CHAPTER 9

9.1 INTRODUCTION

9.1.1 In its first Interim Report the Commission's conclusion regarding Secondary Tax on Companies ("STC") was summarised as follows (paragraph 19.114):

STC should be retained in its present form but various forms of imputation tax should be investigated in order to determine whether an imputation system could replace STC.

9.1.2 The Commission has now referred to a wide range of authorities, as well as to a substantial body of additional evidence, including submissions from organised business. A strong impression that has emerged is that, regardless of the merits of the STC concept, a major part of the problem lies in the perceived tax burden that arises from the combined effects of the basic corporate rate of 35 per cent and the STC rate of 25 per cent.

9.1.3 This problem is two-fold. In the first place, the combined corporate and STC rate is too high, and secondly, the STC component itself is too high. Indeed, most of the conceptual difficulties with regard to STC have existed from its inception in 1993, but it was only after the increase in the rate from 15 per cent to 25 per cent that these problems assumed significant proportions. The Commission observes that no matter what system is in operation, excessive overall rates and an excessive rate upon distribution will accentuate the disadvantages and obviate the advantages of such a system.

9.1.4 The Commission's inquiry into this matter has addressed the conceptual arguments, administrative implications, fiscal considerations, and the foreign perspective. A few other aspects, if STC is to be retained, are also considered below.

9.2 THE CONCEPTUAL ARGUMENT

9.2.1 In paragraphs 11.4.1 to 11.4.5 of the first Interim Report the two main rival systems, namely the classical and the imputation systems, were briefly described. Alongside this categorisation, the taxing of corporate profits can be classified with regard to the burden of tax imposed on the company before distribution and the burden imposed thereafter on the shareholder. In the classical system, both the company and the shareholder are taxed independently. The result is what is referred to as economic double taxation.

9.2.2 The system employed is no indication of the overall tax burden on both a company and its shareholders, of course. A pure classical system with low rates of corporate and dividend tax may result in a lower combined burden than either a tax on the company only or a tax on shareholders and no company tax.

9.2.3 Theorists tend to favour an imputation system for, amongst others, the following reasons:

1. it recognises that only individuals ultimately carry a tax burden;
2. it treats the company as merely the vehicle for generating the earnings of individual shareholders and paying tax on a provisional basis, on their behalf;
3. in its purest form, it allows even corporate earnings to be taxed at progressive personal rates rather than at a flat corporate rate;
4. in attaching tax consequences to the variable characteristics of individual shareholders, it is seen as more equitable;
5. it avoids economic double taxation; and
6. it has other perceived economic advantages, such as enhancing neutrality with regard to investor's portfolio decisions or corporate funding.

9.2.4 The Commission recognises the soundness of these arguments. Account must also be taken of the circumstances in which the corporate tax is to be applied, however. Unless a full credit system is implemented, for example, neutrality will not be achieved where a large proportion of shares are held by tax exempt bodies. (This is of course the current position in South Africa, although recommendations elsewhere in this report may partially remedy this problem.) Considering the role of the tax structure on dividend policy in the United Kingdom which has a partial imputation system, it has been observed that:

Under the imputation system, dividends offer a tax advantage for (tax exempt shareholders), which may result in a higher level of dividend payments by firms than would otherwise be the case. Higher rate taxpayers may have the opposite tax preference, but the current system is certainly not neutral with regard to the company's dividend payout decision... The current tax bias in favour of dividends for tax exempt investors seems hard to justify, and may have an undesirable impact on company investment.

9.2.5 In a comprehensive OECD study the authors note:

There is no consensus on the desirability of integrating the personal and corporate income tax or on what would be the best method to achieve such integration. Whilst most, but by no means all, public finance experts accept that economic double taxation may be distorting the financing and investing decisions of enterprises, there is no agreement on the quantitative significance of these distortions. Also, the introduction of imputation systems may be costly in revenue terms and can complicate international fiscal arrangements.

9.2.6 Even where there may be theoretical unanimity, practical considerations soon enter into the debate to disturb that unanimity. In summarising their views as regards the perceived advantage of imputation credit systems on capital export neutrality, the OECD authors comment:

... in practice neither credit nor exemption systems achieve capital export neutrality. The question which then arises is whether the administrative advantages associated with exemption systems more than offset the potential efficiency gains associated with less than pure credit systems.

9.2.7 In reality, of course, countries select their systems through a combination of local economic priorities, pragmatic fiscal and administrative considerations, international influence, and very often simply historic development. It is therefore not surprising that no country operates a pure imputation system; all are hybrids of some sort.

9.2.8 In Appendix 1 to this Chapter, the position in 66 countries is summarised. Admittedly simplified, this tabulation indicates that:

1. the majority of systems (53 of the 66 countries) still adhere, in essence, to a classical system, modified to varying degrees to reduce double taxation;
2. few developing countries make use of an imputation system and not all industrialised countries have implemented such a system;
3. of the 66 countries, only 9 operate a standard classical system (category 1 in the table) and only 13 operate various forms of imputation systems (categories 6 and 7). The remaining 44 countries operate modified classical systems. Of these, the majority, numbering 26, operate systems which grant full relief to shareholders, although 11 of these (including South Africa) grant this relief only at the cost of a higher corporate tax rate (or a withholding tax) on distributed earnings.

9.2.9 South Africa is no different from other countries in that tax policy should be guided by the realities of economic priorities, fiscal considerations, administrative feasibility and taxpayer compliance costs. Subject to these considerations, the Commission emphasises its preference, in principle, for an imputation system.

9.3 ADMINISTRATION

9.3.1 Most submissions received by the Commission acknowledge that a major drawback of an imputation system is its complexity with regard to legislation, subsequent administration and compliance costs.

9.3.2 It is a feature of the partial credit system used in Australia that the complexity, administrative burden and compliance costs impact particularly on the corporate taxpayer whereas an equalisation approach, as applied in the United Kingdom, results in a great administrative burden on the revenue authorities.

9.3.3 The administrative reforms envisaged for the South African revenue services will no doubt improve their capacity to deal with a complex reform, but this will not occur immediately. The expertise required to administer an imputation system will have to be developed over a period of years. Furthermore, the first priority for an improved administration will be to increase collection effectiveness in the many areas where there is currently a serious revenue leakage. Evidence from senior officials of Inland Revenue support the Commission's perception that introducing an imputation system at this time would severely strain its resources.

9.3.4 The complexity of an imputation system from the perspective of the taxpayer is a serious disadvantage. An imputation system would not be optional and would affect all companies, including close corporations. At a time when it is vital to extend corporate economic activity throughout all levels of society, introducing a new tax system that requires a considerable degree of sophistication and would considerably increase the compliance costs of small companies, in particular, would seem to be ill advised.

9.3.5 The Commission has considered several possibilities of a simplified form of imputation. Many of these simplifications, however, would dilute the basic objectives of an imputation system to such an extent that the change would not be warranted. In addition, apparent simplifications, as occur when any basically complex system is simplified, quickly lead to new complexities. For example, a partial credit system would oblige the revenue authorities to assess credits claimed against other income by some taxpayers on the Standard Income Tax on Employees ("SITE") basis of taxation. This problem might be alleviated by granting individual taxpayers with non-salary income below a certain level complete exemption from taxation of all dividends. This "exemption" might, however, give rise to claims of discrimination against low income shareholders who would forfeit any credit against other income where franked dividends were received. A counter-argument could be raised that unfranked dividends would not be taxed at all. However, introducing floors and ceilings into a tax system makes for complexity in itself, opens opportunities for manipulation, and causes tax to influence commercial behaviour.

9.3.6 STC has its own complexities. However, if only by virtue of the fact that it is levied "closer to source", it is a comparatively simple system to administer. It involves few taxing points, these are typically financially sophisticated, and the system has no need to take account of shareholder characteristics. Revenue authorities and corporate taxpayers alike have learnt to administer the tax.

9.4 FISCAL CONSIDERATIONS

9.4.1 An imputation system will only give rise to the collection of additional tax if:

1. the average individual shareholder tax rate is higher than the corporate tax rate; or
2. only partial input credits are granted; or
3. equalisation taxes are levied and corporations are unable to use such equalisation taxes against their future tax liability.

9.4.2 Given the high concentration of shareholding in the contractual savings industry (which largely comprises funds exempt from tax), and the fact that the maximum individual tax rate is 45 per cent whereas the maximum corporate tax rate, including STC, is 48 per cent, it is unlikely that the introduction of an imputation system would raise the same revenue as is currently raised by STC. Moreover, the adoption of a limited credit system (or the introduction of an equalisation tax which would rank as a future tax credit for the company) would largely remove the minimum tax and capital gains tax elements of the current STC tax system. The expected quantum of tax that could be raised from the taxation of dividends would, in an imputation system, therefore rely on the extent of equity holdings outside of non-exempt funds (unit trusts), individual policy holder funds in life offices which are currently taxed at 30 per cent and individual investors. The granting of only partial credits as a method to raise additional revenue clearly goes against the basic philosophy of an imputation system and would only be effective where equalisation taxes were introduced at corporate level. The administrative implications of this, however, are highly unattractive.

9.4.3 That STC contains a minimum tax element, and effectively subjects companies to a degree of capital gains tax (to the extent that capital gains are distributed), can be seen as disadvantages or advantages. However, these elements contribute to the fiscus whatever their other merits or demerits. As with any system, an imputation system could be adjusted or complemented to accommodate these considerations (for example by the introduction of a separate minimum tax for companies or some form of limited capital gains tax), but such further modifications would involve yet further complexity and administrative strain.

9.4.4 As analysed hereunder, other potential cost factors arise from international considerations. Cognisance should also be taken of the fact that a complex new tax inevitably results in a collection learning curve in the introductory years which reduce the overall collection.

9.4.5 Overall, the Commission considers that a switch to an imputation system would, at least in the short term, hold serious negative revenue implications.

9.5 FOREIGN CONSIDERATIONS

International Recognition

9.5.1 A major criticism of the STC has been that it is not easily recognised internationally. This results in the unavailability to foreign investors of foreign or double tax treaty relief against foreign country taxes. To the extent that this remains true, it is indeed so serious an aspect that even the problems referred to above may have to be reconsidered.

9.5.2 However, Inland Revenue has taken action to mitigate this problem:

1. firstly, wherever necessary and possible, new double tax treaties specifically bring STC within their scope as an income tax;
2. secondly, negotiations to persuade foreign fiscal authorities to recognise STC as an income tax for purposes of existing double tax treaties have continued.

Both approaches have borne fruit, and the recent announcement that the United Kingdom will recognise STC as an income tax for purposes of its treaty with South Africa represents something of a turning point. Inland Revenue has indicated that it has no reason to believe that its continued efforts should not resolve this matter in the majority of double tax treaties with major trading partners.

Branch Profits

9.5.3 STC has been criticised for the way it applies to foreign companies operating in South Africa in the form of a branch. There are three problems with the current dispensation:

1. As noted in the First Interim Report, in law STC is due by foreign companies declaring dividends from profits derived from their branch operations in South Africa. However, this has proved very difficult to enforce, and in practice the tax liability is simply not enforced by the Revenue. Apart from any adverse revenue implications, an almost institutionalised disregard for the law is wholly unacceptable. A provision of law honoured only in the breach undermines respect for the law.
2. The loss of revenue is a disadvantage.
3. The consequent advantage for foreign investors who operate here in branch form over those who incorporate their business is a distorting factor of the kind a tax system should try to avoid.

9.5.4 The Commission agrees with these criticisms and, in the event that STC is retained, considered several options. The following would be possible reactions:

1. the imposition of a branch tax;
2. simply tolerating the position as it exists; or
3. attempting to enforce the STC together with penalties for non-compliance.

9.5.5 The imposition of a branch tax would resolve the three problems noted above, and technically would be feasible. The Commission's research shows that, while the matter would not be entirely beyond debate, there should be no double tax treaty prohibition to such a tax. A rate could be devised that would take cognisance of the fact that it is possible to defer the incidence of STC and would bring about an approximate parity with that tax. However, one major disadvantage would be that such a step, relevant more or less only in the STC context might be seen as a permanent commitment to STC, a position which the Commission is not prepared to adopt at present. Should the circumstances which inhibit a change to some form of imputation regime be removed, and should the Commission's further analysis of the imputation system show positive grounds for such a change, a branch profits tax would be inappropriate and would have to be discontinued. The message of such a reversal would be an unfortunate one of instability in our tax system, particularly for foreign investors and traders.

9.5.6 The existing position could simply be tolerated with the qualification that, in so far as the tax is in any event not collected in the branch situation, its incidence in these instances should formally be removed. This would leave the second and third problems referred to in paragraph 9.5.3 above unresolved.

9.5.7 The Commission accepts that this option would amount to a forfeiture of revenue, but it would in fact not be lost revenue since it is in any event not being collected. Any attempt to change this without some drastic steps such as a branch profits tax is unlikely to make much impact. To enforce the STC effectively at the level of the foreign company would require highly complex anti-avoidance measures. As an example, reference can be made to the possibility of the foreign company simply on-lending its South African branch profits at a market related interest charge. This would qualify the company for an exemption in terms of section 64C(4)(d) of the Income Tax Act, without South Africa having the benefit of taxing that interest in view of its probable non-South African source. Counter measures are possible, but these would have to negotiate carefully around anti-discrimination clauses in our treaties. In any event, evidence seems to be clear that it will always be something of a hopeless pursuit to police profit allocations for purposes of such a collection, or expenses allegedly off-set against the South African originating profits.

9.5.8 The structural favouring of the branch over the locally incorporated form of business will also continue, and the Commission has no doubt that in a few instances this will have influenced the form of the investment. At the same time it must be recognised that there are many other factors, including legal, commercial and strategic factors that influence the business form of operations in a foreign country. While tax is certainly one decision factor, it is by no means the only or even necessarily the most important. Indeed, there seems to be little evidence of an influx of branches as opposed to local subsidiary operations since the introduction of STC. If anything, branches are used internationally as a start-up business form and are then subsequently incorporated for commercial and legal reasons. As such, this temporary benefit to branches may have some positive element.

9.5.9 Some suggestions have been made for more effective enforcement of the STC, such as giving the foreign company an option to pay the STC and provide the necessary information for control purposes, or, if it elects not to do so, to become subject instead to a premium on the normal corporate rate to make up for the non-payment of STC. Such a system could be introduced without tax treaty conflict or undue complexity. However, while the option to accept the STC route remains, the difficulties of enforcement will continue to reduce the actual STC collected in this manner. The revenue gains would therefore be insubstantial, while some degree of unpreventable non-compliance would continue to undermine the status of our tax laws.

9.5.10 The Commission concludes that the negative implications of a branch profits tax for the ongoing process of seeking and implementing a viable alternative to STC outweigh the revenue or apparent structural disadvantages inherent in the current situation. It therefore does not recommend the introduction of such a tax. Instead, it recommends that the status quo be maintained, except for legitimising through appropriate legislation the current factual situation of STC not being collected from foreign branches. Clearly this is a temporary situation and the further development of our corporate and dividend tax regime will have to remove these anomalies at the earliest opportunity.

Exemption of Interest Received

9.5.11 While not linked directly to the question of STC, the Commission draws attention to the provisions of section 10(1)(hA) of the Income Tax Act which provides that interest received by a foreign company (that is, one managed and controlled outside the Republic) will be exempt from South African normal tax. Unlike in section 10(1)(h), there is no qualification that this exemption will not apply if the foreign company carries on business in the Republic.

9.5.12 Some foreign companies are specially incorporated entities operating in South Africa as branches, and it would often be possible to argue that they are in fact managed and controlled locally and that consequently the exemption would not apply to them. However, in many cases it would be very difficult to show such management and control to be exercised in South Africa and, in the absence of a disqualification against companies carrying on business here, they will not be liable to tax on all interest received and accrued. An increasing number of foreign banks are operating locally through branches, and such an exemption may result in an unintended and serious loss of revenue to the fiscus. Furthermore such foreign branches will enjoy a competitive advantage over South African banks which creates unnecessary economic distortions.

9.5.13 The Commission recommends that this matter should be rectified without delay.

9.6 CROSS-BORDER PROBLEMS WITH IMPUTATION

9.6.1 The imputation system leads to difficulties when investment crosses national borders. Conflict between measures to relieve international double taxation, on the one hand, and the relief of domestic double taxation through an imputation system on the other, has led to complex measures such as the equalisation tax (discussed in paragraphs 11.4.9 to 11.4.10 of the first Interim Report). In the United Kingdom, the Advanced Corporation Tax coupled with an imputation system created a disincentive for multi-national corporations to establish local headquarters companies for the purpose of investing outside the country. (South Africa is of course a net capital importer, but within the regional context and more generally once exchange controls have been relaxed, increasing flows of outward investment are likely.) Various resolutions of these problems have been tried, but the available literature indicates that even the most sophisticated systems remain somewhat unsatisfactory.

9.7 A FINAL WITHHOLDING TAX

9.7.1 In looking for alternatives to STC which might be appropriate for South Africa at this time, the possibility of simply converting the STC into a final withholding tax on distribution must also be considered.

9.7.2 In the domestic context, the effects of such a change would be minimal, although the move might lead some exempt recipients of dividends to claim different treatment.

9.7.3 In the international context, however, the switch would have a significant effect. A final withholding tax would immediately be subject to treaty provisions which in many cases would reduce the tax to zero. With the abolition of Non-resident Shareholders Tax, the playing field has already been levelled for foreign investors. While as matter of policy it might be desirable to give foreign investors a further incentive, the Commission remains convinced of its earlier position that the first priority for tax reform, also with respect to the interests of foreign investors, is to lower the standard corporate rate. Any sacrifice of tax through treaty reductions would inhibit progress in this regard. Taking into account the continuing efforts of Inland Revenue to resolve the outstanding problems of international recognition of STC (see paragraph 9.5.2 above), furthermore, the advantages to foreign investors of the change would be slight.

9.8 CORPORATE AND STC TAX RATES

9.8.1 As set out in the opening section of this Chapter, the reduction of the burden of the combined effect of the current level of both company tax and STC is the real priority. Any advantages of the present system are attenuated and its disadvantages magnified in the context of a combined rate of up to 48 per cent. Furthermore, the presence of a tax on distribution, whether in the form of a dual rate on the company or a tax on the shareholder, has distorting effects on dividend policy and both foreign and domestic investment. These effects are exacerbated by the disproportionate rate on distribution relative to the basic corporate rate. In the Commission's view, many of the problems of STC were more theoretical than real when the rate was 15 per cent. At the present rate of 25 per cent, dividend policies have been markedly influenced and capitalisation share issues have replaced cash dividends. If STC is to be retained, this imbalance between the rates must be corrected.

9.8.2 One option would be to increase the basic corporate rate and reduce the STC rate. Some submissions in this regard have referred to a corporate rate of 40 per cent with STC at below 15 per cent. The Commission, however, does not favour any solution that increases the basic corporate rate over the current 35 per cent. Not only would that move against a reduction of the total rate, but it would send an unfortunate message to foreign investors. At 35 per cent South Africa is not out of line with the rest of the world and it would be dangerous to move back from that position. A higher standard rate would also affect small and medium-sized enterprises adversely where profits are usually reinvested. Thus, subject inevitably to budgetary feasibility, the basic corporate rate should be retained at 35 per cent.

9.8.3 If STC were brought back to 15 per cent the maximum combined rate would be reduced to 43,5 per cent. The Commission is persuaded that the revenue yielded by the lower STC rate would be reduced less than proportionally. A reduction in the STC rate is likely to release an increased volume of cash dividends which have been held back. Both delayed dividend declarations and capitalisation issues will have led to some pressure for cash dividends while the STC rate has been high. The Commission favours a substantial reduction in the STC rate from its present level, in order to reduce the burden of the combined corporate tax rates and minimise the distorting effects of the STC.

9.9 TAX LOSSES, CAPITAL GAINS AND EXEMPT RECIPIENTS

9.9.1 Assessed losses, capital gains and exempt recipients all reduce the corporate income tax burden, but not the STC base. To some this represents a disadvantage of STC. On the other hand, of course, the broader base allows for a lower rate.

9.9.2 The effect of not allowing tax losses brought forward to reduce the base is that the STC has something of the character of a minimum tax. As regards capital gains, through all the years that dividends were taxable, capital gains in the company were effectively taxed except upon liquidation. As regard exempt institutions the argument can be raised that with the corporate rate at the former level of 48 per cent the situation was no different. The impact of these aspects would be considerably reduced were the STC rate to be reduced.

9.9.3 In all three of these aspects, changes would introduce considerable complexity, especially in the case of capital gains where there would have to be complex system of identification of underlying sources of each dividend, including dividends which flow through a number of companies.

9.9.4 The Commission recommends that if STC is retained no amendments in respect of tax losses, capital gains and exempt recipients should be made at this time. Adjustments might be considered at a later stage if fiscal and administrative circumstances allow.

9.10 CERTAIN OTHER ISSUES

9.10.1 There are a few other issues regarding the STC which have caused difficulties.

Group Reinvestment

9.10.2 The STC system does not cater fully for group reinvestment. One response to this would be to extend the exemptions within a group or even, albeit at the cost of considerable complexity, to reduce the current exemption requirement to below 100 per cent.

9.10.3 Another approach would be to implement a credit refund system of the kind operating in the VAT context. Fears might arise that this would introduce scope for abuse, but such scope already exists in the current dividend netting-off system. A greater problem would be the large cash flows which would have to be administered.

9.10.4 The Commission recommends that these possibilities be further investigated, including their impact on administration.

9.10.5 In so far as the proposal in paragraph 9.10.2 above cannot be implemented without delay, a few refinements are needed to alleviate the unintended inhibition on group reinvestment.

1. The exemption from STC in terms of section 64B(5)(f) of the Act applies as between a wholly owned subsidiary and its parent. There are, however, situations where a group subsidiary's shares are held by more than one shareholder within the group of companies which are themselves wholly owned subsidiaries. The current exemption should be extended to comprehend these situations as well.
2. The same exemption requires that the holding company should derive its "profits" solely from sources within the Republic. There are two problems with regard to this requirement.
1. The absolute terms of the exemption render it inapplicable in situations where in every sense of substance a company complies, but because of a minuscule receipt from a non-South African source it fails to qualify. The Commission recommends that rather than referring to "solely", the test should refer to "substantially all" so as to allow for a legitimate application of the de minimis principle;
2. The provision is not clear as to the period over which there may be no non-RSA profits. The practice seems to be to apply the test from 17 March 1993 (the date of commencement of STC) to date. This uncertainty is undesirable and this practice will become unmanageable. The Commission recommends that the period should not encompass more than one year of assessment prior to the year in which the dividend is declared.

Intra-Group Loans

9.10.6 Currently, in a group of companies, a loan made by a wholly-owned subsidiary to its holding company or to another company owned by the same shareholder/s can be made without STC implications. This applies only between a subsidiary and its direct holding company, or between a subsidiary and a fellow subsidiary which shares a common direct holding company.

9.10.7 Very often loans are made to a fellow subsidiary which is also a wholly owned subsidiary but which does not share the same direct holding company although it does share a common ultimate holding company. Alternatively, a loan might be made by a wholly owned subsidiary not to its direct holding company but to its ultimate holding company. A similar problem occurs where a company is a wholly owned subsidiary within the group, but its shares are held by two or more companies within that same group. In none of these situations can an interest-free loan be made without adverse STC consequences.

9.10.8 The Commission recommends that such loans between wholly owned companies and subsidiaries be encompassed in the exemption whether the holding is direct or indirect.

9.10.9 The Commission further recommends that "wholly owned" should be defined to allow for employee shareholdings, as is recommended in respect of group taxation in paragraph 10.5.12 of Chapter 10.

Deemed Distributions

9.10.10 In terms of section 64C of the Income Tax Act, certain loans and other effective forms of distribution made to a "recipient" are deemed to have been a distribution for purposes of STC. One of the exclusions from these rules relates to amounts so distributed which exceed the company's profits and reserves available for distribution by way of a dividend.

9.10.11 Where a "recipient" is only a part shareholder, the language is not clear whether the exclusion applies with reference to the recipient's proportionate interest only or whether the deemed dividend subject to STC is unlimited. Under the former section 8B (which dealt with dividends arising in similar circumstances, at a time when dividends were still subject to normal tax), the deemed dividend could not exceed the amount that the relevant shareholder could properly have derived by way of a dividend distribution.

9.10.12 The Commission recommends that this matter be clarified by way of legislation or an appropriate practice note along the lines of the former section 8B.

Prescription

9.10.13 No provision has been made for the three year prescription rules to apply in respect of STC. There are many circumstances where a company may have acted in good faith, for example, as to a market rate of interest for purposes of section 64C(4)(d) or the intention to benefit the recipient under section 64C(3)(a), but may be challenged subsequently.

9.10.14 Because there is no assessment mechanism in these instances, the final proviso to section 79(1) as regards Undistributed Profits Tax should be extended to STC.

9.11 CONCLUSION

9.11.1 The current dual tax system is not without its problems. There are broadly two courses of action available. The first is to mitigate some of these problems; the other is to introduce an imputation system.

9.11.2 It is possible to do the former, the most important requirement being the reduction of the STC rate of tax, as well as thereby the combined rate of corporate tax and STC. In addition, a few legislative changes as proposed would remove certain other problems. The retention of STC at this stage does not preclude a subsequent move to another system.

9.11.3 The implementation of an imputation system is in principle an option the Commission supports, but the consequent complexities argue against this course under present circumstances. This is a matter which should be re-examined once a restructured tax administration is operating effectively and the necessary financial sophistication has been attained throughout the corporate sector.

9.11.4 The interim period will give the authorities the opportunity to evaluate the identified problems with an imputation system, and assess the ongoing efforts of other countries to overcome these problems. The Commission accordingly recommends that the STC should be retained, with certain amendments, but at a reduced rate.

9.12 RECOMMENDATIONS

9.12.1 The Commission recommends that STC be retained at this time. [para. 9.11.4]

9.12.2 It records that in principle it favours a progression towards some form of imputation system, but does not recommend a change under present circumstances owing to the additional administrative burden and greater complexity, both for the revenue authorities and for the corporate sector. [paras. 9.2.9; 9.11.3]

9.12.3 The Commission recommends that while the administrative restructuring is in progress that will remove the practical inhibitions to the kind of comprehensive reform required for an imputation system, further research into alternatives should continue and empirical evidence should be gathered as to how foreign systems are progressing with removing some of the difficulties currently experienced with similar systems. A final decision to change will therefore be dependent on two broad preconditions:

1. practical feasibility in the light of administrative capacity and sophistication in the corporate sector; and
2. satisfactory evidence that the conceptual advantages of an imputation type system can actually be achieved in the South African context. [para. 9.11.3]

9.12.4 The Commission favours a substantial reduction in the STC rate from its present level, in order to reduce the burden of the combined corporate tax rates and minimise the distorting effects of the STC. [para. 9.8.3]

9.12.5 No branch tax should be introduced, but the current law should be amended formally to remove the STC obligation on foreign branches which is simply not being enforced. [para. 9.5.10]

9.12.6 No amendments in respect of assessed losses, capital gains and exempt recipients should be made at this time. Adjustments might be considered at a later stage if fiscal and administrative circumstances allow. [para. 9.9.4]

9.12.7 The Commission recommends that for so long as STC remains in force, amendments should be effected to alleviate the inhibition on group reinvestment, to exempt loans between wholly owned companies and subsidiaries whether the holding is direct or indirect and to clarify certain provisions regarding deemed distributions and prescription, as set out in section 9.10 of this Chapter. [paras. 9.10.2-5; 9.10.8­12; 9.10.14]

9.12.8 Section 10(1)(hA) of the Income Tax Act should be amended so as to prevent the exemption of interest received which this section provides to foreign companies which are managed and controlled outside South Africa from applying in respect of business conducted in the Republic. [paras. 9.5.11-13]