Gordhan needs to find tax and spending measures that will plug the deficit in South Africa’s budget during a time of political instability, an ailing economy and the risk of having its financial rating downgraded to junk status. In his mid-term budget policy statement (MTBPS), announced in October 2016, Gordhan confirmed that significant tax increases will be necessary over the next two years to raise ZAR 43 billion ($3.1 billion) in tax revenues to help stabilise the economy (ZAR 28 billion in 2017-18 and ZAR 15 billion in 2018-19).
However, the tax options available to the finance minister ahead of the budget statement on February 22 appear to be limited.
Nevertheless, Dale Cridlan, tax practitioner and director of Norton Rose Fulbright in Johannesburg, said “CEOs do recognise that we are in a difficult economic environment at the moment and I think there is almost an understanding that rates are going to be increased”.
However, although Erika de Villiers, head of tax policy at the South African Institute of Tax Professionals, acknowledged that tax increases are expected in the budget, she warned that it is not sustainable for South Africa to balance its books by way of tax increases. “Such tax increases are likely to limit growth and increase inflation,” de Villiers told International Tax Review. “Government spending should be well targeted and tightly controlled to assist in bridging the gap between income and expenditure.”
So how could the finance minister fill the budget black hole?
Nazrien Kader, head of taxation services at Deloitte Africa, suggested that the government could maximise its potential by:
- Introducing a surcharge tax on wealthy individuals and all companies;
- Increasing tax collection on inter-generational wealth transfers;
- Increasing the VAT rate from 14% to 15%;
- Introducing a sugar tax;
- Balancing its fiscal drag;Introducing fuel levies among other ‘sin’ taxes;
- Improving tax collection and compliance; and
- Boosting tax revenues through the voluntary disclosure programme.
- By incorporating these measures, Kader said the government could raise more than the necessary ZAR 43 billion.
For businesses, the ‘wish list’ is a little different. Tracy Brophy, head if tax risk management at FirstRand Group Tax, said “corporate South Africa is looking for a reduction in expenditure (wasteful, corrupt or otherwise) by government, since the deficit cannot simply be solved by raising tax revenues. So, any well thought out and achievable proposals in this regard would be welcome”.
“With regard to tax changes, there is a substantial amount of specific anti-avoidance legislation, aimed at specific transactions or structures, being promulgated in South Africa annually, which needs to be debated with National Treasury to ensure that the mischief they seek to curtail is caught rather than commercial transactions. In this regard, it would be nice to see a reduction in the amount of specific anti-avoidance legislation for this cycle in favour of the South African Revenue Service relying on the general anti-avoidance provisions to target any impermissible tax avoidance,” Brophy said, adding that she also expects more BEPS-related initiatives to be announced.
However, nothing is quite so simple.
Corporate tax rates to remain steady
South Africa’s corporate tax rate stands at 28% and there is a possibility of increasing this by a few percentage points to raise tax revenues, but this is doubtful.
Cridlan said that a higher corporate tax rate is unlikely because it would not generate the necessary revenue and would instead “chase away” foreign investment.
If Gordhan chose to raise the tax rate, however, it would not go above the 32% rate in neighbouring Namibia, or Africa’s highest corporate tax rate of 35% in Zambia.
Nevertheless, any increase would mean South Africa would be going against the global downward trend and be above the average 2016 rate across Africa of 27.46% and the global average of 23.62%, according to KPMG’s tax table for 2016.
In addition, Cridlan believes corporate tax incentives are unlikely to change much, with only some “tweaks” being proposed.
However, Deloitte’s Kader said that although a corporate tax hike may not happen, businesses should be ready for “far more vigorous enforcement”, driven by a focus on BEPS and the widening tax gap (the difference between what we ought to be collecting and what we are actually collecting).
Little space to raise corporate capital gains taxes
Another option to generate more tax revenues could be increasing capital gains taxes (CGT) for corporations, but only a slight rise is possible.
Last year, the government increased the amount of gains that would be subject to CGT from 66.6% to 80%, leaving the government with little room to raise it further this year, according to Cridlan.
“If you look at a corporate, for example, what would happen is that 80% of any gain is included in a corporate’s taxable income and taxed at 28%. So, what they did is increase the 80% from 66.6% last year. If they were to increase the 80% to 90%, then there is not much of a difference from 90% to 100%. So, you are then effectively taking away – our CGT rates are lower than income tax rates and effectively by increasing that CGT rate you are not distinguishing between an income tax rate and a CGT rate. So, there is not too much room left to manoeuvre – not on the CGT side.”
However, individuals could face an increase in the CGT because the proportion of capital gains subject to tax is 40% for individuals.
VAT hike ideal, but not possible
With such a large tax gap to fill, many tax practitioners believe a rise in the VAT rate would be the best way to help resolve the deficit and prevent a ratings downgrade.
Kader said that raising the 14% VAT rate to 15% could generate ZAR 15 billion of additional revenue, but would also reduce GDP by between 0.2% and 0.4%, and would also increase inflation.
Although South Africa’s VAT rate is comparatively low by international and even African standards, Cridlan said the government sees it as a regressive tax. “In other words, it’s going to do more harm to poor people than it is to the rich people. And it is seen as a tax that will hit everybody across the board,” Cridlan said. “On the one hand, that is maybe something that South Africa needs to collect taxes more broadly, but every year we predict an increase in the VAT rate and it never happens. I think VAT is just too much of a political hot potato for them to increase the rates, so I don’t think we are going to see an increase in the VAT rates.”
An increase in the rate could cost the ruling ANC party to lose voters and become unpopular. The political issues, coupled with the economic impact of a VAT rate rise mean this is very unlikely.
“Whilst an increase in the VAT rate would impact the entire economy, which the trade unions are fighting on the basis of hardship to the poorer tiers in our society, the Davis Tax Committee has released statistics which indicate that personal income tax and corporate income tax would need to be increased by 6% and 5%, respectively, in order to generate the same increase in revenue as a 3% increase in VAT (and a VAT rate increase would have a less negative impact on GDP and employment, since an increase in personal income tax may encourage a flight of skills and an increase in corporate income tax would be a serious disincentive to foreign direct investment),” said Brophy. “It has also been estimated by certain economists that a 2% increase in the VAT rate may extinguish the deficit. So, the statistics speak for themselves in terms of which ‘tax lever’ would generate the most additional revenue in the most effective way.”
Nevertheless, Cridlan said “it just looks like VAT is not going to be touched”.
Carbon and sugar taxes
South Africa has been planning to introduce a carbon tax and sugar tax for some time. However, the proposals have been stalled at various stages and seem unlikely to be introduced in 2017 as planned.
Cridlan said that big announcements are not likely on the planned carbon or sugar tax in the budget. Instead, there could be some clarity about the direction that government plans to take, with carbon tax being postponed for a further year as stabilising the economy is the bigger concern.
However, Kader said that if the government did introduce the sugar tax, it could potentially generate around ZAR 11 billion in tax revenues, based on preliminary research.
On other ‘sin’ taxes and fuel levies, if the government raised these above inflation, then they could achieve about ZAR 9 billion in additional tax revenues, Kader added.
On carbon tax, Kader said that more details are crucial to held taxpayers to prepare for its introduction. “The carbon tax could make a significant dent in South Africa’s budget deficit, making it more likely that the tax will be introduced sooner rather than later,” Kader said. “A draft of the bill has already been released with a planned implementation date of January 1 2017. Many comments were made on this bill and a new draft is expected early in 2017 with a view to implement the legislation in 2018. There are several outstanding issues that need to be addressed in the revised legislation. Possibly one of the more pressing of these issues is the emissions threshold for paying carbon tax. It is also unclear who the taxpayer will be. There are some indications that groups of companies would be liable, but tax is normally levied at company level.”
“Although a carbon tax is relatively simple in structure, its implementation is likely to be difficult,” Kader added. “This is because carbon taxes are based on fossil fuel consumption, which is not currently measured in the same amount of detail as expenditure and revenue, and is usually not as readily available as financial line items.”
Compliance and TP measures possible
An alternative to numerous tax rate increases is better tax collection through efficiencies in the tax authority.
“The Common Reporting Standard might generate an additional source of revenue with government authorities worldwide cooperating with each other. We could see some tax efficiencies on the tax collection or compliance side, making our revenue authority more efficient in collecting taxes,” said Cridlan.
In addition, Kader said that South Africa’s special voluntary disclosure programme, which aims to bring undisclosed foreign investments held by South Africans into the tax net, could generate significant tax revenue – potentially at least ZAR 10 billion. “Although the amount will only be known when the programme ends in June 2017. The last amnesty in 2003 yielded ZAR 48 billion,” Kader said.
On transfer pricing, Kader believes that further changes could be announced in this year’s budget after the introduction of country-by-country reporting and detailed record retention rules in 2016. “This is likely to keep taxpayers busy, but there may well be further changes announced,” Kader said.
Personal income taxes to rise
With little room to move on businesses taxes, the evidence points to higher taxes for individuals.
Both Cridland and Kader said this was the most likely option, with the rate potentially increasing from 41% to as high as 45% for the top bracket of taxpayers.
“The marginal tax rate for high-earning individuals could be increased from 41% currently to 45%, which would yield an additional ZAR 3.5 billion in revenue,” Kader said. “In addition, the National Treasury could apply a special levy or surcharge to individuals earning above a set threshold. This is also likely to apply to companies based on turnover as a means to collect some tax from companies when profits are non-existent.”
Spending cuts could mark the end of Gordhan’s career as finance minister
In addition to potential tax hikes, spending could be restricted to show that government ministers are not exploiting taxpayer funds for their personal gains.
“There’s almost an announcement every day of some further government wastage on cars or whatever the case may be. So, we could see some further tightening of belts as far as expenditure is concerned,” Cridlan said.
These spending restrictions could see Prime Minister Jacob Zuma deal a big blow to Gordhan’s career but if the South African finance minister was replaced, investor confidence is likely to fall dramatically.
“I think there is a sense that the current government would like for various reasons for the finance minister to go. To be replaced. But I’m hoping that it doesn’t happen because it is not going to be perceived very well by the investment community,” said Cridlan. “As we have seen historically, it isn’t a move that is favoured very well among investors, but there are some noises. There is has been some rumblings that there could be a shuffle in the cabinet.”
The weeks leading up to the annual budget on February 22 could be turbulent for the government, but what is announced on the day and how it is perceived by taxpayers, financial ratings agencies and foreign investors could have a big impact on how the South African economy succeeds – or fails – in the coming year.
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