution of an asset in specie, that asset must be treated as having been acquired by the person to whom the distribution is made on the date of distribution and for expenditure equal to the market value of that asset on that date, which expenditure must be treated as an amount of expenditure actually incurred for the purposes of paragraph 20(1)(a).

(4) Every company that makes a distribution to any other person and every person that pays a distribution to any other person on behalf of a company must by the time of the distribution or payment notify that other person in writing of the extent to which the distribution or payment constitutes a return of capital.

Effective date


Paragraph 76A has been amended – Part disposal of shares

The amended paragraph 76A provides as follows:

(1) Where-

(a) a return of capital by way of a distribution of cash or an asset in specie (other than a share distributed in terms of an unbundling transaction contemplated in section 46(1)) is received by or accrues to a shareholder in respect of a share; and

(b) that return of capital is received by or accrues to that shareholder on or after 1 October 2007 and before 1 April 2012,

that shareholder must be deemed to have disposed of part of that share on the date that the return of capital is received by or accrues to the shareholder.

(1A) Subject to paragraph 76(2), where-

(a) a return of capital by way of a distribution of cash or an asset in specie (other than a share distributed in terms of an unbundling transaction contemplated in section 46(1)) is received by or accrues to a shareholder in respect of a share;

(b) that return of capital is received by or accrues to that shareholder on or after valuation date but before 1 October 2007; and

(c) that share is not disposed of before 1 April 2012, that return of capital must be treated as having been distributed on 1 April 2012.

(2) If paragraph 76(2) applies and the base cost of those shares is a negative amount at the end of 31 March 2012-

(a) that shareholder must be treated as having a capital gain on 31 March 2012 equal to that negative amount; and

(b) the base cost of those shares at the end of 31 March 2012 must be treated as nil.

(3) For purposes of paragraph 33(1) the market value of the part disposed of under this paragraph must be treated as being equal to the amount of the cash or the market value of the asset received or accrued by way of a return of capital.

Effective date

The amended paragraph 76A is deemed to have come into operation on 1 January 2011.

A new paragraph 76B has been inserted– Reduction in base cost of shares as a result of distributions

The new paragraph 76B reads as follows:

(1) Where-

(a) a return of capital or foreign return of capital by way of a distribution of cash or an asset in specie is received by or accrues to a shareholder in respect of a share;

(b) that return of capital or foreign return of capital is received by or accrues to that shareholder on or after 1 April 2012 and prior to the disposal of that share; and

(c) that share constitutes a pre-valuation date asset in relation to that shareholder, for purposes of determining the date of acquisition of that share and the expenditure in respect of the cost of acquisition of that share, that shareholder must be treated as-


(i) having disposed of that share at a time immediately before the return of capital or foreign return of capital is received or accrues for an amount equal to the market value of the share at that time; and

(ii) having immediately reacquired that share at that time at an expenditure equal to that market value-

(aa) less any capital gain that would have been determined had the share been disposed of at market value at that time; and

(bb) increased by any capital loss that would have been determined had the share been disposed of at market value at that time, which expenditure must be treated as an amount of expenditure actually incurred for the purposes of paragraph 20(1)(a).

(2) Where—

(a) a return of capital or foreign return of capital by way of a distribution of cash or an asset in specie is received by or accrues to a shareholder in respect of a share; and

(b) that return of capital or foreign return of capital is received by or accrues to that shareholder on or after 1 April 2012 and prior to the disposal of that share,

the shareholder must reduce the expenditure in respect of the share by the amount of that cash or the market value of that asset on the date that the asset is received by or accrues to that shareholder.

(3) Where the amount of a return of capital or foreign return of capital contemplated in subparagraph (2) exceeds the expenditure in respect of the share in respect of which that return of capital or foreign return of capital is received or accrues, the amount of the excess must be treated as a capital gain in determining that shareholder’s aggregate capital gain or aggregate capital loss for the year of assessment in which that return of capital or foreign return of capital is received by or accrues to the shareholder.

Effective date

The new paragraph 76B comes into operation on 1 January 2012 and applies in respect of returns of capital received or accrued on or after that date.

Distributions in liquidation or deregistration received by shareholder

Paragraph 77(2) of the Eighth Schedule has been amended. The amended paragraph 77 reads as follows:

(1) A shareholder of a company that is being wound up, liquidated or deregistered must be treated as having disposed of all the shares held by that shareholder in that company at the earlier of-

(a) the date of dissolution or deregistration; or

(b) in the case of a liquidation or winding-up, the date when the liquidator declares in writing that no reasonable grounds exist to believe that the shareholder of the company (or shareholders holding the same class of shares) will receive any further distributions in the course of the liquidation or winding-up of that company.

(2) Where-

(a) a return of capital by way of a distribution of cash or assets in specie is received by or accrues to a shareholder contemplated in subparagraph (1) in respect of a share that is treated as having been disposed of in terms of that subparagraph; and

(b) that return of capital is received by or accrues to that shareholder after the date contemplated in subparagraph (1)(a) or (b),

the return of capital must be treated as a capital gain in determining that shareholder’s aggregate capital gain or aggregate capital loss for that year of assessment.

Effective date

The amendments to paragraph 77 of the Eighth Schedule come into operation on 1 April 2012.

Share distributions received by shareholder

Paragraph 78(1) and (3) of the Eighth Schedule have been amended. Although the Taxation Laws Amendment Act, 2011 refers to the substitution of paragraph 78(2), this is an error and it should refer to paragraph 78(1). The amendment to paragraph 78(1) restores the capital gains rules for share distributions. Shares received via a distribution generally have a base cost of nil because share distributions generally fall outside the dividend definition. To the extent a share distribution qualifies as a dividend (under prior, current or proposed law), the shares are deemed to have a base cost equal to the amount recognised as a dividend.

The amended paragraph 78 reads as follows:

(1) Where a company makes a distribution of shares for no consideration, those shares must be treated as having been acquired on the date of distribution for expenditure incurred and paid of nil, except to the extent that the distribution of those shares constitutes a dividend, in which case they must be treated as having been acquired on the date of distribution for expenditure incurred and paid equal to the amount of that dividend.


(2) Subject to paragraphs 11(1)(g), 23 and 35(2), where a company issues shares in substitution of previously held shares in that company by reason of a subdivision or consolidation or a conversion contemplated in section 40A or 40B -

a) the shareholder must disregard any capital gain or capital loss determined in respect of that substitution; and

b) those newly issued shares must be treated as-

i) having been acquired for an amount of expenditure equal to the aggregate expenditure allowable in terms of paragraph 20 incurred in respect of those previously held shares which expenditure must be treated as having been incurred on the same date as the expenditure incurred in respect of those previously held shares; and

ii) having been acquired on the same date as those previously held shares; and

iii) having a market value equal to any market value adopted or determined in respect of those previously held shares in terms of paragraph 29(4),

with the aggregate expenditure or market value as the case may be allocated among all those newly issued shares in proportion to their relative market values.

(3) Where a company issues shares in substitution of previously held shares as contemplated in subparagraph (2) and also effects a return of capital by way of a distribution of cash or assets in specie with respect to those previously held shares-

(a) the shareholder must disregard any capital gain or capital loss determined in respect of that substitution but not in respect of the transfer of those previously held shares exchanged for that return of capital; and

(b) both the substitution and that return of capital must be treated as separate transactions with the expenditure allowable in terms of paragraph 20 and any market value adopted or determined in terms of paragraph 29(4) in respect of those previously held shares allocated between both transactions based on the relative market values of the newly issued shares on the date of distribution and that return of capital received in exchange therefore.

Effective date

The amendment to paragraph 78(1) is deemed to have come into operation on 1 January 2011.

The amendment to paragraph 78(3) comes into operation on 1 April 2012.

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TRANSFER OF RESIDENCE FROM COMPANY OR TRUST

Amendment to paragraph 51A of the Eighth Schedule to the Income Tax Act.

Background to 2010 position

The Explanatory memorandum on the Taxation Laws Amendment Bill, 2010 explained the reasons for amendments made in

2010 to paragraph 51 and 51A.

Before 2001, certain individuals used companies or trusts to purchase residences so as to avoid the imposition of transfer duty. In 2002, this scheme was curbed by a transfer duty anti-avoidance rule that treats the transfer of a residential-property entity as equivalent to a direct transfer of the residential property. Additionally, a dual capital gains tax charge came into effect so that both a company and its shareholders effectively became subject to tax on the same residential property appreciation.

As a result, a company with a residential property became subject to tax (that is, the capital gains tax and the secondary tax on companies (STC)) on the realised appreciation. The shareholders of the company also became subject to the capital gains tax on the same notional gain when they disposed of the company holding the residential property.

In 2002, a two-year window period was granted to provide taxpayers with an opportunity to transfer certain residences out of pre-existing companies or trusts. Under this window period, the capital gains tax, STC and transfer duty liabilities for these pre-existing companies and trusts (along with their owners or beneficiaries) were eliminated. It has since become apparent that many taxpayers failed to use the prior relief period.

In 2009, relief was therefore granted to taxpayers under a restored window period. Under this restored window period, taxpayers qualified for relief similar to that previously allowed. A roll-over relief mechanism was used in place of the market value step-up used in 2002 (the step-up being allowed in 2002 because minimal taxable appreciation was at stake for the capital gains tax, which was introduced only as of 2001).

Upon review, it became apparent that various problems existed with the renewed relief initiated in 2009. Part of the purpose of this relief was to eliminate unnecessary companies and trusts. But the 2009 relief failed to require termination of the entity. Some taxpayers are even seeking to use the continued entity as a means of undermining estate duty and other tax charges.


Furthermore, the 2009 relief provisions did not take into account factual circumstances. For example, a residential property company could have been transferred to new shareholders after formation as part of a cash sale. The 2009 relief also failed to address certain common practical realities (for example, use of the residence by relatives after the death of the initial investor).

The 2009 window-relief period for residence entities has therefore been amended to remedy the above identified inadequacies (and has been extended for another year). But this revised relief retains the same core objective – to assist taxpayers in simplifying their structures when the residence was placed in a company or trust mainly to avoid transfer duty. These provisions apply to disposals that occur from 1 October 2010 and before 1 January 2013.

Company structures

The most common form of residential entity involves the use of a company to hold a residence on behalf of one or more shareholders. In these instances, the relief applies to transfers that satisfy two sets of key requirements, one to use of the residence and the other to liquidation of the company holding the residence. These requirements are outlined in detail below:

To qualify for relief, the primary residence that is disposed of should have been used by individual shareholders of the company or their relatives during the window period (that is, the period between 11 February 2009 and the date of disposal on or before 31 December 2012). This requirement is intended to limit the relief for structures used for non-commercial purposes.

The company must dispose of the residence in anticipation of, or in the course of its liquidation, winding up or deregistration. It must have taken steps to liquidate, wind up or deregister within six months of its disposal of the residence. The purpose of this requirement is to ensure that the relief facilitates government’s objective of eliminating unnecessary entities from the company register, thereby simplifying enforcement.

If the disposal qualifies for relief, no taxable gain or loss will apply to the company when disposing of the residence. But other assets disposed of by it are taxable, including residence-related assets, for example, a golf membership in the common use area. This relief applies regardless of whether the residence is disposed of in exchange for shares or cancellation of debt (all that is required is that the residence must be disposed of to the shareholders or their relatives).

Persons receiving the residence will not have a gain or loss on the company shares surrendered, even if a small portion of value associated with those shares represents taxable non-residence assets. Disposal of the residence is also exempt from transfer duty and STC (or the new dividends tax if the disposal occurs after it comes into effect). STC relief is however subject to the residence being distributed as a dividend in speci and will not apply if the residence if sold and the proceeds are distributed in anticipation of winding-up the company.

The base cost of the residence in the hands of the recipients varies depending on whether the residence is disposed of to the company’s original shareholders or to persons other than its original shareholders:

If the residence is disposed of to persons who acquired all its shares after it acquired the residence, and the value of the residence constituted 90% or more of its value during the window period, the base cost is adjusted. In this instance, the base cost in the residence is to be kept largely in line with the current shareholder cost (and date) of acquiring the shares. This cost must be adjusted for subsequent improvements to the property (not for subsequent depreciation).

In all other instances (for example, disposals to original shareholders), the base cost of the residence is the same as that held by the company. This base cost is its purchase price plus possible adjustments (improvements and some depreciation for partial business use).

The above relief mechanism will be available even if the residence is transferred to a company or trust. But if the residence is disposed of to a company, that recipient company must take steps to liquidate, wind-up or deregister within six months of the disposal. If the residence is transferred to a trust, an application must be made to a competent court for its revocation or its founder, trustees and beneficiaries should have agreed in writing to revoke it. This agreement or application should be made within six months of the date of disposal of the residence.

Example 1

Facts

Husband and wife formed a company in 1995. It purchased a house in 1995 for R360 000. The purchase price was paid out of the proceeds from a bank loan with the full amount guaranteed by the couple who undertook to pay off the loan plus interest in exchange for a loan to the company. The couple stay in the house with their children.


By December 2010 the company owed R200 000 to the bank, and R420 000 to the couple. The house is worth R920 000. Improvements costing R50 000 were made to the house in June 2005.

On 31 December 2010 the company is placed in voluntary liquidation. The couple settle the outstanding bond and waive the amount owing to them on loan account. The house is distributed to the couple as a dividend in specie and shortly thereafter registered in both their names.

Result

The liquidation does not give rise to capital gains tax, transfer duty or STC. The initial R360 000 cost of the house plus the R50 000 improvements are deemed to have been incurred by the couple as if they had incurred those costs directly (with the same 2001 capital gains transitional provisions applying).

The waiver of the shareholders’ loans does not give rise to a capital gain in the company because of the exclusion contained in paragraph 12(5)(cc). The couple must disregard the capital loss on waiver of the loan accounts under paragraph 56(1).

Example 2

Facts

Husband and wife form a company in 1995. It purchased a house the following year for R360 000. In 2004 the couple sold the company to an unrelated individual for R650 000. The individual lives in the house. In December 2010 the individual liquidates the company and transfers the house into his name.

In 2010 the house has a market value of R920 000.

Improvements costing R25 000 were made to the house before the 2004 sale of the company. Another R25 000 of improvements were made in 2008.

Result

The liquidation does not give rise to capital gains tax, transfer duty or STC. The unrelated individual’s base cost in the house is R675 000 (the R650 000 amount paid for the shares in the company by him plus the R25 000 improvements made after his acquisition of the shares in the company).

Trust structures

The other form of residence entity involves a trust. In these instances as with companies, the relief will apply to transfers that satisfy two sets of requirements, one pertains to use of the residence and the other to revocation of the trust. These requirements are similar to those of companies, except that the key parties control the trust through means other than ownership. These requirements are outlined in detail below:

To qualify for relief, the primary residence that is disposed of should have been used by an individual who is a connected person to the trust during the window period (that is, the period between 11 February 2009 and the date of disposal on or before 31 December 2012). This requirement is intended to limit the relief for structures used for non-commercial purposes.

The trust must dispose of the residence in anticipation of, or in the course of its termination. It is deemed to be in termination if an application has been made to a competent court for the trust’s revocation or its founder, trustees and beneficiaries have agreed in writing to revoke the trust. The agreement or application must be made within 6 months of the date of disposal of the residence.

If the disposal qualifies for relief, the trust will enjoy roll-over relief and no taxable gain or loss will apply to the trust when disposing of the residence. But other assets disposed of by it are taxable, including residence-related assets, for example, a golf membership in the common use area. Acquisition of the residence will also be exempt from transfer duty.

The base cost of the residence in the hands of the recipients is the same as the base cost for the trust. This base cost is its purchase price plus subsequent adjustments (improvements). There is no provision for ‘subsequent owners’.

Example 3

Facts

Husband and wife form a trust in 1995. The couple lent the trust R60 000. The trust borrowed R300 000 from a bank. It purchases a house for R360 000. The bank loan was guaranteed by the couple. The couple stay in the house with their children and they pay all bond interest, rates and other expenses in lieu of rent. Improvements costing R50 000 were made to the house in 2004. The trustees obtained a market valuation of the residence at 1 October 2001 for CGT purposes.


In November 2010 the house is sold to the couple for R920 000 and registered in their names. In the process the couple’s loan accounts totalling R410 000 (R60 000 + R300 000 + R50 000) are discharged. The balance of the purchase price R510 000 (R920 000 – R410 000) is paid in cash.

The capital profit of R920 000 – R410 000 = R510 000 is vested by the trustee in the couple and their children in equal shares.

In February 2011 the couple revoke the trust.

Result

The sale of the residence does not give rise to any capital gains tax or transfer duty. Since the loan accounts were discharge for full consideration there are no CGT implications under paragraph 12(5). The house is deemed to be disposed of at base cost under paragraph 51A(2), and no capital gain arises in the trust. The distribution of the capital profit of R510 000 to the couple and their children accordingly does not represent the vesting of a capital gain under paragraph 11(1)(d) and there is therefore no capital gain to be attributed to the beneficiaries under paragraph 80(2).

The initial cost of the house R360 000 plus improvements of R50 000 are deemed to be incurred by the couple as if they incurred those costs directly. Each spouse is deemed to have incurred expenditure of R360 000/2 = R180 000 in 1995 and R50 000/2 = R25 000 in 2004. The actual consideration paid by the couple for the residence of R920 000 is disregarded for base cost purposes. The residence will be pre-valuation date asset in the couple’s hands, and they will have a choice of the time-based apportionment, market-value and 20% of proceeds methods for determining the valuation date value of the house when they ultimately dispose of it.

Example 4

Facts

A couple are contingent beneficiaries of a discretionary trust. The trust holds all the shares in a company. In 1998 the company purchased a house in which the couple resided in ever since as their main residence.

On 16 January 2011 the company distributes the house to the trust as a dividend in anticipation of deregistration. By 31 May 2011 the company is deregistered.

The trust then distributes the house to the couple on 1 March 2011. On 2 April 2011 the couple make an application to the court for the revocation of the trust.

Result

The disposal of the house from the company to the trust qualifies for relief under paragraph 51A(6)(a). The distribution of the house from the trust to the couple also qualifies for relief under paragraph 51A(6)(b).

Background to 2011 changes

The Draft explanatory memorandum on the Taxation Laws Amendment Bill, 2011 gives the following background to further amendments made to 51A.

The technical language relating to the potential transferees of residential property entities creates unnecessary anomalies. The law is clarified to state that these transferees must be connected persons to the liquidating entity (i.e. company or trust), and those connected persons mainly used the residential property for domestic (i.e. non-business) purposes. These persons typically involve the founding family member, the spouse or the dependents who use the property for personal use. This amendment extends the relief to holiday houses used mainly for domestic purposes.

As under the 2010 position, taxpayers holding residential property in a company or trust must terminate the company or trust as a condition for relief. A further amendment adjusts the rules for terminating trusts to be more flexible in line with the rule for companies. Under the revised rule, trusts must take steps to terminate within six months (without the legislation describing the actual specifics).

As under the 2010 position, companies or trust shareholders holding residential property entities must be terminated as a condition for relief (like the required termination of the residential property entity). The proposed amendment adjusts the rules for terminating trust shareholders to be more flexible in line with the rule for company shareholders. Under the revised rule, trust shareholders must take steps to terminate within six months (without the legislation describing the actual specifics).


Section 51A in its amended form

Disposal of residence by company or trust and liquidation, winding up, deregistration or termination of company or trust

It provides in paragraph 51A(1) that subject to paragraph 51A(6), its provisions apply when a company or trust disposes of an interest in a residence and,

a) the disposal takes place on or before 31 December 2012,

b) the residence to which that interest relates is mainly used for domestic purposes during the period commencing on

11 February 2009 and ending on the date of the disposal in paragraph 51A(1)(a) by one or more natural persons who

are connected persons in relation to the company or trust at the time of that disposal, and

c) this subparagraph has been deleted,

d) within a period of six months commencing on the date of the disposal contemplated in paragraph 51A(1)(a),

i) for a company making the disposal, it has taken steps to liquidate, wind up or deregister as contemplated in

section 41(4), or

ii) in the case of a trust making the disposal, steps have been taken to terminate the trust.

Paragraph 51A(2) provides that when a company or a trust makes a disposal of an interest in a residence as contemplated in paragraph 51A(1), it is deemed to have made that disposal for an amount equal to the base cost of that interest as at the date of that disposal.

In terms of paragraph 51A(3), when,

a) an interest in a residence has been acquired by a person as a result of a disposal by a company of that interest to him

as contemplated in paragraph 51A(1),

b) he (together with all other persons holding shares in it) acquired all its shares subsequent to the date of acquisition by it

of that interest, and

c) 90% or more of the market value of the assets held by it during the period commencing on 11 February 2009 and ending

on the date of the disposal contemplated in paragraph 51A(1)(a) is attributable to that interest,

he must,

i) disregard the disposal of all his shares in it for purposes of the determining his taxable income, assessed loss,

aggregate capital gain or aggregate capital loss if that disposal is made in anticipation of or in the course of its

liquidation, winding up or deregistration, and

ii) be deemed to have acquired that interest at a cost equal to the base cost of the shares contemplated in

paragraph 51A(3)(c)(i) as at the date of the acquisition by him of those shares plus the cost of improvements

effected to that interest subsequent to that date of acquisition.

Paragraph 51A(4) provides that when an interest in a residence has been acquired by a person as a result of a disposal by a company of that interest to him as contemplated in paragraph 51A(1) and when paragraph 51A(3) does not apply,

a) he must disregard the disposal of his shares in it for purposes of the determination of his taxable income, assessed loss,

aggregate capital gain or aggregate capital loss if that disposal is made in anticipation of or in the course of its

liquidation, winding up or deregistration, and

b) he and it must be deemed to be one and the same person for,

i) the date of acquisition of that interest by it,

ii) the amount and date of incurral by it of an expenditure for that interest allowable in terms of paragraph 20, and


iii) a valuation of that interest effected by it as contemplated in paragraph 29(4).

In terms of paragraph 51A(5), when an interest in a residence has been acquired by a person as a result of a disposal by a trust of that interest to him as contemplated in paragraph 51A(1), he and it must for purposes of determining a capital gain or capital loss for the disposal by him of that interest so acquired be deemed to be one and the same person for,

a) the date of acquisition of that interest by it,

b) the amount and date of incurral by it of expenditure for that interest allowable in terms of paragraph 20, and

c) a valuation of that interest effected by it as contemplated in paragraph 29(4).

Paragraph 51A(6) then provides that paragraph 51A does not apply to a disposal made to a person unless,

a) within a period of six months commencing on the date of that disposal,

i) when it is a company, it has taken steps to liquidate, wind up or deregister as contemplated in section 41(4), and

ii) where that person is a trust, steps have been taken to terminate the trust, and

b) one or more natural persons contemplated in paragraph 51A(1)(b) acquire the residence contemplated in

paragraph 51A(1)(b) on or before 31 December 2012.

Paragraph 51A(7) has been deleted.

Effective date

Except for the amendment to paragraph 51A(7), the amendments to Paragraph 51A are deemed to come into operation on 1 October 2010 and apply to disposals made on or after that date and before 1 January 2013.

The deletion of paragraph 51A(7) comes into operation on 1 April 2012 and applies to disposals made on or after that date and before 1 January 2013.

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SPECIALISED ENTITIES AND CIRCUMSTANCES

SHARES DEEMED TO BE CAPITAL IN NATURE

Amendment to sections 1 and 9C of the Income Tax Act.

Definition of an equity share in section 1

First substitution

The definition of an ‘equity share’ in section 1 has been amended and now means a share or similar interest in a company, excluding a share or similar interest that, neither as respects dividends nor as respects capital, carries a right to participate beyond a specified amount in a distribution.

The above amendment of an ‘equity share’ is deemed to have come into operation on 1 January 2012.

Further substitution

The definition of an ‘equity share’ in section 1 is then again amended with the addition of the words ‘returns of ’. The further amendment now provides that it means a share in a company, excluding a share that, neither as respects dividends nor as respects returns of capital, carries any right to participate beyond a specified amount in a distribution.

This definition comes into operation on 1 January 2012.

Amendment to section 9C

The term “equity share” is now technically delinked from section 41 for ease of use. However, like the section 41 definition, the term “equity share” includes participatory interests in a portfolio of collective investment scheme (meaning that the disposal of these interests after three years triggers a capital gain/loss).

The following amendments have been made to section 9C:


Since the section 1 definition of an ‘equity share’ no longer includes an interest in a collective investment scheme in securities (a unit in an equity trust) it was necessary for the definition of an ‘equity share’ to be inserted into section 9C(1).

At the same time certain references to section 41 and section 44 have been deleted.

A reference to section 12J(3) has been replaced by a reference to section 12J(2).

The term ‘or foreign dividend’ has been added to section 9C(2).

And section 9C(6) has been amended to clarify that the first-in-first-out (FIFO) valuation method applies only when the shares disposed of are identical shares in the same company.

Effective date

The insertion of the term ‘or foreign dividend’ into section 9C(2) comes into operation on 1 April 2012. The reference change in section 9C(2A) comes into operation on 1 January 2012 and applies in respect of years of assessment commencing on or after that date. All other amendments to section 9C are deemed to have come into operation as from the commencement of years of assessment commencing on or after 1 January 2010.

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REPORTABLE ARRANGEMENTS

Amendment to section 80T of the Income Tax Act.

The term ‘arrangement’ for purposes of reportable arrangements is being changed in line with the term ‘arrangement’ as used for impermissible avoidance arrangements (i.e. section 80L)).

Section 80T of the Income Tax has been amended

The definition of ‘arrangement’ in section 80T now reads as follows:

‘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.

Effective date

The amendment to the definition of ‘arrangement’ in section 80T comes into operation on 1 April 2012.

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ISLAMIC FINANCING – AMENDMENTS TO THE 2010 LEGISLATION

Amendment to section 24JA(1) and (4) of the Income Tax Act, section 3A(1) of the Transfer Duty Act, Section 8 of the Value-Added Tax Act and Section 8A of the Securities Transfer Tax Act.

Background

Legislation was enacted in 2010 that recognises certain forms of Islamic finance as equivalent to traditional finance entailing interest. One of these products involves Murabaha arrangements (as well as the Mudaraba arrangement).

A. Murabaha arrangement

The Murabaha is a mark-up financing transaction generally offered by financial institutions to ensure that a client can obtain financing for the purchase of various assets (e.g. fixed property and equipment). The financial institution will purchase an asset (from a third party) at the instruction of the client and sell the asset to the client at a pre-agreed price. The pre-agreed price represents the cost of the asset acquisition plus a ‘profit’ mark-up. Under the 2010 legislation, banks offering finance pursuant to a Murabaha arrangement are deemed not to be involved in the acquisition or disposal of the asset that is the object of the arrangement. The client is deemed to be acquiring the asset directly from the seller for the cost incurred by the bank (on the client’s behalf) and at the time the bank acquires the asset. This deeming of a direct acquisition by the client eliminates adverse indirect tax (e.g. VAT) consequences for the bank that do not exist in the case of traditional finance.

The ‘profit’ mark-up allocation by the bank is deemed to be interest. It should be noted that the same principles explicitly apply to Murabaha arrangements that entail financing by collective investment schemes to banks.


B. Diminishing musharaka arrangement

Diminishing Musharaka is a partnership arrangement generally used for project financing. Under this arrangement, the client and the bank jointly acquire various assets. Alternatively, the bank acquires an ownership interest in an asset that is already owned by the client in return for financing of a development or refurbishment project. In both circumstances, the Bank’s share in the asset is further divided into smaller units. The bank and the client enter into another agreement in terms of which the client undertakes to purchase the bank’s proportionate interest over time through the periodic purchase of individual units.

Reasons for change

Murabaha

As stated above, the current ambit of the Islamic finance provisions dealing with Murabaha arrangements cater mainly for ‘bank-to-client’ finance (or if the funds came from a collective investment scheme to a bank). These Islamic finance provisions do not apply to arrangements in which the bank borrows funds from other parties. After further analysis, it has been decided that no reason exists to limit this form of Marabaha (deposit) finance. Whether the bank offers the finance or receives the finance (as a deposit) should make no policy difference. In either circumstance as long as a bank is involved in either side of the transaction, the Marabaha arrangement is seeking to achieve the same equivalent result as traditional financing. When a client acquires the asset from the bank in most murabaha transactions, the 30-day period between the first sale and the second sale is often insufficient (due to circumstances outside the parties’ control). For instance, if bank purchases goods from a foreign jurisdiction on behalf of the client, shipping issues may delay the sale dates because the bank may not resell the goods until the bank has physical control of the goods.

Diminishing Musharaka

The current straight line method for calculating income in respect of diminishing musharaka is not in line with the actual calculation. The actual calculation follows the yield-to-maturity method (i.e. as in section 24J), but the legislation allocates amounts on a straight-line basis.

The change

Murabaha

The scope of Murabaha arrangements has been extended to cater for clients that provide financing (e.g deposits) to the bank. Hence, all legal entities and natural persons can now benefit from Marabaha financing to or from banks. As a collateral matter, the term has been extended from a 30-day period to a 12- month period. However, a condition has been added that no receipts or accruals must be derived from the property during the interim period held by the financier (other than from the second disposal of the property). It should be further noted that anomalies exist within the current Murabaha arrangement framework in relation to certain indirect taxes (e.g. the Securities Transfer Tax) that arguably prevent the legislation from having the desired non adverse result. These anomalies have been eliminated.

Diminishing Musharaka

It is proposed that the agreement should be the basis for determining the interest (i.e. profit) element. More specifically, the mark-up of the bank will be deemed to be interest. The deemed interest will be calculated by comparing the installment against the bank’s cost of the proportional interest in the asset annually disposed of by the bank to the client. The net effect of this proposal is to reach the same compounding method result as section 24J.

Example

Facts: Individual X identifies property for R2 million and approaches the Bank for financing using the Diminishing Musharaka arrangement. Individual X pays R 500 000 and the Bank funds R 1 500 000 towards the purchase of the property. Individual X will purchase 1% of the Banks interest over the period of 10 years.

Result: Each payment made by Individual X to the Bank indirectly represents part capital repayment and part deemed interest. The R1 500 000 in the Bank’s books will be the capital outstanding that individual X must settle. Assuming in year 1, individual X pays R165 000 for a 1% interest, the deemed interest element will equal R150 000 (R165 000 less R15 000).

General

All Islamic finance amounts are now deemed to be interest and treated as such for Income Tax purposes. The net result is automatic application of the interest de minimis exemption and the cross-border exemption.


PROPOSED SUKUK

Amendment to section 24JA of the Income Tax Act.

Background

In 2010, Government introduced several provisions dealing with the tax treatment of Sharia compliant arrangements. These provisions mainly provide parity of tax treatment between Islamic finance products vis-à-vis conventional banking products. As part of this reform, the tax system now accommodates the following forms of Sharia compliant arrangements:

(i)’diminishing musharaka’,

(ii) ‘mudaraba’, and

(iii) ‘murabaha’.

The net effect of these accommodations is to treat these forms of Sharia compliant financing as comparable to conventional ‘debt instruments’, thereby eliminating anomalies relating to income tax, VAT, transfer duty and securities transfer tax.

Reasons for change

Creation of an enabling framework for Islamic finance requires more than enacting accommodating tax legislation. Islamic financing, like conventional financing, requires government bonds as a ‘risk-free’ standard so as to set the pricing for all other privately issued Islamic bonds. Moreover, Islamic finance providers typically utilise (and even require) Government bonds for regulating cash-flow and for balancing portfolios. In the case of banks, the need for Government-issued Islamic bonds is more acute. All banks must hold a certain percentage of investments in interest bearing instruments (including Government bonds) in terms of banking regulations.

Yet, Islamic banks are religiously precluded from yielding economic benefits from interest bearing investments according to Sharia law, even if required by local banking regulations. In order to balance both religious and regulatory interests, truly proper Islamic banks surrender the interest received in respect of these investments. This lack of return places Islamic banking at a competitive disadvantage in comparison with conventional banks, thereby lowering the overall yield of Islamic savings products.

To date, Government has never issued any form of Islamic bond (known as a Sukuk). Moreover, current tax legislation fails to accommodate any meaningful potential for a Government Sukuk because these products typically come in the form of an ‘Ijara’ financing arrangement. Ijara financing roughly equates to conventional finance leasing. While the tax system contains anti-avoidance rules to restrict certain practices associated with finance leasing, the tax system does not treat financing leasing as equivalent to interest.

The change

Transfer of funds

A. Proposed Government Sukuk

In view of the above, Government plans to issue a Sukuk to serve as a central focal point for Islamic finance. This Sukuk will come in the form of Ijara so that the bond falls within the dominant global standard for Government issued Sukuks. At this stage, the bond is planned to be issued locally. Strong take-up is expected by local banks and other financial institutions actively engaged in Islamic financing. Demand for local Islamic bonds also exists from certain retail investors.

In essence, an Ijara-styled Sukuk is an Islamic certificate of investment evidencing an investor’s proportional beneficial interest in an underlying asset (or in a comparable usufruct). In the case of the product proposed, the structure envisaged by the National Treasury is as follows:

Step 1: Identification of immovable property (e.g. a government building or facility) for use by a special purpose vehicle (SPV) in the form of trust (i.e. acting as a conduit entity).

Step 2: Transfer of beneficial ownership (or a usufruct) in the immovable property to the SPV. As part of this step, investors will provide funds to the SPV. These funds will then be passed onto National Treasury in exchange for the beneficial ownership (or usufruct) in the immovable property.

Step 3: National Treasury will simultaneously lease back the beneficial ownership (or usufruct) over a period of years. The lease payments provided to the SPV will be allocated to the investors after subtracting an appropriate administration service fee. The lease charge will be based on the market-related cost of funding provided by the

investors.

Step 4: At the close of the lease period, National Treasury will repurchase the beneficial interest (or usufruct) held by the SPV at the initial cost to the SPV (with the final payments again being allocated among the investors). This repurchase price will effectively act as a repayment of principal (i.e. capital) at the end of the term.

It should also be noted that the overall arrangement must be sanctioned by Islamic scholars to ensure that the arrangement satisfies Sharia law.


B. Tax adjustments

Applicable tax principles of present law unfortunately work against the proposed Government Sukuk by triggering multiple adverse tax consequences that do not exist for conventional Government bonds. This tax burden will accordingly be eased so that the overall arrangement operates essentially as interest.

Firstly, the deemed sale by Government to the trust and subsequent repurchase will be ignored for income tax purpose.

Secondly, the yield on the underlying asset (e.g. the lease payment in respect of the immovable property) held by the SPV will be similarly taxed as interest for income tax purposes.

This deemed ‘interest’ yield of the SPV will automatically flow-through to the investors by virtue of the fact that the SPV is an entity in the nature of a trust (i.e. is a conduit under current law).

Adverse indirect tax charges associated with the structure have also been eliminated. In particular, any potential transfer duties associated with the acquisition by the SPV have been eliminated. No transfer duties existed in respect of the repurchase by National Treasury because Government acquisitions were already exempt from transfer duty. The SPV will be deemed not to be an ‘enterprise’ in order to eliminate any potential associated VAT charge with the SPV.


Section 24JA has been amended

The definition of ‘murabaha’ has been substituted as follows:

‘murabaha’ means a sharia arrangement between a financier and a client of that financier, one of which is a bank, whereby-

(a) the financier will acquire an asset from a third party (the seller) for the benefit of the client on such terms and conditions as are agreed upon between the client and the seller;

(b) the client-

(i) will acquire the asset from the financier within 180 days after the acquisition of the asset by the financier contemplated in paragraph (a); and

(ii) agrees to pay to the financier a total amount that-

(aa) exceeds the amount payable by the financier to the seller as consideration to acquire the asset;

(bb) is calculated with reference to the consideration payable by the financier to the seller in combination with the duration of the sharia arrangement; and

(cc) may not exceed the amount agreed upon between the financier and the client when the sharia arrangement

is entered into; and

(c) no amount is received by or accrues to the financier in respect of that asset other than an amount contemplated in paragraph (b)(ii).

After the definition of ‘sharia arrangement’ the following definition has been added:

‘sukuk’ means a sharia arrangement whereby-

(a) the government of the Republic disposes of an interest in an asset to a trust; and

(b) the disposal of the interest in the asset to the trust by the government is subject to an agreement in terms of which the government undertakes to reacquire on a future date from that trust the interest in the asset disposed of at a cost equal to the cost paid by the trust to the government to obtain the asset.

The amended subsection (2) now reads as follows:

(2) Any amount received by or accrued to a client in terms of a mudaraba is deemed to be interest as defined in section 24J(1).

Subsection (3) is substituted as follows:

(3) Where any murabaha is entered into between a financier and a client of that financier as contemplated in paragraph (a) of the definition of ‘murabaha’-

(a) the financier is deemed not to have acquired or disposed of the asset under the sharia arrangement;

(b) the client is deemed to have acquired the asset from the seller-

(i) for consideration equal to the amount paid by the financier to the seller; and

(ii) at such time as the financier acquired the asset from the seller by virtue of the transaction between the seller and the financier;

(c) the murabaha is deemed to be an instrument for the purposes of section 24J;

(d) the difference between the amount of consideration paid for the asset by the financier to the seller and the consideration payable to the financier by the client to acquire the asset as contemplated in paragraph (a)(ii)(bb) of the definition of ‘murabaha’ is deemed to be a premium paid for the purposes of section 24J; and


(e) the amount of consideration paid by the financier to acquire the asset as contemplated in paragraph (a)(i) of the definition of ‘murabaha’ is deemed to be an issue price for the purposes of section 24J.

Subsection (4) has been deleted

Subsection (6) has been substituted as follows:

(6) (a) For the purposes of subsection (5), where an instalment is paid by the client to the bank, a portion of that instalment, the amount of which must be determined in accordance with paragraph (b), is deemed to be interest as defined in section 24J(1).

(b) The amount contemplated in paragraph (a) must be determined in accordance with the formula-

X = A - B

in which formula-

(i) ‘X’ represents the amount to be determined;

(ii) ‘A’ represents the total amount of the instalment payable by the client to the bank;

(iii) ‘B’ represents the expenditure incurred by the bank to acquire the portion of the interest in the asset transferred to the client in exchange for the instalment payable by the client to the bank.

Subsection (7) has been added:

(7) Where any sukuk is entered into-

(a) the trust is deemed not to have acquired the asset from the government of the Republic under the sharia arrangement;

(b) the government is deemed not to have disposed of or reacquired the asset; and

(c) any consideration paid by the government in respect of the use of the asset held by the trust is deemed to be interest as defined in section 24J(1).

Effective date

The amendments to section 24JA come into operation on a date determined by the Minister of Finance by notice in the Gazette.

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DEDUCTION OF DONATIONS BY COLLECTIVE INVESTMENT SCHEMES, AND

CONDUIT PRINCIPLE FOR ORDINARY DISTRIBUTIONS BY COLLECTIVE INVESTMENT SCHEMES

Amendment to sections 18A(1C)(c) and 25(BA) of the Income Tax Act.

Background

A. CIS retention of funds

A collective investment scheme (“CIS”) is an investment vehicle that facilitates portfolio investments for investors (technically referred to as unit holders). For income tax purposes, a CIS is treated as a flow-through entity in relation to amounts of a revenue nature. This treatment is subject to the condition that non-capital amounts received by the CIS must be distributed to the unit holders within twelve months after the date of receipt by the CIS. If the CIS does not distribute these amounts within the required 12-month period, the amounts are deemed to be received by the CIS. Retained amounts retain their character (i.e. interest is be taxed as ordinary revenue and dividends are generally exempt).

B. Islamic CIS finance

With the development of Islamic finance within South Africa, Sharia-compliant CISs have emerged. One pre-requisite of Islamic finance is the required forfeiture of interest and other impermissible income.

In view of this pre-requisite, Sharia-compliant CISs are subject to agreements that prevent impermissible amounts from being distributed to unit holders. These CISs instead donate impermissible amounts to various public benefit organisations. The impermissible amounts typically stem from interest received or accrued as well as dividends arising from profits derived from interest.

Reasons for change

A. Retained dividend amounts

A CIS often retains a portion of the dividends and interest received in order to accommodate services payable to the associated management company. In the case of dividends, the amounts retained essentially act as a cession of the dividends to the CIS in exchange for services. This assignment is similar to the purchase of dividends commonly found in cessions, whereby the character of the dividend consideration should be viewed as transformed in ordinary revenue.


B. CIS Islamic donations of impermissible amounts

Although a CIS is entitled to deduct donations to public benefit organisations classified within Part II of the 9th Schedule like other taxpayers, the 10% taxable income limit on deductible donations poses a practical problem. A CIS typically has little or no taxable income because taxable income is retained solely for management fees. This limit is especially problematic for Islamic finance CISs that regularly donate impermissible receipts or accruals.

The change

A. Revised Tax of CIS dividends

It is proposed that the Dividends Tax should be applicable to regulated intermediaries (including a CIS) only once payment is made by a regulated intermediary. It is proposed that all dividends be treated as ordinary revenue if retained by the CIS beyond the requisite 12-month period.

Example 1

Facts: CIS holds 800 shares in Domestic Company XYZ. CIS has also independently borrowed 600 Domestic Company ABC shares from pension fund (i.e. the long and short positions have no transactional linkage to one another). On 15 July 2012, Domestic Company XYZ announces a dividend of R1 per share, and Domestic Company ABC announces a dividend of R1 per share. As a result, Domestic Company Shareholder receives R800 dividends from the XYZ shares held long and must pay R600 manufactured dividends in respect of the ABC shares held short. Both the XYZ and ABC shares are substantially similar with CIS using R600 of the XYZ dividends to pay the R600 owed in respect of the ABC shares held short. CIS pays a R200 dividend to the unit holders on 1 December 2012.

Result: The XYZ dividends retained by CIS to pay the manufactured dividends are treated as taxable ordinary revenue, (see notes on anti avoidance dividends in respect of borrowed shares). This ordinary revenue is offset by the loss from the short portion. The R200 dividend attracts Dividend Tax on the date of payment by the CIS (i.e. 1 December 2012).

B. CIS donations

The 10% taxable income limit for deductible donations will no longer apply to a CIS. Instead, deductible donations by a CIS will be limited to 0.5% of the weighted average annual value of net CIS assets during the year of assessment in which the donations occur.

Example 2

Facts: CIS (an Islamic CIS) receives a dividend of R1000. Of the R1000, R750 is derived from dividends actively earned by the underlying company and R250 is derived from a money market investment made by the underlying company. CIS X donates the R250 derived from the money market instruments to Public Benefit Organisation.

Result: The R250 donated to the Public Benefit Organisation will not be subject to the Dividends Tax. This amount will instead be deductible to the extent that this donation does not exceed 0.5 per cent of the weighted average annual value of net CIS assets during the year of assessment in which the donations occurs (see CIS donations below). The R600 dividend will be subject to the Dividends tax when CIS X pays the dividends to the participatory interest holders.


Limit of deduction

Section 18A(1) limits the maximum amount of the deduction for donations to approved organizations. Section 18A(1) has been amended to provide a new limit for donations made by approved organizations by CISs. Section 18A(1) now reads as follows:

The deduction must not exceed-

(A) where the taxpayer is a portfolio of a collective investment scheme, an amount determined in accordance with the following formula:

A = B × 0,005

in which formula:

(AA) ‘A’ represents the amount to be determined;

(BB) ‘B’ represents the average value of the aggregate of all of the participatory interests held by investors in the portfol io for the year of assessment, determined by using the aggregate value of all of the participatory interests in the portfolio at the end of each day during that year; or

(B) in any other case, 10% of the taxable income (excluding any retirement fund lump sum benefit and retirement fund lump sum withdrawal benefit) of the taxpayer as calculated before allowing any deduction under this section or section 18.

Effective date

The amendments to section 18A(1) come into operation on 1 January 2012 and apply to amounts paid or transferred during years of assessment commencing on or after that date.


Conduit principle

Section 25BA of the Income Tax Act has been amended to provide for amounts retained by a CIS in securities to pay for services rendered. Section 25BA(b) now reads as follows:

(b) to the extent that the amount is not distributed as contemplated in paragraph (a) within 12 months of its receipt by that portfolio-

(i) be deemed to have accrued to that portfolio on the last day of the period of 12 months commencing on the date of its receipt by that portfolio; and

(ii) to the extent that the amount is attributable to a dividend received by or accrued to that portfolio, be deemed to be income of that portfolio.

Effective date

The amendment to section 25BA comes into operation on 1 January 2012 and applies in respect of amounts received by or accrued to a portfolio of a collective investment scheme during years of assessment of the portfolio commencing on or after that date.

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RECREATIONAL CLUBS Amendment to section 10(1)(cO)(iv)(bb) of the Income Tax Act.

The monetary limit in section 10(1)(cO)(iv)(bb) has been increased from R100 000 to R120 000. Section 10(1)(cO) now provides an exemption from normal tax for the receipts and accruals of a recreational club approved by the Commissioner under section 30A, to the extent that the receipts and accruals are derived-

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

b) from a business undertaking or trading activity that is integral and directly related to the provision of social and

recreational amenities or facilities for its members, is carried out on a basis substantially the whole of which is directed

towards the recovery of cost, and does not result in unfair competition in relation to taxable entities,

c) from fundraising activities that are of an occasional nature and undertaken substantially with assistance on a voluntary

basis without compensation, and

d) from any other source and 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) R120 000.

Effective date

The amendment to section 10(1)(cN)(ii)(dd)(ii) comes into operation on 1 March 2011 and applies to amounts received or accrued on or after that date.

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PUBLIC BENEFIT ORGANISATIONS (PBOS) Amendment to section 10(1)(cN(ii)(dd) of the Income Tax Act.

The monetary limit of section 10(1)(cN)(ii)(dd) has been increased from R150 000 to R200 000. Section 10(1)(cN) now provides that there will be exempt from normal tax the receipts and accruals of a public benefit organisation (PBO) approved by the Commissioner under section 30(3), to the extent that its receipts and accruals are derived otherwise than from a business undertaking or trading activity.

Section 10(1)(cN)(ii)(aa), (bb) and (cc) then allows the PBO’s receipts and accruals to be derived from a business undertaking or trading activity-

a) if the undertaking or activity is integral and directly related to its sole or principal object as contemplated in paragraph (b)

of the definition of ‘public benefit organisation’ in section 30, is carried out or conducted on a basis substantially the

whole of which is directed towards the recovery of cost, and does not result in unfair competition in relation to taxable

entities;


b) if the undertaking or activity is of an occasional nature and undertaken substantially with assistance on a voluntary basis

without compensation;

c) if the undertaking or activity is approved by the Minister by notice in the Gazette, having regard to the scope and

benevolent nature of the undertaking or activity, the direct connection and interrelationship of the undertaking or activity

with its sole or principal object, the profitability of the undertaking or activity, and the level of economic distortion that

may be caused by its tax-exempt status carrying out the undertaking or activity; or

d) other than the above undertakings or activities, its receipts and accruals do not exceed the greater of-

(i) 5% of its total receipts and accruals during the relevant year of assessment; or

(ii) R200 000.

Effective date

The amendment to section 10(1)(cN)(ii)(dd)(ii) comes into operation on 1 March 2011 and applies to amounts received or accrued on or after that date.

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ROAD ACCIDENT FUND PAYOUTS

Amendment to section 10(1)(gB) of the Income Tax Act.

Background

Road Accident Fund compensation

The Road Accident Fund is designed to operate as a national centralised financial pool that provides compensation for damages sustained in motor vehicle accidents (Road Accident Fund Act, 1956 (Act No. 56 of 1996)). Compensation relates to bodily injury and death (including associated direct and indirect costs).

Taxation of lump sums versus annual payments

The starting point for determining gross income is to include all receipts and accruals other than amounts of a capital nature. In terms of court-related claims, lump sum payments would generally qualify as capital amounts so as to be exempt. On the other hand, annualized payments would fall squarely within gross income. Upfront amounts typically replace permanent capital lost; whereas, annualised amounts typically act as a substitute for lost anticipated gross income.

Reason for change

Compensation paid by the Road Accident Fund is currently paid in the form of a lump sum. The Road Accident Fund is now planning to additionally allow for claims to be paid in the form annualised amounts spread over several years. The annualised spreading of income often operates as a better method of providing financial security for victims seeking to recover from (or merely survive) serious vehicle accidents. Annualised payments effectively spare the victims from having to undergo the risk of managing lump sums, thereby covering victims and their families over extended periods of hardship.

The change

While the capital versus ordinary distinction in the case of involuntary compensation was never questioned, special relief existed for various forms of Government payments. This relief for Government payments applies regardless of whether amounts are paid as an annuity or as a lump sum.

For instance, workmen’s compensation paid pursuant to the Compensation for Occupational Injuries and Diseases Act, 1993 (Act No. 130 of 1993) is fully exempt. This exemption applies regardless of whether the amounts paid are in the form of a lump sum or as annualised payments. In essence, workmen’s compensation never fully makes the taxpayer whole from work-related injury, thereby justifying special tax relief. It was accordingly decided that payments pursuant to claims against the Road Accident Fund be treated in the same fashion as workmen’s compensation. Payments in respect of claims from the Road Accident Fund are now fully exempt regardless of whether the payment is in the form of an upfront lump sum or in the form of annualised payments.

Effective date

Section 10(1)(gB)(iv) comes into operation on 1 March 2011 and applies to amounts received or accrued on or after that date.

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EMPLOYEE COMPENSATION FUND ENTITIES

Amendment to section 10(1)(t), 10(1)(gB) of the Income Tax Act and the addition of proviso (xi) to the definition of

‘enterprise’ in section 1 of the Value-Added Tax Act.

Background

Regulatory overview

The Compensation for Occupational Injuries and Diseases Act (COIDA) regulates the compensation relating to the death or personal injury suffered by an employee in the course of employment. The central role-player in respect of COIDA is the Compensation Fund, an entity wholly owned by Government and operated under the supervision of the Compensation Commissioner. Employer contributions to the Compensation Fund are comprised of assessment contributions determined in terms of the Standard Assessment Rate announced in the Government Gazette as set by the Compensation Commissioner. The rates imposed on an employer are based on death/injury risk ratios within the industry in question. The Compensation Commissioner also sets the injury/death benefit payouts to employees (or their dependents). COIDA also allows for the license of private mutual entities to operate comparable injury/death benefit schemes in lieu of the Compensation Fund (section 30 of the COIDA). Minimum employer contributions to these mutual entities and minimum benefit payouts by these mutual entities are set by the Compensation Commissioner. At present, Federated Employee Mutual (FEM) and Rand Mutual Assurance (RMA) are the sole private entities licensed to provide employee compensation. FEM covers the construction industry, and RMA covers the mining industry. FEM provides benefits solely as required under COIDA; whereas, RMA provides COIDA as well as additional death/injury benefits. Both entities predate COIDA.

Current tax treatment

A specific income tax exemption exists for the Compensation Fund under COIDA, thereby allowing for the tax-free growth of the fund. Benefit payouts to employees in terms of COIDA are similarly exempt. The entity-level exemption for the build-up of funds does not apply to private mutual entities licensed under COIDA, but benefit payouts by these entities made in terms of COIDA are exempt. Although the build-up of funds for the private mutual entities is taxable, the build-up of fund reserves for one of the current mutual entities is allegedly exempt under the provisions applicable to public benefit organisations.

The Compensation Fund cannot register for Value-added Tax (VAT) because the Fund operates as a regulated entity under the Public Finance Management Act. Both private mutual entities qualify as vendors under the VAT with premiums payable by employers subject to the VAT just like the payment of any other insurance premiums.

Reason for the change

As discussed above, although private mutual funds operating under COIDA can provide income tax-free COIDA benefits, no specific comparable income tax exemption exists for private mutual funds that build-up of reserves. In this vein, although one mutual fund is allegedly exempt as a PBO (see above), it is likely that the reserves for this mutual entity will soon become taxable in view of SARS’ intention to withdraw the exemption. No reason therefore exists for this uneven treatment, especially to the extent these private mutual entities act in substitution of Government. Similar parity should also exist for VAT. This overall parity of treatment is important to ensure that these entities are not forced to increase premiums or offer lower benefits vis-a-vis the Compensation Fund for the same COIDA benefits.

The change

In view of the above, the relief afforded to the Compensation Fund under COIDA has been be extended to the mutual associations licensed under COIDA. However, in order to receive this entity-level income tax exemption, these licensed mutual entities must solely provide COIDA-required benefits (without any benefits in excess of these amounts). This same condition is required for these mutual entities to be free from VAT registration.

Therefore, FEM will become free from Income Tax and VAT as a result of the amendments. RMA, on the other hand, can only receive the same Income Tax and VAT exemption if the benefits provided in excess of COIDA requirements are segregated from RMA into another entity.


Subparagraph (xvi) has been added to section 10(1)(t) of the Income Tax Act

(xvi) of—

(aa) the compensation fund established by section 15 of the Compensation for Occupational Injuries and Diseases Act, 1993 (Act No. 130 of 1993);

(bb) the reserve fund established by section 19 of the Compensation for Occupational Injuries and Diseases Act, 1993 (Act No. 130 of 1993); and


(cc) a mutual association licensed in terms of section 30 of the Compensation for Occupational Injuries and Diseases Act, 1993 (Act No. 130 of 1993), to carry on the business of insurance of employers against their liabilities to employees, if the compensation paid by the mutual association is identical to compensation that would have been payable in similar circumstances in terms of that Act.

Effective date

The insertion of section 10(1)(t)(xvi) comes into operation on 1 January 2012.

The proviso (xi) has been added to the definition of ‘enterprise’ in section 1 of the Value-Added Tax Act

(xi) reads as follows:

The supply of services by a mutual association licensed in terms of section 30 of the Compensation for Occupational Injuries and Diseases Act, 1993 (Act No. 130 of 1993), to carry on the business of insurance of employers against their liabilities to employees in terms of that Act in respect of which that mutual association pays compensation that is no greater than compensation that would have been paid in similar circumstances in terms of that Act shall be deemed not to be the carrying on of an enterprise.

Effective date

The insertion of proviso (xi) comes into effect on 10 January 2012 and applies to services supplied on or after that date.

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TRANSFER DUTY

DEFINITIONS

Deeds Registry

Amendment to the definition of ‘deeds registry’ in section 1 of the Transfer Duty Act

The definition of ‘deeds registry’ in section 1 of the Transfer Duty Act, 1949 has been amended to include the Mineral and Petroleum Titles Registration Office established by section 2 of the Mining Titles Registration Act No. 16 of 1967.

Fair Value

Amendment to the definition of ‘fair value’ in section 1 of the Transfer Duty Act

References to repealed Acts contained in the definition of Property have been deleted.

Property

Amendment to the definition of ‘property’ in section 1 of the Transfer Duty Act

Reference to repealed Acts has resulted in the deletion of paragraph (b) and as a consequence paragraph (b) has also been amended.

Transaction

Amendment to the definition of ‘transaction’ in section 1 of the Transfer Duty Act

References to repealed Acts contained in the definition of Property have been deleted.

Effective date

The amendments to the above definitions come into operation on 10 January 2012.

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IMPOSITION OF DUTY

Amendment to section 2 and 9 of the Transfer Duty Act

Background

The Transfer Duty had two different sets of rates. Natural persons acquiring property were subject to a 0%, 5% of 8% charge depending on the value of the immovable property acquired. On the other hand, legal entities (companies and trusts) acquiring immovable property were subject to an eight per cent charge regardless of value.


Reason for change

Many years ago, the higher transfer duty rate for companies and trusts could be justified. At one time, a company (or trust) could be used to avoid the transfer duty by holding immovable property indirectly on behalf of a natural person. Under this scenario, the company share or trust interest could seemingly be sold free of transfer duty even if the legal entity held immovable property as the entity’s sole asset. The only transfer duty that could be applied was on the initial acquisition by the legal entity. With the anti-avoidance amendments of 2002, the acquisition of immovable property companies or trusts now triggers transfer duty as if the immovable property were acquired directly. The enactment of capital gains tax adds further layers of tax. With these changes, the higher transfer duty for legal entities is no longer necessary because the overall tax burden on the appreciation of immovable property within companies or trusts is at least as high as immovable property directly held by natural persons. More importantly, non-tax reasons often exist for using legal entities to hold immovable property. For instance, many investors prefer to hold rental properties in the form of a company to obtain the benefit of limited liability protection. This limited liability protection protects investors from excessive losses. The use of multiple companies can also be used so that the separate properties can be protected against the risks of one another. The current flat 8% on immovable property companies and trusts creates a cost that makes these commercial uses prohibitive.

Changes

The flat transfer duty rate for legal entities has been removed. All persons (natural and legal) will henceforth be subject to the same graduated rates. Because the differences in transfer duty rates will no longer exist, tax-free “asset-for-shares” (e.g. formations) are now permitted. It should be noted that the anti-avoidance rules for property legal entities remains in order to ensure that legal entities do not hold property mainly for tax motivated reasons.

Amendments giving effect to the above

Section 2 has been amended by the deletion of section 2(1)(a) and the substitution of section 2(1)(b).

Section 2(1) now provides that subject to the provisions of section 9, there is levied a transfer duty on the value of a property (which value is determined in accordance with the provisions of section 5, 6, 7, and 8) acquired by a person on or after the date of commencement of this Act by way of a transaction or in another manner, or on the amount by which its value is enhanced by the renunciation, on or after the said date, of an interest in or restriction upon the use of or disposal of it, at the rate of:

0% of so much of the said value or the said amount as does not exceed R600 000,

3% of so much of the said value or the said amount as exceeds R600 000 but does not exceed R1 million,

5% of so much of the said value or the said amount as exceeds R1 million but does not exceed R1.5 million, and

8% of so much of the said value or the said amount as exceeds R1.5 million.

Section 2(5) has been amended by deleting the word ‘natural’ in relation to a person and now extends to all persons.

Section 2(8) has been deleted as a result of the rate of duty applicable to a legal entity.

Effective date

The amendments to sections 2(1), 2(5) and 2(8) come into operation on 23 February 2011 and apply to property acquired or interest or restriction in a property renounced on or after that date.

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SHARIA COMPLIANT FINANCING ARRANGEMENTS

Amendment to section 3A of the Transfer Duty Act

Refer detailed notes on Islamic Financing Arrangements in the Income Tax section of these notes.

Murabaha

Section 3A(1) has been amended and now provides that for a ‘murabaha’ as defined in section 24JA(1) of the Income Tax Act:

(a) the financier is deemed not to have acquired property under the sharia arrangement,

(b) the client is deemed to have acquired property from the seller-


(i) for an amount equal to the consideration paid by the financier to the seller; and

(ii) at such time as the financier acquired the property from the seller by virtue of the transaction between the seller

and the financier.

Sukuk

Section 3A(3) has been added to included a ‘sukuk’ and provides that for the purpose of payment of duty for a sukuk as defined in section 24JA(1) of the Income Tax Act the trust is deemed not to have acquired the asset from the government of South Africa.

Effective date

The above amendments are deemed to have come into operation on a date to be determined by the Minister of Finance by notice in the Gazette.

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FAIR VALUE DETERMINATION

Amendment to section 5 of the Transfer Duty Act

Cessions

Section 5(5) has been amended as consequence of the deletion of paragraph (b) of the definition of property in section 1. It now provides that for the cession of a lease or sub-lease referred to in paragraph (c) of the definition of ‘property’ in section 1, the value on which duty is payable is the amount of the consideration payable by the cessionary to the cedent for the cession or, if no consideration is so payable, the declared value of the property acquired under the cession.

Valuations

Section 5(7)(d) has been amended to update the title of a government office. ‘Director-General: Mineral Resources’ replaces ‘Government Mining Engineer’.

Section 5(8)(a) has been amended to update the title of the same government office.

Effective date

The above amendments are deemed to have come into operation on a date to be determined by the Minister of Finance by notice in the Gazette.

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EXEMPTIONS

Amendment to section 9 of the Transfer Duty Act

Corporate restructuring provisions – Asset-for share transactions

Section 9(1(l) has been amended by the insertion of a new subparagraph (iA). It provides that no duty is payable for the acquisition of property by a company under an asset-for-share transaction contemplated in section 42 of the Income Tax Act.

Effective date

The above amendments come into operation on a date to be determined by the Minister of Finance by notice in the Gazette.

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VALUE –ADDED TAX


Amendment to the definition of ‘enterprise’ in section 1 of the Value-Added Tax Act and amendment of section 18A(1) of the Value-added Tax Act.

Sukuk

Refer detailed notes on Islamic Finance – proposed Sukuk.

The definition of ‘enterprise’ contained in section 1 of the Value-Added Tax Act has been amended to make provision for a Sukuk. Subparagraph (xii) has been added and provides as follows:

(xii) any activity carried on by a trust contemplated in the definition of ‘sukuk’ in section 24JA(1) of the Income Tax Act shall be deemed not to be the carrying on of an enterprise.

Effective date

The amended definition of ‘enterprise’ comes into operation on a date determined by the Minister of Finance by notice in the Gazette.

Section 8A was inserted into the VAT Act to provide for a Murabaha.


Section 8A(1) has been amended and now reads as follows:

(a) the financier shall be deemed not to have acquired or supplied goods under the sharia arrangement;

(b) the client shall be deemed to have acquired the goods-

(i) from the seller for consideration equal to the amount paid by the financier to the seller; and

(ii) at such time as the supply was made by the seller by virtue of the transaction between the seller and the financier; and

(c) any premium paid or payable to the financier by the client shall be deemed to be consideration in respect of a financial service supplied by the financier as contemplated in section 2(1)(f):

Provided that this paragraph shall not apply to the extent to which the consideration constitutes any fee, commission or similar charge.

Effective date

The amendment to section 8A(1) of the Value-Added Tax Act comes into operation on a date determined by the Minister of Finance by notice in the Gazette.

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DELINKING VAT FROM TRANSFER DUTY

Amendment to the definition of ‘input tax’ in section 1 of the Value-added Tax Act and amendment to section 16(3) of the Value-Added Tax Act.

Background

A. Basic concepts

The purchase of fixed property from a non-vendor is subject to transfer duty as opposed to VAT. If the purchaser is a vendor who acquires the property, the purchaser may receive notional input credits (e.g. these inputs are often available for developers who develop and on-sell fixed property or for vendors using fixed property for non-residential rental commercial use). These notional inputs arise because the fixed property purchased is viewed as secondhand goods.

The rationale for notional input credits when acquiring second-hand goods is primarily based on the need to eliminate double VAT charges on the same value-added. For instance, if a VAT vendor develops and sells fixed property, the selling vendor charges VAT on the sales price. If the fixed property is sold to a non-vendor, the VAT charge is an additional cost for the non-vendor. If the non-vendor further on-sells the same fixed property to a second VAT vendor, the second VAT vendor indirectly bears the cost of the VAT borne by the non-VAT vendor in respect of the initial purchase (and for VAT incurred in respect of improvements).

Notional inputs for the second VAT vendor in respect of these second hand goods (i.e. fixed property) eliminate double VAT charges on the same value-added by providing notional input relief in the absence of actual inputs.

B. Anti-avoidance

In the case of fixed property, notional input credits for VAT vendors were based on the lesser of:


(i) the purchase price, or

(ii) the open market value of the fixed property;

both of which were limited to the transfer duty payable in respect of the purchase. The main rationale for these notional input ceilings was to undermine schemes that sought to artificially inflate notional input claims. These claims were possible because notional inputs were not matched by outputs when a VAT vendor acquired property from a non-Vendor. With the introduction of the transfer Duty limit, notional input credits were instead matched against transfer duty payable.

Reasons for change

While the transfer duty ceiling for notional inputs in respect of second-hand fixed property prevents avoidance, the ceiling was arguably unfair. The ceiling generally meant that the notional inputs allowed did not fully compensate the VAT vendor for most or all of the VAT probably paid by previous owners. Indeed, no notional input credits were allowed at all for the purchase of smaller residential properties because these smaller properties were free from transfer duty (due to the R600 000 threshold).

Admittedly, rules are needed to prevent avoidance schemes (see Amor van Zyl Trust case and ITC 1686). The question is whether the transfer duty ceiling was the best mechanism, especially since the transfer duty undermines the objective of notional input credits. In this vein, it should be noted that an open market value ceiling exists that equally eliminates the avoidance scheme of inflating prices for fixed properties (without undermining the objective of notional input credits).

The change

The transfer duty ceiling has been eliminated as superfluous. Amongst other limits, the open market value rule will remain intact to prevent the over-inflation of prices. Given the relative ease of valuing local residential properties, pricing manipulation for VAT purposes becomes an extremely risky proposition.

Instead, acquisition of fixed property from non-VAT vendors will be subject to largely the same rules applicable for the claiming of notional input tax credits in respect of other secondhand goods. Hence, fixed property notional input credits are deferred to the extent of actual payment (i.e. which excludes promissory notes and loan accounts). Notional inputs in respect of fixed property acquisitions must be deferred further until the fixed property concerned is registered in the vendor’s name.

Example

Facts: Individual directly or indirectly holds all the shares of Property Company and Company X. Company X issues a R1 million promissory note to Property Company in exchange for fixed property. Property Company is a non-VAT vendor, and Company X is a vendor.

Result: Company X cannot claim any notional VAT inputs on the purchase in respect of the promissory note. Notional inputs are allowed only in respect of payment that reduces or discharges liabilities.

The payment rules effectively prevent purchasers from obtaining notional input credits fin respect of seller financed property until payment. Taxpayers seeking to undermine this limitation through indirect seller finance schemes will most likely be in violation of the general anti-avoidance rule.


The definition of ‘input tax’ in section 1 of the Value-Added Tax Act has been amended

The proviso to paragraph (b) has been deleted. Prior to its deletion it read as follows:

Provided that where such second-hand goods consist of-

i) fixed property in respect of the acquisition of which transfer duty is, in terms of the Transfer Duty Act, payable or would have been payable had an exemption from transfer duty (whether in terms of the Transfer Duty Act or any other Act of Parliament) not been applicable; or

ii) a share in a share block company in respect of the original issue or registration of transfer of which stamp duty is, in terms of the Stamp Duties Act, payable or would have been payable had an exemption from stamp duty (whether in terms of the Stamp Duties Act or any other Act of Parliament) not been applicable,

such amount shall not exceed the amount of transfer duty or stamp duty, as the case may be, which is or would have been payable in respect of such acquisition, original issue or registration of transfer, as the case may be.

The amended paragraph (b) of the definition of ‘input tax’ now reads as follows:

(b) an amount equal to the tax fraction (being the tax fraction applicable at the time the supply is deemed to have taken place) of the lesser of any consideration in money given by the vendor for or the open market value of the supply (not being a taxable supply) to him by way of a sale on or after the commencement date by a resident of the Republic (other than a person or diplomatic or consular mission of a foreign country established in the Republic that was granted relief, by way of a refund of tax as contemplated in section 68) of any second-hand goods situated in the Republic.

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Effective date

The amendment to paragraph (d) of the definition of ‘input tax’ in section 1 of the Value-Added Tax Act comes into operation on 10 January 2012 and applies in respect of goods consisting of fixed property supplied on or after that date.

Calculation of tax payable

Section 16(3)(a)(ii)(aa) provides for a notional input tax deduction for the supply of second-hand goods. It has been amended and section 16(3)(a)(ii)(aa) now provides as follows:

(aa) subject to the provisions of item (bb), in respect of supplies of second-hand goods to which paragraph (b) of the definition of ‘input tax’ in section 1 applies to the extent that payment of any consideration which has the effect of reducing or discharging any obligation (whether an existing obligation or an obligation which will arise in the future) relating to the purchase price for those supplies has been made during that tax period;

Section 16(3)(a)(ii)(bb) provides for a notional input tax deduction when the transfer of second hand goods constitutes fixed property or shares in a share block company. Section 16(3)(a)(ii)(bb) has been amended and now reads as follows:

bb) in respect of supplies of second-hand goods to which paragraph (b) of the definition of 'input tax' in section 1 applies which consist of-

(A) fixed property in respect of which the provisions of section 9(3)(d) apply if transfer of that fixed property was effected by registration in a deeds registry and the fixed property was registered in the name of the vendor that makes the deduction during that tax period;

(B) a share in a share block company which confers a right to or an interest in the use of immovable property if a signed use agreement has been entered into between the company that operates the share block scheme and a member of that company.

Effective date

The amendments to section 16(3) come into operation on 10 January 2012 and apply in respect of supplies made on or after that date.

Second-hand goods

Section 18(4) of the Value-Added Tax Act has been amended

Section 18(4) applies when an asset of a person commences to be used by him, or the partnership of which he is a member, in a VAT enterprise. The vendor (person or partnership) can claim a VAT input deduction determined in accordance with the following formula:

A × B × C × D

Symbol D applies if the goods are second-hand goods. It has now been amended as part of the delinking of VAT from transfer duty.

The exclusion of second-hand goods to which the proviso to paragraph (b) of the definition of ‘input tax’ in section 1 applies has been removed. Symbol D now provides that when section 18(4)(c) applies it represents the ratio that the amount paid, which payment reduces or discharges an obligation (whether an existing obligation or an obligation that will arise in the future) for or consequent upon, whether directly or indirectly, the consideration in money for the supply of second-hand goods, bears to the total consideration in money, expressed as a percentage.

Effective date

The amendment to section 18(4) comes into operation on 10 January 2012 and applies to supplies made on or after that date.

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MICRO - BUSINESS TURNOVER TAX

Amendment to section 8(2C) of the Value-added Tax Act.

Refer detailed notes on Micro - Business Turnover Tax.

Section 8(2C) provided a concession for vendors who deregister because they have become a micro business. It provided that when a supply is deemed to have been made by a vendor for the sole reason that he has registered as a ‘micro business’ as defined in the Sixth Schedule to the Income Tax Act, the tax payable for that deemed supply must be paid in six equal monthly instalments, or so many monthly instalments as the Commissioner may allow.

Section 8(2C) has been deleted as a consequence of the amendments made to the Sixth Schedule to the Income Tax Act.

Effective date

The deletion of section 8(2C) comes into operation on 1 March 2012.

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Amendment to section 10(5A)


Section 10(5A) provided a concession for vendors who deregistered because they became a micro business. It provided that when goods or services are deemed to be supplied by a vendor under section 8(2) and when Section 8(2C) is applicable, the supply is deemed to be made for a consideration in money equal to the consideration as determined in section 10(5) reduced by R100 000.

Section 10(5A) has been deleted as a consequence of the amendments made to the Sixth Schedule to the Income Tax Act.

Effective date

The deletion of section 10(5A) comes into operation on 1 March 2012.

Registration – deletion of section 23(9)


Section 23(9) provides that when a registered micro business is deregistered under paragraph 10 of the Sixth Schedule to the Income Tax Act, (compulsory de-registration) other than by reason of its disqualification under paragraph 3(a) to paragraph 3(g)(ii) of the Sixth Schedule (disqualified persons), the person is a vendor from the date the deregistration takes effect. Section 23(9) has been deleted as a consequence of the amendments made to the Sixth Schedule to the Income Tax Act.

Effective date

The deletion of section 23(9) comes into operation on 1 March 2012.

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TEMPORARY RELIEF FOR THE RENTAL OF RESIDENTIAL PROPERTY BY DEVELOPERS

Amendment to section 10(7) and 18(B) of the Value-added Tax Act.

Background

A. Basic concepts

The supply of fixed property by a VAT vendor is subject to VAT at the standard rate of 14%. The standard rate applies irrespective of how that fixed property is used in the hands of the purchaser.

If the purchaser intends to use the fixed property for residential purposes (either as a dwelling or for residential rental), VAT becomes a permanent cost to the purchaser. The policy rationale for leaving residential rentals outside the VAT base is to ensure that residential rental properties and owner-occupied residential properties are placed on par (i.e. are neutral) to one another.

On the other hand, if the purchaser is a VAT vendor that acquires fixed property for resale (or for commercial rentals), the 14% VAT charge becomes only a temporary charge. In these instances, the VAT vendor purchasing the property can claim input credits for the VAT paid. However, the VAT vendor must also charge VAT on resale (with the sales price increased for the value-added). One common set of role players in this area are developers.

B. Change in use adjustment

As indicated above, input credits for VAT vendors are based on the assumption that the acquisition is for the purposes of making wholly taxable supplies (thereby giving rise to a VAT charge on resale). Therefore, if a VAT vendor’s principal intention is to sell fixed residential property but subsequently the vendor changes the use/application of the fixed residential property so that the property is to be used for non-taxable purposes (partly or wholly), the vendor is obliged to make a change in use adjustment. In the case of residential fixed property developers, change in use adjustments commonly arises when these developers shift from a resale intention to a rental application.

Reasons for change

Developers that develop residential fixed property (e.g. townhouse complexes) with the principal purpose or intention of supplying that fixed property for sale are sometimes forced to rent these properties due to weak selling market conditions. Current weakness in the property markets and the economic climate has exacerbated this difficulty. In this scenario, rental operations are designed to provide the developer with temporary cash inflows to cover the carrying cost associated with the extended holding of the property.


At a technical level, developers have a VAT change in use of a residential property when renting that property (even if only temporarily). This change in use creates a major problem for developers in economic distress because this change in use places the developer in the unenviable position of being forced to pay VAT on a deemed supply. This deemed supply is deemed made at open market value (at the change in use date).

This VAT cost escalates if the developer is forced to rent multiple residential rental properties. All of these VAT charges undercut the cash-flow gains otherwise associated with temporary rentals and may even force certain developers into insolvency.

The change

A. Short-term solution: Temporary residential rentals permitted

The VAT rules concerning change in use adjustments for property developers that temporarily rent residential properties are problematic from a practical and a legal theory perspective. From a practical perspective, premature imposition of VAT upon developers because of forces outside their control seems questionable as an economic matter, especially if the charge can undermine their continued viability. From a legal theory perspective, a host of questions arise that strike at core concepts within the VAT as a whole (see ‘Theoretical issues raised’ below). Proper resolution of these theoretical issues will undoubtedly require a thorough and time-consuming analysis.

In the meantime, legislative intervention is urgently required in order to ensure that the VAT system does not force certain VAT developers into insolvency. This urgency is highlighted by the ongoing economic global uncertainty impacting the local residential property market. To this end, temporary relief has been granted to developers that rent residential fixed properties before intended sale. While not trying to solve the larger legal theoretical issues, developers have been given a maximum grace period of 36 months to rent fixed residential property before sale. This 36 month period commences when the fixed property is rented for the first time. If the vendor rents the residential fixed property beyond the permissible 36 month period, the deemed change-in-use charge will apply. This deemed charge will trigger a deemed supply at market value of the property as of the 36 month cut-off date.

In order to qualify for this relief, two requirements must be satisfied:

the vendor at issue must be a ‘developer as defined’ where a ‘developer’ generally means a vendor who continuously or regularly construct, extend or substantially improves fixed property consisting of any dwelling or for the purpose of disposing of that fixed property

and the developer must have the overriding purpose/intention of selling the property as soon as the opportunity arises.

Example 1

Facts: Vendor (a property developer) buys a townhouse for R1 000 000 as stock in trade (i.e. for resale purposes). Vendor repairs the townhouse after a period of 6 months, Vendor cannot find a buyer for the townhouse and is forced to rent out the property to cover some of interest costs for the financing of the property. Vendor rents out the property for a 12 month period and is fully committed to selling the property when the opportunity arises.

Result: Vendor qualifies for relief in terms of the interim provisions as the intention to resell has not been abandoned.

Example 2

Fact: Vendor (a property developer) develops 20 units as part of a townhouse development. Vendor initially sells 15 of the units off plan. However, 12 months after completion of the development, Vendor struggles to find buyers for the remaining 5 units. Vendor opts to rent out the units to cover the interest costs of financing development (at the time of renting, the market value per unit is R2 million). Initially, Vendor does undertake this rental as a short term measure but thereafter decides that the rental option is ultimately preferred.

Vendor, accordingly decides to ‘take the townhouses off market’ and use the property solely for rental (i.e. Vendor abandons the sell intention; the market value of a unit at a time when is R2,5 million).

Result: Vendor initially qualifies for the interim relief but loses this relief when the intention to sell the property changes. In this case, Vendor B is subjected to the normal rules governing the change in use adjustment and must account for VAT as of the date that the intention to sell has been abandoned.

B. Theoretical issues raised

The problem of vendors (i.e. developers) renting fixed property for exempt residential use is not unique to South Africa. When a vendor rents fixed property for an exempt use, three main issues come into consideration:

(i) purpose versus application;

(ii) consumption versus recoupment; and

(iii) rental charged as a proxy for consumption/recoupment.

These issues are discussed briefly below.


(i) Purpose versus application

In New Zealand, a few court cases have addressed the situation where taxpayers have acquired residential fixed property for development and resale but subsequently (i.e. rents those properties temporarily due to circumstances outside their control). This unanticipated rental use has precipitated the question of what is the taxpayer’s ‘principal purpose’ and whether an adjustment is required. In CIR v Morris, the New Zealand High Court held that the taxpayer’s principal purpose of making taxable supplies continued despite the fact that apartments were simultaneously used for the separate purpose of making non-taxable supplies by way of residential accommodation. The Court did not consider the extent to which the apartments had been committed to a non-taxable use, but the Court instead referred this issue to the New Zealand Taxation Review Authority for consideration. Upon remittance, the Taxation Review Authority held that a change in use had occurred.

In CIR v Carswell Investments Ltd, the taxpayer was a property development company whose main activity was the acquisition of vacant sections onto which existing houses were located. The taxpayer rented out twenty properties as rental accommodation pending their sale. The New Zealand Commissioner and the taxpayer agreed that the principal purpose for which the properties were held was a taxable one (property development), but the New Zealand Commissioner considered that the renting of houses (which is exempt in terms of the New Zealand GST Act) triggered a change in use that required an adjustment. The taxpayer objected to this decision and the New Zealand Taxation Review Authority held that the taxpayer did not change the taxpayer’s principal purpose of making taxable supplies. The New Zealand Commissioner appealed to the High Court, which sided with the New Zealand Commissioner.

South Africa’s VAT seems to espouse the same approach taken in New Zealand (from a legislative standpoint). A reading of section 17(1) with the section 1 definition of ‘input tax’ within the VAT Act, specifies that input tax can only be deducted if the intention or purpose is to make taxable supplies. It is submitted that although the intention of the developer is to sell the unit, the developer changes the application or use of the unit. VAT, unlike the income tax, does not hinge solely on an ‘intention’ test; ‘application’ seems to be an interdependent but intervening variable. Stated differently, although intention is important for VAT purposes, intention goes hand-in-hand with application or use. As a result, a change in application brings about a supply by the vendor (refer to section 18(1) of the VAT Act).

(ii) Consumption versus recoupment

Taxing consumption

South Africa’s approach to change in use adjustments is based on the principle that VAT needs to reflect the consumption of goods or services in a given period. The New Zealand change in use rules apply to industries where vendors make a mixture of taxable and exempt supplies (e.g. financial service providers and some property developers). The change in use rules ensure that private use is taxed. For example, assume a luxury yacht is acquired and initially used exclusively in a chartering business (primary purpose), but at a later stage also privately. Under these circumstances, this charge is subject to the GST change in use rules. This change in use ensures that parity of treatment exists with a similar yacht purchased and used exclusively for private purposes. It is recognised that the intention of a developer to sell the fixed property that is now being rented for residential purposes does not change yet, it is an accepted fact that the developer has changed the use of that fixed property (although arguably only for an intermittent period). The corollary for this change is that current consumption must be taxed (thereby triggering a VAT event) in the hands of the vendor.

Recoupment

Also at issue is the debate of recoupment versus consumption. When a change in use occurs, should the effect be:

(i) To recoup input tax previously claimed by the vendor (i.e. effectively, placing the vendor in the same position as if the vendor had originally incurred the input tax for a non-taxable purpose), or

(ii) To tax current consumption in the hands of the vendor?

In New Zealand, the Court of Appeal in the Lundy Family Trust case considered the issue of how to treat adjustments previously made when assets are returned to an original taxable purpose. The New Zealand Court ruled that a vendor can deduct output tax adjustments previously declared. The New Zealand Court also seemed to suggest that output tax adjustments made in respect of the change in use must be capped to the amount of the original input tax deduction received by the vendor. This view seems to sanction the recoupment of previously deducted input tax when a change in use occurs.

Lastly, it is unclear whether the change in use adjustment (be it consumption or recoupment based) is temporary or permanent. A temporary charge seems to infer that the fixed property does not leave the VAT base and that the subsequent sale by the developer is subject to VAT. At variance is a permanent charge which infers that the

asset is ‘burnt up’ once the deemed charge is made by the vendor and that any subsequent sale is not subject to VAT.

(iii) Rental income as a proxy for consumption/recoupment

As stated above the predicament faced by property developers who temporarily rent out residential units, is fully recognised. It is also fully recognised that the current value of the change in use adjustment (i.e. deemed supply) is disproportionate to the exempt rental income received for lease of the property. Hence, there is a view that a claw-back of the monthly rental income can serve as a proxy:


to tax private consumption in the hands of the developer on a monthly basis; or

to recoup, on a monthly basis, a portion of input tax previously deducted by the developer.

It must, however, be borne in mind that this approach is tantamount to subjecting the rental income to VAT, which would lead to its own set of policy ramifications. In view of the complexities above, a short-term solution to the problem faced by developers is established. Once all issues have been fully evaluated, a permanent solution will be undertaken to address the problem facing developers that temporarily rent residential fixed properties.


Value of supply

Section 10(7) has been substituted as a consequence of the insertion of section 18B(3) into the Value-Added Tax Act. Section 10(7) now provides that when goods or services are deemed by section 18(1) or section 18B(3) to be supplied by a vendor, the supply will, subject to the provisions of section 10(8), be deemed to be made for a consideration in money equal to the open market value of the supply.

Effective date

The amendment to section 10(7) comes into operation on 10 January 2012.

Temporary letting of residential fixed property

Section 18B has been inserted into the Value-Added Tax Act as a short-term solution for the rental of residential property by developers. Section 18B reads as follows:

(1) For the purposes of this section ‘developer’ means a vendor who continuously or regularly constructs, extends or substantially improves fixed property consisting of any dwelling or continuously or regularly constructs, extends or substantially improves parts of that fixed property for the purpose of disposing of that fixed property after the construction, extension or improvement.

(2) Notwithstanding the provisions of section 18(1), where goods being fixed property consisting of any dwelling-

(a) is developed by a vendor who is a developer wholly for the purpose of making taxable supplies or is held or applied for that purpose; and

(b) is subsequently temporarily applied by that vendor for supplying accommodation in a dwelling under an agreement for the letting and hiring thereof,

the supply of such fixed property shall, subject to subsection (3), be deemed not to be a taxable supply in the course or furtherance of that vendor’s enterprise.

(3) The fixed property contemplated in subsection (2) shall be deemed to have been supplied by that vendor by way of a taxable supply for a consideration as contemplated in section 10(7) in the course or furtherance of that vendor’s enterprise at the earlier of-

(a) a period of 36 months after the conclusion of the agreement contemplated in subsection (2)(b); or

(b) the date that the vendor applies that fixed property permanently for a purpose other than that of making taxable supplies.

(4) Where a vendor makes a supply of fixed property as contemplated in subsection (2) the vendor shall within 30 days of making that supply furnish the Commissioner with a declaration (in such form or manner as the Commissioner may prescribe) containing such information as may be required.

Effective date

Section 18B comes into operation on 10 January 2012 and ceases to apply on 1 January 2015.

Compliance – amendment to section 58

Offences

Section 58(1) has been amended as a consequence of the insertion of section 18B into the Value-Added Tax Act. It applies when a person fails to notify the Commissioner about anything that he is required to notify him about by section 18B(4), section 24(3), section 25 or section 48(7). This person is then guilty of an offence and liable on conviction to a fine, or imprisonment for a period not exceeding 24 months.

Effective date

The amendment to section 58 comes into operation on 10 January 2012.

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INTRA-WAREHOUSE TRANSFERS

Insertion of section 13(2A)of the Value-added Tax Act.

Background

The import and entry of goods into a bonded storage warehouse does not give rise to VAT or customs duty consequences. Goods may also be sold or otherwise disposed of while in the storage warehouse, subject to the permission of the customs authority. If a sale or disposal of this nature occurs, the seller and the buyer are required to complete a declaration evidencing the transfer of ownership. This transfer of ownership will not trigger a liability for import VAT as long as the goods remain in the storage warehouse and have not been entered for home consumption. The liability for import VAT will only be triggered after transfer if the buyer removes the goods from the storage warehouse for entry into home consumption. The buyer is required to complete a customs declaration when this entry for home consumption occurs.

Reasons for change

If a buyer removes goods from a bond storage warehouse after a transfer of ownership in the warehouse, a risk to the fiscus exists that the buyer may utilise the value for customs duty purposes (i.e. the value of the goods when first entered into the storage warehouse) as the VAT import value. The buyer will often rely on this value because this value will be lower than the intra-warehouse sale value. Reliance on this lower value is misplaced because the intra-warehouse sale is the best indicator of true arm’s length value.

The change

The valuation of goods entered for home consumption has been changed to reflect intra-warehouse sales before entry. In particular, if a VAT vendor acquires goods located in a bonded warehouse before entry, the value of the goods upon entry for home consumption will instead be deemed to equal the value of the goods taken into account when the VAT vendor acquired the goods (i.e. the intra-warehouse sales value. The import value will be ignored.

Insertion of section 13(2A) and (2B) of the Value-Added Tax Act to give effect to the above

Section 13(2A) and (2B) read as follows:

(2A) The value to be placed on the importation of goods into the Republic which have been imported and entered for storage in a licensed Customs and Excise storage warehouse but have not been entered for home consumption shall be deemed to be the greater of the value determined in terms of subsection (2)(a) or the value of acquisition determined under section 10(3) if those goods while stored in that storage warehouse are supplied to any person before being entered for home consumption.

(2B) Notwithstanding subsection (2), the value to be placed on the importation of goods into the Republic where Note 5(a)(ii)(aa) of Item No. 470.03/00.00/02.00 of Schedule 1 to this Act is applicable shall be the value determined under section 10(3).

Effective date

Section 13(2A) and (2B) come into operation on 10 January 2012 and apply in respect of goods imported on or after that date.

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MINIMUM VAT EXEMPTION FOR IMPORTED SERVICES

Amendment to section 14(5) of the Value-added Tax Act.

Background

VAT is payable on the importation of goods and services into South Africa. However, the VAT Act provides for a minimum threshold exemption in respect of certain imported goods. For example, books, newspapers and journals imported by post are exempt if the value does not exceed R100. No similar exemption exists with regard to imported services.

Reasons for change

The absence of a minimum threshold with regard to imported services means that VAT is payable on importation no matter how insignificant the consideration. This lack of a threshold creates a compliance burden for the importer and an enforcement burden for SARS even though nominal revenue is at stake. Furthermore, the existence of a threshold for goods with the absence of a threshold for services effectively results in an imported hard copy publication being exempt under R100 while the same on-line publication is subject to import VAT.


The change

In view of the above, the introduction of a minimum threshold exemption of R100 for the importation of services has been added. This threshold for imported services matches the threshold exemption for imported goods.

Section 14(5)(e) has been added to give effect to the above

Section 14(5)(e) provides that VAT is not payable on a supply of imported services if the value of the supply does not exceed R100, it reads as follows:

(e) a supply of services of which the value in respect of that supply does not exceed R100 per invoice.

Effective date

(Section 14(5)(e) comes into operation on 10 January 2012 and applies in respect of services imported on or after that date.

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INPUT TAX DENIED

Amendment to section 16(2) of the Value-added Tax Act.

Section 16(2) provides that no deduction of input tax for a supply or the importation of goods into South Africa, or any other deduction, is made under the Value-Added Tax Act, unless the requirements prescribed in section 16(2)(a) to section 16(2)(f) have been complied with.

The wording in section 16(2) has been amended with the term ‘of goods or services’ being added to qualify the word ‘supply’. It now provides that no deduction of input tax for a supply of goods or services, the importation of any goods into South Africa or any other deduction will be made under the Value-Added Tax Act unless the prescribed requirements have been complied with.

Effective date

The amendment to section 16(2) comes into operation on 10 January 2012 and applies for supplies made on or after that date.

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DISCOUNT VOUCHERS

Amendment to section 16(3)(i) of the Value-added Tax Act.

Background

Manufacturers or producers may issue tokens, vouchers or stamps as part of their normal business activities in order to promote the marketing of their products. The holder of the token, voucher or stamp is entitled (upon redemption thereof) to a discount of the price of goods purchased. The redemption by the holder of the token, voucher or stamp can be undertaken directly from the manufacturer/producer or from an agent of the manufacturer/producer (typically a retailer) vendor. In the later case, the manufacturer/producer reimburses the agent (retailer) for the discount allowed. In terms of the valuation rules, the monetary value of the token, voucher or stamp is deemed to include the VAT when the manufacturer/producer provides reimbursement.

Example

Facts: Book Publisher issues R28 worth of vouchers for the promotion of certain books in its catalogue. Individual M redeems a R28 voucher for the purchase of a book priced at R228 at Book Store (an agent of book publisher). Book Publisher reimburses Book Store the R28 discount allowed.

Result: Book Publisher claims a deduction of 14/114 of R28 (i.e. R3.44). The total consideration for the supply made by Book Store is R228 (with the R28 voucher including VAT at 14%).

Reasons for change

Deemed inclusion of the VAT for tokens, vouchers or stamps can be problematic. When the holder of a token, voucher or stamp redeems these items in respect of a supply subject to the zero rate of tax then unintended consequences may arise. This is best illustrated by way of example.

Example

Facts: Manufacturer specialises in the manufacture of certain foodstuffs. Manufacturer issues R8 vouchers for the promotion of all of its foodstuffs. Individual N redeems two R8 vouchers at a supermarket store for the purchase of eggs and pilchards (two zero rated items). Manufacturer subsequently reimburses the supermarket store for the discount allowed on the supply.


Result: Manufacturer claims a deduction of 14/114 of R16 (i.e. R1.96) reimbursed to the supermarket store. This result follows even though no VAT arose in relation to the underlying purchase.

The change

The anomaly referred to above has been removed because the VAT rules were not designed to cater for tokens, vouchers or stamps being redeemed in respect of zero rated supplies. This will result in the vendor issuer of a token, voucher or stamp only being allowed to claim an input deduction if the underlying supply is taxable at the standard rate.

Amendment to section 16(3)(i) to give effect to the above change

The amended section 16(3)(i) reads as follows:

(i) an amount equal to the tax fraction of any payment made by the vendor during the tax period in respect of the redemption with him, or his agent, of the monetary value of any token, voucher or stamp contemplated in section 10(20), to a supplier of goods or services who has granted a discount on the surrender to him of such token, voucher or stamp by a recipient of a supply of goods or services if those goods or services are not charged with tax at the rate of zero per cent under section 11.

Effective date

The amendment to section 16(3)(i) comes into operation on 10 January 2012 and applies in respect of supplies made on or after that date.

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UNPAID GROUP MEMBER DEBT

Amendment to section 22 of the Value-Added Tax Act.

Background

Special anti-avoidance rules apply in the case of debt created pursuant to an unwritten agreement. In this scenario, indebted vendors registered on the VAT invoice basis must return VAT inputs previously claimed to the extent these indebted vendors have not paid for previously received supplies within a 12-month period. This required charge-back applies to the unpaid consideration (i.e. the amount outstanding).

The required pay-back provision aims to create neutrality for the fiscus once the creditor is taken into account. The creditor can generally claim VAT inputs in respect of VAT previously paid at any time that the creditor writes off the debt (to reverse the prior output).

In terms of the debtor, the charge-back provision is based on the commercial assumption that the creditor will typically write off unwritten debt after 12 months. In effect, the charge-back provision is designed to ensure that the corresponding debtor doesn’t delay payment past this 12-month period.

Reasons for change

In practice, group companies often do not have written agreements with one another for each VAT transaction processed via loan accounts (because written agreements in this context are too cumbersome). Intra-group loan accounts are typically reflected solely as mere accounting journal entries. Group members often operate internal loan accounts for commercial reasons without clearing these accounts for many years (in effect, these loan accounts act as a form of interest-free financing for related group company members). Therefore, the 12-month pay-back provision is unrealistic in a group context, between wholly-owned members within a group of companies.

The change

In view of the above, pay-back provision no longer apply within wholly-owned members of a group of companies. However, this exclusion from the 12-month rule comes at a price – the creditor providing the supply to the indebted group member cannot claim a deduction for a bad debt written off. The net effect of the amendment is to provide relief for unwritten intra-group debt without placing the fiscus at risk. The extension of the pay-back provision and the write-off last as long as the debtor and creditor are within the same wholly-owned group.

Changes to section 22 of the Value-Added Tax Act to give effect to the above

Section 22(1) has been made subject to section 22(6). Under section 22(1), a vendor who accounts for VAT on the invoice basis, and has furnished a VAT return in which the output tax on a particular debt is accounted for may claim a deduction of the VAT fraction of the part of that debt that has become bad.

Section 22(3) has been made subject to section 22(3A) and section 22(3A) has been added. Section 22(3) and (3A) now reads as follows:

(3) Subject to subsection (3A), where a vendor who is required to account for tax payable on an invoice basis in

terms of section 15-

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a) has made a deduction of input tax in terms of section 16(3) in respect of a taxable supply of goods or services made to

him; and

b) has, within a period of 12 months after the expiry of the tax period within which such deduction was made, not paid the

full consideration in respect of such supply,

an amount equal to the tax fraction, as applicable at the time of such deduction, of that portion of the consideration which

has not been paid shall be deemed to be tax charged in respect of a taxable supply made in the tax period following the

expiry of the period of 12 months: Provided that-

i) the period of 12 months shall, if any contract in writing in terms of which such supply was made provides for the payment

of consideration or any portion thereof to take place after the expiry of the tax period within which such deduction was made,

in respect of such consideration or portion be calculated as from the end of the month within which such consideration or

portion was payable in terms of that contract;

ii) where—

aa) the estate of a vendor is sequestrated, whether voluntarily or compulsorily;

bb) the vendor is declared insolvent;

cc) the vendor has entered into a compromise or an arrangement in terms of section 311 of the Companies Act, 1973 (Act

No. 61 of 1973), or a similar arrangement with creditors, or

dd) the vendor ceases to be a vendor as contemplated in section 8(2),

within 12 months after the expiry of the tax period within which that deduction was made, not paid the full consideration, the

vendor must account for output tax in terms of this section equal to that portion of the consideration which has not been

paid-

AA) at the time of sequestration, declaration of insolvency or the date on which the compromise or the arrangement or

similar arrangement was entered into; or

BB) immediately before the vendor ceased to be a vendor as contemplated in section 8(2); or

iii) paragraph (ii) shall not be applicable where a vendor has already accounted for tax payable in accordance with this

subsection.

(3A) Subject to subsection (6)(a), subsection (3) shall not be applicable in respect of a taxable supply made by a vendor which is a member of a group of companies, to another vendor which is a member of the same group of companies for as long as both vendors are members of the same group of companies.

Section 22(6) has been added and it provides as follows:

(6) (a) Where a vendor which is a member of a group of companies makes a taxable supply to another vendor which is a member of the same group of companies, the vendor who made the taxable supply may not make a deduction in terms of subsection (1) read with section 16(3) of any amount of tax that has become irrecoverable for as long as both vendors are members of the same group of companies.

(b) For the purposes of paragraph (a) and subsection (3A), a ‘group of companies’ means a group of companies as defined in section 1 of the Income Tax Act if any other company would be part of the same group of companies as that company if the expression ‘at least 70% of the equity shares of’ in paragraphs (a) and (b) of that definition were replaced by the expression ‘100% of the equity shares of’.

Effective date

The above amendments to section 22 come into operation on 10 January 2012.

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SYNCHRONISING VAT AND CUSTOMS RELIEF FOR TEMPORARY IMPORTS

Amendment to clause 143(1)(b) of schedule 1 to the Value-Added Tax Act.

Background

VAT is generally payable when goods are imported into South Africa. However, through the use of a Schedule Item Number (i.e. Item No. 470.03/00.00/.01 of Schedule 1 to the VAT Act), VAT exempts goods that are temporarily imported for manufacturing, processing, finishing, equipping or packing of goods as long as the goods are destined exclusively for export. A corresponding Schedule Item Number also exists in the Customs and Excise Act, whereby dutiable goods are allowed to enjoy a full duty rebate (i.e. Rebate Item No. 470.03/00.00/01.00 in Part 3 of Schedule 4 to the Customs and Excise Act). For practical purposes, SARS Customs officials administer the VAT exemption solely through reliance on the corresponding Customs and Excise Schedule Item Number.

Reasons for change

The current VAT exemption for temporary imports is facing operational barriers in the case of duty-free imported goods. This operational difficulty exists because SARS effectively relies on the Customs and Excise Item Schedule to apply the VAT exemption. SARS Customs uses this Schedule Item Number only to clear goods that are dutiable. However, the lack of coverage for duty-free goods causes operational difficulties for Customs officials who are controlling the exemption determination. To date, this issue has mainly impacted platinum and gold imported temporarily into South Africa for the purposes of beneficiation. The net result has been to undermine South Africa’s role as a regional beneficiation stakeholder.

The change

In order to remedy this anomaly, the wording of the applicable Schedule Item Number in the Customs and Excise Act (Rebate item 470.03 (Tariff Heading 00.00) of Part 3 to Schedule 4) has been amended to additionally include duty free goods. Correspondingly, the VAT Act (Item No. 470.03/00.00/02.00 of Schedule 1) has been amended to mirror the applicable Schedule Item Number in the Customs and Excise Act. The amendments will ensure that SARS Customs officials can apply the VAT temporary exemption equally for both duty-free and dutiable goods.

Amendment to Schedule 1 of the Value-Added Tax Act to give effect to the above

By the addition to Item No 470.00 of the following Note:

5. For the purposes of Item No. 470.03/00.00/02.00:

(a) Where the importer is contractually entitled to keep a portion of the goods manufactured, processed, finished, equipped or packed in lieu of payment for the operations carried out, that importer must-

(i) also export those goods within the period of 12 months contemplated in Note 2(a); or

(ii) (aa) process a bill of entry at the office of the Controller for payment of the value-added tax on the goods retained; and

(bb) adjust by voucher of correction the rebate bill of entry in respect of the quantity and value of the goods used to manufacture the goods retained.

(b) The importer is required to maintain the records prescribed in terms of section 75 of the Customs and Excise Act.

By the insertion after Item No. 470.03/00.00/01.00 of the following item:

470.03/00.00/02.00 Goods free of duty, for use in the manufacture, processing, finishing, equipping or packing of goods exclusively for export.

Effective date

The above amendments to Schedule 1 of the Value-Added Tax Act come into operation on 10 January 2012.

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UNEMPLOYMENT INSURANCE CONTRIBUTIONS

Amendment to section 4 of the Unemployment Insurance Contributions Act of 2002.

Unemployment Insurance Contributions

The amendment excludes various government officials (including members of Parliament, the National assembly, municipal council and Council of Traditional Leaders) from being required to make unemployment insurance contributions. These parties are excluded because these persons do not receive corresponding Unemployment Insurance Fund benefits.

Section 4(e) and (f) have been added and read as follows:


(e) the President, Deputy President, a Minister, Deputy Minister, a member of the National Assembly, a permanent delegate to the National Council of Provinces, a Premier, a member of an Executive Council or a member of a provincial legislature;

(f) any member of a municipal council, a traditional leader, a member of a provincial House of Traditional Leaders and a member of the Council of Traditional Leaders.

Effective date

The amendments to section 4 are deemed to have come into operation on 1 April 2002.

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SECURITIES TRANSFER TAX

DIVIDEND CESSIONS Amendment to section 1 of the Securities Transfer Tax Act

Dividend cessions will no longer be subject to the Securities Transfer Tax in view of the fact that dividend cessions will now be treated as ordinary revenue for purposes of the Income Tax Act. In essence, dividend cessions are viewed as an income right totally independent of the underlying shares.

To give effect to the above, the definition of ‘security’ in section 1 of the Securities Transfer Tax Act has been amended. The

amended definition of ‘security’ reads as follows:

‘security’ means-

a) any share or depository receipt in a company;

b) any member's interest in a close corporation;

c) [deleted]

Effective date

The above amendment to the definition of ‘security’ in section 1 of the Securities Transfer Tax Act comes into operation on 1 April 2012.

Section 4 has been amended

The amendment deletes section 4(b). The amended section 4 reads as follows:

Unless tax is payable on a transfer contemplated in section 3, the taxable amount in respect of any transfer of a listed security effected by a participant is-

a) where that security is a security referred to in paragraph (a) of the definition of ‘security’-

i) the amount of the consideration for that security declared by the person who acquires that security; or

ii) if no amount of consideration referred to in subparagraph (i) is declared, or if the amount so declared is less than the

lowest price of that security, the closing price of that security.

Effective date

The amended section 4 comes into operation on 1 April 2012.


The amendment deletes section 5(1)(b). The amended section 5(1) reads as follows:

Unless tax is payable on a transfer contemplated in section 3 or 4, the taxable amount in respect of any transfer of a listed security is-

a) where that security is a security referred to in paragraph (a) of the definition of ‘security’-

i) the amount of the consideration for that security declared by the person who acquires that security; or

ii) if no amount of consideration referred to in subparagraph (i) is declared, or if the amount so declared is less than the

lowest price of the security, the closing price of that security.

Effective date

The amended section 4 comes into operation on 1 April 2012.

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Amendment to section 8A(1) of the Securities Transfer Tax Act.


Section 8A was inserted into the Securities Transfer Tax Act to provide for a Murabaha.

Section 8A(1) has been amended and now provides as follows:

(1) In the case of any murabaha as defined in section 24JA(1) of the Income Tax Act, 1962 (Act No. 58 of 1962)-

(a) the financier shall be deemed not to have acquired any beneficial ownership of the security under the sharia arrangement; and

(b) the client shall be deemed to have acquired beneficial ownership of the security from the seller-

(i) for an amount equal to the consideration paid by the financier to the seller; and

(ii) at such time as the financier acquired the beneficial ownership of the security from the seller by virtue of the transaction between the seller and the financier.

Effective date

The amended section 8A(1) of the Securities Transfer Tax Act comes into operation on a date determined by the Minister of Finance by notice in the Gazette.

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REGIONAL ELECTRICITY DISTRIBUTORS

Amendment to section 8(1)(m) of the Securities Transfer Tax Act.

The national restructuring of regional electricity distributors will no longer proceed as planned. Therefore, the exemption of the securities transfer tax to facilitate that restructuring is no longer necessary.

Section 8(1)(m) has been deleted. Prior to its deletion it provided that tax is not payable on the transfer of a security to any ‘regional electricity distributor’ as defined in section 1 of the Income Tax Act, on or before 1 January 2014 or a later date that may be determined by the Minister by notice in the Gazette.

Effective date

The above amendment to section 8(1)(m) comes into operation on 10 January 2012.

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TEMPORARY ADJUSTMENT TO THE BROKER – MEMBER EXEMPTION

Amendment to section 8(1)(q) of the Securities Transfer Tax Act.

Background

Taxpayers purchasing (or otherwise acquiring) listed and unlisted shares are generally subject to the Securities Transfer Tax. This indirect tax applies at a rate of 0.25% in respect of the share value acquired. This tax (like other taxes) contains a number of exemptions.

Among these exemptions, an exemption exists for members purchasing listed shares for their ‘account and benefit’. In practice, a ‘member’ is a broker with a permit to operate directly on the JSE. A broker can act in capacity as principal or as an agent on behalf of others.

The exemption for brokers-member dates back many years to predecessor versions of the Securities Transfer Tax. The purpose of the exemption is to ensure liquidity on the JSE. As a general matter, the 0.25% gross purchase charge should not unduly impact the liquidity of the market due to the low nature of the percentage involved. However, problems may arise when broker-members operate as market-makers that enhance JSE share liquidity. This market making typically involves short-term trades with profit spreads as low as 0.1-to-0.25%. The current broker-member exemption accordingly exists in order to ensure that the Securities Transfer Tax does not disrupt these short-term trades.

Reasons for change

Share and share-based products have become increasingly sophisticated since the broker-member exemption was introduced many years ago. It has now come to Government’s attention that the broker-member exemption is being used in circumstances outside the initial intention.

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More specifically, it appears that certain financial institutions have engaged in many transactions with broker-members acting as ‘principal’. In the most prominent circumstances, these financial institutions are operating as market makers for derivatives.

More specifically, the institutions at issue offer derivatives to a client while maintaining a perfectly hedged position with a broker (that is often ‘connected’ in terms of ownership). The broker-member would simultaneously hold the underlying shares in the capacity as principal to offset the derivative offered to the institution.

The nature of the back-to-back relationship would typically remove all the risks and rewards associated with the position in respect of the broker-member. In exchange for the broker-member’s participation, brokers in these circumstances would typically receive consideration equivalent to that of a service fee offered to an agent.

At issue is whether these broker-members are acting for their own benefit within the meaning of the Securities Transfer Tax. In particular, the concept of ‘account and benefit’ was intended to ensure that the broker had a beneficial interest in the share acquired (i.e. bore the risks and rewards). Review of the law would accordingly suggest that these transactions should at least be viewed as ‘problematic’.

The change

A. Technical versus policy considerations

Application of the broker member exemption raises two types of issues – one at a technical level and one at a policy level.

At a technical level, Government maintains its view that the broker-member must be operating as the ‘beneficial owner’ of the acquired share to obtain the exemption. Formal treatment as ‘principal’ for JSE purposes is not sufficient by itself to satisfy the standard of beneficial ownership. Were beneficial ownership of this nature is to be accepted, any taxpayer could simply undermine the Securities Transfer Tax by using a broker-member as an intermediary (acting in the nominal capacity as ‘principal’).

On the other hand, the policy issues are not so straight-forward. Many of the transactions at issue appear to operate as a form of market-making not envisioned by the initial legislation. As outlined above, many of the shares at issue are being used to facilitate market-making in derivatives (and seemingly lack a primary tax motivation). Sudden imposition of the Securities Transfer Tax in these circumstances could accordingly disrupt the derivatives market, thereby reducing liquidity.

B. Temporary legislation

In view of the above, a two-fold solution has been introduced. In order not to disrupt the market, it is proposed that the broker-member exemption be expanded to cover all broker-member activities wherein the broker-member is acting in the capacity as principal. This exemption would allow the parties involved to carry on as before without further tax risk.

On the other hand, the expanded exemption will apply only from 1 January 2011 (roughly when the matter was first raised with Government at a policy level). SARS remains free to enforce the law in respect of acquisitions occurring prior to this date. This proper enforcement should not adversely impact the market because of the expanded broker-member exemption will apply going forward (at least for a year).

Moreover, the expanded exemption will only last for a temporary period – i.e. until the close of 2012. This interim period will be used to further investigate whether the transactions at issue provide meaningful value in terms of liquidity and whether the expanded exemption can be maintained without imposing an undue risk to the tax base.

Also at issue is the question of competitiveness of the JSE as opposed to the London Stock Exchange. At this stage, it is understood that share acquisitions on the London Stock Exchange are subject to a 0.5% charge, but this foreign charge contains more exemptions (i.e. the South African Securities Transfer Tax carries a lower overall rate but with a broader base).

Changes to section 8 of the Securities Transfer Tax Act to give effect to the above

Section 8(1)(q) has been amended.

The amended section 8(1)(q) provides that tax is not payable on the transfer of a security if the person to whom that security is transferred is a member who has purchased the security in that member’s capacity as principal.

Effective date

The amendment to section 8(1)(q) is deemed to have come into operation on 1 January 2011 and applies in respect of transactions entered into-

(a) on or after that date; and

(b) on or before 31 December 2012.

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TAX ADMINISTRATION BILL

The Tax Administration Bill No.11B of 2011 was passed by the National Assembly on 24 November 2011

BACKGROUND The drafting of the Tax Administration Bill (TAB) was announced in the 2005 Budget Review as a project to incorporate into one piece of legislation certain generic administrative provisions, which are currently duplicated in the different tax Acts. These provisions include, for example, the objection and appeal procedures, search and seizure provisions, provisions relating to secrecy and collection processes. The scope of the project has since been extended so that it can now be seen as a preliminary step to the re-write of the Income Tax Act, 1962, since the administrative part of the Act comprises about 25% of the Act.

A first round of public comment on the TAB took place over the period 29 October 2009 to 28 February 2010 and the deadline for the second round of comments was 15 December 2010. Following the comments received and discussions held with tax practitioners in the first round:

Changes were made to the TAB in the light of the comments and further review.

The TAB was submitted to external constitutional experts for a constitutional review, to the Office of the Chief State Law Adviser and to Cabinet.

Consequential amendments to the other tax Acts were drafted.

The Tax Administration Bill No. 11B of 2011 was passed by the National Assembly on 24 November 2011.

We expect the Act to be promulgated during 2012.

OBJECTS OF THE TAB The TAB seeks to provide a single body of law that outlines common procedures, rights and remedies and to achieve a balance between the rights and obligations of both SARS and taxpayers in a transparent relationship. The TAB takes account of the constitutional rights of taxpayers but does not seek to re-codify them.

The drafting of the TAB focused on reviewing the current administrative provisions of the tax Acts administered by SARS, to close certain gaps identified by the review and seeks to provide a foundation for further development and simplification of the administration of the tax Acts and systems.

The Tax Administration Bill, 2011 runs to 201 pages and consists of the following sections:

Page 1 to 92 – The Tax Administration Bill, 2011. See below for details of how the 272 sections have been arranged.

Page 93 to 177 – Schedule 1 which amends all the underlying tax Acts that are covered by the TAB.

These are:

Transfer Duty Act No 40 of 1949;

Estate duty Act No 45 of 1955;

Income Tax Act No 58 of 1962;

Value-Added Tax Act No 89 of 1991;

Skills Development Act No 9 of 1999;

Unemployment Insurance Contributions Act No 2 of 2002;

Diamond Export Levy (Administration) Act No 14 of 2007;

Securities Transfer Tax Administration Act No 26 of 2007; and

Mineral and Petroleum Resources Royalty (Administration) Act No 29 of 2008.

Page 178 to 201 – Memorandum on the objects of the Tax Administration Bill, 2011. See below where it has been reproduced.


ARRANGEMENT OF THE 272 SECTIONS OF THE TAB, 2011 CHAPTER 1

DEFINITIONS

1. Definitions

CHAPTER 2

GENERAL ADMINISTRATION PROVISIONS

Part A

In general

2. Purpose of Act

3. Administration of tax Acts

4. Application of Act

5. Practice generally prevailing

Part B

Powers and duties of SARS and SARS officials

6. Powers and duties

7. Conflict of interest

8. Identity cards

9. Decision or notice by SARS

Part C

Delegations

10. Delegations by the Commissioner

Part D

Authority to act in legal proceedings

11. Legal proceedings on behalf of Commissioner

12. Right of appearance in proceedings

Part E

Powers and duties of Minister

13. Powers and duties of Minister

14. Power of Minister to appoint Tax Ombud

Part F

Powers and duties of Tax Ombud

15. Office of Tax Ombud

16. Mandate of Tax Ombud

17. Limitations on authority

18. Review of complaint

19. Reports by Tax Ombud

20. Resolution and recommendations

21. Confidentiality

CHAPTER 3

REGISTRATION

22. Registration requirements

23. Communication of changes in particulars

24. Taxpayer reference number

CHAPTER 4

RETURNS AND RECORDS

Part A

General

25. Submission of return

26. Third party returns

27. Other returns required

28. Statement concerning accounts

29. Duty to keep records

30. Form of records kept or retained

31. Inspection of records

32. Retention period in case of audit, objection or appeal

33. Translation


Part B

Reportable arrangements

34. Definitions

35. Reportable arrangements

36. Excluded arrangements

37. Disclosure obligation

38. Information to be submitted

39. Reportable arrangement reference number

CHAPTER 5

INFORMATION GATHERING

Part A

General rules for inspection, verification, audit and criminal investigation

40. Selection for inspection, verification or audit

41. Authorisation for SARS official to conduct audit or criminal investigation

42. Keeping taxpayer informed

43. Referral for criminal investigation

44. Conduct of criminal investigation

Part B

Inspection, request for relevant material, audit and criminal investigation

45. Inspection

46. Request for relevant material

47. Production of relevant material in person

48. Field audit or criminal investigation

49. Assistance during field audit or criminal investigation

Part C

Inquiries

50. Authorisation for inquiry

51. Inquiry order

52. Inquiry proceedings

53. Notice to appear

54. Powers of presiding officer

55. Witness fees

56. Confidentiality of proceedings

57. Incriminating evidence

58. Inquiry not suspended by civil or criminal proceedings

Part D

Search and seizure

59. Application for warrant

60. Issuance of warrant

61. Carrying out search

62. Search of premises not identified in warrant

63. Search without warrant

64. Legal professional privilege

65. Person’s right to examine and make copies

66. Application for return of seized relevant material or costs of damages

CHAPTER 6

CONFIDENTIALITY OF INFORMATION

67. General prohibition of disclosure

68. SARS confidential information and disclosure

69. Secrecy of taxpayer information and general disclosure

70. Disclosure to other entities

71. Disclosure in criminal, public safety or environmental matters

72. Self-incrimination

73. Disclosure to taxpayer of own record

74. Publication of names of offenders


CHAPTER 7

ADVANCE RULINGS

75. Definitions

76. Purpose of advance rulings

77. Scope of advance rulings

78. Private rulings and class rulings

79. Applications for advance rulings

80. Rejection of application for advance ruling

81. Fees for advance rulings

82. Binding effect of advance rulings

83. Applicability of advance rulings

84. Rulings rendered void

85. Subsequent changes in tax law

86. Withdrawal or modification of advance rulings

87. Publication of advance rulings

88. Non-binding private opinions

89. General rulings

90. Procedures and guidelines for advance rulings

CHAPTER 8

ASSESSMENTS

91. Original assessments

92. Additional assessments

93. Reduced assessments

94. Jeopardy assessments

95. Estimation of assessments

96. Notice of assessment

97. Recording of assessments

98. Withdrawal of assessments

99. Period of limitations for issuance of assessments

100. Finality of assessment or decision

CHAPTER 9

DISPUTE RESOLUTION

Part A

General

101. Definitions

102. Burden of proof

103. Rules for dispute resolution

Part B

Objection and appeal

104. Objection against assessment or decision

105. Forum for dispute of assessment or decision

106. Decision on objection

107. Appeal against assessment or decision

Part C

Tax board

108. Establishment of tax board

109. Jurisdiction of tax board

110. Constitution of tax board

111. Appointment of chairpersons

112. Clerk of tax board

113. Tax board procedure

114. Decision of tax board

115. Referral of appeal to tax court

Part D

Tax court

116. Establishment of tax court

117. Jurisdiction of tax court


118. Constitution of tax court

119. Nomination of president of tax court

120. Appointment of panel of tax court members

121. Appointment of registrar of tax court

122. Conflict of interest of tax court members

123. Death, retirement or incapability of judge or member

124. Sitting of tax court not public

125. Appearance at hearing of tax court

126. Subpoena of witness to tax court

127. Non-attendance by witness or failure to give evidence

128. Contempt of tax court

129. Decision by tax court

130. Order for costs by tax court

131. Registrar to notify parties of judgment of tax court

132. Publication of judgment of tax court

Part E

Appeal against tax court decision

133. Appeal against decision of tax court

134. Notice of intention to appeal tax court decision

135. Leave to appeal to Supreme Court of Appeal against tax court decision

136. Failure to lodge notice of intention to appeal tax court decision

137. Notice by registrar of period for appeal of tax court decision

138. Notice of appeal to Supreme Court of Appeal against tax court decision

139. Notice of cross-appeal of tax court decision

140. Record of appeal of tax court decision

141. Abandonment of judgment

Part F

Settlement of dispute

142. Definitions

143. Purpose of part

144. Initiation of settlement procedure

145. Circumstances where settlement is inappropriate

146. Circumstances where settlement is appropriate

147. Procedure for settlement

148. Finality of settlement agreement

149. Register of settlements and reporting

150. Alteration of assessment or decision on settlement

CHAPTER 10

TAX LIABILITY AND PAYMENT

Part A

Taxpayers

151. Taxpayer

152. Person chargeable to tax

153. Representative taxpayer

154. Liability of representative taxpayer

155. Personal liability of representative taxpayer

156. Withholding agent

157. Personal liability of withholding agent

158. Responsible third party

159. Personal liability of responsible third party

160. Right to recovery of taxpayer

161. Security by taxpayer

Part B

Payment of tax

162. Determination of time and manner of payment of tax

163. Preservation order

164. Payment of tax pending objection or appeal


Part C

Taxpayer account and allocation of payments

165. Taxpayer account

166. Allocation of payments

Part D

Deferral of payment

167. Instalment payment agreement

168. Criteria for instalment payment agreement

CHAPTER 11

RECOVERY OF TAX

Part A

General

169. Debt due to SARS

170. Evidence as to assessment

171. Period of limitation on collection of tax

Part B

Judgment procedure

172. Application for civil judgment for recovery of tax

173. Jurisdiction of Magistrates’ Court in judgment procedure

174. Effect of statement filed with clerk or registrar

175. Amendment of statement filed with clerk or registrar

176. Withdrawal of statement and reinstitution of proceedings

Part C

Sequestration, liquidation and winding-up proceedings

177. Institution of sequestration, liquidation or winding-up proceedings

178. Jurisdiction of court in sequestration, liquidation or winding-up proceedings

Part D

Collection of tax debt from third parties

179. Liability of third party appointed to satisfy tax debts

180. Liability of financial management for tax debts

181. Liability of shareholders for tax debts

182. Liability of transferee for tax debts

183. Liability of person assisting in dissipation of assets

184. Recovery of tax debts from responsible third parties

Part E

Assisting foreign governments

185. Tax recovery on behalf of foreign governments

Part F

Remedies with respect to foreign assets

186. Compulsory repatriation of foreign assets of taxpayer

CHAPTER 12

INTEREST

187. General interest rules

188. Period over which interest accrues

189. Rate at which interest is charged

CHAPTER 13

REFUNDS

190. Refunds of excess payments

191. Refunds subject to set-off and deferral

CHAPTER 14

WRITE OFF OR COMPROMISE OF TAX DEBTS

Part A

General provisions

192. Definitions

193. Purpose of Chapter

194. Application of Chapter


Part B

Temporary write off of tax debt

195. Temporary write off of tax debt

196. Tax debt uneconomical to pursue

Part C

Permanent write off of tax debt

197. Permanent write off of tax debt

198. Tax debt irrecoverable at law

199. Procedure for writing off tax debt

Part D

Compromise of tax debt

200. Compromise of tax debt

201. Request by debtor for compromise of tax debt

202. Consideration of request to compromise tax debt

203. Circumstances where not appropriate to compromise tax debt

204. Procedure for compromise of tax debt

205. SARS not bound by compromise of tax debt

Part E

Records and reporting

206. Register of tax debts written off or compromised

207. Reporting by Commissioner of tax debts written off or compromised

CHAPTER 15

ADMINISTRATIVE NON-COMPLIANCE PENALTIES

Part A

General

208. Definitions

209. Purpose of Chapter

Part B

Fixed amount penalties

210. Non-compliance subject to penalty

211. Fixed amount penalty table

212. Reportable arrangement penalty

Part C

Percentage based penalty

213. Imposition of percentage based penalty

Part D

Procedure

214. Procedures for imposing penalty

215. Procedure to request remittance of penalty

Part E

Remedies

216. Remittance of penalty for failure to register

217. Remittance of penalty for nominal or first incidence of non-compliance

218. Remittance of penalty in exceptional circumstances

219. Penalty incorrectly assessed

220. Objection and appeal against decision not to remit penalty

CHAPTER 16

UNDERSTATEMENT PENALTY

Part A

Imposition of understatement penalty

221. Definitions

222. Understatement penalty

223. Understatement penalty percentage table

224. Objection and appeal against decision not to remit understatement penalty

Part B

Voluntary disclosure programme

225. Definitions


226. Qualifying person for voluntary disclosure

227. Requirements for valid voluntary disclosure

228. No-name voluntary disclosure

229. Voluntary disclosure relief

230. Voluntary disclosure agreement

231. Withdrawal of voluntary disclosure relief

232. Assessment or determination to give effect to agreement

233. Reporting of voluntary disclosure agreements

CHAPTER 17

CRIMINAL OFFENCES

234. Criminal offences relating to non-compliance with tax Acts

235. Criminal offences relating to evasion of tax

236. Criminal offences relating to secrecy provisions

237. Criminal offences relating to filing return without authority

238. Jurisdiction of courts in criminal matters

CHAPTER 18

REPORTING OF UNPROFESSIONAL CONDUCT

239. Definitions

240. Registration of tax practitioners

241. Complaint to controlling body of tax practitioner

242. Disclosure of information regarding complaint and remedies of taxpayer

243. Complaint considered by controlling body

CHAPTER 19

GENERAL PROVISIONS

244. Deadlines

245. Power of Minister to determine date for submission of returns and payment of tax

246. Public officers of companies

247. Company address for notices and documents

248. Public officer in event of liquidation or winding-up

249. Default in appointing public officer or address for notices or documents

250. Authentication of documents

251. Delivery of documents to persons other than companies

252. Delivery of documents to companies

253. Documents delivered deemed to have been received

254. Defect does not affect validity

255. Rules for electronic communication

256. Tax clearance certificate

257. Regulations by Minister

CHAPTER 20

TRANSITIONAL PROVISIONS

258. New taxpayer reference number

259. Appointment of Tax Ombud

260. Provisions relating to secrecy

261. Public officer previously appointed

262. Appointment of chairpersons of tax board

263. Appointment of members of tax court

264. Continuation of tax board, tax court and court rules

265. Continuation of appointment to a post or office or delegation by Commissioner

266. Continuation of authority to audit

267. Conduct of inquiries and execution of search and seizure warrants

268. Application of Chapter 15

269. Continuation of authority, rights and obligations

270. Application of Act to prior or continuing action

271. Amendment of legislation

272. Short title and commencement


MEMORANDUM ON THE OBJECTS OF THE TAX ADMINISTRATION BILL, 2011

1. PURPOSE OF BILL

The Bill consolidates, as detailed in paragraph 2 below, the common administrative provisions of the Transfer Duty Act, 1949 (Act No. 40 of 1949), Estate Duty Act, 1955 (Act No. 45 of 1955), Income Tax Act, 1962 (Act No. 58 of 1962), Value-Added Tax Act, 1991 (Act No. 89 of 1991), Skills Development Levies Act, 1999 (Act No. 9 of 1999), the Unemployment Insurance Contributions Act, 2002 (Act No 4 of 2002), Diamond Export Levy (Administration) Act, 2007 (Act No. 14 of 2007), Securities Transfer Tax Administration Act, 2007 (Act No. 26 of 2007) and the Mineral and Petroleum Resources Royalty (Administration) Act, 2008 (Act No. 29 of 2008).

2. OBJECTS OF BILL

2.1 General

The drafting of the Tax Administration Bill (the ‘‘TAB’’) was announced in the 2005 Budget Review as a project to incorporate into one piece of legislation certain generic administrative provisions, which are currently duplicated in the different tax Acts. The scope of the project has since been extended so that it can now be seen as a preliminary step to the re-write of the Income Tax Act. The TAB project will assist in dividing the work of the re-write into more manageable parts, since the administrative part of the Income Tax Act comprises about 25% of the Act. Tax legislation typically comprises two aspects: tax liability provisions or ‘‘tax charging’’ provisions, and tax administration provisions. The TAB only deals with tax administration. The drafting of the TAB focused on reviewing the current administrative provisions of the tax Acts administered by SARS, but excludes the Customs and Excise Act, 1964, since that Act operates in a somewhat different context and is the subject of a separate rewrite process.

The current administrative provisions in tax legislation are outdated. Although the provisions have been amended over the years, the tax Acts have become fragmented and disparate provisions arose in the different tax Acts. The current framework is outdated and needs to be aligned with modern approaches, business practices, accounting practices and constitutional rights.

In essence, therefore, the rationale for a tax administration review in South Africa is to adapt to a fast developing world, and lower the cost and burden of tax administration.

A new and modern legislative framework is accordingly required for:

(a) The modern administration of the collection of revenue.

(b) The consolidation of duplicate provisions.

(c) The alignment of disparate requirements in existing law.

To achieve the above, the TAB incorporates into one piece of legislation certain administrative provisions that are generic to all tax Acts and administrative provisions currently duplicated in the different tax Acts, excluding the Customs and Excise Act, 1964. The TAB also seeks to remove redundant administrative provisions. It seeks to provide a simplified and single body of law that outlines common procedures, rights and remedies and to achieve a balance between the rights and obligations of both SARS and taxpayers in a transparent relationship.

Importantly, the TAB seeks to achieve a balance between the powers and duties of SARS, on the one hand, and the rights and obligations of taxpayers, on the other. This balance will contribute to the equity and fairness of tax administration. International experience has demonstrated that if taxpayers perceive and experience the tax system as fair and equitable, they will be more inclined to fully and voluntarily comply with it.

The TAB takes account of the constitutional rights of taxpayers, but does not seek to re-codify them, because all legislation, including the TAB, must be read together with the provisions of the Constitution. Particularly the right to administrative justice as well as the application of the fairness requirements are very fact and context specific. Codifying these rights in respect of every administrative action by SARS will be an almost impossible task and may only serve to unnecessarily limit or modify them. The TAB rather seeks to effect protection of administrative fairness rights through affording taxpayers more effective and overarching remedies, such as the creation of a Tax Ombud’s Office, and specific procedural rights in the clauses dealing with SARS’ powers, such as the right to an audit findings report after finalisation of an audit and providing reasons for assessments.

In drafting the TAB, due regard was given to the following principles of international best practice in tax administration:

(a) Equity and fairness to ensure that the tax system is fair and also perceived to be fair, which should in turn enhance compliance.

(b) Certainty and simplicity so that tax administration is not seen as arbitrary but transparent, clear and as simple as the complexity of the system allows.

(c) Efficiency, where compliance and administration costs are kept to a minimum and payment of tax is as easy as possible.

(d) Effectiveness, so that the right amount of tax is collected, active or passive non-compliance is kept to a minimum, and the system remains flexible and dynamic to keep pace with technological and commercial development.


For example, to ensure consistent treatment of taxpayers in comparable circumstances, and consequently greater equity and fairness in tax administration, certain discretionary powers of SARS are now linked to objective criteria. Open-ended discretions on important matters have been fettered.

Apart from consolidating and harmonising existing provisions, the TAB seeks to provide a foundation for further modernisation of the administration of the tax Acts and to close certain identified gaps.

The TAB also extends SARS’ powers, for example its information gathering, assessment and collection powers to enhance tax compliance. In this regard:

(a) The TAB gives recognition to the fact that the majority of taxpayers are compliant and want a more modern and responsive revenue administration, but that there is a minority that seeks to evade tax or defraud the government.

(b) SARS has a duty to actively pursue tax evaders to maintain confidence in the integrity of the tax system.

(c) Tax evasion undermines compliant taxpayers’ morale and places an unfair burden on them if it is not countered effectively.

(d) Over the years, it became apparent that stricter enforcement powers are required to target increasingly sophisticated tax evaders and tax evasion schemes.

The purpose of the TAB in the context of these extended powers, therefore, is the extension of powers to more effectively target tax evaders, who demonstrate certain behaviour.

The drafting of the TAB was informed by international best practice and a comparative evaluation of the tax administration laws of other countries with practical experience with tax administrative laws over long periods, such as Australia, Botswana, Canada, New Zealand, the United Kingdom and the USA.

The layout of the TAB largely follows the administrative life cycle of a taxpayer, commonly referred to as a step-by-step approach. This is reflected in the Chapter headings.

2.2 Summary of proposed changes to current law and purpose thereof

2.2.1 Chapter 1: Definitions

Interpretation

Terms used in the TAB which are defined in the tax Acts retain their defined meaning in the TAB, unless the context in which they are used in the TAB indicates otherwise, or if they are specifically defined in the TAB. Terms defined in the TAB apply to tax Acts unless the context in the tax Act indicates otherwise, or if they are specifically defined in the relevant tax Act.

New definitions

2.2.1.1 The term ‘‘assessment’’ is defined to ensure that it includes both the determination of the amount of a tax liability or a refund by way of self-assessment by the taxpayer and assessment by SARS. It does not include, as is currently the case in the Income Tax Act, any decision which in terms of a tax Act (including the TAB) is subject to objection and appeal. These decisions are now separated from the concept of an assessment for purposes of the TAB.

2.2.1.2 ‘‘Biometric information’’, which may be required by SARS for registration, means specified biological data but also caters for the inclusion, by way of regulation, of other, less intrusive biological data that may become available in the future. It is not envisaged that this will include, for example, DNA data as this is generally regarded as more intrusive.

2.2.1.3 The term ‘‘date of assessment’’ is defined to refer to the date of the issue of an assessment by SARS or date of the submission of a return which constitutes a self-assessment.

2.2.1.4 The definition of the term ‘‘effective date’’ is important as this determines the date from which interest due to or payable by SARS accrues. Interest is generally determined from this date until the date of actual payment.

2.2.1.5 For purposes of the TAB ‘‘income tax’’ means normal tax referred to in section 5 of the Income Tax Act, 1962, but excludes provisional tax and employees’ tax. This distinction is particularly relevant for the purposes of the definition of ‘‘tax period’’, the effective date for the payment of interest determined under Chapter 12 and the determination of the amount of an administrative non-compliance penalty under Chapter 15 in respect of a person who is exempt from income tax.

2.2.1.6 The definition of ‘‘official publication’’, which means a binding general ruling, interpretation note, practice note, or public notice issued by a senior SARS official or the Commissioner, is particularly relevant for purposes of what constitutes a ‘‘practice generally prevailing’’ under clause 5 and what constitutes exceptional circumstances that may warrant the remittance of an administrative non-compliance penalty in Chapter 15.

2.2.1.7 The concept of an ‘‘original assessment’’, i.e. the first assessment in respect of a tax period, is now a defined term that relates to a specific type of assessment, in the same way as ‘‘additional assessment’’ and ‘‘reduced assessment’’ are individually defined. The term ‘‘estimated assessment’’ previously used in tax Acts, is replaced by the concept of an original, reduced or additional assessment based on an estimation.


2.2.1.8 The term ‘‘relevant material’’ is important for information gathering under Chapter 5 and means any information, document, or thing that is forseeably relevant for tax risk assessment, assessing tax, collecting tax, or showing noncompliance with an obligation under a tax Act or showing that a tax offence was committed.

The standard of foreseeable relevance, which is inter alia regarded by the OECD as the standard in the context of specifying the information that should be exchanged between countries, is intended to provide for the procurement of information in tax matters to the widest possible extent and, at the same time, to clarify that revenue authorities are not at liberty to engage in ‘‘fishing expeditions’’ or to request information that is unlikely to be relevant to the tax affairs of a given taxpayer. This is a narrower term than ‘‘may be relevant’’, which is the standard used in some tax jurisdictions. Risk assessment, as reflected in clause 44, is one of the premises of SARS’ audit selection process and involves assessing the risk profile of taxpayers (‘‘risk assessment’’) and then allocating resources in accordance with the risk profiles (‘‘risk-led resource allocation’’) which should result in more targeted audits. Risk assessment also assists in addressing emerging tax risks in real-time, which should enable SARS to provide tax certainty to taxpayers sooner and quicker guidance on tax matters and to reduce the need for protracted forensic audits (typically some years after targeted transactions occurred). Risk-driven processes should also limit disputes and reduce the incidence of tax underpayments and understatement penalties or administrative non-compliance penalties. Obtaining real-time ‘‘relevant material’’ from taxpayers is key to effective risk management of taxpayers.

2.2.1.9 ‘‘Return’’ is defined to include the submission of a prescribed form to SARS for purposes of both self-assessment and assessment by SARS.

2.2.1.10 ‘‘Self-assessment’’, in turn, is defined as a determination of the amount of tax payable under a tax Act by a taxpayer and submitting a return which incorporates the determination or, if no return is required, the act of making payment of the tax. Throughout the TAB, provision is made for the transition to a full self-assessment system, which system can be described as follows:

(a) Self-assessment is a mechanism applied as part of a tax collection system.

(b) Under self-assessment, the taxpayer is required to report the basis of assessment (for example taxable income), to submit a calculation of the tax due and, usually, to simultaneously pay any outstanding tax due as calculated by the taxpayer. The onus is on the taxpayer to calculate the correct amount of tax payable.

(c) The role of SARS in this system is to verify the correctness of the assessment by the taxpayer by means of a combination of risk based and random audits.

(d) It contrasts with the role of SARS in an assessment system where the taxpayer is called upon to submit the information to SARS. The onus on the taxpayer is to submit a true and complete return of the information required. SARS is responsible for establishing the tax due, normally by means of an assessment, the assessment specifies the period within which the tax must be paid.

2.2.1.11 The term ‘‘serious tax offence’’ means a tax offence for which a person may be liable on conviction to a fine or to imprisonment for a period exceeding two years, and is relevant for purposes of the referral of an audit for separate criminal investigation under clause 45.

2.2.1.12 ‘‘Tax’’ for purposes of the administration of the TAB is widely defined as a tax, duty, levy, royalty, fee, contribution, penalty, interest and any other moneys imposed under a tax Act. This wide definition is to ensure the application of the TAB across taxes.

2.2.1.13 The term ‘‘taxable event’’ means an occurrence which affects or may affect the liability of a person to tax, and is important to determine the ‘‘tax period’’ for purposes of transaction based taxes, as well as the meaning of administration of a tax Act in clause 3(2) in that context.

2.2.1.14 A ‘‘tax Act’’ is an important definition in the TAB, as it serves to include the Tax Administration Act, an Act and a portion of an Act administered by the Commissioner, but excludes the Customs and Excise Act, 1964.

2.2.2 Chapter 2: General administration provisions

New provisions

2.2.2.1 Purpose of the Tax Administration Act: Clause 2 describes the purpose of the Tax Administration Act, which essentially is to provide for the effective and efficient collection of tax, the alignment of the administration provisions of tax Acts, to the extent practically possible. Administrative requirements and procedures for purposes of the performance of any duty, power or obligation or the exercise of any right in terms of a tax Act is, to the extent not regulated in a tax Act, now regulated by the TAB. Administrative provisions that are specific to a tax Act or the relevant tax type remain in that Act.

2.2.2.2 Administration of tax Acts: Clause 3 determines that SARS is responsible for the administration of this Act under the control or direction of the Commissioner, and describes the ambit of administration of the tax Acts. As mentioned, it is unnecessary to include references to the constitutional provisions and obligations that guide the exercising of administrative authority within the TAB.


2.2.2.3 Application of the Tax Administration Act: In terms of clause 4, the TAB applies to every person who is liable to comply with a provision of a tax Act (whether personally or on behalf of another person). This clause also deals with the resolution of any inconsistencies between the TAB and a tax Act, if any should arise, by providing that in the event of any inconsistency between the TAB and another tax Act, the tax Act prevails.

2.2.2.4 Practice generally prevailing: In terms of clause 5 the sources of SARS’ ‘‘binding’’ practices will be official publications i.e. a binding general ruling, interpretation note, practice note, or public notice issued by a senior SARS official or the Commissioner that deals with the application or interpretation of a tax Act. Taxpayers are often unsure of the existence of a practice generally prevailing as a result of reliance on publications such as the ‘‘Income Tax Practice Manual’’ published by LexisNexisTM, ‘‘hear-say’’, media releases or published articles, operational practices or procedures and guides. None of these necessarily reflect the application or interpretation of a tax Act that is binding on and generally applied by the whole of SARS.

This concept is used in the TAB in the context of both defining and limiting SARS’ power to issue an additional or reduced assessment (clause 99) and placing limitations upon taxpayers in claiming refunds (clause 190(3)(a)). Where the grounds of objection are based on a change in the practice generally prevailing which applied on the date of the disputed assessment, the period for objection may not be extended (clause 104(5)(c)).

Clause 5(2) deals with a situation where a practice generally prevailing ceases to be one, for example, legislative amendments or judgments that are amended to an extent material to the practice.

2.2.2.5 Limitation of administrative powers: Clause 6 provides that the exercise of any power or duty under a tax Act by a SARS official, including whatever may be fairly regarded as incidental to or consequential to such powers or obligations, must be related to and within the ambit of the purpose and ambit of the administration of the tax Acts.

Generally in a tax administration Act the administration provisions place the day-to-day administration of the tax laws in the hands of a statutory body (SARS) or a specific office holder (the Commissioner). In terms of current law, unless a power is specifically assigned to the Commissioner personally, any SARS official acting under the direction, supervision and control of the Commissioner may exercise the powers, duties and obligations under the tax Acts. To ensure the reservation of more serious powers for the Commissioner or senior SARS officials, the TAB departs from this common approach by dividing the ‘‘Administration of the Act’’ into three tiers. In terms of the new ‘‘three tier decision making levels’’ powers, duties or functions may be exercised by:

(a) The Commissioner personally, where powers are assigned to him personally, unless he or she specifically delegates such powers.

(b) Senior SARS officials authorised by the Commissioner to exercise more serious and impactful powers or functions.

(c) SARS officials in general.

This new approach is aligned with what happens in practice.

2.2.2.6 Further limitations on SARS’ powers: The TAB imposes limitations on the powers of SARS officials in administering tax to further counteract potential abuse.

These include:

(a) Conflict of interest provisions (clause 7): These provisions, for example, prohibit a SARS official from becoming involved in the administration of a tax Act matter relating to a person with whom the official has or had, in the previous three years, a personal, family, social, business, employment or financial relationship. The provisions will be supplemented by more specific internal policy guidelines.

(b) Identity Cards (clause 8): This provision compels a SARS official exercising powers and duties for purposes of the administration of a tax Act to carry a SARS identification card, which card must be shown upon request.

(c) Decision or notice by SARS (clause 9): The withdrawal or amendment of a decision or notice (to a specific taxpayer—not general notices), excluding a decision given effect to in an assessment or notice of assessment, made by a SARS official is largely similar to current law, except that it is clarified that a taxpayer may request such withdrawal or amendment.

In the case of withdrawals or amendments adverse to the taxpayer, procedural fairness is implicit. SARS may not withdraw or amend a decision with retrospective effect more than three years after the date of the written notice of the decision or the date of the assessment giving effect to the decision if all the material facts were known.

(d) Delegations (clause 10):A SARS official acting under a delegation must be so delegated in writing with the mandate or authority specified.

2.2.2.7 Authority to act in legal proceedings (clauses 11 and 12): These provisions place limitations on SARS as to who may deal with and the manner in which legal proceedings to which the Commissioner or SARS is a party must be dealt with (for example, the laying of criminal charges). Clause 12 deals with which senior SARS officials have the right of appearance on behalf of the Commissioner in proceedings before the tax court or High Courts.


2.2.2.8 Powers and duties of the Minister: Clause 13 provides that the Minister may delegate his or her powers, except for the power to appoint the Tax Ombud and to issue regulations, to the Deputy-Minister and the Director-General of National Treasury. The Director-General may in turn delegate the powers and duties delegated to him or her by the Minister to a person under the control, direction, or supervision of the Director-General.

2.2.2.9 Establishment of Offıce of Tax Ombud: Clauses 14 to 21 establish the office of the Tax Ombud, the creation of which was foreshadowed in 2003 at the launch of the current tax dispute resolution process and SARS Service Monitoring Office (the ‘‘SSMO’’).

The steps in the tax dispute resolution process of objection, alternative dispute resolution, appeal to the tax board, in simple cases, or the tax court, in more complex cases, and finally access to the normal court system serve as a check on SARS’ powers to assess tax. The SSMO was intended as the first step in the creation of a mechanism to serve as a check on SARS’ administrative powers by addressing SARS’ failures to follow procedures or respect taxpayer’s rights. It was not, however, intended to be the last step. As the then Minister of Finance noted at the launch of the SSMO: ‘‘Once SARS’ processes and procedures have improved sufficiently, the next important step that will be taken in emulating international standards will entail an important role for an Ombud.’’ An independent Tax Ombud will fill a gap in the mechanism that currently exists between SARS’ internal processes and access to the normal court system. Public comments on the first draft TAB confirmed the public’s desire for the establishment of a separate and independent Tax Ombud’s Office. The Tax Ombud’s office should, it was proposed, provide accessible and affordable remedies for taxpayers affected by non-adherence to procedures or failure to respect taxpayers’ rights.

The introduction of a Tax Ombud is, therefore, proposed in view of the fact that:

(a) The creation of an independent and effective recourse for taxpayers would be in line with the objective of the TAB to achieve a balance between SARS’ powers and duties and taxpayer obligations, remedies and rights.

(b) It would be in line with international best practice, particularly the framework of the Canadian ‘‘Taxpayer Ombudsman’’ and the UK ‘‘Revenue Adjudicator’’.

(c) It would also be consistent with what the Constitutional Court has had to say on the valuable role played by effective internal remedies, namely that although courts play a vital role in providing litigants with access to justice, the importance of more readily available and cost-effective internal remedies cannot be gainsaid.

To ensure the necessary independence from SARS, the Minister of Finance must appoint the Tax Ombud and determine his or her terms of office. In line with the Canadian, UK and USA models, SARS employees will be seconded to the Ombud’s office after consultation with the Ombud.

The mandate of the Tax Ombud will be to review and address any complaint by a taxpayer regarding a service matter or a procedural or administrative matter arising from the application of the provisions of a tax Act by SARS, generally only after the taxpayer has exhausted the available complaints resolution mechanisms within SARS.

There are also specific limitations on the mandate of the Tax Ombud, such as that the Ombud may not review legislation, tax policy, SARS policy or practice generally prevailing. The Ombud may deal with a service matter or a procedural or administrative matter arising from the application of the provisions of a tax Act by SARS. In the context of matters subject to objection and appeal, the Ombud may only deal with any administrative matter relating to such objection and appeal.

The Tax Ombud must also identify and review systemic and emerging issues related to service matters or the application of the provisions of this Act and the tax Acts relating to administrative matters that impact negatively on taxpayers. The Tax Ombud will have review and mediatory powers and report directly to the Minister of Finance.

Chapter 6, Confidentiality of Information, applies mutatis mutandis to the Tax Ombud’s office. The Ombud or any person on the Ombud’s behalf, may not disclose information obtained under Part F of Chapter 2, including to SARS, except to the extent required for purposes of the performance of functions and duties under Part F. SARS, however, must allow the Ombud access to the information that relates to the Ombud’s powers and duties under Part F.

2.2.3 Chapter 3: Registration

New provisions

2.2.3.1 Registration requirements for all taxes (clause 22): A person obliged to apply or who may voluntarily apply for registration under a tax Act must do so in accordance with this clause.

The TAB, in clause 22(2)(b), in pursuit of creating a single view of a taxpayer in SARS’ systems, provides a framework for the single registration for all taxes by a taxpayer. In this regard:

(a) Single registration may be effected using a single form.

(b) In the absence of a specific period for registration in a tax Act, a registration period of 21 ‘‘business days’’ applies across taxes from the date that a taxpayer becomes liable or entitled to register under a tax Act.


A person who fails to provide all particulars and documents required for a specific registration will be regarded as not having applied for registration until those particulars and documents are provided. Also, where a taxpayer that is obliged to register with SARS under a tax Act fails to do so, SARS may register the taxpayer for one or more tax types as is appropriate under the circumstances, for example, turnover tax if that is more appropriate to the circumstances of the taxpayer.

Biometric information (which may include fingerprints; facial recognition; vocal recognition and iris or retina recognition) may be required for registration, essentially to ensure proper identification and counteracting identity theft and fraud. The main advantages of biometrics over standard identification and validation systems are:

(a) Biometric traits cannot be lost or forgotten (while identity documents and passwords can).

(b) Biometric traits are difficult to copy (while passwords and reference numbers, once disclosed, are not).

(c) Biometrics require the person being authenticated to be present at the time and point of authentication.

Furthermore, in view of the highly private nature of biometric information, additional protection in the context of the disclosure thereof is afforded in the confidentiality of information Chapter to the extent that not even a High Court may order the disclosure thereof. It may, however, be disclosed for purposes of criminal prosecution.

2.2.3.2 Communication of change in particulars (clause 23): The provision of updated information, such as any change in postal or physical address, representative taxpayer, banking particulars used for transactions with SARS and electronic address used for communication with SARS, is required under this clause. The Commissioner may also prescribe additional information required for registration by public notice, and specific notifications may still be required in a tax Act, for example section 25 of the Value-Added Tax Act, 1991.

2.2.3.3 Taxpayer reference number (clause 24): SARS may allocate a taxpayer reference number in respect of one or more taxes to each person already registered under a tax Act or Chapter 3. The use of a taxpayer reference number allocated by SARS is compulsory in all correspondence with SARS. This is aimed at ensuring more efficient processing of taxpayer communication, particularly once a single registration number for all taxes is implemented.

2.2.4 Chapter 4: Returns and records

In this Chapter more generic return provisions have been drafted to cater for future modernisation of the tax system, for example a full self-assessment system.

New provisions

2.2.4.1 Submission of return (clause 25): If the obligation to submit a return is imposed in a tax Act, the taxpayer must do so in accordance with the requirements of the TAB. Specific returns required under current law, for example income tax returns by companies, will now be regulated under this general clause and the specific information required will be set out in the prescribed form.

Under this clause, SARS may also request or allow a person, prior to the issue of an original assessment, to submit an amended return to correct an undisputed error in a return. This will typically apply in the eFiling environment as a measure to avoid the issue of an incorrect assessment, pursuant to bona fide errors made in the return, which once an assessment had been issued can then only be rectified through more formal dispute resolution processes.

2.2.4.2 Third party returns (clause 26): The concept of listing specific types of information required from third parties in tax legislation (for example interest returns by banks or certain returns required from companies) is replaced by a duty on third parties to automatically submit returns of information as may be prescribed by the Commissioner when called on to do so by way of a public notice. The notice will prescribe the type of information and the frequency of submission.

2.2.4.3 Other returns required (clause 27): SARS may require a person to submit further or more detailed returns regarding any matter for which a return is required or prescribed by a tax Act, for example returns relating to income from controlled foreign companies or certain representative vendors.

2.2.4.4 Statement concerning account (clause 28): If a taxpayer submits financial statements or accounts prepared by another person in support of the taxpayer’s submitted return, SARS may require a certificate or statement as to the extent of the examination and verification of the correctness of the transactions, receipts, accruals, payments, or debits reflected in the financial statements. This is not a requirement for audited financial statements, but the certificate or statement allows SARS to evaluate the degree of reliance that may be placed on the financial statements and potentially avoid further verification or audit by SARS.

2.2.4.5 Record retention (clauses 29 to 33): The TAB imposes a general record keeping requirement on taxpayers as well as third parties obliged to submit returns, for example under clause 26, in respect of the records that enable a person to demonstrate to the satisfaction of SARS that the requirements of a tax Act have been observed. Specific records may still be required under a tax Act, for example section 55 of the Value-Added Tax Act, 1991.

Records must be kept in their original form or a form generally prescribed by the Commissioner. A senior SARS official may, upon request by a specific taxpayer, authorise the retention of information contained in records or documents by that taxpayer in a different but acceptable form.


Regarding the manner of keeping records, a new requirement that records must be kept in an orderly fashion and in a safe place, is added. This is to ensure the orderly and safe retention of the records and efficient access thereto by SARS, for purposes of an inspection or audit, during the required five year retention period (subject to the qualification described in the paragraph below).

To ensure that records are kept in the correct form, provision is made that SARS may inspect the records for this purpose, in addition to an examination, audit or investigation under Chapter 5.

Clause 32 deals with matters subject to an audit or objection or appeal, and provides that records must be retained until the conclusion of the audit, objection or appeal even if this means records are retained for longer than 5 years. If the information is not in one of the official languages of the Republic, a senior SARS official may require a translation by the taxpayer, a sworn translator or other person approved by the official.

2.2.4.6 Reportable arrangements (clauses 34 to 39): No significant changes were made to reportable arrangements, except that all listed arrangements likely to lead to an undue tax benefit are to be identified by the Commissioner by public notice, and the Commissioner may determine an arrangement to be an excluded arrangement by public notice. Failure to report a reportable arrangement will not constitute a criminal offence, but is subject to an administrative non-compliance penalty under Chapter 15.

2.2.5 Chapter 5: Information gathering

SARS’ information gathering powers are substantially supplemented or extended by the TAB. This is essentially to address the problem that too many requests for information by SARS result in protracted debates as to SARS’ entitlement to certain information. This is contrary to the internationally established principle that a revenue agency’s resources or energy should not be wasted on disputes over whether or not it is entitled to have access to a particular item of information, but should rather be focused on ensuring that all taxpayers pay the correct amount of tax on time based on timely available information. However, taxpayer’s rights are amplified and made more explicit to counterbalance SARS’ new information gathering powers.

Chapter 5 comprises two parts, i.e. Part A which deals with ‘‘General rules for inspection, verification, audit and criminal investigation’’ and Part B which deals with ‘‘Inspection, request for relevant material, audit and criminal investigation’’.

New provisions

2.2.5.1 Selection for inspection, verification or audit (clause 40): The basis upon which a person may be selected for an inspection, verification (for example through a ‘desk audit’) or audit is prescribed as either on a random or risk assessment basis. This is not the basis for criminal investigations, which are triggered by indications of the commission of an offence under the tax Acts.

SARS’ new powers:

2.2.5.2 Inspections (clause 45): SARS may, without prior notice, arrive at and inspect a premises to determine the identity of the person occupying the premises, whether the person occupying the premises is conducting a trade or an enterprise and is registered for tax and keeps the required records. These inspections will typically be used for tax base broadening purposes or verification, for example, of the existence of an enterprise for purposes of VAT registration.

2.2.5.3 Requests for relevant material (clause 46): The ambit of such requests by SARS is extended to identifiable taxpayers. This includes, for example, where a taxable event demonstrates that a taxpayer exists, but SARS does not have such person’s name or other details. Information procurement from third parties in respect of identified classes of taxpayers, for example taxpayers involved in certain types of potential tax avoidance structures, is now specifically included. Provision is also made that SARS may extend the period within which the relevant material must be submitted on good cause shown. A request for information for purposes of revenue estimation is limited to information that the requested person has available.

2.2.5.4 Informal examination at a SARS offıce (clause 47): SARS may require a person to attend a meeting at a SARS office for purposes of being interviewed regarding the taxpayer’s own or another person’s tax affairs. The aim of the meeting is to clarify issues of concern to SARS to render further examinations or an audit unnecessary. The interview cannot be used to conduct a criminal investigation.

2.2.5.5 Field audits or criminal investigations (clause 48): These provisions are largely aligned with current law, except for clarifying that both on-site audits and criminal investigations require prior notice.

2.2.5.6 Search and seizure (clause 63): SARS may under certain narrow circumstances conduct a search without a warrant. This power may only be invoked if the person affected consents thereto or if a senior SARS official on reasonable grounds is satisfied that:

(a) There may be an imminent removal or destruction of relevant material likely to be found on the premises;

(b) If SARS applies for a search warrant under the relevant empowering section of the Act, a search warrant will be issued; and

(c) The delay in obtaining a warrant would defeat the object of the search and seizure.


This power is consistent with that found in other legislation in South Africa, some of which has been reviewed and accepted by the courts in that context and is comparatively supported. This power should inter alia assist in tax base broadening and addressing the reality that tax evaders who, upon approach by SARS, waste no time in destroying all records and evidence of their fraudulent activities and details of income derived.

Taxpayers’ new rights and obligations:

2.2.5.7 Authority for SARS offıcial to conduct an audit or criminal investigation (clause 41): A SARS official must demonstrate his or her authority to conduct audits or criminal investigations, as these powers may only be exercised by duly authorized officials, failing which a taxpayer may lawfully refuse to allow the audit or investigation until such official shows that this authority exists.

2.2.5.8 Keeping taxpayer informed (clause 42):

(a) A taxpayer is entitled to a report on the progress of an ongoing audit in the form and manner as may be prescribed by the Commissioner by public notice.

(b) A taxpayer must receive notification of the final outcome of an audit or criminal investigation whether conclusive or not. If an audit identified potential adjustments of a material nature, an audit findings letter must be sent to the taxpayer unless the taxpayer waives this right, for example where a taxpayer has been sufficiently informed during the audit or is aware of the audit findings.

(c) The taxpayer may respond to the audit findings in writing and within the prescribed period before the assessment based on the audit is issued. An extension of time to respond to the audit findings may be given by SARS if reasonably required.

(d) Exception: SARS need not comply with the above where a senior SARS official has reasonable belief that the audit progress report, audit findings letter or response to the audit findings by the taxpayer may impede or prejudice the purpose, progress (for example prescription) or outcome of the audit.

However, SARS is then required to provide the grounds of the assessment within 21 business days of the assessment or the further period that may be required based on the complexities of the audit. This does not affect the right of the taxpayer to request further reasons or to object to the assessment.

2.2.5.9 Separation of audit and criminal investigation (clauses 43 and 44): Audits and criminal investigations of serious tax offences by SARS are separated to ensure that the rights of taxpayers who are suspects in a criminal investigation are given proper effect to. The use of audit information in criminal proceedings may be inadmissible if a taxpayer has not been informed that he or she was also being investigated for criminal offences.

2.2.5.10 Field audit or criminal investigation notice (clause 48): Prior notice of an audit or criminal investigation at the premises of a taxpayer must be given at least 10 business days before the audit or investigation, and the taxpayer must revert at least 5 business days before the audit or investigation if the date is not suitable. Although the notice must inter alia indicate the initial basis and scope of the audit or investigation, this may obviously change or extend as the audit or investigation progresses. A taxpayer may waive the right to notice, for example, if it is convenient for the taxpayer to resolve an audit issue without delay.

2.2.5.11 Assistance during field audit or investigation (clause 49): Taxpayers are now obliged to give SARS reasonable assistance during field audits or investigations and execution of search and seizure warrants. The aim of this requirement is to ensure the effective and efficient conclusion of field audits or investigations without impediments as a result of obstructive taxpayers refusing reasonable assistance. Assistance may include actions such as answering questions or practical assistance such as providing working space and facilities. For example, if the taxpayer has a photocopier on the premises, it should be made available to SARS for use at SARS’ cost. Failure to provide such reasonable assistance may constitute non-compliance for purposes of the imposition of an administrative non-compliance penalty under Chapter 15 and a criminal offence under Chapter 17.

2.2.5.12 Inquiries (clauses 50 to 58): No significant changes to the proceedings under current law were effected.

2.2.5.13 Application for and issuance of a search and seizure warrant and the carrying out of a search (clauses 59 to 66): No significant changes to the proceedings under current law were made, except for affording further protection of taxpayers subjected to a search and seizure, including:

(a) A provision making explicit the duty on SARS to conduct a search with strict regard to decency and order.

(b) A requirement that SARS must make an inventory of seized material in the form, manner and time that is reasonable under the circumstances.

(c) If the removal of original documents or computers may prejudice the continuance of a taxpayer’s business, SARS has a discretion to make and remove copies if appropriate.

(d) A provision that a taxpayer may request SARS to pay or, if SARS declines, for a Court to order payment of the costs of physical damage caused during the conduct of a search and seizure.


2.2.5.14 Protection of legal professional privilege during execution of search and seizure (clause 64): This clause is aimed at ensuring that assertions of legal professional privilege in respect of relevant material subject to search and seizure during the execution thereof, whether under a warrant or not, are dealt with fairly and expeditiously. The documents must be secured or sealed and handed to an attorney who must make a determination of whether the privilege applies. The attorney must be an attorney from the panel from which the chairpersons of the tax board must be selected under clause 111, i.e. an attorney appointed by the Minister of Finance in consultation with the relevant Judge-President to act as chairperson of the tax board.

If this attorney is not available to attend at the premises and seal the information, he or she may appoint a substitute attorney to be present on the appointing attorney’s behalf during the execution of a warrant. The determination may, however, only be made by the attorney from the panel appointed under clause 111 and must be made within 21 business days.

If the determination is not made or a party is not satisfied with the determination by the attorney, the attorney must retain the documents pending final resolution of the dispute by the parties or an order of court. A substitute attorney and the attorney making the determination must be paid in the same manner as if acting as chairperson of the tax board.

Where the need to search for material over which the taxpayer may claim legal professional privilege is foreseeable, SARS must arrange for the attendance of the attorney before execution of the warrant. If an attorney is not present and the issue arises during execution of the warrant, the material must be sealed and handed over to the attorney, who must then make the determination of whether privilege applies.

2.2.6 Chapter 6: Confidentiality of information

The information protection laws of most countries are based on the basic principle that personal information should not be used for purposes incompatible with the purpose for which it was collected. In South Africa a citizen’s right to privacy is entrenched in a constitution that regulates the right to protection of privacy. Taxpayers have a right to expect that any information provided by them is treated in confidence and used for tax purposes only and that their affairs will not be disclosed to third parties, including other organs of state. This form of data protection is reinforced by the mandatory protection of SARS’ records by section 35(1) of the Promotion of Access to Information Act, 2000, and further underpinned by case law wherein strict requirements are laid down before a court will order disclosure of tax information.

However, in several developed jurisdictions it is recognised that it is important that tax information is available to other organs of state within proper limits. Specifically, it is recognised that in the context of law enforcement:

(a) Where certain information is likely to be of value to a criminal investigation, it is in the public interest that tax information is available to law enforcement agencies within certain limits.

(b) Such limited disclosure will ensure that there is a potential for information flow in two directions, i.e. between a revenue authority and law enforcement agencies and vice versa.

New provisions

The secrecy provisions are now aligned across taxes, are more explicit as to who is subject thereto and when disclosure is permitted. In the context of disclosure to organs of state and related agencies, disclosure for non tax administration purposes is widened.

2.2.6.1 General prohibition of disclosure (clause 67):

(a) SARS information is distinguished from taxpayer information and different disclosure rules apply.

(b) The provision, read with the definition of SARS official, is now specifically applicable to the Commissioner, an employee of SARS or a person contracted by SARS for purposes of the administration of a tax Act, whether formerly or currently so employed or contracted.

(c) All SARS officials, including a person contracted by SARS, are obliged to take an oath of secrecy. Failure to take the oath before commencing duties is a statutory offence.

(d) The general prohibition of disclosure rule is now specifically applicable to information unlawfully obtained by any person. This would apply, for example, where a current or former SARS official discloses information contrary to the secrecy provisions to the media, in which case the media would be prohibited from publishing the information.

(e) A new exception to the general prohibition of disclosure rule is that the Commissioner may, for purposes of protecting the integrity and reputation of SARS as an organisation, disclose information to counter or rebut false

allegations or information disclosed in the media or in any other public manner by a taxpayer, the taxpayer‘s representative or another person acting under the instructions of the taxpayer. The proposed checks and balances for the exercise of this power are:

Only the Commissioner personally may approve such disclosure;

The disclosure must be for the protection of the integrity and reputation of SARS as an organisation;

The disclosure must be limited to taxpayer information that is necessary to rebut the false allegations;


The false allegations must have been made by the taxpayer personally or someone authorised to do so by the taxpayer; and

Prior notice of at least 24 hours before publication should be given to the taxpayer.

2.2.6.2 SARS confidential information (clause 68): A new definition of SARS confidential information is included and the disclosure of SARS confidential information is regulated and unauthorised disclosure criminalised. SARS confidential information is information that is relevant to the administration of a tax Act that is, for example, confidential information such as internal policies, legal opinions and memorandums.

The concept is narrowly defined and only information relevant to tax administration is included. The disclosure of SARS confidential information to a SARS official who is not authorised to have access to the information is also prohibited.

2.2.6.3 Secrecy of taxpayer information and general disclosure (clause 69): The general rule in this regard, i.e. that a person who is a current or former SARS official may not disclose taxpayer information to a person who is not a SARS official, has the following exceptions:

(a) In the course of performance of duties under a tax Act, which includes disclosure—

to the South African Police Service or the National Prosecuting Authority of information relating to tax offences for purposes of the prosecution thereof;

as a witness in any civil or criminal proceedings under a tax Act; or

subject to section 69(3) and (4), by order of a High Court.

(b) Disclosure under any other Act, including a tax Act, which expressly provides for the disclosure of the information notwithstanding the secrecy provisions, for example section 71(1) of the Prevention of Organised Crime Act, 2000, and sections 36 and 37 of the Financial Intelligence Centre Act, 2001.

(c) Disclosure ‘‘by order of the High Court’’:

The current law provides that a competent Court may order disclosure of taxpayer information. This includes a Magistrate’s Court, Maintenance Court and a section 205 enquiry by a Magistrate under the Criminal Procedure Act, 1977. This power is now limited to the High Court to ensure better protection of taxpayer information.

An application procedure is prescribed which requires at least 15 business days notice to SARS, as well as the criteria which a judge must consider before granting a disclosure order.

(d) Disclosure is also permitted if the information is public information.

2.2.6.4 Disclosure to other entities (clause 70): This clause generally provides for disclosure to organs of state and other institutions of information to the extent required for purposes of the performance of legislative functions under the legislation regulating such institutions. However, despite the provisions in this clause permitting disclosure, a senior SARS official has an ‘overriding discretion’ not to disclose information that may otherwise be disclosed under this clause if the official is satisfied that the disclosure would seriously impair a civil or criminal investigation under a tax Act.

Under current tax law the disclosure of certain information to the following entities is

permitted:

The Director-General of the National Treasury;

The Statistician General;

The Board administering the National Student Financial Aid Scheme;

The Governor of the SARB (only information required for functions under the Exchange Control Regulations); and

The Auditor-General, for purposes of his or her functions, has full access to SARS’ records and information.

Also, the current disclosure to an employer of the income tax reference number, identity number, physical or postal address of an employee and such other non-financial information as that employer may require in order to comply with its obligations in terms of a tax Act, is now included under this clause. This disclosure, inter alia, is aimed at ensuring the correctness of employees’ tax certificates (IRP5’s).

Disclosure to a Commission of Enquiry established by the President of the Republic of South Africa is now included under this clause.

In addition to disclosures and the extent thereof permitted under current law, a new legislative framework for the disclosure of financial regulatory or basic information to specified organs of state, related agencies and certain other institutions is proposed in this clause.


(a) Disclosure to financial regulatory agencies: The TAB proposed the disclosure of specific information under prescribed conditions to the following agencies:

Financial Services Board (FSB);

South African Reserve Bank (SARB);

Financial Intelligence Centre (FIC); and

National Credit Regulator (NCR).

This follows the proposal in the 2010 Budget Review that the secrecy provisions of the various ‘‘regulatory and enforcement agencies under the umbrella of the Minister of Finance’’ be revised to allow for exchange of information within a legislative framework.

A review of the taxpayer secrecy provisions was undertaken for purposes of proposing a mechanism to effect such information exchanges between SARS and other organs of state and its agencies and other institutions. This review was also necessitated by the fact that the current legislative mechanisms for allowing disclosure of taxpayer information to such entities are disjointed and inconsistent.

The Bill proposes to consolidate the current legislative frameworks for the disclosure of taxpayer information into a single framework in the TAB setting out the general criteria for and extent of such disclosure. Essentially, it is

proposed that the framework should only permit disclosure to the extent that the disclosure is—

necessary to exercise a power or perform a function or duty under the legislation of that particular organ of state or agency; and

relevant and appropriate to what the disclosure is intended to achieve as determined under the legislation governing the functions of the applicable organ of state or agency.

(b) Disclosure for purposes of verification of basic information: The accuracy of identifying and other basic information relating to a taxpayer is essential to SARS and organs of state. Therefore, the TAB in this clause provides for the disclosure of information for purposes of the verification of the correctness thereof to an organ of state or institution listed in a public notice issued by the Minister of Finance. An ‘‘institution’’ may include a private institution.

The information that may be disclosed is limited to the name and taxpayer reference number of a taxpayer, any identifying number assigned to a taxpayer (e.g. an identity or passport number or company registration number), the physical address, postal address and other contact details of a taxpayer (e.g. telephone number and email address.), the name, address and contact details of the taxpayer’s employer; and other non-financial information as the organ of state or institution may require for purposes of the verification of the above information.

2.2.6.5 Disclosure to SAPS or NPA of information regarding non-tax offences (clause 71): An application for a court order for the disclosure of information regarding specified types of serious offences may be brought by means of ex parte Court application by SARS, or by the South African Police Service (‘‘SAPS’’) or the National Prosecuting Authority (‘‘NPA’’).

Under current law only SARS may initiate such proceedings, but this does not adequately cater for circumstances where the SAPS or the NPA has reason to believe that such information is in the possession of SARS and wishes to apply for the disclosure thereof. As the application is ex parte no notice to the taxpayer concerned is required, but an application procedure as between SARS and the NPA or SAPS is prescribed which requires at least 10 business days notice to SARS by the NPA or SAPS when initiating the application.

2.2.6.6 Disclosure to taxpayer of own records (clause 73): A taxpayer is entitled to:

(a) Access to information which the taxpayer provided to SARS.

(b) A certified copy of the recorded particulars of an assessment or a decision subject to objection and appeal under clause 104(2) of the TAB.

(c) Information obtained by SARS, from third parties or other sources, provided that a request for this information is made under the Promotion of Access to Information Act, 2000 (PAIA). This would entitle SARS, where necessary, to refuse disclosure on an applicable basis of refusal listed in PAIA, for example where disclosure is premature and will prejudice the outcome of an investigation, or reveal the identity of an informant.

2.2.6.7 Publication of names of offenders (clause 74): The information regarding a convicted tax offender which may be published, after all appeal rights have been exhausted, excludes such offender’s address and may now only refer to the area of residence of the person concerned.


2.2.7 Chapter 7: Advance rulings

Clauses 75 to 90: The advance ruling system currently regulated in the Income Tax Act and the Value-Added Tax Act is incorporated in the TAB. The provisions establish the framework for the system and set out basic rules regarding the application process, fees, exclusions and refusals, the effect of rulings, the impact of subsequent law changes, retrospectivity and the publication of rulings. They also provide for specific rules in respect of the three primary types of rulings, i.e. binding general rulings, binding private rulings and binding class rulings.

2.2.8 Chapter 8: Assessments

In general, more generic terms regarding assessments are used to include future modernisation initiatives such as a full self-assessment system.

New provisions

2.2.8.1 Original assessments (clause 91): The concept of an ‘‘original assessment’’, i.e. the first assessment in respect of a tax period, is now a defined term that relates to a specific type of assessment, similar to other types i.e. ‘‘reduced assessment’’ and ‘‘additional assessment’’. Generally, an assessment by SARS may be based on the return information or other information available or obtained in respect of the taxpayer.

In the context of self-assessment, the submission of a return which incorporates a determination of the amount of a tax liability constitutes an original assessment. If a tax Act requires a taxpayer to make a determination of the amount of a tax liability and no return is required, the payment of the amount of tax due is an original assessment. If no return or payment is made, SARS may issue an original assessment based on an estimation. If the taxpayer thereafter submits the return or makes the required payment, it would constitute an additional or reduced assessment, as the case may be.

2.2.8.2 Additional assessments (clause 92): Provision is made for simplified grounds on which additional assessments may be issued to achieve alignment across taxes. A new simplified concept ‘‘prejudice to SARS or the fiscus’’ will be used as a basis for the issue of additional assessments, for example a previous understatement of income prejudices SARS or the fiscus in that the correct amount of tax was not assessed. This general concept is used essentially to cater for all circumstances in the tax Acts which may give rise to an additional assessment.

2.2.8.3 Reduced assessments (clause 93): Changes were effected to current law to clarify that a reduced assessment will also be issued in the case of an undisputed error made by the taxpayer in a return, for example the omission of deductions to which the taxpayer would otherwise be entitled to. If the error is disputed, for example where SARS is not satisfied than an understatement was purely erroneous, the taxpayer will need to object against the disputed assessment.

2.2.8.4 Jeopardy assessments (clause 94): Jeopardy assessments, also known as a ‘‘protective assessments’’, are introduced and may be issued in advance of the date on which the return is normally due in order to secure the early collection of tax that would otherwise be in jeopardy or where there is some danger of tax being lost by delay. A jeopardy assessment may be issued where the taxpayer, for example, tries to place assets beyond the reach of SARS’ collection powers when an investigation into the taxpayer’s tax affairs is initiated. In addition to the power to object and appeal the assessment, an affected taxpayer may apply to a High Court for a review of the assessment on the basis that the amount thereof is excessive or that the circumstances on which SARS relied to justify a jeopardy assessment do not exist.

2.2.8.5 Estimation of assessments (clause 95): In the TAB the concept of an ‘‘estimated assessment’’ is replaced with the concept of an assessment based on an ‘‘estimation’’. To counteract non-, late or inadequate filing, SARS may issue an assessment on an estimation based on information readily available to it. Provision is still made for an agreed assessment, if a taxpayer is unable to submit an accurate return.

2.2.8.6 Notice of assessment and recording of an assessment (clauses 96 and 97): The requirements for a valid assessment are set out. Also, the following additional information must be provided by SARS:

(a) In the case of an assessment based on an estimation or an assessment that is not fully based on a return submitted by the taxpayer, a statement of the grounds for the assessment.

(b) In the case of a jeopardy assessment, the grounds for believing that the tax would otherwise be in jeopardy.

2.2.8.7Withdrawal of assessments (clause 98): In addition to the circumstances under current law as to when assessments may be withdrawn, provision is made for the withdrawal of an assessment issued as a result of an incorrect payment allocation by SARS, which may inter alia occur in the case of self-assessment for which no return is required.

2.2.8.8 Period of limitations for issuance of an assessment (clause 99): The periods of limitation for the issue of an assessment by SARS is:

(a) In the case of an assessment by SARS, three years after the date of the original assessment.

(b) In the case of self-assessment for which a return is required, five years after the date of the actual submission of the return (i.e. the ‘‘original assessment’’) by the taxpayer or, if no return is submitted by the taxpayer, the date of the issue of the original assessment by SARS.


(c) In the case of a tax for which no return is required, five years from the date of the actual payment of the tax. If only a portion of the tax was paid, for example under an instalment payment agreement, the period will run from the date of the last payment prior to defaulting under such an agreement. If no payment was made in respect of the tax for the tax period, it is five years after the effective date, as referred to in clause 187(4).

(d) In the case of an additional or reduced assessment, no further assessment may be issued if the preceding assessment was issued in accordance with a practice generally prevailing at the date of the assessment.

(e) In the case of self-assessment for which no return is required and payment is made, which payment constitutes an original assessment, no further assessment may be issued if the payment was made in accordance with the practice generally prevailing at the date of that payment.

(f) If a dispute has been resolved under Chapter 9 of the TAB, no further assessment may be issued.

The above limitations on the issue of assessments by SARS do not apply to the extent that:

(i) In the case of assessment by SARS, the fact that the full amount of tax chargeable was not assessed was due to fraud, misrepresentation or non-disclosure of material facts.

(ii) In the case of self-assessment, the fact that the full amount of tax chargeable was not assessed was due to fraud, intentional or negligent misrepresentation, intentional or negligent non-disclosure of material facts or the failure to submit a return or, if no return is required, the failure to make the required payment of tax.

(iii) SARS and the taxpayer agree prior to the expiry of the limitation period that the limitations do not apply.

(iv) An assessment must be issued to give effect to the resolution of a dispute under Chapter 9 or a final judgment pursuant to an appeal under Part E of Chapter 9 and there is no right of further appeal. Particularly in the latter regard, if a dispute is pursued to the Supreme Court of Appeal, judgment is often given more than three to five years after the ‘‘date of assessment’’, as defined in clause 1, of the original assessment.

2.2.8.9 Finality of assessment or a ‘decision referred to in clause 104(2)’ (clause 100): All instances where an assessment or ‘decision’ which is subject to objection and appeal will become final and conclusive are listed in this clause. This is done for the sake of clarity, as under current law the provisions are dispersed throughout the tax Acts.

Although the finality of an assessment or ‘‘decision’’ under clause 100(1) does not prevent SARS from making an additional assessment, reduced assessment or making a ‘‘decision’’, this will not be possible after the expiry of the limitation periods referred to in clause 99, unless the exceptions to the limitation apply, for example fraud, misrepresentation or non-disclosure of material facts.

In the case of an assessment that is final pursuant to a judgment by the tax court, SARS may only make an additional assessment, even within the limitation period, in respect of an amount of tax that has been dealt with in the disputed assessment, in the event that the fact that the full amount of tax chargeable was not assessed was due to fraud, misrepresentation, non-disclosure of material facts or the failure to submit a return or, if no return is required, the failure to make the required payment of tax.

However, if the assessment became final in consequence of a judgment by a higher court, no additional assessment or reduced assessment may be issued.

2.2.9 Chapter 9: Dispute Resolution

Only specific clauses in this Chapter will be discussed, as the remainder are largely based on current law.

New provisions

2.2.9.1 Definitions (clause 101): An important definition for purposes of Chapter 9 is a ‘‘decision’’, which if used in single quotation marks means a decision which is subject to objection and appeal under clause 104(2). The word assessment, as explained above, does not include a ‘decision’ as is the case in current law.

2.2.9.2 Burden of proof (clause 102): The rule has been changed to align it across taxes.

(a) Burden of proof on taxpayers: These provisions have been amended to align the general burden of proof on taxpayers across taxes.

(b) Burden of proof on SARS: The burden of proving whether an estimation on which an assessment is based is reasonable, and the grounds for the imposition of an understatement penalty, is on SARS.

2.2.9.3 Rules for dispute resolution (clause 103): The current enabling provision for these rules, i.e. section 107A of the Income Tax Act, 1962, will be deleted in the Schedule of Amendments to the TAB and new, revised rules will be issued under this clause.

2.2.9.4 Objection against assessment or decision (clause 104):A taxpayer may object against:

(a) Any assessment where the taxpayer is aggrieved by the assessment.

(b) A decision by SARS not to extend the period for objection or appeal where the

taxpayer requested such extension.

(c) A decision not to authorise a refund under clause 190.


(d) Any decision that may be objected to or appealed against under a tax Act.

Such decisions in the Income Tax Act will be included in section 3 of that Act pursuant to the amendment thereof by the Schedule of Amendments to the TAB. In the Value-Added Tax Act, 1991, these decisions are mostly to be

found in section 32 of that Act.

2.2.9.5 Decision on objection (clause 106): This clause specifically provides that the notice by SARS informing a taxpayer of the disallowance or partial allowance of an objection, must state the basis for the decision and a summary of the procedures for appeal.

Clause 106(6) inserts a new test case provision, under which a senior SARS official may designate an objection or appeal as a test case if the official considers that the determination of the objection or appeal, whether on a question of law only or on both a question of fact and a question of law, is likely to be determinative of all or a substantial number of the issues involved in one or more other objections. The official may then stay the other objections or appeals by reason of the taking of a test case on a similar objection or appeal before the tax court. The test case procedure will be regulated by the rules to be issued under clause 103, which will inter alia provide for remedies for taxpayers who do not wish their objections or appeals to be stayed or subject to the outcome of a test case.

2.2.9.6 Appointment of chairpersons of the tax board (clause 111): This clause inter alia obliges a chairperson of the tax board to withdraw where there is a conflict of interest which may give rise to bias, whether on own volition or upon application by either of the parties. Such application may also be made in the event of other indications of bias.

2.2.9.7 Decision of tax board (clause 114): The tax board is available as a more informal forum to resolve tax disputes involving tax in dispute of, currently, less than R500 000 and should be a more expeditious process than an appeal to the tax court. The tax board’s decision period (60 business days) is prescribed to avoid current problems where chairpersons take, for example, up to 2 years to deliver the decision. If the chairperson fails to deliver the decision within the 60 day period, the taxpayer may require that the appeal be referred to the tax court to be considered afresh.

2.2.9.8 Conflict of interests of tax court members (clause 122): This clause inter alia obliges a member of the tax court to withdraw where there is a conflict of interest which may give rise to bias, whether on own volition or upon application by either of the parties. Such application may also be made in the event of other indications of bias.

2.2.9.9 Sittings of tax court not public (clause 124): A new exception to this rule is inserted, namely that the court may direct on application by any party and under exceptional circumstances that a sitting be held in public.

This was inserted as a result of the concern that a constitutional difficulty may arise if only the taxpayer concerned may request that a sitting be held in public, as this may conflict with the open justice principle.

2.2.9.10 Order for costs by tax court (clause 130): Where a cost order is granted in favour of SARS in the tax court or a higher court, these amounts would constitute funds of SARS within the meaning of section 24 of the SARS Act. The main reason for this is that cost orders are intended to reimburse a party for its legal costs—this is not achieved if SARS uses its own money to pay for legal proceedings and the money pursuant to a costs order in favour of SARS is then paid into the National Revenue Fund.

2.2.9.11 Publication of judgments of tax court (clause 132): All tax court judgments must be published for general information, whether marked reportable or not, in a format that does not reveal the identity of the taxpayer (unless the sitting of the tax court was public under the circumstances referred to in clause 124(2)). The reason for providing that all judgments be published, is essentially to address complaints that currently only SARS has the benefit of access to unreported and unpublished judgments.

2.2.9.12 Settlement of disputes (clauses 142 to 149): These provisions are changed to cater more clearly for the implications for SARS and rights of SARS where the taxpayer defaults after conclusion of the settlement. The change essentially enables SARS to choose between regarding the settlement agreement as breached as a result of which the full disputed amount remains due (and the dispute must continue) or enforcing specific performance of the settled amount in which event the dispute is regarded as finalised.

It is also clarified that a settlement can only be concluded after the issue of an assessment. When the section 88A settlement procedures were introduced in 2003 in the Income Tax Act, 1962, the underlying assumption was that the settlement of disputes would only commence after the relevant assessment. This assumption is reinforced by the fact the section 88H of Income Tax Act, 1962, provides for ‘‘a revised assessment’’ to give effect to a settlement i.e. section 88H is based on the assumption that the dispute would be based on an existing assessment that needs to be revised.

Operational uncertainty, however, arose after 2003 as to whether settlements may be concluded prior to assessments. Settlement procedures under the TAB are accordingly limited to post-assessment disputes which should, inter alia, avoid the possibility of ‘‘negotiated assessments’’ and ensure proper reporting of settlements to the Auditor- General and Minister of Finance.


2.2.10 Chapter 10: Tax liability and payment

New provisions

2.2.10.1 New categories of persons liable to tax (clauses 151 to 159): This Chapter includes new categories of persons liable to tax in order to simplify and clarify the tax liability of different persons, and the capacity in which they may be liable for tax debts.

The circumstances when a tax liability in respect of each category of person will arise both in representative capacities and personal capacities are then described. The categories are:

(a) Persons chargeable to tax (primary liability)

(b) Representative taxpayers

(c) Withholding agents

(d) Responsible third parties

(e) A person who is the subject of a request to provide assistance under an arrangement made with a foreign government by an agreement entered into in accordance with a tax Act (for example section 108 of the Income Tax Act).

2.2.10.2 Right to recovery of taxpayers (clause 160): A representative taxpayer, withholding agent and responsible third party who pays a tax in that capacity is entitled to recover the amount so paid from the taxpayer on whose behalf it is paid, or to retain an equivalent amount out of money or assets of the taxpayer in that person’s possession. A taxpayer, on whose behalf an amount was withheld and paid by a withholding agent under the agent’s statutory obligation to do so, may not recover the amount from the withholding agent.

2.2.10.3 Security by taxpayer (clause 161): Under certain circumstances a taxpayer, in any of the listed situations, may be required to provide security for purposes of safeguarding the collection of tax, for example, where the taxpayer is a withholding agent who has frequently failed to withhold or pay the tax due.

In addition, in the case of a taxpayer which is not a natural person and cannot provide the required security, any or all of the members, shareholders or trustees who control or are involved in the management of the taxpayer may be required to enter into a contract of suretyship in respect of the taxpayer’s liability for tax which may arise from time to time. As security provided by a taxpayer under this clause is aimed at securing the recovery of tax that may, in future, be in jeopardy a decision to require security is not subject to objection and appeal, but is otherwise reviewable by, for example, requesting SARS to review the decision internally under clause 9(1)(b) or by pursuing external remedies. Security in the form of a cash deposit may be recovered under the recovery provisions contained in the TAB.

2.2.10.4 Determination of time and manner of payment of tax (clause 162): The TAB provides for enabling provisions allowing SARS to determine the time and manner of payment of tax. Provision is also made for an expedited due date for payment or the provision of security where there is a risk of dissipation of assets to evade or frustrate the collection of tax.

2.2.10.5 Preservation of assets order (clause 163): SARS may apply for a preservation of assets order by a High Court and may, in anticipation of such order, seize assets about to be dissipated. Where SARS seizes the assets first, the order must be applied for within 24 hours of seizure. This power is also available as a conservancy measure for purposes of mutual assistance in the recovery of tax on behalf of foreign governments under clause 185. Assets seized under this clause must be dealt with in accordance with the directions of the High Court which made the preservation order.

2.2.10.6 Payment of tax pending objection or appeal (clause 164):

(a) Clarity is provided that the obligation to pay tax, which arises upon the issue of an assessment, is not ‘‘automatically’’ suspended by an objection or appeal. The obligation can only be suspended by SARS upon request by the taxpayer.

(b) In view of the fact that the due date for the payment of tax under an assessment is normally before the due date for lodging an objection and to cater for pre-objection requests for adequate reasons, a suspension request may be made before an objection is lodged. However, such suspension will be automatically revoked if no objection is lodged. If the objection is lodged but is based on frivolous or vexatious grounds, the suspension of the obligation to pay may be revoked by SARS.

(c) The discretion to suspend payment or to revoke it is based on criteria specified in the TAB, to enable a taxpayer to understand what criteria will be considered in reviewing a request for suspension.

(d) A new obligation is placed on the senior SARS official to periodically review the suspension (on a risk basis) during the dispute, and to revoke the suspension in the case of dissipation of asset risks or delaying tactics employed by the taxpayer.

(e) No recovery proceedings by SARS may commence during the period commencing on the day SARS issues its decision not to suspend payment or a notice of revocation, and 10 business days thereafter. This is to enable a taxpayer to consider its rights, for example whether to bring a review application against the decision not to suspend or to revoke.

(f) A taxpayer who pays and whose objection is upheld, is entitled to interest from the date of payment of the disputed amount to the date on which such amount is refunded. This rule applies across all taxes.


2.2.10.7 Taxpayer account and allocation of payments (clauses 165 and 166): A framework to support the modernisation of SARS’ accounting system is created, within which:

(a) A single taxpayer account with a rolling balance may be created.

(b) Payment allocation rules may be applied in respect of a specific tax type or a group of tax types, for example, the application of the first-in-first-out rule.

2.2.10.8 Deferral of payment (clauses 167 and 168): Where a taxpayer is unable to pay a tax debt in a single amount within the prescribed payment period, provision is made for a formal instalment payment arrangement in accordance with prescribed criteria and procedures. This is essentially a debt relief mechanism but is only applicable if the criteria to qualify for such an arrangement are met. A senior SARS official may enter into such an agreement with a taxpayer, under which the taxpayer may be allowed to pay a tax debt in a single amount after a prescribed period or in instalments. SARS may terminate an agreement if the taxpayer fails to pay an instalment or fails to otherwise comply with its terms, and payments made prior to the termination will be retained by SARS as part payment of the tax debt.

2.2.11 Chapter 11: Recovery of tax

Generally, the strengthening of rights to collect tax from responsible third parties effected in this Chapter is aimed at strengthening SARS’ collection powers:

(a) In respect of transactions involving the transfer of assets offshore.

(b) Where certain events result in the limitation or frustration of the collection of tax debts by SARS.

In addition, the potential personal liability of parties involved in the financial affairs of a company should serve as encouragement to comply with the tax laws by ensuring correct and timely payment of tax.

No major changes were effected in respect of the provisions enabling SARS to assist in the collection of foreign taxes.

New provisions

2.2.11.1 Period of limitation on collection of outstanding tax debts (clause 171): The current 30 year prescription period for tax according to the Prescription Act, 1969, is now prescribed in the TAB and is reduced to 15 years. This will ensure a more practical and realistic approach to SARS’ debt book management and is more aligned with international best practice.

2.2.11.2 Application for civil judgment for recovery of tax (clause 172): To ensure alignment with the ‘‘pay now argue later’’ rule under which SARS may recover a disputed amount of tax as contemplated in clause 164, clause 172(2) provides that SARS may file a statement, that has the effect of civil judgment for debt, irrespective of whether or not the amount of tax is subject to an objection or appeal under Chapter 9, unless the obligation to pay the amount has been suspended under clause 164.

2.2.11.3 Liability of third party appointed to satisfy tax debts (clause 179): Under current law, this is an ‘‘agent appointment’’ effected under, for example, section 99 of the Income Tax Act, 1962. The use of the term ‘‘agent’’ was considered unnecessary —

under this clause any third party who holds or owes or will hold or owe monies to the taxpayer, may by notice by a senior SARS official be required to pay the amounts to SARS. If that person is unable to comply with a requirement of the notice the person must advise the senior SARS official of the reasons for not complying within the period specified in the notice, and SARS may withdraw or amend the notice as is appropriate under the circumstance.

A person receiving a notice must pay the money in accordance with the notice and, if the person parts with the money contrary to the notice, the person is personally liable for the money.

If SARS under this recovery power requires a third party, for example, an employer to pay amounts to SARS in satisfaction of the taxpayer’s tax debt, provision is made that SARS may, on request by a person affected, extend the period over which the amount must be paid to SARS to allow the taxpayer to cover his or her and legitimate dependant’s basic living expenses.

2.2.11.4 Personal liability of person involved in financial management (clause 180): A person who controls or is regularly involved in the management of the overall financial affairs of a taxpayer with outstanding tax debts may be held personally liable for such debts where a senior SARS official is satisfied of negligence or fraud on the part of such person in the payment of tax debts of the taxpayer. Liability is proportional to the extent that the negligence or fraud resulted in the non-payment of the tax debt.

2.2.11.5 Liability of shareholders and liability of transferees (clauses 181 and 182): Provision is made for the liability of shareholders who receive assets from an unlisted company with outstanding tax debts within one year of its winding-up, as well as the liability of transferees who are connected persons in relation to the transferor with an outstanding tax debt and who receive property for no consideration or below fair market value.

2.2.11.6 Liability of person assisting in dissipation of assets (clause 183): A person who knowingly assists a taxpayer in the dissipation of assets to avoid or frustrate the collection of tax may be held jointly and severally liable with the taxpayer for the tax debt. The person’s liability is, however, limited to the extent that the assistance reduces the assets available to pay the taxpayer’s tax debt i.e. the actual amount by which the assets are reduced as a result of the person’s assistance.


2.2.11.7 Recovery powers against responsible third parties (clause 184): SARS has the same powers of recovery referred to in Part D of Chapter 11 against the assets of a responsible third party as SARS has against the assets of the taxpayer.

2.2.11.8 Compulsory repatriation of foreign assets of taxpayer (clause 186): Where a taxpayer has offshore assets which could be utilised to satisfy tax debts, provision is made that SARS may apply to the High Court for an order to compel the repatriation of these assets. The Court may impose certain sanctions where the taxpayer fails to comply, for example imprisonment based on contempt of court, or the imposition of other limitations (for example requiring the taxpayer to cease trading), until the taxpayer has complied with the court order.

2.2.12 Chapter 12: Interest

Chapter 12 creates inter alia a framework to support the modernisation of SARS’ accounting system regarding interest, within which interest provisions may be aligned across taxes and interest due or payable calculated on the daily balance owing and compounded monthly.

The general rule is that that interest accrues from the ‘‘effective date’’, as described in clause 187(4), to the date of payment.

Interest on an amount refundable under clause 190 is calculated from the later of the effective date, or the date that the excess was received by SARS to the date the refunded tax is paid by SARS. In other words, if the overpayment only occurred after the effective date, interest will be calculated from such ‘‘out of pocket’’ date and not the earlier ‘‘effective date’’.

If a refund is offset under clause 191 against an existing tax debt of the taxpayer, the date on which the offset is effected is considered to be the date of payment of the refund. Exceptions to this rule may remain in some tax Acts, for example section 45 of the Value-Added Tax Act, 1991. The effective date in relation to an additional assessment or reduced assessment is the effective date in relation to the tax payable

under the original assessment. Separate provision is made for interest payable in respect of the first and second payment of provisional tax in clause 188(2). The discretion to remit interest is retained, but limited to specified circumstances beyond the taxpayer’s control.

2.2.13 Chapter 13: Refunds

This Chapter caters for the payment of refunds by SARS to a taxpayer. A taxpayer is generally entitled to a refund of:

(a) an amount properly refundable under a tax Act and reflected in an assessment (i.e. including a return which is a self-assessment such as a VAT return); or

(b) the amount erroneously paid in respect of an assessment in excess of the amount payable in terms of the assessment (for example, where a taxpayer while making an EFT payment erroneously pays more than what is required in the assessment).

Provision is made for a refund paid into a wrong account by SARS to be collected as if it was a tax. In the absence of such a provision SARS, pursuant to paying amounts into incorrect accounts, will only be able to recover the amounts through protracted common law remedies such as unjust enrichment.

Furthermore, a refund need not be authorised by SARS until such time that a verification, inspection or audit of the refund has been finalised. A taxpayer will remain entitled to interest from the later of the effective date or date that the overpayment was made, to the date of the payment of the refund by SARS after finalisation of the verification, inspection or audit. SARS must authorise the payment of a refund before the finalisation of the verification, inspection or audit if security in a form acceptable to a senior SARS official is provided by the taxpayer.

2.2.14 Chapter 14: Write off or compromise of tax debts

These provisions provide for what is essentially a form of tax debt relief which may be afforded to taxpayers under certain prescribed circumstances. No major changes were made to current law, except that the circumstances where it is appropriate to compromise a tax debt were made less restrictive, by removing some of the factors that disqualify the tax debtor from a compromise agreement.

2.2.15 Chapter 15: Administrative Non-Compliance Penalties

The administrative penalties introduced under section 75B of the Income Tax Act are included in the TAB so as to apply across taxes, but are referred to as an ‘administrative non-compliance penalty’ to distinguish it from an ‘understatement penalty’ imposed under Chapter 16 (referred to under current law as ‘additional tax’). These penalties relate to failures to comply with administrative requirements of the tax Acts.

Non-compliance that results in an understatement of tax due, is addressed under the understatement penalty regime in Chapter 16.

New provisions

2.2.15.1 Fixed amount administrative penalties may only be imposed in respect of non-compliance listed in a public notice by the Commissioner, and not any non-compliance with an obligation under a tax Act. The purpose of the notice is to only target impactful or more serious non-compliance and only when SARS’ systems are in place to do so effectively.


2.2.15.2 In terms of clause 213, percentage based penalties are imposed under the TAB if SARS is satisfied that an amount of tax was not paid as and when required under a tax Act. SARS may impose a ‘‘penalty’’ equal to the percentage, as prescribed in the relevant tax Act, of the amount of unpaid tax. The procedures for the imposition and remittance of a percentage based penalty are regulated by the TAB, but the circumstances that trigger the imposition of the penalty remain in the tax Act.

2.2.15.3 The current administrative non-compliance penalty of R1 million or more for failure to report a reportable arrangement has been included in this Chapter and changed to ensure that the amount of the penalty is imposed on a more proportionate basis. The basis, amount and procedure for the imposition and remittance of this penalty are, therefore, regulated by the TAB.

2.2.16 Chapter 16: Understatement penalty

Provision is made that the current open-ended discretion to impose an understatement penalty (under current law referred to as ‘additional tax’) of up to 200% is now limited by a new structure whereby the percentage of the understatement penalty will be determined by the taxpayer’s behaviour and objective criteria listed in a table. This is aimed at ensuring consistent treatment of taxpayers in comparable circumstances. The rationale for replacing the concept of ‘additional tax’ with the term ‘understatement penalty’ is:

(a) It would remove any uncertainty as to whether ‘additional tax’ is a tax that may only be imposed under a money bill as contemplated in section 77 of the 1996 Constitution.

(b) The South African courts have held on more than one occasion that additional tax is in essence a penalty, and not a tax on, for example, income as the name suggest.

New provisions

2.2.16.1 Understatement penalties under the TAB now predominantly target more serious non-compliance, such as conduct that includes elements of tax evasion. An understatement penalty is triggered by an ‘‘understatement’’ as defined in clause 221, and the percentage of the understatement penalty imposed will be based on specified behaviour. A table of understatement penalty percentages based on specified and defined (where required) behaviour is included.

2.2.16.2 The onus to prove the grounds for imposition of an understatement penalty and the applicable percentage now rests on SARS.

2.2.16.3 Voluntary Disclosure Programme (‘‘VDP’’) (clauses 225 to 233): A permanent legislative framework for voluntary disclosure applicable across all tax types, excluding customs and excise, is included in this Chapter. The main purpose of such a framework will be to enhance voluntary compliance and is in the interest of the good management of the tax system and the best use of SARS’ resources. The permanent framework in the TAB will not provide interest or exchange control relief but will on a permanent basis provide the following relief:

(a) If the taxpayer has remedied all non-compliance with any obligation under a tax Act, 100% relief in respect of an administrative non-compliance penalty that was or may be imposed under Chapter 15, excluding a penalty imposed under that Chapter or in terms of a tax Act for the late submission of a return.

(b) The relief in respect of any understatement penalty referred to in column 5 or 6 of the Understatement Penalty Percentage Table in clause 223.

(c) SARS will not pursue criminal prosecution.

2.2.17 Chapter 17: Criminal offences

General statutory offences are now included in the TAB but tax type specific offences may remain in the other tax Acts. Provision is made for non-compliance offences, tax evasion and contravention of secrecy provisions. Criminal sanction under this Chapter may be pursued by SARS in addition to imposing an administrative non-compliance penalty or an understatement penalty.

New provisions

2.2.17.1 Tax evasion ‘‘reverse onus’’ (clause 235(2)): The reverse onus on a taxpayer under current law has been removed. SARS has been advised that this onus in its current form will not survive a constitutional challenge and should be replaced by a ‘‘lesser onus’’, in terms of which the taxpayer will only need to prove that there is a reasonable possibility that the taxpayer was ignorant of the falsity of the fraudulent statement and that such ignorance was not due to negligence.

2.2.17.2 Decision to lay a complaint of statutory tax evasion (clause 235(3)): The decision to lay a complaint for tax evasion must be taken by a senior SARS official.

2.2.18 Chapter 18: Reporting of unprofessional conduct

No major changes were effected, except that a condition has been added to the existing requirement that a person who gives tax advice must register as a tax practitioner with SARS. A person who during the five years before his application for registration has been removed from a related profession or professional body for dishonesty, or convicted for a crime involving dishonesty, may not be so registered.


2.2.19 Chapter 19: General provisions

These provisions are predominantly based on current law, except for clause 244 that limits the period within which a taxpayer may request the extension of a deadline after the expiry of the deadline as well as the circumstances under which such extension will be considered. Also a new provision is inserted in clause 254 which caters for non-material defects in procedural requirements for the issue of documents, for example, assessment. Such defects do not affect the validity of the procedure provided the taxpayer concerned has effective knowledge of the fact of the notice or document and of its content. The procedures and the requirements for the issue of a tax clearance certificate are now regulated in the TAB under this Chapter.

2.2.20 Chapter 20: Transitional provisions

These provisions are aimed at ensuring a smooth transition from current law to the Tax Administration Act, upon commencement of that Act.

Clause 272, which provides for the commencement of the Tax Administration Act, makes provision for different commencement dates including the commencement of certain amendments to the Tax Acts in Schedule 1.

3. CONSULTATION

The TAB involved an extensive review of the existing position in South Africa, an analysis of the international situation to establish best practice and a detailed discussion of a proposed South African model. SARS was also assisted by international tax experts from the IMF and local constitutional experts.

The drafting process involved input from internal stakeholders, and discussions were also held with the National Treasury. During March 2009 a conceptual draft TAB was submitted to the then Minister of Finance, who approved the holding of a closed workshop with external tax experts in May 2009.

Pursuant to the closed workshop, discussions and internal workshops, the commentary received was considered during an extensive internal review of the draft and resulted in certain changes.

A first draft of the TAB was released for public comment on 29 October 2009.

Another workshop was held with external stakeholders at the beginning of March 2010 after the close of the public comment cycle on 26 February 2010, which gave the commentators a further opportunity to debate substantial issues and to raise any additional concerns.

All comments were duly considered and changes where considered necessary were affected to the draft Bill submitted to the State Law Advisers for pre-certification. A workshop with the Economic Sectors, Employment and Infrastructure Development Cluster was held in August 2010, whereafter the draft TAB was submitted for Cabinet approval for the introduction thereof in Parliament, which was given at the end of September 2010.

A second draft of the Bill, including the schedule of amendments to the other tax Acts, was published for public comment on 29 October 2010 and the comment period closed on 15 December 2010.

During February, two further workshops were held with commentators, again to give them a further opportunity to debate substantial issues and to raise any additional concerns.

Comments and input during the above process were received from inter alia the following institutions and interested parties in the tax arena:

ACCA (Association of Chartered Certified Accountants)

ASISA (Association for Savings and Investment South Africa)

BASA (Banking Association of South Africa)

Cape Bar Council

Cliffe Dekker Hofmeyr Inc. Attorneys

Deloitte

Edward Nathan Sonnenbergs

Ernst & Young

KZN Law Society

LSNP (Law Society of the Northern Provinces)

LSSA (The Law Society of South Africa)

PAG (Payroll Authors Group)


PricewaterhouseCoopers

SAICA (South African Institute of Chartered Accountants)

SAIPA (South African Institute for Professional Accountants)

SAIT (South African Institute of Tax Practitioners)

Werksmans Attorneys

Changes arising from the commentary period and the consultative workshops were effected to the Bill and the Bill was submitted for final certification by the State Law Advisers.

4. CONSTITUTIONAL IMPLICATIONS

The TAB focuses on compliance with a number of broad constitutional principles that should apply to each administrative rule, such as equity, fairness, and efficiency. Where fundamental rights are affected, remedial rights of taxpayers or mitigation of the impact are addressed. The TAB was reviewed by external constitutional experts, which review was provided to the Office of the Chief State Law Adviser for consideration during the pre-certification of the TAB for submission to Cabinet.

5. IMPLICATIONS FOR VULNERABLE GROUPS

The simplification of tax administration should assist smaller taxpayers to understand and comply more easily with the tax laws, thereby reducing their compliance burden.

6. IMPLICATIONS FOR PROVINCES

None.

7. FINANCIAL IMPLICATIONS FOR STATE

One of the primary objectives of the TAB is to reduce the costs of tax administration in the medium to longer term. In the short term, however, implementation costs may arise from system changes, changes to prescribed forms, staff training etc., which will be covered from existing funds in SARS’ budget.

8. PARLIAMENTARY PROCEDURE

8.1 The State Law Advisers and SARS are of the opinion that this Bill must be dealt with in accordance with the procedure established by section 75 of the Constitution of the Republic of South Africa, 1996, since it contains no provision to which the procedure set out in section 74 or 76 of the Constitution applies.

8.2 The State Law Advisers are of the opinion that it is not necessary to refer this Bill to the National House of Traditional Leaders in terms of section 18(1)(a) of the Traditional Leadership and Governance Framework Act, 2003 (Act No. 41 of 2003), since it contains no provision pertaining.

Delegate Handbook - Fasset

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