South Africa: The 2006/7 Budget

Originally published in Tax Werks, Volume 24/February 2006

Welcome and generous are perhaps the best words for this year’s budget proposals.

Except for companies, for which there are no tax cuts or startling breaks. They will have to wait for next year, as there are indications that corporate tax, including STC, is being reviewed by SARS and National Treasury. But in July this year they will be relieved of the dysfunctional regional services or joint service council levies.

But for others – individuals, small businesses, public benefit organisations, donors and heirs – there are not insignificant tax reductions. Small business, particularly, will benefit from lower tax liabilities, including for capital gains tax, and the naughty ones are to get a tax amnesty.

Savers will be encouraged by the generous increases in the tax-exempt amounts of interest and foreign dividends, and by the halving of the tax on retirement funds rate. They will still have to wait for the much delayed retirement tax review.

Individual investors offshore and corporates investing in Africa will benefit from further Exchange Control relaxation.

Sinners may be encouraged to reform by the largish tax increases of between 5% and 20% on the booze and smokes.

Travellers should not complain about the small increase in fuel taxes.

And the fight against those evil tax dodgers continues.

On 15 February 2006 the Minister of Finance delivered his budget speech to Parliament. A summary of the more significant tax proposals is provided below.

Unless otherwise indicated, all rate amendments become effective on 1 March 2006.

INCOME TAX (INCLUDING CGT)

Relief will be granted by adjustments to the personal income tax table, as follows:

The relief is illustrated in the following comparative table –

The tax exemption enjoyed by natural persons for interest and foreign dividends is to be increased from R15 000 to R16 500 (persons under 65 years) and from R22 000 to R24 500 (persons 65 years or older).

The portion of the exemption applicable to foreign interest income and dividends is to be increased from R2 000 to R2 500 per year.

The following CGT exclusions are to be increased:

• the annual capital gain/loss exclusion from R10 000 to R12 500
• the primary residence exclusion from R1 million to R1.5 million
• the exclusion on death from R50 000 to R60 000

The STC rate, and the tax rates applicable to trusts and companies, other than small business corporations, remain unchanged.

The following changes will apply to the tax rates of small business corporations with effect from tax years ending on or after 1 April 2006 (typically from the tax year beginning on 1 March 2006):

With effect from tax years ending on or after 1 April 2006 the maximum annual turnover threshold to access the tax benefits available to small business corporations is increased from R6 million to R14 million.

With effect from tax years commencing on or after 1 March 2006 the following additional relief will be available to small business corporations:

• their once off CGT exemption will (when the owner is retiring) increase from R500 000 to R750 000;
• the threshold of assets eligible for the 100% depreciation allowance will increase from R2 000 to R5 000 per individual small item purchased for business purposes (it is not clear if this will be limited to small business corporations or available to all taxpayers).

The rate of the tax on retirement funds, which is, essentially, levied on gross interest, net rental and foreign dividend income, is reduced from 18% to 9%.

The new transfer duty rates applicable to individuals are summarised in the table below:

The flat transfer duty rate of 10% applicable to companies and trusts will be reduced to 8%.

The threshold exemption for stamp duties on leases will be increased from R200 to R500 per lease agreement.

The annual donations tax exemption is to be increased from R30 000 to R50 000.

The general estate duty exemption is to be increased from R1.5 million to R2.5 million per person.

Sin taxes will be increased with effect from 15 February 2006, in particular:

The general fuel levy on petrol (leaded and unleaded) and diesel has not been increased due to the revenue overrun in 2005/06 and the higher prices of oil worldwide.

The Road Accident Fund levy on petrol and diesel will be increased by 5 cents per litre with effect from 5 April 2006.

It is proposed to implement a tax amnesty for small businesses. Only businesses with turnover of R5 million or less (during the 2005 tax year) will qualify.

The amnesty will entail a waiver of taxes due for tax years ended on or before 31 March 2004, together with a waiver of penalties, additional taxes and interest.

The submission by a small business of an income tax return for 2005 will be a prerequisite to qualify for the amnesty. The cost of the amnesty will be a penalty of 10% based on taxable income for the 2005 tax year.

As was the case with the recent exchange control and tax amnesty, the amnesty will not be available to small businesses that have already disclosed the amounts in respect of relevant amounts, or who would have been notified that they are under investigation before the commencement of the amnesty.

The amnesty will have two aspects: First, an amnesty for the taxi industry, which will commence on 1 August 2006 and will endure until 31 May 2007, and, secondly, an amnesty for other small businesses, which will commence later this year (no indication was given of the commencement date for the second phase).

It is proposed that the 40% surcharge on oil and gas profits be removed and that an accelerated depreciation allowance be granted to facilitate oil and gas exploration.

The deduction for current research and development expenditure will be increased from 100% to 150% and the depreciation allowance for capital R&D expenditure will be accelerated from 40:20:20:20 to 50:30:20.

With effect from 1 March 2007, scholarships and bursaries to current and future employees will be tax-exempt subject only to the requirements that the employer must pay tuition and tuition-related expenses directly and the employees must be required to repay the employer upon failure to fulfil their scholarship or bursary obligations. Bursaries for relatives of employees are exempt up to R2 000. This will be reconsidered or adjusted.

The learnership allowance that was set to expire in October 2006 will be extended to October 2011. The maximum initial allowance and completion allowances will both be increased from R17 500 to R20 000 per year for existing employees and from R25 000 to R30 000 for new employees. Employers employing disabled persons as learners will qualify for an initial allowance of 150% of the annual salary of an existing learner with a disability, subject to a cap of R40 000 and 175% for an unemployed learner with a disability, subject to a cap of R50 000. Finally, employers will qualify for a tax allowance upon completion of a learnership of a disabled person equal to 175% of the employee’s annual salary, subject to a cap of R50 000.

The current income tax exemptions and deductions for mining rehabilitation trusts will be extended to insurance products and other instruments dedicated solely to rehabilitation funding. Similar concessions and benefits will apply to the cost of complying with environmental rehabilitation obligations in sectors other than mining.

It was announced that a review of the distinction between revenue and capital will commence during 2006 as the test relating to a taxpayer’s intent at the time of acquisition of an asset creates "uneven results". It is not clear what is meant in this regard, but it appears that the current legislation providing a taxpayer an election as to whether the proceeds derived from the disposal of listed shares held for more than 5 years, should be treated as capital or revenue in nature, is to be extended to other assets.

Benefits derived by PetroSA from high crude oil prices are to be shared with the public – presumably in the form of a tax on these benefits.

The new regime for medical scheme contributions and medical expenses, effective from 1 March 2006, as well as to car allowances (the second phase of which takes effect on 1 March 2006), and which was announced in last year’s budget, was confirmed. It was also announced that 60%, and no longer 50%, of a travel allowance will attract employees’ tax (PAYE).

The abolition of RSC levies with effect from 30 June 2006 was also confirmed.

Apart from the cut in the tax on retirement funds rate, certain tax reforms in the industry are also on the cards. These will be directed towards the objective of passing on benefits derived from the rate cut to members of retirement funds and to avoid the tax savings from being applied towards excessive charges, penalties, commissions, etc.

Cooperatives that operate like small business corporations will enjoy the same benefits applicable to these corporations.

It is proposed that municipal property rates will be VAT zero-rated for tax periods commencing on or after 1 July 2006.

Also, most appropriations and grants to municipalities will be zero-rated.

The VAT turnover threshold for small farmers and small business four-monthly filers will increase from R1 million to R1.2 million for tax periods commencing on or after 1 July 2006.

These are proposals to plug loopholes, fill gaps, counter abuses and address anomalies, inconsistencies, over zealousness and unfairness in the tax legislation.

It is proposed to adjust the tax rules for public benefit organisations, so as to refine the list of tax-exempt PBO activities, exempt foreign PBOs operating in South Africa, allow deductible donations for the conservation, environment and animal welfare activities of a PBO, have a single statutory tax rate for all PBOs’ trading income regardless of their legal form and relax rules relating to permissible investments by PBOs.

Provision is to be made for a full or partial income tax exemption for the receipt in South Africa of development assistance granted by international organisations.

The tax-exempt status of recreational clubs is to be reviewed, as it appears that some of them are claiming exemption whether or not their amenities are used by the general public or only by their members and certain others are carrying on trading activities to raise funds (rather than by way of member contributions).

Steps are to be taken to modernise and streamline the corporate income tax administrative system, including a self-assessment system, bringing into operation of the advance tax ruling provisions, starting a pilot programme for e-filing for large company returns and, from March 2007, aligning the provisional tax system of all taxpayers more closely to current income, rather than using the historical "basic amount". Further, some e-filing for individual income tax returns will be introduced by June 2006.

It is envisaged that the legislation for the new general anti-avoidance provision (section 103) will be finalised in the latter half of 2006.

Rules will be introduced for determining the CGT base costs of inherited offshore assets from foreign deceased estates. The base cost of these assets should be their market value when they fall within the South African tax jurisdiction.

The formula to determine the taxable amount of the fringe benefit of residential accommodation provided to employees is to be changed so that that part of the formula for prior-year’s salary less R20 000 will be prior-year’s salary less R40 000.

It is proposed that the R500 cap for cross-border travel benefits to transport employees be dropped.

The tax-free subsistence allowance for foreign travel may be reviewed so as to fix amounts per country, so that it is more closely aligned with the actual costs likely to be incurred.

An apparent anomaly where depreciable assets are subject to CGT and recoupment of prior depreciation when disposed of by a trust is to be addressed. Also, the rules for recoupments on the distribution or donation of depreciable assets apparently "do not trigger appropriate results", so this is to be looked at. In addition, transfers for consideration below market value will also be treated as donations in this regard, even if not considered to be donations under the common law.

It is proposed that the dividend that arises when a collective investment scheme buys back its own participatory interests will be clarified by amendments or interpretation. Two anti-avoidance rules are proposed to counter certain arrangements by which a collective investment scheme purports to "convert" taxable interest into tax-free dividends for investors.

The "effective value" determination on the disposal of mining property, where the consideration is received in instalments and cannot be quantified upfront, will be clarified.

Apparently the deductibility of leasehold improvements effected on Government land in the context of public-private partnerships is creating difficulty, which will require remedial legislation.

The rule against double deductions is to be reviewed to address some abuse with repurchase agreements, and arguments that the rule against double deductions does not apply if the deductions claimed occur in different years.

The argument that the connected person rules are only applicable with reference to South African companies is to be addressed.

Consideration will be given to introducing a higher cap for tax-free medical scheme contributions for adult dependants and a lower one for child dependants.

The potential CGT unfairness that may arise where a spouse enters into a redistribution agreement in terms of which he or she exchanges unwanted inherited assets for those inherited by another family member is to be addressed.

Corporations are exploring options that will limit the amount of their post-retirement medical liabilities as a future financial liability for financial reporting purposes. The viability of some of these options may require regulatory and ancillary tax changes.

It appears that some anomalies still remain in the CFC rules, including the treatment of certain CFC mobile businesses as qualifying business establishments, royalties that are central to the core activities of CFC business operations, offshore business operations that are subject to CFC diversionary rules even though the CFC’s activities are no threat to the South African tax base, the taxation of a CFC business operating in multiple countries as part of a single economic market, and the clarification of the "country of residence" concept.

There is also apparently a technical problem that prevents the taxation of liquid portfolio currency gains regardless of whether the gains exist in the hands of a South African resident or a CFC, which will be addressed as necessary.

The financial instrument holding company definition is to be revisited, so as possibly to exclude financial instruments that pose little threat to the South African fiscus.

The inability to claim a tax base cost on the cross-issue of shares or debt may be too rigid, especially where cross-issues are required to satisfy other Government regulatory requirements, is to be revisited.

Consideration will be given to relaxing the share-for-share rollover relief requirements where minority shareholders, who do not meet the requirements, are forced to exchange their shares. In the case of a company formation transaction it is proposed that the gain on a post-company formation transaction disposal be limited to the gain that would have arisen at the time of the original transaction.

Apparently the reportable transaction rules are not having the desired effect - to act as a supplement to the general anti-avoidance rule. Accordingly, these rules will be adjusted to achieve their objective.

The issue of the absence of place of supply rules for VAT, now particularly for internationally traded services, is to be considered.

Apparently some taxpayers fail to account for VAT on an amount received in excess of the invoiced amount. Consideration will be given to clarifying the imposition of VAT on the excess, and allowing an input tax deduction for the excess when refunded.

Provision will be made to shorten the 12-month period for the VAT accounting of irrecoverable debts if the vendor is deregistered.

Apparently certain taxpayers are entering into bare dominium schemes designed to disguise exempt financial services as rental payments, thereby qualifying for an input tax deduction. The VAT implications will be clarified either by way of amendments or interpretation.

The VAT Act provides that the supply of goods or services into a customs controlled area (CCA) within an industrial development zone is zero-rated, but the zero rating needs to be limited so that it does not apply to goods and services artificially routed through the CCA or to goods or services that are not economically used, consumed or transformed in the CCA.

Consideration will be given to allowing an input tax deduction for entertainment expenses for the personal subsistence for overnight business travel for independent contractors.

The imposition of UST, in the case of listed collective investment schemes, on both the collective investment scheme level and at the holder of a participatory interest level is to be remedied.

The transfer duty exemption for the transfer of property on divorce is to be extended to all transfers arising from all types of unions, not only marriages in community of property.

A recent court decision held that SARS cannot collect estate duty from an executor on a dutiable property if that property is not directly under the control of the executor. Legislation will be enacted to provide SARS with a right to appoint collection agents for the estate duty on this kind of property.

There are a number of proposed changes to the Customs & Excise Act, and a number of technical corrections, the details of which have not yet been announced.

The foreign investment allowance for individuals is to be increased from R750 000 to R2 million.

The requirement for control of a foreign entity, of more then 50%, is to be reduced to 25% for direct foreign investments in Africa by South African corporates and mandated parastatals.

When these relaxations will become effective is still to be announced, but indications are that it will be soon.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.