Judge Denis Davis, judge of the Cape High Court and a member of the Katz Commission on tax reform, has commented on the impact of the far-reaching changes to the Income Tax Act in recent years, suggesting that a pause is needed before the authorities address the three major areas still needing reform. All the changes in the past few years have had profound effects on tax legislation in South Africa, the main two being the change from the source to the residence based system and the introduction of capital gains tax (CGT). The tax system, according to Judge Davis, is now enormously complex, whereas the Commission had advocated as simple a system as possible.
Judge Davis referred to an information overload, which has left tax advisers at a loss as to how to advise their clients in circumstances where the law is changing each year and, recently, every few months. He went on to identify three areas still requiring attention, but implied that the changes would either be simple or would be delayed for a few years. The three areas he mentioned were:
- the tax on retirement funds. At present retirement funds are subject to a 25% tax on their income, with a consequent disincentive effect on the desire of taxpayers to invest in such funds. Not only does this make it more difficult for taxpayers to provide for their own old age, but there is less incentive to save, and savings, as Judge Davis pointed out, are vital for fixed investments;
- the role of incentives in the tax system. Experience has shown that the use of tax legislation to achieve commercial, social or political objectives invariably results in the incentives being used for purposes other than those for which they were intended, and this leads to more complicated anti-avoidance legislation, which adds to the complexity of the taxing statutes. South Africa has lived through export allowances, capital investment allowances, sponsorship allowances and many others, always with similar results. One assumes and hopes that Judge Davis is suggesting that such incentives should be offered by means other than tax legislation; and
- secondary tax on companies (STC). The aim of STC was to encourage the reinvestment of profits by imposing a 12.5% tax on companies on their dividends declared. The effect has been to make the South African tax regime less competitive. This disadvantage is increasingly noticeable in the present international trading environment.
Judge Davis also identified three future challenges facing the authorities: the desirability of tax harmonization between African countries to ensure that tax systems were a neutral factor in decisions as to where to locate foreign investment; the policing of tax havens; and the taxation of e-commerce.
All taxpayers would agree that the system is very complex, to the point where most people need professional help to complete their annual returns. Several factors have contributed to this state of affairs, including: the increasing complexity of modern business; the greater sophistication of tax planning techniques; and the effects of globalization as more and more taxpayers begin to invest and do business offshore. It is therefore understandable that the legislation is complex, and it is difficult to envisage how this can be overcome. However, it is unfortunate that two major changes have been introduced almost simultaneously, following on the heels of several amendments in recent years that were complex in themselves but whose complexity pales in comparison with the residence and CGT changes.
As if that was not enough, an amending bill due to be passed into law before the end of November introduces five complex provisions relating to corporate formations. The new provisions are largely intended to defer the incidence of CGT when assets move within a group structure. The categories of transaction are:
- transactions where persons transfer assets to a company in exchange for shares;
- share for share transactions;
- intra-group transactions involving the transfer of assets;
- unbundling arrangements; and
- liquidations of entities within a group.
Detailed discussion of each of these is beyond the scope of this article, but their introduction is yet another addition to the growing complexity of the legislation facing taxpayers.
It is to be hoped that the authorities will heed the sound advice of Judge Davis to give taxpayers a chance to digest the new legislation and absorb the implications before they embark on the next step. However, most taxpayers would agree that the three areas identified by Judge Davis for action certainly do need attention, and this attention does not necessarily require complex changes to the Act.