Pretoria - The contribution of corporate income tax to total tax collections in South Africa has diminished over the years. Corporate tax collections of R207 billion this year was slightly lower than the estimate.
Latest statistics show that company taxes represent just under 17 percent of the total tax contribution – down from 20 percent in the distant past.
The Davis Tax Committee has invited public submissions as part of its review of South Africa’s tax system. One of the issues that will be addressed is the efficiency of the current corporate income tax structure.
The deadline for submissions was the end of last month.
The South African Institute of Tax Professionals (SAIT) says in its submission to the committee that South African “has a pressing need” for tax transparent vehicles for large scale private investments such as investments in infrastructure funds, private equity or venture capital funds.
Erika de Villiers, head of policy at SAIT, says there are various different regimes or vehicles that are tax-transparent, both in South Africa and globally.
“A trust is mostly tax-transparent in that it acts as a conduit or flow-through (tax-transparent vehicle) whereby the profits flow through the trust and are taxed only in the hands of the beneficiaries.”
Similar principals apply for partnerships. However, the biggest downsides for using trusts or partnerships as investment vehicles are complexity and risk of the investors losing their limited liability. Losing their limited liabilities means their assets can be seized in instances where the vehicle has debt.
“Companies are better vehicles to provide limited liability but they are, generally, not tax transparent as they are subject to tax in their own right,” says De Villiers.
Investment vehicles which are not tax transparent (such as venture capital companies) introduce an additional layer of tax.
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SAIT CEO Keith Engel says problems arise when a group of investors want to invest through an investment holding company vehicle such as venture capital companies or private equity funds.
The holding company typically hold one or more operating companies. They are typically sold off once profits can be realised.
The effect is that once the holding company sells off the underlying investments it pays capital gains tax on the profits. Once it distributes those after tax profits to its investors they too pay tax – a whopping 20% dividends withholding tax.
“The additional layer created by the investment holding company makes the investment non-viable,” says Engel.
In a tax-transparent vehicle the income or gains flow-through as if the vehicle was not there for tax purposes at least.
Ernest Mazansky, director at Werksmans Tax, says South Africa sorely needs more modern law relating to tax transparent vehicles - not just as investment vehicles - but generally as business vehicles.
South Africa is seriously lagging the world in relation to tax-transparent vehicles which also give limited liability.
The principle vehicles housing South African private equity funds investing in South Africa are limited liability partnerships (called en commandite partnerships) and trust structures.
“Our en commandite partnership rules, which are based on the common law, are cumbersome and archaic. We could seriously do with an overhaul, which could include the introduction of the US limited liability company or the UK limited liability partnership, both for businesses and professionals,” says Mazansky.
Unfortunately, the drafting of the legislation fails under the Department of Justice, and not under National Treasury.
That is not to say that the Davis Tax Committee could not recommend treasury to request it from justice, says Mazansky.
In its submission SAIT illustrates that an indirect investment (through the holding company) currently attracts an effective tax rate on the gains of 37.9 percent whereas a direct investment has an effective tax rate on the same gain of 18 percent.
“Ideally an investor should be neutral for tax purposes, whether they invest directly or through an invest vehicle,” he says.
De Villiers says although companies are in general not tax-transparent – there are exceptions such as the real estate investment trusts (REITs). They are
listed companies, but have a specific tax regime that make them tax-transparent. Generally the REIT is not subject to tax and the REIT investors are not liable to dividends tax, but the investors pay tax on the net rental income of the REIT as if they earned it themselves (the flow-through principle).
“The price of inaction at the domestic level is the unnecessary additional layer of tax that may prevent investment. This deterrence is especially problematic for infrastructure investments.”
If foreign investors are involved, the typical choice is to shift the holding vehicle offshore to Mauritius where the additional tax layer can easily be avoided. The net result is to reinforce the advantages of Mauritius as a regional hub for investment as opposed to South Africa, SAIT says.
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