History has proved that a key driver of sustained economic growth is international integration: the extent to which capital, goods and services move across borders and between countries. By discouraging foreign businesses from investing in South Africa, we imperil our fragile economy and risk a worsening unemployment situation rather solving it. SA desperately needs more rapid economic growth if it is to tackle one of the globe’s lowest employment ratios.

Taxing Times – Ruan Jooste and Sharda Naidoo

When foreigners scour the globe for attractive investment destinations to set up shop, a stable legislative framework and political stability are top of mind. SA, once seen as a desired destination as a gateway into the rest of Africa, is beginning to lose its appeal.

Cries for the nationalisation of mines and banks in SA and uncertainty over tax rules have international investors and local business in a tailspin. More recently deals have had to be put on ice while government dithers over the details of new policies.

Banks and mining companies confirm having to field calls daily from foreign investors about whether nationalisation will become a reality. The politics and leadership battles ahead of the next general election are another concern.

A recent Citi Global Markets report warns of “great value destruction” if nationalisation materialises in a sector that is already unattractive to foreign investors. SA mining activities contribute up to 20% of GDP, but the report says SA is facing increased competition from Russia, Australia, Canada and Brazil.

These countries have turned their large resource bases into large-scale potential greenfield project growth. SA’s large reserve base (estimated at US$2,5trillion), however, shows a limited number of greenfield projects (translating into low levels of production growth), which indicates low levels of investment .

Though the SA miners’ tax rate is around 36% of earnings (before interest and tax but excluding secondary tax on companies) and below that of the US (42%), Australia (43%) and Brazil (41%), many mining houses say they would rather invest in countries with higher tax rates to ensure tenure, which brings the nationalisation debate to the fore. Analysts say talk of nationalisation raises risk premiums for SA miners (normally around 8%, but which could double) as they would have to make more profit to compensate for potential nationalisation .

But there are other more taxing burdens for investors. Tax and the absence of exchange controls are elements that make a country attractive as a gateway. SA has relaxed exchange controls somewhat, but its complex and uncertain tax laws have pushed foreign investors to go elsewhere on the continent to register their companies and set up their African headquarters.

Foreign investors are snubbing SA in favour of countries like Mauritius, which has a simpler tax structure, a more stable political environment and no exchange controls. Rob Hudson, MD of Hayes, Matkovich & Associates, the local promoter of two integrated resort scheme developments (La Balise Marina and Villas Valriche) in Mauritius, says: “We’ve seen a direct link between our sales for investment in Mauritius and political uncertainty. Every time there’s talk of nationalisation , we see a peak in sales for property. Mauritius offers [ what is tantamount to] an insurance policy for South Africans and other foreign investors.” (See story on page 38.)

Kenya, Botswana, the Seychelles and Dubai are also becoming popular alternatives. SA’s tax rates are not competitive with these countries. SA’s corporate tax rate stands at 34,5%, if secondary tax on companies (STC) is included, compared with Mauritius’s 3% for foreign companies. If SA’s withholding tax regime (of 10%) is enforced, as proposed, in 2012, corporate tax will revert to 28%. SA has an effective capital gains tax rate of 10%. Most of these countries don’t have the added burden of capital gains or dividend taxes (see comparative rates table on page 39).

Apart from not being attractive enough, the tax regime has been thrown out of kilter by two unexpected controversial changes in the Draft Taxation Laws Amendment Bill last month. For example, the suspension, until December 2012, of section 45 of the Income Tax Act, which allowed for intergroup transfer of assets in a tax-neutral manner, will raise the cost of dealmaking in SA.

“This ability to transfer assets tax-free is fundamental in any tax system to enable corporate activity,” says Stephan van der Walt, head of corporate finance at international equity and debt house Bravura. “Section 45 is often used in internal restructuring and acquisitions and [its suspension] will affect deals, including black economic empowerment (BEE) deals, which are already seen as a constraint to international businesses.”

Many companies which negotiated and priced deals under the old rules will have to go back to the drawing board to examine their feasibility . A Bravura study shows that the suspension of section 45 could jeopardise BEE transactions such as those done by Aveng, African Bank, MTN, Altech, Palabora Mining and Sasol. Van der Walt says the suspension of section 45 and the proposed change to the tax treatment of preference shares will force BEE parties to rely on special purpose vehicles, raising the funding cost by about 40%.

From April 2012, dividends on preference share funding will be treated as interest, which is subject to tax. It is proposed that the period within which preference shares can be sold be extended from three to 10 years while dividends on third party-backed shares would be deemed to be interest in the hands of the recipient. This means parties to BEE transactions would be taxed three times: within the companies where the profits were generated; on receipt of dividends on ordinary shares subject to pre-emptive rights; and again on dividends gleaned by the funder.

The use of preference-share funding is, in many cases, the only practical form of funding, says Van der Walt. “This will have a detrimental effect on the majority of transactions.” The removal of section 45, he says, has left the market with not much choice.

Ernie Lai King, head of tax services at international law firm Norton Rose SA (formerly Deneys Reitz), says the proposals will affect pricing and financial terms of existing and new deals. “The lack of certainty around these changes is disruptive to commercial activity and disappointing as the tax system has been relatively stable in the past,” he says. “Uncertainty arising from talk of nationalisation and tax surprises is not attractive to business and foreign investment,” he says . “Investors are deterred by unpredictability.”

The fact that mining minister Susan Shabangu has dismissed talk of nationalisation on international investor road shows and finance minister Pravin Gordhan’s pronouncement that the taxman will, at its discretion, grant BEE transactions a tax reprieve, hasn’t done much to dispel industry concerns. Many businesses are adopting a wait-and-see approach on deals until there is further legislative clarity.

“Unless the law is changed, it is difficult to envisage how the SA Revenue Service (Sars) can bless certain transactions as qualifying for section 45 tax relief when that section has been suspended,” says Barry Garven, tax director at Bowman Gilfillan Attorneys. Under current legislation, Sars has no authority to approve any type of transaction, except under the advance ruling process. “The [Income Tax] Act allows Sars to give advance tax rulings only, applied for by taxpayers who are unsure of how a certain part of the act should be applied.” Such a ruling is binding on both the taxpayer and Sars.

However, even under the advance ruling process, Sars cannot approve a transaction as qualifying for tax relief if it falls outside the act’s tax-relief provisions, he adds. The act does not specify that BEE deals should get preferential tax treatment, either.

Lai King suggests that treasury and Sars should rather address their concerns through the use of anti-avoidance provisions, of which there are plenty. “A specific anti-avoidance provision could be introduced into section 45, rather than a holus- bolus suspension, which gives the impression of a knee- jerk panic reaction.”

The general anti- avoidance regulations consist of many complex sections aimed at identifying the type of transactions that are “impermissible tax avoidance arrangements”. Sars has sweeping powers in such transactions. Lai King says it would be preferable to leave the judgment of tax transgressions to the courts. “Tax authorities should not be the sole judge and jury.”

Treasury is not averse to the idea of using the anti-avoidance tools at its disposal as a preferred option. But Ismail Momoniat, treasury’s deputy director- general responsible for tax & financial sector policy, says they have to make judgment calls to curb abuses that are “overly aggressive, and bleeding” the tax system.

“We strive to be fair and equitable, and have a transparent and consultative process to deal with new tax legislation, but sometimes we have to be harsh,” he says. “At times abuse of rules falls out of proportion to the benefit it creates and we need time to investigate.”

He concedes that “we don’t always get it right when we make tax announcements”, and often have to “revise our original proposals” after taking into account public comments. “This is the nature of the tax process,” he says. The public had until last week (July 5) to submit their comments.

Momoniat adds that they will not be intimidated by those consultants making the most noise. “They are often the ones making lots of money from such tax- avoidance structuring.”

But SA’s tax laws are not all restrictive . Treasury is making an effort to attract foreign investors who have been eyeing countries like Mauritius, largely on the basis of their benign tax regimes.

From January 1 this year, treasury introduced less strenuous tax rules under the foreign headquarter (HQ) company framework, offering special dispensation to companies using SA as their regional headquarters for their subsidiaries.

“The incremental tax cost of coming to SA has been taken out of the system,” says Werksmans tax director Ernest Mazansky (see infographic on benefits on page 33).

But independent tax specialist Johan Troskie says the rules are more applicable to holding companies than an HQ regime. “An HQ regime implies that other taxes — like interest, royalties, dividends and management fees — will be tax-free, but it is still taxable at the corporate tax rate of 28%.”

Also, existing companies do not qualify for the regime as they must have had uninterrupted compliance with most of SA’s tax conditions from inception. “It is not attractive enough, still too complicated and administrative-intensive,” says Troskie. “The recent Taxation Laws Amendment Bill added to that burden by requiring HQ companies to prove annually that they still qualify.”

Mauritius, for example, goes out of its way to not tax income, or at a low rate. “By doing that the investment that followed and jobs that were created proved to be very lucrative,” says Troskie.

Momoniat disagrees that SA’s corporate tax rate is uncompetitive. “We need to take long-term sustainability into account and not create artificial bubbles through a race to the bottom, especially after the financial crisis,” he says.

Ireland, for example, has a particularly low tax rate of 12,5% and now finds itself in crisis. Greece’s problems are even worse. “We strive to ensure certainty in the tax system, particularly for those companies and investors that don’t indulge in aggressive tax-avoidance measures,” he says.

He believes SA has a favourable tax regime to attract foreign investment, citing the HQ rules, various tax incentives in the Income Tax Act and cash incentives offered by the department of trade & industry as proof . “These incentives are internationally competitive.”

But Lai King insists these measures are not enough to make SA as attractive as some neighbouring countries, which offer tax holidays and other incentives. And SA should be careful of introducing incentives only to withdraw them a short while later. “The explanatory memorandum on the Tax Laws Amendment Bill admits to some of the shortcomings of the incentives, like greenfield projects for example, which have led to a small uptake by business.”

There is also suspicion among industry players about Sars’ overall ability to administer the complex (and ever-changing) tax rules. “The tax system’s complexity increases every year and it is not only taxpayers who are struggling to keep up,” says Lai King. “Perhaps that may explain why there has been what is perceived to be an overreaction from the fiscus in this year’s amendments.”

Lai King says if the skills and systems were sufficient to implement, monitor and police tax concessions, “there perhaps would not be such fear of abuse of the system”.

The introduction of the Tax Administration Bill at the end of June this year might address some of these concerns. Sars feels it will have a profound effect on tax administration in SA to the benefit of both the taxman and compliant taxpayers.

“The bill , once law, will establish a solid legal framework for Sars to continue modernising its systems, redesigning its processes and optimising its pool of talented staff,” says Sars spokesman Anton Fisher. “Like other organisations in SA we do feel the effects of a lack of specialist skills, but this has not constrained us at any point to where we are unable to execute our mandate.”

Looking at past achievements, particularly in areas such as improved compliance, Fisher says Sars recorded improvements in personal income tax returns submitted by deadline between 2008 and 2009 from 58% to 80%. In the past financial year (2010/2011) Sars collected about R2bn more than was targeted. “In fact a total of more than R674bn was collected.”

On the suspension of section 45 and the subsequent outcry, Fisher says its litigation record provides clear evidence that “bad apples” are being identified and dealt with. “The proposed suspension of section 45 was about managing the risk presented by unacceptable avoidance schemes.”

But not everyone is comfortable with the new powers allocated to Sars under the Tax Administration Bill and the way it has been conducting its business in the past. Prof Henry Vorster, chairman of the taxation committee of the Law Society of SA, says they commented on several provisions of the bill during this public submissions period but only some of their concerns have been addressed.

“It has changed significantly, but is still materially flawed in many respects,” he says. “Of major concern to the Law Society was the exclusion of the high court in relation to disputes with Sars searches without warrants and the enforcement of payment before consideration of a taxpayer’s objections to an assessment.”

He says Sars informed the Law Society that it had received advice from external constitutional experts that the bill was constitutionally compliant. “We asked Sars to produce those opinions for discussion and evaluation but Sars has refused to do so,” he says. “We have followed the procedure provided for in the Promotion of Access to Information Act 2000 after our internal appeal was refused, and we are considering our position in relation to that.”

He expects though that Sars will feel compelled to make these opinions available to the parliamentary committee and the Law Society will gain access to the information at that stage. “Unfortunately we’ll have to wait until the law is enacted before we are able to challenge it.” The real concern, he says, is “how Sars officials will exercise these powers to the detriment of taxpayers”.

Tax collection is crucial to a sound fiscus. But SA tax authorities’ overzealous focus on tax avoidance restricts the regime unnecessarily.

Dealmakers and related parties feel SA can achieve much more by using global best practice and setting up a competitive structure. They’re not suggesting SA become a tax haven, but there is definitely room for a more attractive regime that is competitive with other African countries . Treasury should take a leaf out of Mauritius’s book.

 Print This Post