Draft Taxation Laws Amendment Bill 2011 comments

2 Draft Taxation Laws Amendment Bill pages - huge number of amendments Burning issues  Section 45 suspension  Section 8E and 8EA  Headquarter company regime

Burning issues These proposals breach the core principles of Certainty Fairness Reasonability 3

Suspension of intra-group relief in section 45 “intra-group relief is a common feature of most advanced tax systems” ( National Treasury, 2 June 2011 Media Statement”) “Section 45 rollover relief will be wholly suspended for … approximately 18 months. During this period, the continued need for this relief will be re- evaluated …” ( National Treasury, 2 June 2011 Media Statement”) 4

5 Section 45 Long standing feature of our Income Tax Act Where assets are moved within a group of companies, section 45 allows for tax neutrality because in substance there is no economic gain or loss. The relief is needed for reorganisations, BEE transactions and mergers and acquisitions aimed at increasing efficiency, profits, growth and jobs. Suspending a provision found in all advanced tax systems sends a message of uncertainty and lack of sophistication to foreign investors. The persons who will be harmed by this measure are South African businesses and their employees.

Suspension of intra-group relief in section 45 Effective 3 June but no mention of this in the Budget No advance consultation with commerce/industry/advisors Immediate implementation regardless of  the significant cost to the economy  major disruption to many taxpayers (e.g. Mustek)  negative message to foreign investors What is the emergency??

Suspension of section 45 Has an economic study been done, weighing both cost and benefit, that concludes this radical move is justified? Where is the scientific analysis of –  the revenue impact of the abuses?  alternative measures?

8 What is the emergency ? The justification given for an immediate, absolute, retrospective suspension is that Treasury needs more time to  “get all the facts”  think about the problem Two problems – Funnel schemes Excessive debt schemes – debt pushdown

9 Funnel schemes Treasury and SARS have known about funnel schemes in detail for at least 5 years. Funnel schemes are described and categorised as abusive in the SARS’ Tax Avoidance Discussion document Media Statement on funnel schemes issued 20 March “probable tax legislation to follow during the second half of the year” Treasury and SARS know who sold these schemes, who they were sold to and how they work. Their failure to take targeted action in the last 3 years needs to be explained.

Funnel schemes Our General Anti-Avoidance Rule can and should be applied. National Treasury themselves admitted this in 2008 “the funnel financing masquerade is a direct violation of the GAAR on multiple levels” They also noted in 2008 that funnel schemes are “likely to be disregarded as a simulation”. Strong support for SARS for a simulation challenge can be found in the recent NWK case.

11 Excessive interest –debt push down structures Fundamentally different from funnel schemes!! “Real” and necessary debt is incurred by a third party investing in SA –this debt is then “pushed down” so it is deductible. against the operating income of the business acquired SARS has been aware of these structures in detail, and the reasons taxpayers enter into them, since at least Discussions with industry in 2007 and 2008 – changes made to s 45 to prevent sales proceeds leaving the country. SARS given new powers in 2008 to ask taxpayers to report on s 45 transactions – never exercised. Positive advance tax ruling on use of s45 in debt push down structure issued in 2009 (BPR 058).

Debt push down structures What new facts can be uncovered in the next 18 months that SARS has not been able to uncover in the last 7 years? If the concern is that current law allows for companies to become over-leveraged, why are we not discussing the introduction of specific debt limitation rules?

Excessive interest For interest paid to SA residents, SARS is neutral – interest expense is matched by interest income For interest paid abroad, SARB approval is required in all cases and transfer pricing and thin capitalisation rules limit the deductions allowed where the parties are connected For debt paid to foreign unconnected parties, a 10% withholding tax is to be introduced If merited, consideration can be given to further measures to keep deductible interest expense within reasonable limits – there is a significant amount of precedent for this in other countries.

14 Section 8E & 8EA No mention of these amendments in the Budget No advance consultation with commerce/industry/advisors Tantamount to retrospective legislation, as these amendments will apply to existing shares in issue at 1 April 2012  significant impact on existing equity funding structures  tax gross-up clauses in existing agreements will financially cripple many borrowers

15 Section 8E & 8EA Equity funding is often used in minority share deals, where interest-bearing debt proves to be too expensive given the non-deductibility of finance raised to acquire shares. In particular, many of South Africa’s prominent broad-based BEE transactions have legitimately used equity funding for this very purpose. These transactions are likely to be severely impacted by these amendments. If enacted, these amendments will, in many cases, make equity funding significantly more expensive than “unproductive” debt funding!

16 Section 8E & 8EA Section 8E  why the need to drastically increase the safe-haven period from 3 to 10 years?  more than tripling the term of these funding arrangements will dramatically increase the cost of funding  existing reportable arrangement rules already police instruments with a < 10-year term. No indication has been given that these measures have been ineffective, or that abuse has been identified

17 Section 8E & 8EA Section 8EA  put options, security arrangements, and guarantees are standard features in most arm’s length equity funding arrangements  these arrangements are not engineered to disguise interest income as tax free dividends, but are negotiated for a multitude of commercial reasons including ensuring an affordable cost of funding to the borrower  although taxpayers can apply for exemption from section 8EA for shares issued prior to 1 April 2012, the proposed exemption procedure is impractical and highly subjective

18 Headquarter companies The need to obtain Ministerial approval in order to qualify as a headquarter company will kill this concept Impractical, time-consuming and subjective Thinly disguised measure to exclude companies with South African shareholders – possibly a harmful tax practice Very unattractive to investors who have other choices and are looking for certainty

19 Headquarter companies Mauritius South Africa No pre-approval process No exchange controls at all Certainty of tax treatment (no subjective approval criteria/ inflexible annual income test/ frequent changes to tax law) Low tax rate on e.g. interest/ management fees