The introduction of International Financial Reporting Standards into the Income Tax Act is setting a dangerous precedent, according to tax and legal experts. The changes will bring about a fundamental change in the way South Africans will be taxed in future, and will certainly not simplify tax matters.
A new section in the Income Tax Act that deals with fair value taxation of financial instruments has imported International Financial Reporting Standards (IFRS) into South Africa’s tax legislation, and will become effective on January 1 next year. This will apply to banks, bank branches, or a controlling company as defined by the Banks Act.
Andrew Wellsted, head of tax at law firm Norton Rose, says the reliance on an international financial reporting standard in the newly introduced section 24JB of the Income Tax Act will lead to a “seismic shift” in the rationale of South African taxation to date.
“Previously, taxpayers were only taxed on realised profit received by or accrued to them, yet now they will be taxed on the value of assets held.”
He gives the example of a share trader who acquires a share for R100. Currently the trader would only be taxed on the difference between the proceeds and the initial R100 once he sells the share.
Mr Wellsted explains that this tax principle changes significantly with the introduction of section 24JB. This is because designated parties trading financial instruments will be taxed annually on the mark-to-market value of the financial instruments held by them.
“In other words, the Income Tax Act, relying on IFRS, will in essence be taxing parties on unrealised gain, prior to their having disposed of the assets in question,” he says.
Piet Nel, project director of tax at the South African Institute of Chartered Accountants (Saica), says even though the Treasury says it is merely following international trends by introducing accounting standards into tax legislation, he is not entirely sure how many other countries are doing the same.
The Treasury says the rules pertaining to income tax and financial accounting have completely diverged. The sheer volume of financial transactions for large financial institutions needs expensive systems that require constant adjustment. Tax deviations are often then accounted for manually, with the increased possibility of introducing inaccuracies.
From the South African Revenue Service’s (SARS’s) point of view, the divergence between tax and accounting has become so great that accounting is often no longer a useful benchmark for assessing risk in terms of the accuracy of taxable income, the Treasury says.
Tracy Brophy, head of tax-risk management at FirstRand, says the banks have been in “extensive consultation” with the Treasury and agree with most of the principles.
“We applaud the Treasury for taking this step to introduce legislation, which to a large degree codifies the taxation treatment already in the current legislation, but which SARS has been reluctant to approve,” she says.
Ms Brophy also says it should be noted that the pending changes will apply only to banking groups and stockbrokers in respect of their traded financial instruments. As they are short-dated, these generally result in frequent cash flows.
So there should not be “undue hardship” in taxing an unrealised gain, since it should be realised and settled in a relatively short period. The outcome is that a bank will be taxed on the same trading profit which it reports to its shareholders, and it has certainty in determining its tax treatment thereof.
Bongeka Nodada, project director of financial reporting at Saica, says the International Financial Reporting Standard (IFRS 9) due to replace the current accounting standard IAS 39 will only be fully implemented in January 2015. Banks will be able to use the current standard until then to account for financial instruments.
However, Patrick Bracher, a senior partner at Norton Rose, questioned the legality of introducing IFRS into South Africa’s legislative framework, even if this is limited.
“The principle of legality is a foundational value of our constitutional democracy.… It is a cardinal tenet of the rule of law which admits no exception.”
He also says there is nothing precise about what the International Accounting Standards Board does.
It does not consist of lawyers, is not made up of South Africans, and it is certainly not Parliament. The board is responsible for the development of reporting standards.
Mr Bracher says IFRS 9 was issued in November 2009, amended and reissued in 2010, and now limited changes are again being considered. He says this means every time IFRS publishes an amendment to the standard, South Africa’s tax law changes without having gone through the legislative process required by the constitution.