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29 June 2018
On 12 April 2018 the Davis Tax Committee (DTC) released a media statement announcing the publication of four additional final reports and the conclusion of its work based on its terms of reference (for further details please see "Davis Tax Committee releases final reports").
This update examines certain aspects of the report on the efficiency of South Africa's corporate income tax (CIT) system, with particular reference to the reviews undertaken in respect of the efficiency of the CIT rate and corporate restructuring rules (CRRs).
On 31 October 2016 the DTC formed a CIT sub-committee to prepare a CIT report setting out the DTC's position. To ensure that the recommendations made in the report were practical, the DTC took into consideration South Africa's present economic position as well as its outlook. The DTC recognises that in the context of low economic growth, taxes must be raised in a manner that causes as little disruption to economic growth and employment as possible.
In 1997 the Katz Commission specified that a residence-based system of taxation in South Africa would carry the danger of promoting the export of South African human capital and contributing to an undeveloped South African multinational sector. However, despite the commission's recommendations, a residence-based system was introduced into South Africa's income tax system for the years of assessment commencing on or after 1 January 2001.
The relevance of the residence-based system of taxation stems from the definition of 'resident' as defined in the Income Tax Act (58/1962), particularly when it comes to the identification of the residence of a corporate, which is dependent on whether it is incorporated, established or formed within South Africa or where it has its place of effective management. With the increase in globalisation and the mobility of capital, the concept of a place of effective management is capable of being manipulated, enabling a corporate's residence to be a matter of deliberate choice rather than one of circumstance, especially in the digital economy. Therefore, should the CIT rate be seen as too high in comparison with other jurisdictions, corporates will be motivated to move their place of effective management to jurisdictions with lower tax rates.
South Africa has seen a decline in the CIT rate from 40% in 1994 to the present rate of 28%, which has been consistent since 2010. As noted from the CIT rate movement during the past 24 years, the CIT rate responds quickly and negatively to the economic conditions faced by South Africa. Therefore, the CIT sub-committee noted the importance of taking into account the economic climate when deciding whether to adjust the CIT rate. Although it remained at 28% following the 2018 budget speech, the minister of finance acknowledged that the rate was still high by international standards. This could have an impact on the competitiveness of South African corporates in a market which is already highly competitive in nature.
Arguments for and against decreasing the CIT rate have been set out in the CIT report. In this regard, the CIT sub-committee indicated that international tax competition has played a significant role in applying pressure within competitive jurisdictions, which as a result has caused the decrease in CIT rates in other jurisdictions to attract multinational corporates. Another argument put forward in favour of decreasing the CIT rate was that corporates would have less incentive to shift their profits outside South Africa with the aim of eroding their tax bases. Further, evidence has shown that there is a higher level of compliance in jurisdictions with lower tax rates. Earlier in 2018 the South African Revenue Service announced that approximately 21 million CIT returns were outstanding. The DTC's argument that jurisdictions with lower CIT rates see a higher level of compliance may be of interest to the National Treasury for the 2019 budget.
Arguments against a decrease in the CIT rate must also be considered in order to make the most appropriate recommendations going forward. The significant contribution of corporate revenue to the fiscus in South Africa means that without some level of certainty that a reduced CIT rate would be effective in stimulating growth and thus increasing the overall tax base and collection of taxes, a resultant reduction in revenue would need to be compensated for elsewhere. From an international perspective, it appears that the best approach may be to leave the CIT rate the same while using other efforts to widen the tax base (eg, introducing restrictions in respect of deductions and allowances), as well as bringing new forms of income into the tax net. The National Treasury appears to have adopted this approach.
The DTC made the following recommendations regarding the CIT rate in South Africa's present economic circumstances.
One reason for the introduction of the CRRs in 2001, taking into account the policy objectives of competitiveness, was to promote the domestic restructuring of South African groups of companies (as defined in Section 41 of the Income Tax Act) in order to promote growth. The second reason was to alleviate unintended hardships caused by the enactment of capital gains tax, which was also introduced into South Africa's tax system in 2001. The CRRs not only provide relief from the tax consequences of capital gains tax, but also defer the incidence of income tax, donations tax, dividends tax, transfer duty, securities transfer tax and value-added tax.
In terms of the corporate restructuring rules, the CIT sub-committee has raised concerns, especially with regard to the specific anti-avoidance provisions that apply to transactions between connected persons. The main issue raised is the volume of anti-avoidance provisions which create unintended difficulties to ordinary commercial transactions. The anti-avoidance provisions are addressed in more detail below. The concerns identified and addressed in the CIT report in respect of the CRRs include the following:
The DTC made the following recommendations with regard to CRRs and anti-avoidance provisions.
The CIT report will be presented to the minister of finance. However, as the DTC is only advisory in nature, it remains to be seen whether its recommendations with regard to the CIT rate and CRRs will be considered and implemented going forward.
For further information on this topic please contact Candice Gibson at Cliffe Dekker Hofmeyr by telephone (+27 115 621 000) or email (firstname.lastname@example.org). The Cliffe Dekker Hofmeyr website can be accessed at www.cliffedekkerhofmeyr.com.
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