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Speculation is rife as to what lies in wait for South African taxpayers when Finance Minister Tito Mboweni takes to the lectern on Wednesday, 26 February 2020 to deliver what must arguably be one of the most significant Budget Speeches in the history of democratic South Africa.

While the country desperately needs to boost its coffers, the general feeling ahead of the speech is that the country has reached the top of the Laffer Curve, says Hilary Dudley, Managing Director of Citadel Fiduciary, referencing the theory which describes the relationship between tax rates and total tax revenue.

The Laffer Curve points to an optimal tax rate and the delicate balance which must be maintained by officials. The view is that if you tax a population too highly, then you discourage work and investment. The theory also indicates that sometimes cutting tax rates can act as a stimulus for an economy, thereby boosting economic activity and increasing tax revenue. At all times a government must aim for an optimal mixture of revenue from taxes while encouraging economic activity. 

The potential to affect compliance with punitive tax hikes is something of which the South African Revenue Service (SARS) is keenly aware, if you consider the 2018-2019 annual report which notes: “Revenue collection is driven by the state of the economy, the fiscal policy choices, legislation, administrative efficiency, taxpayer compliance, tax morality and sentiment.” A public survey into attitudes around tax compliance by SARS in 2018 noted that tax diligence and tax morality were key drivers of tax compliance, at 85% and 82% respectively.

“The SARS report shows that personal income tax is still the biggest single contributor to revenue at 38.3% of total revenue collected and then corporate tax is less than half of that in terms of its total value,” says Dudley. SARS is also below its estimates for personal income tax by R5 billion, indicating that further squeezing could prove fruitless.

What remains concerning from a sustainability perspective is the fact that just three million people actually pay personal income tax. This out of 22 million people registered for income tax, due to new rules that businesses must register all employees for income tax, even if they fall outside the tax bracket.

Given the fact that 38% of tax collections are funded by just three million people, adding too much pressure could have a negative impact on collections and the economy. “We are at the point where there is a risk that if you increase tax more, then people just won’t comply,” she says. “Indeed, there is a recognition that this point has been reached, so government will have to look elsewhere for more revenue.”

The question is, where?

BROADEN THE BASE

As we enter the final straight towards the 26 February 2020 Budget Speech, many economists are speculating that VAT will go up again and that the tax brackets will not be adjusted for inflation. These two moves could deliver an extra R35 billion in tax revenue, working on a one percentage point hike in VAT to 16%.

“There were criticisms in 2018 that government should have taken the bull by the horns and hiked VAT by two percentage points rather than by one,” says Dudley, noting that the 2018 hike from 14% to 15% did little to fill the deficit.

“VAT is the easiest way to collect tax in a broad way and perhaps the fairest,” she says. “Provided you increase the basket of excluded goods to make sure that the poorest of the poor are not prejudiced and don’t suffer, then it’s probably the most effective way in the short term to increase collections. It remains one of the broadest tax base options. The other positive is that it is an existing tax that is understood and systems are already in place to collect VAT. There is, accordingly, no need to use up capacity at SARS and confuse the taxpayer by introducing a new tax.”

AN EYE ON CAPITAL GAINS TAX

A focus on the wealth market is, perhaps, inevitable in the 2020 Budget, but this is more likely to be through methods such as changing existing “wealth taxes”, such as capital gains tax (CGT), rather than the introduction of a new wealth tax. You may recall that the rates of other “wealth taxes”, namely estate duty and donations tax, were stepped up in March 2018.

“In our industry there is always a buzz regarding a potential change around the CGT inclusion rate, where currently individuals pay on 40% of the gains and companies and trusts on 80% of gains,” says Dudley. “For three years now there has been talk at this time of the year that SARS will make the individual inclusion rate the same as for the corporate and trust rate. This would double your effective rate as an individual. While this hasn’t been widely reported on in the media, this does come up in industry discussions and, as we head into the 2020 Budget, this buzz is back.” Dudley notes that recent commentary has pointed to the view that the inclusion rate for individuals may be increased by 10% to 50%, rather than being doubled.

Last year, some investors expected this to happen and were triggering capital gains before the Budget Speech, then it didn’t happen. Dudley notes that, if gains are triggered in trusts and awarded to beneficiaries, it is essential that the trustees ensure that the proper governance and paper work is in place before 26 February. This is in case there is a query down the line around the timing of the transaction, as happened when the dividends tax rate was increased on the day of the Budget Speech in 2017. “Some advisors are going as far as to suggest that resolutions be signed before a government official who can date stamp the document as proof of the signature date,” she says.

WHAT ABOUT DIVIDEND WITHHOLDING TAX?

“There has also been a buzz around dividend withholding tax going up, and some companies are already declaring dividends now because SARS caught people the last time they put the tax up when they said that the change would be effective on the day of the Budget Speech and not 1 March,” recalls Dudley.

In both the CGT and dividend withholding tax examples, it is important to appreciate that nobody has a crystal ball and any decisions can and should be made with a clear head and in consultation with your financial advisor. Although an important element to consider, tax considerations should never be the driver of investment decision-making.

FOCUS ON PENSIONS

Another thing to keep an eye out for, says Dudley, would be any movement towards following a recommendation from the Davis Tax Committee that Treasury look at tax break benefits which pension funds enjoy from a tax perspective. “Looking to tax those income and pension funds might be another option open to Treasury,” she says.

“At the time the committee’s Wealth Tax Report was released, it was reported that South Africa had one of the highest-value pension pots in the world, estimated at around R4 trillion or around US$300 billion,” says Dudley. “This is nearly the size of South Africa’s GDP. So it might make more sense – rather than prescribing what sort of assets pension funds must invest in to boost the economy – to tax them more.”

The conundrum, of course, which the Davis Tax Committee noted, is that many South Africans only save into a pension and have no discretionary assets, so a cap would be required to protect savers at the lower end of the economic spectrum.

IN A NUTSHELL

While it remains to be seen what Mboweni announces come Wednesday, what is crystal clear is that government must act to kickstart the economy, address corruption and grow the tax base, says Dudley. “Most people don’t object to paying tax, but they do object to the perceived mismanagement of the tax revenue,” she says. “So to retain that goodwill in the tax base it’s going to be extremely important to see government actively doing things to sort out corruption and to deal with what is coming out of these commissions of inquiry.”

She notes that: “People are frustrated with how long things appear to be taking, but it is important that due process or the rule of law is followed in these matters. But if you look at the changes at Eskom and now SAA, things are happening. The changes at SARS are positive, with SARS Commissioner Edward Kieswetter taking over from Tom Moyane in 2019.”

Over and above of the specific details shared by the Finance Minister during the upcoming Budget Speech, rest assured that our experts will continue to ensure that your portfolios are managed with the utmost diligence, with regard to all taxation rules and requirements and with an eye to any potential future developments, as well as current changes.

Citadel’s approach to wealth management is at all times pragmatic and forward looking, which ensures that during times of uncertainty, country risk and economic pressure your portfolios are safeguarded for your future and that of your family.