Tax incentives under fire again

The proliferation of tax incentives in South Africa has again come under fire because of their destructive impact on the tax base and their economic consequences.

Prominent players in the tax industry, including South African Revenue Service Commissioner Edward Kieswetter, have highlighted the distortive effect on resource allocation and the potential for abuse that incentives create.

Michael Katz, chair of ENSafrica, told delegates at the annual Tax Indaba in Cape Town that his one plea is for a massive re-evaluation and elimination of tax incentives that have reduced the tax base significantly.

The matter was also interrogated during the 2020 Tax Indaba, where figures from National Treasury were quoted – including that 4.5% of the R1.3 trillion tax revenue back then was foregone in the form of incentives.

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Blunt instrument

Kieswetter says tax is a blunt instrument to use when trying to make an investment more attractive.

But one cannot defy gravity, he said during the opening session of this year’s Tax Indaba.

“If the business case does not stack up, no amount of tax adjustments and early write-offs or any other form of incentive will make a bad business case a good one.”

He referred to the Section 12J allowance, which was not extended past its sunset date. That incentive was introduced to stimulate investments in small and medium-sized enterprises (SMEs) through venture capital companies (VCCs) – but was tweaked when government saw abusive schemes surfacing.

Taxpayers initially received a full tax deduction on investments in VCCs. Shortly before the incentive died, the deduction was capped at R2.5 million for individuals and trusts, and R5 million for companies per tax year.

Apparently, some investors used the VCCs to fund low-risk projects instead of investing in sectors that could drive economic growth and create jobs.

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Abuse

Kieswetter also referred to the employment tax incentive that has been a target for abuse. The incentive was introduced to promote youth employment by reducing the cost of hiring young workers.

Many companies sent their employees on training with little concern about the outcome. They outsourced the training to a third-party service provider and were happy to have bums on seats and to qualify for the incentive. The provision was made available to promote employment and not employability.

“I am personally not a great proponent of incentives,” said Kieswetter. “Apart from being hard to implement, you invariably advantage people who do not need the advantage and there is a significant amount of abuse.”

Trevor Manuel, former minister of finance, remarked that in the absence of proper coordination the “myriad of incentives” – including the research and development, renewable energy, and special economic zones incentives – become a major problem.

“I am not sure how you begin to take them apart.”

He said in 1994 the “transitional levy” that was introduced created a big advantage. It funded the country’s budget deficit and economic reforms. Although incentives do have a role in changing behaviours and attracting foreign investments, they can cause distortion.

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Missing the mark

Katz is outspoken about incentivising foreign investments.

“If a foreign investor puts up a factory in SA and gets an incentive, they will enhance their profits. The foreign fiscus gets the benefit and not us.”

Manuel believes it is necessary to “put the entire system on a sound footing again”.

Companies, notwithstanding the extent of deindustrialisation, probably still have their entire pricing based on incentives.

Manuel referred to the decision to zero-rate paraffin for value-added tax (Vat).

The thinking was that people who use paraffin are “really poor” and needed the tax relief.

However, people purchase paraffin from spaza shops, which are not regulated for tax. The 14% (now 15%) that should have been an advantage for the end user never materialised.

“People had no choice as the spaza shops sold paraffin and didn’t ask whether you wanted to pay Vat or not. You always tend to advantage people who are not meant to be advantaged,” Manuel added.

Kieswetter also mentioned the initial consideration to zero-rate brown bread for Vat purposes.

“It turns out that the people who eat brown bread are health-conscious people and not poor.

“Poor people eat white bread,” said Kieswetter.

Keith Engel, CEO of the South African Institute of Taxation, said National Treasury did manage to eliminate many of the incentives up to about 2009. However, they started creeping back into the tax system.

Some incentives may work, while others are not always well thought through. They’re not practical, or the wording allows for different interpretations of the legislation.

This article was republished from Moneyweb. Read the original here.