A fundamental question posed by commentators around the 2018 National Budget was whether an increase in personal or corporate income tax rates, or both, would be announced. The consensus, which proved to be correct, was that such increases were unlikely. The main reasons given were that personal and corporate income tax rates are already high by international standards. Personal income tax rates, mainly due to the introduction of the 45% maximum marginal rate in the 2017/2018 income tax year of assessment for taxable income above R1.5 million, and also since relatively high marginal rates are reached at low taxable income levels, by global standards. Corporate income tax rates, as the rates in most of our main trading partners are lower than ours and globally rates are decreasing.
This invites the question whether income tax rates, corporate or personal, are too high. In other words, whether in terms of the Laffer curve South Africa has already passed the top and is on the downward slope. The Laffer curve illustrates the relationship between tax rates and tax revenues. Up to a certain point, increases in tax rates result in increases in tax revenues. However, after that point the opposite holds true, due to the increasing disincentive to produce income at higher rates. Other factors play a role too. Higher rates push taxpayers to avoid or evade taxes, and Government corruption and inefficiencies are cited as excuses for taxpayer non-compliance.
While it is extremely difficult to determine the top of the Laffer curve, the tax:GDP ratio may be indicative that we have reached it. The tax:GDP ratio was around 26.0% in the 2016/17 fiscal year and remained static, slightly declining to 25.9% in the 2017/18 fiscal year. This, despite sizeable increases in personal income tax rates through the introduction of the 45% marginal tax rate and minimal adjustments for bracket creep, which should have reflected in the 2017/18 fiscal year. Since then the top marginal income tax rate remained at 45% and the corporate tax rate at 28%.
One often finds in practice that investors into Africa consider South Africa or Mauritius as possible gateway jurisdictions. The attraction of the latter is the low corporate tax rate of 3% which could be reduced even further by foreign tax credits. The lack of foreign exchange controls adds to the attraction. Factors favouring South Africa include the developed infrastructure, large domestic market, and a more extensive double tax treaty network. The relatively high corporate tax rate of 28% certainly does not help South Africas cause, although it is doubtful whether South Africa would ever consider lowering its corporate rate to such an extent so as to compete with the low rate of Mauritius. South Africa also offers a headquarter company tax regime that effectively allows external investors leeway on the pricing of debt finance and intellectual property royalties in a number of situations, which may result in minimal exposure to South African corporate tax.
The effect of a decrease in corporate or personal tax rates on stimulating economic activity and tax revenues in South Africa is difficult to assess. It seems likely that decreases in personal tax rates would impact economic activity less than decreases in corporate tax rates. The corporate tax rate has remained static at 28% for many years. The corporate tax rate was last reduced around a decade ago in the 2008/2009 fiscal year, when the rate reduced from 29% to 28%. Before that, the rate was decreased, also by one percentage point, in the 2005/2006 fiscal year. On both occasions the ratio of corporate tax collections to GDP increased, although of course there were many other factors that could have had a material influence on the ratio.
On the other hand, the corporate tax rate, if combined with the dividends tax rate, should not lead to tax arbitrage if compared to the personal tax rate. Presently, the effective corporate tax plus dividends tax rate, if the dividend is paid to a South African resident, is 42.4% whereas the top marginal personal tax rate is 45%. This results in a 2.6% arbitrate opportunity, favouring conducting business in a company, assuming that an investor already reached the highest marginal personal tax rate. A reduction in the corporate tax rate should be linked to a reduction in the personal tax rate, to reduce arbitrage possibilities.
The 2018 National Budget Review acknowledged the international trend towards lower corporate tax rates in the context of an exclusion from our controlled foreign company regime. Presently an exclusion exists which is intended to cater for SA- controlled foreign companies operating in highly taxed foreign jurisdictions. The benchmark of what constitutes high levels of foreign taxes was set at a minimum of 75% of the comparative South African income taxes that would have been payable on the equivalent taxable income of the controlled foreign company. However, with corporate income tax rates in the UK, for example, currently at 19% and set to decrease to 17%, we are left in a situation that compared to 75% of South Africas rate of 28% i.e. 21%, a SA-controlled foreign company taxed in the UK no longer falls into the exclusion. The Budget Review stated that a review of the appropriateness of the 75% threshold would be undertaken to determine whether a reduction in the threshold is warranted.
There is no doubt that South Africa is in desperate need of economic growth and increased taxpayer compliance. It is certainly not axiomatic that our relatively high rates of income tax are producing more tax revenue than would be produced by lower rates. Consideration should be given to the lowering of income tax rates as a possible way of benefitting the National fiscus.
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