Budget 2017 has been described as possibly Finance Minister Pravin Gordhan’s toughest budget to date, against the backdrop of a R30,4 billion shortfall in revenue collection due to declining tax collection and other revenue underperformance. This is the largest underperformance relative to budget estimates since 2009/10. Also, for the first time since 2009/10, tax revenues have not kept pace with economic growth.
And South Africa’s investment grade rating still hangs very much in the balance. This is intensified by speculation about ex-Eskom chief Brian Molefe’s imminent appointment to the finance committee.
Minister Gordhan put forward a budget that was refreshing in its frankness as to the issues facing the country, especially with regards to fruitless expenditure. It is hoped that these words will indeed be acted on.
Making up the revenue shortfall
The budget proposes to raise an additional R28 million by collecting R20 billion more in personal taxes and R6,8 billion through an increase in the dividend withholding tax rate. The balance is raised through the taxes on fuel, tobacco and excise duties.
Emphasis on cutting expenditure
A reduction in spending ceilings by a total of R26 billion over the next two years has been announced. The Minister clearly recognises that the value for money spent is too low and must be improved. The budget speech even refers to the possibility of voluntary public sector severance packages.
By 2015, the public servant wage bill had swelled more than 80% over the last decade, with annual increases averaged at more than 6% above inflation. In 2016, Government responded to this additional pressure by withdrawing nearly all identified funding for vacant posts and blocking appointments to non-critical vacant posts on the payroll system. The National Treasury and the Department of Public Service and Administration are now working with departments to reduce headcount.
As of 2017, negotiations on a new public-sector wage agreement are due to begin. A revised agreement that takes account of fiscal constraints will reduce some of the pressure on staff headcount and enable government to direct a larger portion of expenditure to capital investment.
Taxpayers paying more as a result of limited relief for inflation
An additional R12 billion is raised through the fiscal drag effect whereby the various tax bands have not been increased in line with inflation. The Minister recognises that government annually raises the effective personal income tax rate by not being in a position to provide full inflationary relief. In the Minister’s own words: “Continuing to raise the personal income tax burden over a long period could have negative consequences for growth and investment.”
Marginal personal income tax raised from 41% to 45%
This is accentuated by the tax rate for high-income earners which has been raised sharply. A new top personal income bracket of 45% for taxable incomes above R1,5 million per year has been introduced.
This tax on higher-income individuals is expected to raise over R4 billion in additional revenue. A progressive tax system which taxes high-income earners more heavily than those earning less, would seem to be more equitable in South Africa, but government needs to be very careful about where to draw the line. There is only so far it can squeeze the small percentage of the population that pays tax.
The late 1980s was the last time when the marginal tax rate was this high. From the late 1980s until the late 1990s, there has been substantial relief in personal income tax for all income groups. It seems as if this trend is now being reversed.
The income tax rate on trusts was increased from 41% to 45%.
Dividend withholding tax rate increased from 15% to 20%
The increase in the rate of dividend withholding tax to 20% will have a negative impact on shareholders, especially individual investors.
The higher dividend withholding tax rate will make the distribution of dividends less attractive to private investors, where corporates are declaring dividends to non-corporate shareholders. The increase in dividend withholding taxes will not necessarily affect foreign investors, since they are able to rely on relief provided for by Double Tax Agreements applicable between certain countries, or alternatively, the associated foreign tax credits available for foreign taxes paid.
Estate duty and donations tax
Surprisingly there was no increase in the estate duty rate, and the change to the donations tax rate which everybody expected did not take place. This does not mean that the coast is clear, we believe this will definitely be addressed in the 2018 budget. Taxpayers therefore still have time to utilise the current legislation to arrange their affairs in respect of their estates.
No change in the Capital Gains Tax rate
Even though there was no official increase in the Capital Gains Tax (“CGT”) inclusion rate, taxpayers will still be affected by a higher CGT rate due to the increase in the marginal tax bracket for Trusts and Individuals.
Taxpayers will now effectively pay CGT on the higher marginal income tax rate of 45%, the effective rate being 36%, on Capital Gains in a Trust. Individual taxpayers earning more than R1.5 million per annum, will now pay CGT on the effective rate of 18%, resulting in an increase in CGT payable by Trusts and Individuals.
It is worth noting that, on the introduction of capital gains tax to South Africa in 2001, the basis for lower inclusion rates was an alternative means of providing relief against inflation as opposed to the indexation allowances seen in other territories. The erosion of the relief in this regard has the potential to place South Africa on an uncompetitive footing compared to other investment jurisdictions.
No change in VAT
Whilst there was no change to the headline VAT rate this year (unchanged at 14%) a clear marker was placed for future consideration of this in the context of the balance to be achieved between direct (income) taxes and indirect taxes such as VAT.
Possible future changes
A few aspects were not mentioned in the budget speech, but we believe these changes are imminent, requiring taxpayers to plan accordingly.
Contributed tax capital
There are proposed amendments to the definition of “contributed tax capital”, to prevent the abuse of capital distributions to international companies, thereby avoiding the payment of dividends tax. This may result in a difference in outcome between the repayment of share capital versus loan capital.
Share buy-backs
In 2016, an announcement was made to review schemes involving share-buyback arrangements. No proposed counter-measures have been introduced or put in place to date but it is still on the radar of SARS to address this issue.
Tax on expatriates
An exemption applies to South African residents working in a foreign country for more than 183 days a year, in terms whereof the employment income earned by them is tax exempt in South Africa. This exemption applies irrespective of whether any tax is payable in the foreign country.
It is proposed to amend this exemption to only apply to foreign employment income that is taxable in the foreign country. Thus, the foreign employment income will only be tax exempt in South Africa if it is subject to tax in the foreign country. In effect, taxpayers (businesses and individuals) may find it less attractive to work in foreign jurisdictions or for corporates to incentivise individuals to go and work in international subsidiaries.
Conclusion
The Minister managed to show how he is going to collect the additional R28 billion required, but this is based on a quite a few assumptions, including a growth rate of 2%, which may not materialise.
The substantial increase in the personal income and trust tax rate and resultant increase in Capital Gains Tax rate is in essence a “wealth tax”. This may impact on the decision making of individuals who are mobile in the sense that they can leave South Africa and move to more tax friendly jurisdictions.
