Much has been said about Finance Minister Nene’s maiden Budget speech in the month since he has announced an increase in personal tax rates. While some feel taxpayers got off lightly with a 1% personal tax increase combined with the higher fuel levy and the increased sin taxes, others caution that it is just quiet before the storm.
Our taxes must still be applied to help narrow the budget deficit in the absence of real economic growth, as well as fund the bulging public sector wage bill, battling parastatals like SAA and Eskom, and soon also National Health Insurance (NHI). Considering these factors and the fact that our local labour relations are still precarious which may lead to extended industrial action again, there is a case to be made by the doomsayers.
Perhaps however, Minister Nene will surprise us and turn to the wise words of Sir Winston Churchill, who famously said in 1904: “…I contend that for a nation to try tax itself into prosperity is like a man standing in a bucket and trying to lift himself up by the handle…”.
Or perhaps the view of a more modern, but much respected statesman, John F. Kennedy, who said: “…It is a paradoxical truth that tax rates are too high today and tax revenues are too low, and the soundest way to raise the revenues in the long run is to cut the tax rates…”.
Only time will tell. Until then, our aim is to continue to help our clients structure their tax affairs most efficiently while they steer through the ever-changing minefield of tax legislation. In this month’s edition of e-taxline:
A recent case before the Supreme Court of Appeal has shed significant light on how legislation in respect of deferred delivery share (DDS) schemes should be interpreted and also on the meaning of simulated transactions. Barry Visser, associate tax director at Grant Thornton Johannesburg has summarised the most pertinent points from this case.
Tax partner at Grant Thornton, Louis van Manen, explains how Subordinated Debt and Interest is affected by Section 8F of the Income Tax Act.
Determining the taxable benefit arising from an employee’s right to use a company car has changed from 1 March 2015. Doné Howell, tax partner at Grant Thornton Johannesburg, explains how employers and employees are affected.
And finally, Carin Grobbelaar, senior tax consultant from Grant Thornton Cape, gives us the ins and outs of the new Tax Clearance Certificate system.
In case you missed it, download our 2015 Tax Data Card, view our commentary about the Budget, or use our Tax Calculator.
Deferred delivery share schemes under scrutiny
By Barry Visser, tax director Grant Thornton Johannesburg
The Supreme Court of Appeal judgement of Commissioner for SARS v Bosch (394/2013)ZASCA 171, which concerned a deferred delivery share (DDS) scheme, has shed significant light on how legislation in respect of DDS should be interpreted and also on the meaning of simulated transactions.
In this case, employees had the option to purchase shares but had to exercise this option within 21 days of the offer date. However, the payment for the shares and delivery thereof would take place in tranches two, four and six years after the option was exercised.
The issues in dispute were:
- which of the two dates, the date on which the option was exercised or the date of payment and receipt of shares, was the effective date for tax purposes?
- whether the contract arising by exercising the option was conditional?
- whether the contracts between the employees and the trust administering the DDS scheme are simulated transactions.
Date of exercise and Interpretation of section 18A(1)(a)
SARS’ main contention was that only once the shares were paid for and received or, if they elected to sell them, did ‘the exercise of the right to acquire the shares’ occur in terms of this section.
However, the Court held that the section is concerned with the action by the employee that precedes a binding contract by which the employee will be entitled to acquire the shares, whether the acquisition by transfer to the employee occurs immediately, or is postponed to a future date. Therefore, SARS’ main contention was rejected.
In the alternative, SARS contended that the sale agreement fulfilled as a consequence of the employees exercising their options was conditional because the employees would have to be employed on each of the three future anniversary dates to receive the shares.
The agreement between employer and employees included a variety of other circumstances that would entitle the employees to receive the shares, regardless of whether they were employed for the full period. Furthermore, the company or trust was entitled, at their election, to cancel the sale. Although the contention by SARS, that the contract was subject to various conditions, was accepted by the Court, the conditions did not affect the determination of timing in respect of the tax liability.
Simulation – Substance over form
SARS submitted that the mechanism by which the DDS scheme operated was a simulation and that once the disguise with which it had been concealed was stripped away, the true exercise of the right to acquire the shares occurred when the shares were paid for and delivered.
The Court held that SARS’ submission involved a misunderstanding of the judgment in Commissioner for SARS v NWK Ltd  (2) SA 67 (SCA) and stressed that:
“simulation is a question of the genuineness of the transaction under consideration. If it is genuine then it is not simulated, and if it is simulated then it is a dishonest transaction, whatever the motives of those who concluded the transaction…
Tax evasion is of course impermissible and therefore, if a transaction is simulated, it may amount to tax evasion. But there is nothing impermissible about arranging one’s affairs so as to minimize one’s tax liability, in other words, in tax avoidance.”
It was considered that if SARS regard any particular form of tax avoidance as undesirable they are free to amend the Act, as occurs annually, to close anything they regard as a loophole. That is what occurred when section 8C was added to the Act, to specifically deal with DDS schemes.
t was held that the employees in the DDS scheme did not intend, when exercising their options to enter into agreements of purchase and sale of shares, to do so on terms other than those set out in the scheme. There was no advantage to the parties in entering into a conditional contract of purchase and sale when they were free to enter into an unconditional contract and postpone performance of the obligation to pay the purchase price and deliver the shares.
SARS’ contention based on the notion of substance over form was rejected.
This case provides proof that when the plain meaning of legislation is not clear, it is unwise to choose the literal interpretation to legislation. If there is any possibility that the text could have more than one interpretation, taxpayers should consider all the relevant circumstances, as well as any subsequent legislation and the way SARS may have interpreted the legislation in the past, before making tax decisions. If you have any questions relating to your share scheme, contact us.
Subordinated Debt and Interest
By Louis van Manen, tax partner at Grant Thornton Johannesburg
From 1 April 2014, interest incurred on subordinated debt is no longer deductible.
Section 8F of the Income Tax Act 58 of 1962 (“the Act”) is an anti-avoidance provision which deems interest on hybrid debt instruments to be a dividend in specie and effectively disallows the deduction of affected interest. Section 8F applies in respect of amounts incurred on or after 1 April 2014.
The disallowed interest is regarded as a dividend in specie in the hands of both the debitor and creditor with the result that dividend receipt should usually be exempt from income tax.
Where dividends tax is payable, it must be borne by the debtor (and not the creditor as is the case with dividends other than dividends in specie). If the creditor is a South African tax resident company, the entity is exempt from the dividends tax.
In its simplest form, section 8F applies to interest incurred on loans between connected persons where the loans are not repayable within 30 years and are not payable on demand. However, the section also applies to interest incurred on subordinated debt. Paragraph (b) of the definition of “hybrid debt instrument” includes an “arrangement where the obligation to pay an amount in respect of that instrument is conditional upon the market value of the assets of that company not being less than the market value of the liabilities of that company”.
Subordination Agreements are commonly used in group scenarios and typically contain the following clause:
“The Creditor hereby agrees that, until such time as the assets of the Company fairly valued exceed its liabilities, it shall not be entitled to demand or sue for or accept repayment of the whole of any part of the said amount owing to it by the company and set-off shall not operate in relation to the subordinated claim in respect of any debts owing by it now or in the future; provided that if the auditor of the Company shall report in writing that he has been furnished with evidence which reasonably satisfies him that the amount of the subordinated claim exceeds the amount by which the liabilities of the Company exceed its assets, such excess portion of the subordinated claim as is specified in the said certifcate shall be released from the operation of this agreement”.
In most cases, the natural conclusion would be simply to delete the clause above from the Subordination Agreement. However, the mere deletion of the clause does not change the intrinsic legal nature and effect of a Subordination Agreement. The legal effect of a loan subordination is that repayments can only commence once the assets of the debtor, fairly valued, exceed its liabilities, also fairly valued, which places subordinated debt squarely within the parameters of par (b) of the definition of a ‘hybrid debt instrument’.
Furthermore, in the case of Ex Parte De Villiers and Another NNO: In re Carbon Developments (Pty) Ltd¹, Goldstone JA made the following remarks:
¹1993 (1) SA 493
“Save possibly in exceptional cases, the terms of a subordination agreement will have the following legal effect: the debt…continues to exist…but is enforceability is made subject to the fulfilment of a condition. Usually the condition ois that the debt may be enforced by the creditor only if and when the value of the debtor’s assets exceeds his liabilities, excluding the subordinated debt… In the event of the insolvency of the debtor, [liquidation] would normally mean tht the condition upon which the enforceability of the debt depends will have become incapable of fulfilment. The legal result of this would be that the debt dies a natural death. The result would be that the erstwhile creditor would have no claim which could be proved in insolvency…The debt would not normally survive [liquidation].”
It is quite clear that the legal nature of a Subordination Agreement cannot be changed by amending the wording contained therein. The substance and true legal intention of the agreement remains even though the words giving effect thereto may be altered.
There is accordingly a significant risk to taxpayers who have entered into Subordination Agreements that section 8F will apply. A further hindrance is that by their nature, subordinated loans cannot be repayable on demand, which could otherwise potentially place them beyond the ambit of section 8F.
It’s important to bear in mind however, that section 8F will only apply to interest bearing subordinated debt, so taxpayers with interest-free subordinated debt, so taxpayers with interest-free suborindated debt may rest assured that at this stage they do not fall within the section 8F net.
Proposed tax changes to company cars
By Doné Howell, tax partner, Grant Thornton Johannesburg
With the continued review of tax legislation, whether prompted by the Davis Commission’s mandate or simply by a need to correct anomalies in current drafting, more and more tax changes seem unavoidable. One such change was introduced from 1 March 2015 to eliminate the inequities and anomalies in determining the taxable benefit arising from an employee’s right to use a company car.
Employees who are required to travel for business purposes and make use of a company car, are subject to fringe benefit tax of 3.25% (if there is a maintenance plan in place) or 3.5% (with no maintenance plan) of the “determined value of the company car.
The changes introduced on 1 March, will only affect employees using company cars ‘acquired’ after 1 March 2015, i.e. the calculation of the taxable benefit for existing company cars will not be affected by the proposed change.
Company cars acquired before 1 March 2015
The “determined value” of company cars acquired prior to 1 March 2015, is defined as:
- the original cost of the vehicle paid by the employer (excluding any finance charge or interest payable), if the car was purchased through a bona fide arm’s length agreement of sale or exchange
- the cash value of the car, if this car is financed through a lease as is described in paragraph (b) of the definition of ‘instalment credit agreement”
- the retail market value of the car, on the first date that the employer obtained the right to use the vehicle, if the vehicle is financed through any other type of lease agreement but not an ‘operating lease’ or
- the market value of the car, at the time that the employer first acquired the vehicle or right use of the vehicle, will apply to all other circumstances not described above.
For employees of new and used car dealers or employees in the motor vehicle rental industry, SARS accepted that the “determined value” of the company car was equal to the average cost of all stock in trade or rental vehicles on hand at the end of the employers’ preceding year of assessment.
Furthermore, in the past, the determined value of motor manufacturers’ company cars was equal to the cost of manufacture of a car. Currently however, these cars’ determined value is equal to the market value, or ‘Dealer Billing Price’ of the car at the time the employer first obtained the right to use it and that.
Company cars acquired after 1 March 2015
From the above it is clear that the ‘determined value’ will differ greatly depending on the means of acquisition of the car or the nature of the employer’s business. In an effort to align the determined value for all employers and employees, the definition of determined value will be actual retail market value of the car, including VAT but excluding finance charges and interest, regardless of the type of acquisition or the nature of the employer’s business.
The impact of a company car on the employee’s tax
If the vehicle was acquired under an operating lease (as defined) before 1 March 2015, the monthly taxable value used to determine the employee’s taxable benefit, is equal to the employer’s actual cost incurred under that operating lease and the cost of fuel in respect of that vehicle.
For vehicles acquired or financed after 1 March, the employee will be taxed on the new deemed value, i.e. retail market value including VAT but excluding finance charges and interest less any consideration paid by the employee towards the cost of the vehicle.
80% of the taxable benefit will be subject to monthly PAYE but the percentage may be reduced to 20% if the employer is satisfied that at least 80% of the use of the company car will be for business purposes.
One submission of the employee’s personal tax return he/she will be permitted to claim as a tax deduction his/her proven business kilometers. SARS will reduce the value placed on the private use of the car by the proven business kilometers, provided it is substantiated by an accurate and detailed logbook of business kilometers travelled. Download the Grant Thornton logbook here.
The ins and outs of the new Tax Clearance Certificate system
By Carin Grobbelaar, senior tax consultant, Grant Thornton Cape
A new and simpler process to apply for ‘Tax Clearance Certificate’ has been introduced, but it is not without pitfalls.
A ‘Tax Clearance Certificate’ (‘TCC’) is a written confirmation from SARS that a person’s tax affairs are in order at the date of issue of the TCC. TCC’s are critically important to business in today’s economy because tenders are awarded only to taxpayers whose tax affairs are in good standing. However, obtaining a TCC from SARS can be rather time consuming and frustrating.
To alleviate taxpayers’ frustration, SARS introduced a new tax clearance system (‘TCS’) to modernise and enhance the process of issuing of tax clearance certificates. Taxpayers can apply for a TCC via eFiling or at a SARS branch but a single application form (TCC 001) now replaces all previous forms. The good news is that applications are now processed online and in real-time, with the exception of a TCC required for a Foreign Investment Allowance or emigration (which will still need to be manually submitted to SARS together with the supporting documentation).
The new process
When applying for a TCC, all supporting documents must be provided to speed up the application process. A response on the outcome will be provided within five (5) business days. An email notification will be sent, where application, and include a reason for being declined, if applicable.
If a TCC application is not immediately approved, it will be sent away for review and can no longer be finalised at a SARS branch. Again, taxpayers will receive an email notification within five (5) business days, informing them of the result of their application and if the application is declined, a reason will be provided or if approved, the TCC must be collected at a SARS branch.
Requirements and potential pitfalls
SARS will only issue a TCC if the following requirements have been met:
- he taxpayer must have registered for Income Tax before applying for a TCC
- the taxpayer’s account must be in good standing for all types of tax
- any deferred arrangements made, must be honoured
- all returns and/or declarations must be up to date and in the process of being assessed by SARS
- all tax reference numbers must be active and correct, e.g. the tax reference number must not be de-registered or suspended on the SARS system
- the registration details on the TCC 001 must correspond with the information on the SARS systems.
The SARS website provides that where a TCC is requested for a holding company via eFiling, the holding company’s tax reference numbers (i.e. Income Tax-, Value-Added Tax (VAT) – and/or Employees Tax (PAYE) numbers) must be used. Where the application is for a branch or division of the main company, the branch VAT number and PAYE number must be used. SARS will add all sub-entities belonging to the holding company and provide a combined TCC.
A potential pitfall to this system is that the tax compliance of sub-entities, divisions or branches of a corporate entity will have an impact on the holding company’s tax compliance status, meaning if any one of the sub-entities is non-compliant, the holding company will also be regarded as non-compliant and a TCC will be declined.