While most individual investors and taxpayers are likely to focus on the tax changes outlined in the Budget Speech, it is also important to keep an eye on the bigger picture.
A Budget based on realistic macroeconomic assumptions? Mostly.
The Budget is a projection of expected tax revenue, spending and borrowing over a three-year horizon. If not based on realistic macroeconomic assumptions, it immediately loses credibility. National Treasury cut its real economic growth forecasts in October to 1.7% in 2016 and 2.6% in 2017 but these were still too high. It now expects growth of 0.9% in 2016, 1.7% in 2017 and 2.4% in 2018. The 2017 and 2018 forecasts might still be on the optimistic side. The inflation forecast was lifted from 6% in 2016 to 6.8% and from 5.9% in 2017 to 6.3%. Weaker economic growth means tax revenue growth can be expected to slow, while higher inflation lifts the cost of inflation-linked spending (particularly wages, which consume 35% of overall spending).
A credible strategy to reduce the Budget deficit without pushing the economy into recession? Largely.
At a minimum, the Budget deficit projection from the October Medium Term Budget Policy Statement needed to be improved on, despite much weaker expected tax revenue growth. This was achieved, which is important for ratings agencies and investors (as seen in the dotted line on graph two). The 2015 deficit is more or less as expected at 3.9% but the projected consolidated budget deficit for 2016/17 is now 3.2% of Growth Domestic Product (GDP), 2.8% for 2017/18, and 2.4% in 2018/19. Treasury expect to run a primary surplus (budget balance before interest payments) this fiscal year for the first time in years. This should stabilise the government debt-to-GDP ratio at around 46.2% by 2017/18.
On the tax revenue side, taxpayers will feel relieved. Finance Minister, Pravin Gordhan, wants to raise an additional R18 billion this year but is tapping small increases in different sources of revenue, rather than a big-ticket increase. Effective Capital Gains Tax (CGT) for individuals will increase from 13.4% to 16.7% (through the increased inclusion rate), raising an additional R950 million in the coming fiscal year. Higher CGT rates for companies will raise another R1 billion. The usual sin tax increases will raise another R2.2 billion. New taxes include a sugar tax (from next year), a tyre levy, a vehicle emissions levy and a light bulb tax but these will not raise much extra revenue. The 30 cents per litre (or 12%) fuel levy hike will raise an additional R6.8 billion but should not leave consumers in a worse-off position in the short term, as the over-recovery on the fuel price is currently almost R1 per litre.
There were no changes to personal income tax rates but only R5.5 billion in relief for fiscal drag (inflation pushing taxpayers into higher brackets), compared to R8.5 billion last year.
The much debated increase in Value Added Tax (VAT) did not materialise, nor did any “wealth tax” but these are still under review. The Budget notes that R15 billion per year in additional tax revenue would have to be raised in the following two fiscal years, without describing how this will be done.
On the spending side, the expenditure ceiling, which limits allocations to departments and provinces, has been reduced by R10 billion in 2017/18 and R15 billion in 2018/19 from October levels. It will still grow by around 7% per year, in nominal terms, over the next three years, which is only slightly ahead of inflation. The emphasis on, and achievement of, greater spending discipline is very encouraging. This is done through cutting waste, centralising procurement and reprioritising. For instance, the new travel and accommodation policy is expected to reduce spending by R1.6 billion over the next three years. Every bit helps.
The very generous (one might say unaffordable) public sector wage increase means other areas of spending will be cut. The wage increase also eats deeply into the contingency reserve – government’s rainy day fund. With Agri-SA lobbying for R12 billion in drought relief and students demanding free education, a bigger contingency reserve would have been handy. However, growth in the wage bill will be capped to 7.6% over the next three years by a hiring freeze on managerial and administrative staff.
Social grant increases this year will be slightly below inflation. Debt service costs remain the fastest growing item in the Budget, with increases of 11.4% per year expected over the medium term, increasing to R178 billion by 2018/19. This highlights the importance of getting debt under control. The combination of spending cuts and tax increases will be a headwind for the economy. However, by themselves they should not tip the economy into recession. This was probably the motivation for not pushing fiscal consolidation further.
Concrete steps to reduce the burden of underperforming State Owned Enterprises on government finances (and the broader economy)? Not really.
Other than noting that a common governance framework is being drawn up and that a process of stabilisation and rationalisation is underway, the Budget was disappointingly thin on detail with regards to state-owned enterprises. It noted that government will look at opportunities to allow the private sector to get involved in infrastructure projects and also in South African Airways. Details on these measures are keenly anticipated.
Confidence-building economic policy reforms that will boost economic growth expectations? Yes, but…
Given the lack of “fiscal space” the government cannot do much to support the weak economy cyclically or over the short term. But it can contribute to structurally raising the economy’s growth rate. Stronger growth over the long term is needed to improve the sustainability of government debt and social spending. Growth is therefore the key variable for the ratings agencies, perhaps more so than the actual Budget deficit.
The Minister announced few new measures; hoping instead that better implementation of existing measures (infrastructure upgrades, industrialisation incentives, some red-tape reduction for small businesses and the Operation Phakisa “ocean’s economy” project) will do the trick. It is encouraging that government and business leaders have more actively engaged over the past two months than at almost any time over the previous decade. Only good can come from that.
A long and uncertain road ahead
Leading up to the 2016 Budget Speech, expectations that Finance Minister, Pravin Gordhan would deliver a “good” Budget rose strongly. There was always the risk of disappointment.
It is worth noting that in the current context, a “good” Budget from the perspective of investors is a “bad” Budget for the proverbial man on the street, as it would involve increases in some tax rates, little tax relief and reduced government spending in key areas. But over the longer run, the interests of investors and taxpayers align. A downgrade to sub-investment grade (or junk status) hurts everyone, and ever-increasing government debt means there is less money to spend on other important areas. Taxpayers and consumers, especially higher income earners, actually came off lightly this year. So was the Budget “good” enough to avoid our foreign currency sovereign debt rating going junk? The projected deficits are encouraging but there is little detail on the growth side. The Budget can probably postpone the dreaded downgrade but not avoid it. To avoid it completely will require careful and consistent implementation but also a bit of luck. Global conditions will also have to become more favourable to emerging markets and the commodity rout will have to stabilise. It is therefore likely to be a long and uncertain road ahead.
INCOME TAX RATES AND REBATES
Income is taxed at a flat rate of 41%.
INCOME TAX RATES FOR COMPANIES
Income tax rates for companies with a financial year ending between 1 April 2016 and 28 February 2017
Income is taxed at a flat rate of 28%. This rate remains unchanged from the previous year of assessment.
DEDUCTIONS FOR INDIVIDUALS
Pension, Provident and Retirement Annuity fund contributions
Contributions are limited to a deduction rate of 27.5% (the higher of taxable income or remuneration) with an annual maximum rand amount of R350 000.
Any excess contribution over the limit may be carried forward to the following year of assessment.
TAX ON LUMP SUMS FROM RETIREMENT FUNDS AND SEVERANCE PAYMENTS
Severance payments, retrenchment, retirement and death
The tax bands have remained unchanged compared to the previous budget:
Dividends tax is a final tax at a rate of 15% on dividends paid by resident companies and by non-resident companies in respect of shares listed on the Johannesburg Stock Exchange (JSE). This remains unchanged from previous years of assessment.
Dividends are tax exempt if the beneficial owner of the dividend is a South African company, Retirement Fund or other exempt person. This also applies to dividends non-residents receive from Real Estate Income.
INTEREST EXEMPTIONS FOR INDIVIDUALS
Domestic interest exemptions
Individual’s domestic interest exemption remains at R23 800 for persons under the age 65. For persons over the age of 65, the exemption remains at R34 500 per annum.
Medical tax credits
The medical aid tax credits increased:
- R286 per month for the first two beneficiaries and
- R192 per month for each additional dependent on the medical scheme for the new tax year
An individual who is 65 and older, or has a spouse or child with a disability, qualifies for a medical expense credit equal to the aggregate of:
- 3% of the amount by which their contributions exceeds three times their tax credit (for contributions), plus
- 3% of their out of pocket expenses.
Individuals younger than 65 qualify for a medical expense credit of 25% of an amount to the aggregate of:
- The amount by which their contribution exceeds four times their tax credit, plus
- Their out of pocket expenses equal to qualifying medical expenses that exceeds 7.5% of their taxable income (excluding any retirement fund lump sum benefit, retirement fund lump sum withdrawal benefit and severance benefit).
The use of a log book is compulsory to claim travel expenses for business purposes. The new table for the deduction of business travel where no records of actual costs are kept is as follows:
80% of the travelling allowance must be included for the purposes of calculating PAYE.
If the employer is satisfied that at least 80% of the vehicle use will be for business purposes, the amount to be included for PAYE can be reduced to 20%.
No fuel cost may be claimed if the employee has not borne the full cost of fuel used in the vehicle. No maintenance cost may be claimed if the employee has not borne the full cost of maintaining the vehicle (e.g. if the vehicle is subject to a maintenance plan).
The fixed cost must be reduced on a pro-rata basis if the vehicle is used for business purposes for less than a full year. The actual distance travelled during a tax year and the distance travelled for business purposes substantiated with a log book are used to determine the costs, which may be claimed against a travelling allowance.
CAPITAL GAINS TAX
Maximum Effective Rates
ITEMS UNDER REVIEW
Government has postponed the annuitisation requirement on Provident and Preservation Provident Funds to March 2018. The aim of the postponement is to gain further clarity on the impact of the annuitisation requirement. The harmonisation and deduction regime relating to retirement reform will continue and will take effect as of 1 March 2016.
Further changes are required to amend other aspects:
- Amendment to Section 11 (k) of the Income Tax Act regarding retirement contributions to allow deductions against passive income;
- Amendment to Section 11 (k) to allow rollover of excess contributions to Retirement Annuities and Pension Funds, accumulated up to 29 February 2016; and
- Proposals to remove the requirement for a tax directive for tax-free transfers from Pension Funds to Provident Funds.
The Retirement Reform changes will impact how employees view their tax benefits and remuneration, as well as from an administrative and/or payroll perspective. Employer contributions to Pension and Provident Funds are considered a taxable fringe benefit but may be a deemed deduction.
Opportunity has been provided for non-compliant tax payers to now make amends and make the relevant disclosures regarding the previously undisclosed offshore assets. A time frame of six months has been proposed to allow voluntary disclosures from 1 October 2016.
Tax Treatment of Trusts
Trusts are in certain instances utilised to avoid donations tax and estate duty. Proposals are being considered to include in the estate of the donor at death, the asset transferred to a trust utilising a loan account. Further measures will be considered to limit the use of trusts for purposes of income splitting and avoidance in this regard.
Tax Free Savings Accounts
Investors in tax free savings accounts are currently required to submit an exempt dividends tax return. It has been proposed that an amendment be made to remove this requirement.
Financial Sector Regulation
National Treasury, with industry stakeholders, have been charting the way forward with regulatory framework changes. Further definitive changes may be seen with regard to the Twin Peaks financial model, market conduct, prudential conduct and the regulatory authorities, which facilitate the regulation of these aspects.
Transfers of Tax Free Investments between service providers
Draft regulations detailing the process to transfer tax free investments between service providers is to follow soon. The implementation date to allow transfers of tax free investments between service providers will be postponed from 1 March to 1 November 2016.
THE BOTTOM LINE
Personal income tax
The long anticipated changes are reflected in the first three personal income tax rate bands. Due to fiscal strain only partial relief is afforded, which is specific to the lower and middle income bands. In addition the primary rebate has been increased from R13 257 to R13 500 for all individuals, while the secondary and tertiary rebates remain unchanged.
Capital Gains Tax (Effective 1 March 2016)
An increase in the CGT effective rates for individuals and entities lead to an increase in the inclusion rate.
- Individuals and Special Trust: 40%
- Companies: 80%
- Trusts: 80%
The exclusion of R 300 000 at death remains unchanged.
The change in the CGT rate may have an impact as to how investments may be taxed for capital gains, with the exception of retirement fund investments and tax free investments.
Retirement Reform, which is effective 1 March 2016, reflects certain changes.
- A single deduction rate (27.5%) of the greater of taxable income or remuneration. This replaces the differing deductions which were available to pension and retirement annuity funds.
- The 27.5% deduction is subject to a maximum annual amount of R350 000 regardless of whether it is a Retirement Annuity, Pension or Provident Fund and includes a rollover of deductions in excess of R350 000.
- Commutation of small Retirement Fund values minimums increased from R75 000 to R247 500 – (per fund).
In the past we have seen an increase in the marginal tax rate. However future considerations are to include increasing value-added tax while ensuring effective utilisation of such funds.