Minister of Finance Trevor Manuel is in a good position to cut both corporate and personal income tax, should he wish to do so, when he makes his 10th Budget speech on February 15, due to the tax overrun of almost R40-billion that the Treasury has accumulated.
Billy Joubert, partner at Deloitte and Touche, said that although Manuel had cut corporate tax by 1% in the last Budget, he might consider further cuts or even cuts in the personal income-tax rate, “because there’s a gap between the corporate rate and the individual rate”.
“It’s 29% for companies and a marginal rate of 40% for individuals, but individuals aren’t subject to secondary tax on companies [STC], so the gap isn’t quite as big as it looks — the effective rate is probably around 36% if a company distributes all its profits as it pays income tax and STC as well.”
Nevertheless, a disparity between company and personal income tax encourages arbitrage — taxpayers move their income base between corporate and personal income in order to lessen tax payments.
“Manuel should be looking at cutting the marginal rate as well — one of the reasons for that is a disparity in rates gives people an incentive to arbitrage between the two, so someone might try and operate through a company rather than in their personal capacity to try and take advantage of that lower rate — and that’s not desirable — one shouldn’t use a company for that reason,” Joubert said.
STC
As the Treasury relies heavily on STC — often cited as an obstacle to encouraging foreign investment — Joubert doesn’t think that the tax will be abolished, but suggests that it be replaced by a withholding tax on dividends.
“I don’t think STC will be abolished altogether — that would be huge step and it might be a good thing — but I don’t see the minister going that far. But what he might consider doing and what I’ve been saying he should do this for sometime is replacing it with a withholding tax on dividends, which is the more common kind of tax around the world and foreigners would understand what it is.”
In addition, Joubert said, foreigners might even be able to claim double tax relief in terms of double tax agreements (DTAs).
“South Africa has DTAs with a huge number of different countries and a lot of those would entitle residents of that country to claim relief from this withholding tax. So obviously there’s a cost for the South African Revenue Service [SARS], but a move in this direction would encourage foreign investment.”
The cost of doing business in South Africa remains high.
“Although the nominal rate is only 29%, the sting in the tail is STC. Corporate tax rates vary from 0% — in tax havens — to around 40%, and we are somewhere in the middle, but we’re a relatively high tax jurisdiction,” Joubert explained.
Personal income tax
Turning to personal income tax, Joubert said that deductions would benefit taxpayers across all income brackets: “Everyone has been getting relief over the past few years because of the adjustments in the brackets — that’s in order to avoid so-called fiscal drag or bracket creep.
“What that meant was that when we had a relatively high inflation environment, they would adjust the brackets by less than inflation and that meant that even though your salary was only keeping up with inflation, you were paying more and more tax on it.”
Joubert noted that for the past few budgets the taxpayer were given more generous adjustments because South Africa is now in a relatively low inflation environment compared with previous years. However, top earners have not benefited.
“If you’re earning R300Â 000, those shifts are quite significant, but if you’re earning R1-million a year, then it’s completely irrelevant because it’s only affecting the first R300Â 000 of your income. So, the thing that would be most meaningful to the high earners would be a cut in the marginal rate.”
CGT
Turning to capital gains tax (CGT), Joubert said the CGT exemption of R1-million on the sale of a primary residence has not risen since CGT was implemented in 2001. Since that time, property prices have rocketed.
“In 2001, they probably thought unless you’re very wealthy you’re not going to get taxed, but these days you can have a house in quite an average suburb of Johannesburg and make more than a million rand gain, so given that our property prices have — I would think since 2001 — doubled at least or trebled, maybe they should think of moving that up quite a bit as well.”
Ian MacKenzie, head of corporate tax at Webber Wentzel Bowens, said it is unlikely that the corporate tax rate of 29% would be reduced again this year.
“It is, however, possible that the minister could reduce the STC rate from 12,5% to 10%, which would reduce the maximum effective rate of a company that distributes all its after-tax profits as a dividend from 36,89% to 35,45%.
“Suggestions that STC could be abolished will not be adopted by the minister, because of the political need to have a tax on dividends and the fact that STC is the simplest tax of this nature and is very easy to administer,” MacKenzie said.
Withholding tax
He added that a withholding tax on dividends would have the same commercial implications as STC, except the tax burden would fall on the shareholders instead of the company paying the dividend.
“The withholding system (assuming it will be a final tax) will have to provide for tax credits in respect of dividends moving through chains of companies in the same way as the STC system does. Overall, any such change will amount to cosmetic shuffling with no real benefit for the fiscus.
“It will, however, benefit foreign shareholders who fall within the double tax treaty provisions for exemption or partial exemption from South African tax on dividends, leading to lower tax collections. If the withholding tax is not a final tax, it will give rise to huge administrative issues for SARS.”
MacKenzie said he doesn’t think that STC per se puts off foreign investors — “it is the combination of corporate tax and STC and the high effective rate that puts them off”, he said.
David Clegg, tax partner at Ernst & Young, is of the opinion that there may be a further reduction in the number of tax brackets, although he does not see the amount at which the top rate kicks in — at R300Â 000 — being extended, as inflation is low and the top bracket has moved in the past five years. He does, however, think that the top marginal rate will come down.
“There is already an uneasy imbalance between the corporate rate of tax, including tax on distributed profits — 36,9% — and the top marginal rate for individuals of 40%. Economic theory suggests these top rates should align, so as to remove any incentive to operate in incorporated or unincorporated form dependent purely upon the tax rate to be enjoyed,” he noted.
Turning to the question of whether STC should be abolished, Clegg said: “It is a complication in the system which I would happily do without, but if its originally proclaimed purpose — that is, to encourage companies to retain funds for reinvestment rather than to distribute to shareholders — still exists, then it presumably is still doing a reasonable job.
“If, on the other hand, like most taxes, it is now just a part of the moneymaking machine, then my sense is it will be better to do away with it and raise the base corporate rate by sufficient to compensate. Revenue collection statistics suggest that this might result in a corporate rate of about 33%.
“But maybe, given the surpluses available and that it actually generates very little — around R7-billion — it can just go!” — I-Net Bridge