Taxation Laws Amendment Bill In A Nutshell
02 October 2012
Posted by: Author: David Warneke
Taxation Laws Amendment Bill In A Nutshell
Some changes were as announced in the Budget; others are new
SARS released a second Draft Taxation Laws Amendment Bill on 5 July 2012. 186 pages long, the Bill gives effect to the majority of the changes to tax legislation announced by Finance Minister Pravin Gordhan in his Budget speech on 22 February 2012. As is normal for such a Bill, it also includes other unannounced changes. What follows is a summary of the most important of the proposals contained in the full version of the Bill.
With effect from the 2015 year of assessment, medical contributions and expenses will be fully taxed under a credit only system, as opposed to the current hybrid system. With effect from the 2014 year of assessment, variable cash remuneration arising in the form of commissions, bonuses, overtime payments, travel reimbursement and leave pay will only be taxable in the hands of the employee when paid. The employer will only be able to claim the corresponding deduction when the amount is paid. With effect from the 2014 year of assessment, non-deductible excess contributions by an individual to retirement funds will be able to be used to exempt annuities paid to the individual by the fund. At present only lumpsum awards by the fund (not annuities) are subject to exemption in the case of non-deductible contributions.
The hybrid equity instrument and third party backed share provisions that were amended and enacted, respectively, in 2011 will come in for further amendments. The amendments to the hybrid equity instrument provisions mainly introduce an exception from re-characterisation of the instrument in circumstances where the instrument is issued as a financing tool to acquire substantial interests in a target operating company. The amendments to the third party-backed share provisions mainly refine the operating company exclusion.
Debt that contains significant equity features will be reclassified as a non equity share. This reclassification will apply for purposes of the dividends tax as well as capital gains and income tax in the case of repayments or disposals of the ‘share’. The reclassification will arise in circumstances where either the nature of the instrument itself, i.e.the corpus or the nature of the yield has significant equity-like features.
For example, the nature of the corpus will trigger reclassification if it is redeemable only at the option of the issuer, or if it is only redeemable after 30 years from the date of issue. It will also be triggered if the debt is automatically convertible into shares or is convertible into shares at the option of the issuer. Notably, the three year time limit on conversion will be deleted. On the other hand, examples of where the nature of the yield will trigger reclassification are if the yield is not determined with reference to time value of money principles (for example if the yield is based on company profits) and where the timing of the payment is subject to liquidity or solvency of the issuer.
The provision is subject to small business and bank capital relief. The provision will apply to preexisting and new arrangements from 1 January 2014. With effect from 1 January 2013, deductions in respect of interest or royalties paid to exempt persons will be suspended until the interest or royalties are paid or become payable. The suspension of the deduction will apply even if the recipients are subject to with-holding tax.
Where assets are transferred in exchange for the assumption of debt by a company or the issuing of shares by a company and the market value of the assets is either higher or lower than the debt assumed or the shares issued, tax consequences will arise whether or not the transaction occurs between connected persons.In the case of an asset for share exchange, if the market value of the asset disposed of exceeds the market value of the shares issued, the company issuer will be subject to an additional level of gain or ordinary revenue. If the shares issued have a market value that exceeds that of the asset received in exchange, the excess amount will be deemed to give rise to a dividend in specie.
The tax cost of the assets received by the company in such a scenario will also be adjusted,either upwards or downwards. In the case of asset for debt exchanges, if the market value of the asset exceeds the market value of the debt issued, the company issuer will be subject to an additional level of ordinary or capital gain. If the market value of the debt exceeds that of the assets received in exchange, the excess will be deemed to give rise to ordinary revenue in the hands of the transferor. Also, in these circumstances the tax cost of the assets received by the company will be adjusted, either upwards or downwards. The provisions will apply in respect of asset transfers occurring on or after 1 January 2013. After this date, the current value-shifting provisions in the Eighth Schedule will no longer apply in respect of companies, but will continue in respect of trusts and partnerships.
Interest on debt used to acquire controlling domestic equity share interests in a target company (i.e. more than 70%) will be allowed as a deduction in a ‘group’ company scenario. This amendment will be effective in respect of acquisitions undertaken on or after 1 January 2013.
A new ordering system will apply to the numerous provisions in the Income Tax Act dealing with debt reductions for less than full value that take place on or after 1 January 2013. The provisions do not apply to the extent that the reduction was subject to donations tax, estate duty, or was taxed as a fringe benefit.
•In the case of debt used directly or indirectly to finance the acquisition of trading stock, the reduction is first applied against the cost of the trading stock (if the trading stock is still held by that person at the time of the debt reduction); next it is applied to reduce any balance of assessed loss of the person;thereafter any excess remaining is taxed as a recoupment, limited in total to the deductions enjoyed.
•In the case of debt used directly or indirectly to finance the acquisition of other types of deductions or allowances, the reduction is first applied against any balance of assessed loss of the person; thereafter it is taxed as a recoupment limited in total to the deductions or allowances enjoyed.
•In the case of debt used directly or indirectly to finance the acquisition of a capital asset, the base cost of the capital asset is first reduced; any excess reduces any assessed capital losses of the taxpayer; thereafter any remaining excess is not taxed. Debt used directly or indirectly to finance the acquisition of a capital asset that is no longer held by the taxpayer at the time of the debt reduction is applied to reduce any assessed capital losses of the taxpayer; thereafter any remaining excess is not taxed. Paragraph 12(5) of the Eighth Schedule will be deleted,as will Section 20(1)(a) of the principal Act.
A new system of taxing and regulating property investment schemes will replace the existing system which currently classifies property investment schemes into property unit trusts (‘PUTS’) and property loan stock companies(‘PLS’), the latter of which are taxed in terms of ordinary rules. New tax rules relating to such entities which fall into a new definition to be inserted into the Act, of a Real Estate Investment Trust (‘REIT’), which inter alia must be a listed entity, will apply with effect from a date to be determined by notice in the Government Gazette.
A REIT will be subject to tax on receipts and accruals as if its income were ordinary income without regard to any exemptions. On the other hand, the distributions of the REIT will, in most instances, be deductible by the REIT. A REIT will not be subject to Capital Gains Tax. Investors in a REIT will be subject to capital gains tax only on disposal of their interests in the REIT (assuming that these investors hold such interests on capital account).
The participation exemption in respect of the disposal of foreign equity shares will be narrowed for disposals taking place on or after 1 January 2013. This is in part as a result of the extension of the rollover regime for offshore intra-group reorganisations, and in part to curb the inappropriate use of this exemption.
In order to qualify for the participation exemption after the above date, the following requirements will need to be met:
1.The transferor must hold at least 10 percent of the equity shared in the foreign company;
2.The transferor must have held this interest for at least 18 months prior to the disposal;
3.The transferred foreign equity shares must be disposed of to a foreign person other than a CFC;
4.The disposal must occur for full value consideration (based on market values).
For purposes of determining the market value received in exchange for the shares, any consideration received in shares will be ignored. The foreign financial instrument holding company restriction will be dropped.Various changes are proposed relating to the corporate rollover relief rules mainly in the case of ‘foreign to foreign’ transfers, to unify the principles in terms of which such transfers will qualify for rollover treatment. The types of ‘foreign to foreign’ transfers that qualify for relief are the following:
1.Transfers of foreign equity shares for equity shares in a CFC(Section 42);
2.The amalgamation of a foreign company into a CFC (Section44);
3.The unbundling of equity shares held in a foreign company into the hands of a shareholder of the unbundling company (Section46); and
4.The liquidation of a foreign company (Section 47).
In addition, the intra-group transfer provisions (Section 45) which currently do not allow for the transfer of assets from or to a foreign company, will in future allow for the transfer of equity interests in a foreign company held by a transfer or company to a fellow group company in relation to the transfer or company. The proposals would be effective for transactions entered into on or after 1 January 2013.
Withholding taxes relating to dividends, interest and royalties differ as to their rates, timing and other procedures. Changes have been proposed to lighten the administration and compliance burden of these taxes by making withholding tax on interest and royalties more aligned with dividends withholding tax. To this end, the withholding tax rates for interest and royalties will be increased to 15% with effect for royalties and interest paid or payable from 1 January 2013.
The timing of incurral and payment of royalties and interest withholding tax will be aligned with dividends tax, and the refund mechanisms for these taxes will be simplified. The ‘place of effective management’ test to determine residency be eliminated in the case of South African-owned foreign subsidiaries if the subsidiary is a CFC which has a foreign business establishment, and where the subsidiary is subject to a sufficiently high level of tax. Little by way of revenue would accrue to the South African fiscus in these circumstances as a credit against South African tax would in any event be given for foreign tax suffered by the foreign subsidiary.
The proposal would be effective for years of assessment commencing on or after 1 January 2013. In similar vein, relief from the transfer pricing provisions will apply to loans and intellectual property transactions with highly taxed CFC’s. The relief would apply if the holder of the loan or intellectual property is a South African company; the obligor is a CFC in relation to the holder and 10per cent directly owned by that holder; the CFC is sufficiently highly taxed; and the CFC has a foreign business establishment. Section 24I, dealing with gains and losses on foreign exchange items will be the subject of three main amendments:
1.The current deferral rule in respect of exchange gains and losses stemming from the acquisition of pre-production assets will be removed;
2.The current rule scoping in, in the case of the acquisition of assets, only exchange items where the disposal of the asset would give rise to South African sourced income will be removed; and
3.The current regime whereby exchange gains and losses arising from exchange items between connected persons are either spread or disregarded until they are realised will be overhauled to align it more closely with that under IFRS.
In terms of the proposal, the exchange gains and losses on such exchange items will only be deferred until realisation if the taxpayer and the foreign company are a group for purposes of IFRS and in respect of debt between such group entities; the debt is a claim for which settlement is neither planned nor likely to occur in the foreseeable future; and, in respect of hedges, the contract is designated as an effective hedge for purposes of IFRS. The above changes would be effective from 1 January 2013. Paragraph 43 of the Eighth Schedule, dealing with capital gains and losses on the disposal of assets which were either acquired or disposed of in a foreign currency will be amended so as to more closely align the treatment of such gains and losses with that under IFRS. More specifically, it is proposed that in the case of the disposal of assets by a company or a trading trust, the calculation of capital gains and losses in circumstances where expenditure and proceeds are denominated in the same foreign currency will from the effective date of the amendment take into account fluctuations of the rand vis a vis the foreign currency.
Under the current treatment, the capital gain or loss is calculated in the foreign currency before being translated into rands. These changes would be effective in respect of transactions entered into on or after 1 January 2013.
Source: By David Warneke (Taxbreaks)