The budget speech delivered in Parliament by Finance Minister Trevor Manuel on February 23, 2000, is likely to have a fundamental impact on taxation in South Africa. From a taxation point of view this was the most far reaching budget ever delivered in South Africa's history. Michael Katz, who chaired the inquiry into the restructuring of our tax system, gives his views.
Naturally the two most important features of the tax proposals are the proposed introduction of capital gains tax and the conversion of South Africa's tax system from a source to a residence-based tax.
A factor that has not been sufficiently emphasised is that the implementation of these proposals will bring South Africa in line with the majority of other countries, including, more importantly, our major trading partners and countries that have an investment relationship, both inwards and outwards, with South Africa.
In a world that is characterised by an almost infinite mobility of capital and skills, it is of fundamental importance that our tax system in all of its aspects, including base, rates, methods of taxation, concepts and the language of the legislation should, as far as is possible, be the same as the rest of the world.
The implementation of the tax proposals in this year's budget should go a long way to achieving this objective. Thus, far from deterring investment in, and trade with, South Africa, the opposite should be the case. Foreigners dealing with South Africa will be dealing with a system and concepts with which they have great familiarity and understanding.
Space does not permit me, in this article, to traverse the advantages and disadvantages of a capital gains tax. In any event there is widespread understanding of these issues. I prefer to deal with some of the likely implications of the introduction of capital gains tax and also with some features of the design of the proposed system. In this latter regard there is as yet no finality on the precise detail of the proposed legislation as Government deliberately deferred the date of the introduction of capital gains tax so as to enable it to embark on an extensive consultative process with the private sector and all interested parties.
Commentators on the proposed capital gains tax have often overlooked the fact that a capital gains tax does not eliminate the distinction between capital and revenue. A particular gain must be examined in the light of the traditional tests for the determination of the distinction between capital and revenue; if, on these tests, a gain is revenue in nature, it is taxable at full rates; if capital, then it is not taxable at all. These tests will continue to apply after the introduction of capital gains tax, the only difference being that a gain, which is determined to be a capital gain, will now be subject to tax but at a lower rate (companies 15 percent and individuals 0 to 10,5 percent, dependent on their maximum marginal tax rate) than is applicable in the case of revenue gains.
In this context I respectfully believe that a likely impact of the introduction of capital gains tax is greater certainty, as a matter of practicality, in the distinction between capital and revenue.
Since the South African Revenue Service (SARS) will at least receive some tax in the case of capital gains, as opposed to the all or nothing of the past, it does not have the same imperative to contest every capital versus revenue matter.
Another likely outcome of the introduction of capital gains tax is that it facilitates further tax reform. Since Government will receive a direct yield from capital gains tax as well as an indirect yield from the rounding-off impact that capital gains tax has on ordinary income tax, it makes the ordinary income tax system more effective, further concessions in the personal income tax system will become more affordable and politically attainable. We have already seen in the very budget that introduced capital gains tax some fairly extensive reductions in personal income tax, including more specifically, reductions in the maximum marginal rate of tax.
Insofar as concerns the design of the capital gains tax, there are some noteworthy factors.
First, the base has been narrowed by the exclusion of a number of personal assets. By virtue of this fact the Government has set a very low exclusion threshold of R1 000 a year. Secondly, insofar as concerns those assets which are in the net, such assets will be in whether or not they were owned at April 1, 2001 - the introduction date (D-date) or acquired after D-date. Some countries have chosen this route, others only bring in assets acquired after D-date. South Africa's proposal expands the base in this regard. In the calculation of the gain, however, only growth after D-date is taken into account.
Since the length of the period that a taxpayer holds an asset from date of acquisition to disposal is irrelevant in the proposed calculation of capital gains tax, there is unlikely to be any pronounced lock-in effect. Thus there should not be any distortion of the capital markets or any immobilising of capital assets.
Capital gains tax in South Africa will only be triggered on realisation of the asset and not on accrual. This is advantageous as it will avoid complex annual valuations of assets.
From a design point of view, the feature of the proposed new capital gains tax system that is attracting most discussion is the aspect of inflation adjustment. The proposals seek to deal with this issue by having a low inclusionary factor - 25 percent of the gain in the case of individuals and 50 percent in the case of companies. Naturally, the way in which this aspect is finally resolved will have an important consequence on the system.
Finally, I would add that, in addition to all the aforegoing factors, perhaps the most decisive impact that the introduction of capital gains tax will have is to the income tax system as opposed to the capital gains regime itself. Planning in the context of the income tax system will change dramatically including, for example, the following:
* The dividend policy of closely held companies - hitherto dividend declarations were suppressed as they would have attracted secondary tax on companies (STC) whilst the sale of the shares in the company swollen with profits did not attract capital gains tax. In the new regime it will be better to apply dividends to reduce the value of the shares;
* The allocation of the purchase price in the sale of a business to capital assets will now change. Hitherto it has been advantageous from the seller's point of view, to allocate the purchase price to assets such as goodwill. This will change;
* Certain arbitraging will also become unattractive; and
* The use of trusts may become less widespread, especially as a vehicle for holding certain personal assets such as property.
Tax planning will change radically after the implementation of the new proposals.