For several years commentators have been sounding alarm bells about South Africa’s steadily rising debt whilst economic growth has stalled. As the Minister himself put it: “Our problem is that we spend more than we earn. It is as simple as that”. On top of that State Owned Enterprises (SOEs) have been poorly led and even more poorly governed as President Ramaphosa recently said that R500 billion has gone missing due to state capture.
This has put our debt past 50% of GDP (from the low twenties a decade ago), nonproductive government spending has risen, salaries now account for 35% of state expenditure and low economic growth stifles tax collections. In addition, Eskom has received extra funding of R52 billion this year. As they say, something has to give.
There have already been consequences as two of the three major ratings agencies (Fitch and S&P) have downgraded South African debt to junk status and Moody’s (as we discuss more fully below) are closely watching.
South Africa is also in a delicate socio-economic position with rising social unrest, growing unemployment and it is recovering from state capture. Thus, drastic spend cuts or growth in SARS income are unrealistic. That leaves selling state assets as the most viable alternative to arresting the ongoing rise in our debt.
It is not just ratings agencies that have been anticipating the MTBPS but also business which could throw large resources into the economy if it sees that government is committed to turning around the slide of recent years.
So, how did the Finance Minister do?
The initial reaction to the MTBPS was one of disappointment, symbolized by the rand shedding 2.5% against the US dollar and bond yields dipping. It was not just that the Minister painted a picture of a sliding economy over the next three years but there were few specifics as to how the South African economy is going to get out of an increasingly nightmarish hole.
For example, Minister Mboweni was expected to provide some detail as to how Eskom’s debt (R450 billion) was going to be restructured but all he said was that Eskom must implement meaningful reforms before tackling its debt. In the Minister’s own words: “In addition to low growth, South Africa’s biggest economic risk is Eskom … Over the medium term and beyond, government will manage the massive risk to the economy and the fiscus associated with Eskom.”
The main indicators – bad news and good
- GDP was forecast at 1.5% for 2019 in the February Budget, it is now forecast at 0.5% for this year, rising to 2.4% in 2023.Comment: This is disappointing as population growth is 1.6%, so in reality GDP will grow by 0.8% in 2023 and be negative this year.
- Inflation will remain benign throughout this period staying in the 5.3% average.Comment: As inflation hits the poor the hardest, this is good news.
- Debt/GDP which is a key ratio for ratings agencies will progressively deteriorate, a function of low economic growth and rising costs. This is 56.8% for the current year and increasing to nearly 69% in 2023. This is before support to State Owned Enterprises (SOE) like Eskom and South African Airways.Comment: If we look back a few years, government were saying that Debt/GDP would peak at around 50%. We have gone through that and are now looking at 70% and beyond. The nation is in danger of falling into a debt trap – rather like the consumer who, unable to borrow more money, finally maxes out his credit cards and spends most of his time paying off debt.
So, what does that mean for us?
The Finance Minister showed a bleak scene and clearly the government is struggling to get consensus as to how to address what is becoming a very serious problem. The Minister highlighted that in the next three years R150 billion has to be found either in tax increases or spending cuts. In the February budget he will give the nation concrete measures to be taken.
For the man in the street expect more tax increases in the February budget.
Moody’s and our junk status risk
On 1 November, Moody’s changed its outlook on South Africa from stable to negative. In a blunt statement, it gave the government notice that unless it comes up with “a credible fiscal strategy to contain the rise in debt” in the budget in February, Moody’s will most likely downgrade South Africa to junk status. That will trigger overseas financial institutions selling an estimated US$15 billion of South African bonds.
Until last year taxpayers had to accrue interest owed to them by SARS. This proved difficult for taxpayers as SARS can take a few years to refund the interest to you. This is exacerbated by the fact that SARS frequently adjusts the interest due to you, which can relate to a prior year.
Thus, taxpayers have found it difficult to correctly account for the interest owed to them.
The accrual concept
This is well established in tax law and frequently we are obliged to show even income still to be paid to us as received because it is legally due to us although not necessarily paid. Property development is a good example – when a developer sells off plan, the income from the sale falls into taxable income even though it may be a year or two before full payment is received.
But SARS have been proactive
To clear up these practical difficulties for taxpayers, the Income Tax Act was amended with effect from 1 March 2018 so that taxpayers only have to show SARS’ interest due in the year it is received. This will make it easier to complete your tax return and will also assist with your cash flow as now tax is only due on actual receipt of the interest, not on accrual.
One issue is how do you account for tax accrued in previous years? For example, if you had to include R1,000 in interest due in 2018 but now in 2019 this interest is paid to you. Including it in your 2019 assessment will mean you have paid tax on the interest twice (in 2018 and now again in 2019).
SARS has yet to issue a final Binding General Ruling (BGR) on this but the draft BGR addressed this by stating that interest need not be included in taxable income if it had been accrued in prior years. Hopefully, SARS will soon release this BGR in its final form and resolve this problem.
SARS is having trouble meeting its revenue targets and this is clearly putting enormous pressure on the South African economy. Further economic deterioration in the economy will probably result in a downgrade to junk status by Moodys. This will mean that all three of the major ratings agencies will have consigned our economy to junk status which means further currency weakness and probably a recession.
Most of the tax paid in South Africa is paid by individuals and it is logical that SARS will focus on maximising its revenue with this segment of taxpayers. Thus, one can expect more auditing by SARS of employees’ tax returns.
Implications for employees
Any SARS queries will be initially directed at employees who will have to justify what they have claimed. Most employees will go back to their employer and say, for example, ‘there is this query on my car allowance and how should I respond?’
It would make sense for employers to ask all employees to run SARS’ questions through the employer so that SARS receive a consistent answer (employees may have their own tax adviser to help the employee respond to the query, but the adviser may not understand how the employer’s tax administration works).
Implications for employers
If SARS are not satisfied with the responses to their queries, they may start to look at how the employer administers its employee tax obligations.
SARS places a substantial onus on employers to collect tax and to pay it over to the Revenue authorities. This involves a knowledge of taxes like:
- Remuneration and benefits paid to:
- expatriate employees
- local employees
- executives and directors
- Retirement benefits for employees, executives and directors
- Payments to labour brokers and independent contractors
- Share incentive schemes
- Cash book payments
- Gifts, prizes, awards and gift vouchers
- Loans to employees
- Company cars
- Travel allowances and reimbursements
- The Employment Tax Incentive (ETI).
These taxes are all different and require an understanding of tax legislation and the administrative systems required to process and collect the taxes.
In making their enquiries of the employer, SARS will most likely look to get an understanding of the employer’s systems and if dissatisfied with the response may audit the employer.
An audit can take up to one year to complete and apart from the stress of the audit there will be penalties, interest plus tax due where SARS finds the tax has been incorrectly calculated. SARS can also go back several years when they find errors, and this can become a costly exercise. At the moment, SARS appears to be homing in for the most part on the ETI, labour brokers, company cars and travel allowances – perhaps therefore pay particular attention to these taxes.
So, it is a prudent idea to frequently test how robust your systems are and how well you understand the tax laws. SARS often tweaks the law and issues interpretation notes on how businesses should levy and pay over tax.
Contact us if you have any tax related queries.
This form is designed so that employers can easily reconcile their payroll taxes (PAYE, UIF and SDL).
These taxes have proved difficult to reconcile and this redesigned form is intended to simplify this process. It is important to get this right to avoid paying penalties and interest.
A significant step taken by SARS is that employers can now actively manage their payroll taxes.
Businesses can now make adjustments to their account and can correct misallocated payments.
Omissions and other account mistakes can be corrected (there are misallocations going back a few years) and SARS accept they will have to assist in resolving some of the queries.
A case management system has been established so that taxpayers can monitor the progress SARS is making with these queries.
There are other enhancements to the Statement of Accounts such as grouping of like transactions and a receipt number for payments and journals which will help employers trace these payments to their bank statements.
With employers having the ability to make adjustments to payroll tax submissions comes increased accountability to manage their payroll taxes.
It will also help SARS to streamline their workload.
The ramping-up of country-by-country (CbC) reporting to regulate transfer pricing and combat cross-border tax evasion, in terms of the Organization for Economic Co-Operation and Development’s (OECD) base erosion and profit shifting (BEPS) policies heralds a new tax landscape. It makes different demands of tax authorities worldwide and considers information at a finer level of detail. It also creates greater visibility amongst tax authorities and exposes companies with international structures especially those that have not been implemented correctly.
The risk associated with international structures thus rises significantly and companies need relevant strategic advice to ensure that these structures withstand the scrutiny of tax authorities across the world.
It is important to note that ‘tax’ should always follow business and never the other way around. There should always be a valid business purpose and commercial rationale for setting up an offshore structure. The following international tax principles should always be considered:
Substance over form, whereby true effect will only be given to the legal form of a transaction if the substance is the same. It would be important to demonstrate that there are capital infrastructure and people in the offshore entity sufficient to support the revenue that is being recognized in that country. You cannot have a post box in a tax favourable jurisdiction without people functions, risks and assets that are commensurate with the revenue being recognized there. How would a revenue authority know, you may ask? They could request the financial statements of the offshore entity and soon deduce that there is no substance by virtue of income being accounted for but no corresponding rental expense, payroll and other expenses that would need to be incurred in the production of that income, in other words, no substance.
Residence, place of effective management (‘POEM’) or management and control are basic tests of residency in most countries. In other words, you cannot have an offshore entity in country B that is effectively managed in another country, country A. In that case, the offshore entity in country B could be considered to be a tax resident of country A. The basic principle around POEM is it is the place where the key decisions are taken by directors and senior managers i.e. the place where the ‘shots are called’.
Controlled Foreign Company Rules (‘CFC’) which are implemented in tax legislation in most countries. In South Africa, these rules apply if an SA tax resident or residents, either individually or jointly, hold more than 50% of the participation rights or are able to exercise more than 50% of the voting rights either directly or indirectly in a foreign entity. In that case that foreign entity is considered to be a CFC and subject to tax in SA subject, to certain exclusions one of which is the Foreign Business Establishment exclusion which in broad strokes means that it must have an office that it intends to occupy for at least a year with people, capital infrastructure and resources.
Transfer pricing generally relates to all intercompany transactions. In South Africa, the legislation applies to all cross-border intercompany transactions between connected parties which generally means where there is at least a 20% shareholding. It would need to be supported to Revenue Authorities across the globe that pricing is market-related. The recent implementation of Country by Country reporting creates greater visibility to tax authorities’ across the world on the activities, size, financial and tax position of companies within the Multinational Entity Group.
South Africa Sourced Income – South Africa has a worldwide basis of taxation whereby non-residents are taxed on South African sourced income. As such if your offshore entity conducts activities in South Africa and these activities are considered the originating cause of income, such income would be subject to tax in South Africa subject of course to any double taxation relief that may exist by virtue of a Double Taxation Agreement.
General Anti Avoidance Provisions would be the overarching wrapper to ‘catch all other’ not caught by one or more of the above principles.
South African beneficiaries of Offshore Trusts – South African resident beneficiaries as a general rule are taxed where a donation is made to an offshore trust but also where interest-free loans are advanced. In such case, the attribution rules apply to attribute income and capital gains of the offshore trust which are taxed in the hands of the SA beneficiary.
Where a distribution is made by the offshore trust to an SA beneficiary the latter will be taxed on that distribution based on the nature of the income out of which it was distributed e.g. if it was a foreign dividend the beneficiary will be taxed at an effective rate of either 0% or 20% depending upon the shareholding in the foreign company declaring the dividends and if it is interest, a marginal tax rate of 45% may be applied or a tax rate of 18% on a capital profit.
In terms of the Act, there is an exemption from tax on foreign dividends where the person holds at least 10% of the equity shares and voting rights in the foreign company; referred to as the participation exemption. This exemption also applies to the disposal of share where the disposal is exempt from CGT.
As such, if the current year’s income of the trust comprised a dividend, that dividend is not taxable in the hands of the donor or the lender under the interest-free loan and neither is it taxable as a capital gain if the trust had disposed of the shares.
Similarly where such dividend or gain has been capitalized and in a future year that capital was awarded to a beneficiary in SA that award would be exempt from tax on the dividends or the CGT. However if the trust had earned the dividend and distributed in the current year, the beneficiary would have been taxable at the rate of 20% while a capital profit made in the same year is not taxable.
Draft legislation has now been put out for public comment incorporating the following changes to the attribution and distribution rules.
In determining an amount that should be included as taxable income in the hands of a resident who made a donation, settlement or other dispositions to a foreign trust and that foreign trust holds shares in a foreign company, it is proposed that the participation exemption in respect of foreign dividends should be disregarded, provided that those foreign dividends are paid by a foreign company where more than 50 per cent of the total participation rights or voting rights in that foreign company, are directly or indirectly exercisable by that resident who made a donation settlement or other dispositions to a foreign trust or connected person in relation to the resident.
If these attribution rules do not apply and a trust receives a dividend where it holds a greater than 50% interest, and the dividend is capitalized, an award out of capital in the future year to a beneficiary in SA will be taxable at an effective rate of 20%. The participation exemption will not apply.
The new rules if included in the legislation will also apply to CGT so that where CGT would not have applied under the attribution rules, or out of an award of capital in the current or future year, will in future be subject to CGT. The participation exemption will not apply.
The new rules are intended to apply to any dividend received or disposal of shares on or after 1 March 2019.
If these changes are successfully implemented, it should mean that any dividend on a qualifying interest or any profit on disposal of a qualifying interest derived by an offshore trust on or before the 29 February 2019 and capitalised should still be able to be awarded out of capital, tax-free in the following year
Contact us at Tuffias Sandberg if you in need of assistance in local or international tax-related issues.
Here’s some good news on a win/win/win scenario for businesses (big and small), young work-seekers, and South Africa generally.
Everyone will be happy to learn that government’s initiative to encourage increased youth employment, the Employment Tax Incentive or ETI (commonly also referred to as the “Youth Employment Tax Incentive”), has now been extended for ten years.
So let’s recap what the ETI is, how it works, what conditions apply, and how it benefits you as an employer on the tax front, as summarised in a convenient ETI Calculation Table from SARS.
There is chronic unemployment in the country and it is especially felt by the youth where up to 50% cannot find a job. The Employment Tax Incentive (ETI) is designed to encourage companies to employ “youths” (between the ages of 18 to 29) for 1 to 2 years.
Incentives for employers to make use of the ETI are attractive. You can deduct from your monthly PAYE owing the amounts shown below in the third column. In addition, these deductible amounts are exempt from Income Tax i.e. you get a double benefit.
The monthly calculated ETI amount per qualifying employee is determined as follows:
There are conditions – the employer must be in good standing with SARS and employees (apart from being aged 18 to 29) must have valid ID documents (or be a legal refugee).
This is a good incentive and it helps to address one of South Africa’s intractable problems. Another advantage is you can over the two year period identify employees with potential who will fit into your business.
Speak to us to ensure you claim this incentive correctly.