Corporate tax rate in need of review

South Africa’s corporate tax rate is high compared to its most important trading partners, but it would not be in the country’s best interest to reduce the rate in the current environment.

The Davis Tax Committee (DTC) says in its final report on corporate income tax that the risk with a reduced rate is that other policy measures, together with political and social uncertainty, will still act as disincentives for further or new investments. These policy measures include immigration laws, the ability to guarantee electricity and water supplies, security of tenure and corruption.

South Africa’s current rate of 28% is on par with the African average rate of 28.21%, but is way above that of the European average of 19.71%, Asia’s 21.28%, the European Union’s 21.51%, and the global average of 24.29%. Kyle Mandy, partner and head of National Tax Technical at PwC in South Africa, says he agrees with the recommendation of the committee not to reduce the corporate income tax rate at this point. “There is no question that there are much greater deterrents to investment in South Africa, which will have to be addressed before the tax rate becomes a significant factor in investment decisions.”

Mandy says the recommendation by the DTC is quite pragmatic since South Africa cannot afford to lower its corporate tax rate in the current fiscal environment.

“However, the committee did recognise that the corporate rate should be lowered in the longer term as the tax base is broadened by eliminating ineffective incentives and other measures.”

The committee says a reduction in the corporate tax rate implies that there will need to be some level of certainty that the reduced rate will be effective in stimulating growth, and thus increasing the overall tax base and collections. If this is not the case, the resultant reduction in revenue will have to be compensated for elsewhere. Patricia Williams, partner at law firm Bowmans, says a very clear theme in the report is that South African companies are being overtaxed.

In light of this view, the committee recommends that the dividend withholding tax rate be reduced back to 15% from 20%, for corporate income tax to be reduced in the longer term and for effective reductions to capital gains tax. She says the committee has a very strong message for the South African Revenue Service (Sars) and National Treasury.

“Policymakers should ensure that taxes are not increased merely so as to satisfy revenue collection needs without consideration of the long-term fiscal impacts of the whole tax system.”

The dividend withholding tax rate was increased on March 1, 2017 from 15% to 20%, effective February 11, 2017. The DTC says the 20% rate gave rise to “certain negative outcomes”. In particular, the impacts on black economic empowerment policy objectives and investment decisions were highlighted.

Williams, also chair of the tax administration work group of the South African Institute of Tax Professionals (Sait), says employee share incentive schemes, personal savings and investment and broad-based black economic empowerment schemes were all negatively impacted by the dividends tax increase.

“The inequity between non-residents investing into South Africa and South African resident shareholders was also aggravated by the dividends tax rate increase.” Most tax treaties often reduce the dividend tax rate payable by non-residents to 5%. These issues would be mitigated by a return of the dividend tax rate to 15%, says Williams.

The committee also expressed concerns about the dramatic increase in the Capital Gains Tax (CGT) inclusion rates for corporates from 50% to 66.6% to 80%, without consideration of the impact of inflation. Mandy says that at the current rate, inflationary gains are being subject to tax and acts as a deterrent to savings and investment. From a purist perspective, only real gains should be subject to CGT at the full rate applicable to income. “The lower effective tax rate was a trade-off between the complexity of indexing base costs and the taxation of inflationary gains. However, this trade-off has been undermined by the increased inclusion rates,” says Mandy.

Keith Engel, CEO of Sait, echoes the concerns regarding the high company tax rate for capital gains, and of special concern is company holdings in subsidiary shares. “We are now seeing a very serious cascading effect. Subsidiary growth is taxed once at 28% ordinary rates. The growth is then taxed again upon sale of the same subsidiary shares at ever higher capital gain rates.” The committee recommends that the CGT regime be reviewed and that the inclusion rate be reduced to levels which “adequately compensate for the effects of inflation”.

Williams refers to an alternative measure, favoured by the committee, where the base cost of an asset is “stepped up” by the impact of inflation (and taxpayers are not taxed on artificial gains).

Mandy says in general the committee’s recommendations are “business- and growth-friendly” while also addressing considerations of equity in the tax system.

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