Digital Economy and Taxation Policy: National Treasury, PBO & SARS input

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Finance Standing Committee

09 June 2020
Chairperson: Mr Y Carrim (ANC, KwaZulu-Natal) and Co-chairperson: Mr J Maswanganyi (ANC)
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Meeting Summary

Video: Joint Meeting: Standing Committee on Finance and Select Committee on Finance, 9 JUNE 2020

The Committee was briefed by the Parliamentary Budget Office (PBO), National Treasury and the South African Revenue Services (SARS) on the digital economy and the implications for taxation policy, with regards to the generation of new income tax revenues.

The PBO stated that Government’s ability to raise tax revenue has, in part, been hindered by the lack of targeted digital economy taxation measures. As a result, South Africa continues to lose potential income tax revenue from digital economic activities. The COVID-19 crisis is expected to amplify the loss of government income tax revenue because non-digitalised sectors that contribute to government taxes will see a decline in their taxable income. The Organisation for Economic Co-operation and Development (OECD) Inclusive Framework draft recognises the need for unitary taxation. There is currently no consensus as many OECD countries are in the process of adopting a unilateral taxation approach in spite of the drafted Inclusive Framework. National Treasury pointed out that the current form of the Framework is too expensive for a small economy like South Africa. An alternative would be a unilateral approach however, government needs to consider the implications for international cooperation and the role of international agreements that are based on international tax rules. For instance the issue of the 1998 World Trade Organization (WTO) Moratorium needs to be considered.

SARS said the existing treaty network government agreement restricts its right to tax foreign businesses in the digital space. This is because the agreement is framed on the old nexus of having a degree of physical presence in South Africa in order for the foreign business to be subject to income tax. Due to the Constitution, South Africa does not have the option to override its treaty agreements with domestic law. Members raised concerns regarding the incorrect interpretation of sections 231, 232 and 233 of the Constitution. It was pointed out that these sections indicate that where there is conflict between international and domestic law, national legislation is to be given preference. 

National Treasury said that in an increasingly digitised world, taxation needs to go beyond the idea of taxing the revenue of a company that is physically present in a country. The digital world has other jurisdictions and requires agreements. A small country like South Africa cannot go about doing this unilaterally as it could face countervailing actions such as what happened in France. After it announced that it would tax digital commerce, the United States (US) immediately threatened to take action and France had to pull back from implementing its policy.

Members of the Committees agreed that the discussions on the digital economy and tax collection should involve the Department of Trade and Industry (DTI) and other relevant departments. Members emphasized that there needs to be national legislation regulating the digital economy to ensure consumer protection and maximal tax revenue collection. The Committees acknowledged the complexities involved, as well as the international protocol that needs to be considered in the process. Members agreed that National Treasury and SARS should come back with clear recommendations on policy and legislative framework for regulating the digital economy. Government can eventually deal with the multilateral aspects. Members raised concerns about a unilateral approach disincentivising investment, and were reassured that legislation has not been the biggest factor in disincentivising investment. The Committees agreed that a follow-up meeting with the DTI on an action-plan for government is required.
 

Meeting report

Chairperson Carrim welcomed everyone in attendance and explained that the purpose of the meeting is for Members to be briefed on the taxing and processing of the digital economic activities, and progress on the illicit trade by the PBO, National Treasury and SARS. Both the Standing Committee and Select Committee on Finance have decided to focus on the digitalisation of economic activities and its likely impact on government tax revenue.

The Committee Secretariat noted an apology from Mr W Wessels (FF+).  

Briefing by the Parliamentary Budget Office (PBO)
Dr Dumisani Jantjies, Deputy Director: Finance, PBO, said the outbreak of COVID-19 has led to the shutdown of many economies around the world, to slow the spread of the virus while research for a vaccine continues. Since the national lockdown, there has been greater digitalisation of economic activities. The global economy has rapidly digitalised, due to the advancement of technology and innovations. The socio-economic impact has been different across countries. There is no consensus on the anticipated human and economic effects of the continued digitalisation of economic activities, although many economies have been disrupted resulting in a loss of jobs and of government revenues. Government needs to ensure economic policies and its regulatory frameworks, including tax rules, keep up with the rapid digital transformation of economies. Failure to do so could potentially accelerate economic inequalities and further restrict the human and economic development of many developing countries.

He stated that South Africa is one of the first countries to introduce taxation on the consumption of digital economy activities, through Value Added Tax (VAT). The first four years of introducing VAT on digital economy raised more than R2 billion in additional tax revenue. However, the introduction of taxation measures for the income of digitalised economic activities is yet to be realised. Government’s ability to raise tax revenue has, in part, been hindered by the lack of targeted digital economy taxation measures. As a result, South Africa continues to lose potential income tax revenue from digital economic activities. The COVID-19 crisis is expected to amplify the loss of government income tax revenue because non-digitalised sectors that contribute to government taxes will see a decline in their taxable income.

There is currently an international debate on how to transform the international tax rules to account for the rapid growth of the digitalisation of economies globally. The Organisation for Economic Co-operation and Development (OECD) Inclusive Framework draft recognises the need for unitary taxation. However, its current form implausible for developing countries such as South Africa to implement it without a higher compliance cost. There is no consensus as many OECD countries are in the process of adopting unilateral taxation approach in spite of the drafted Inclusive Framework. Further delays in reaching consensus leads to a continued loss of potential tax income.

South Africa can consider a unilateral approach to taxing specific income from digital economic activities. However, government may require additional human and institutional technological capacity to develop and implement unilateral taxation effectively on the digital economy. There would also be a need to consider implications for international cooperation and the role of international agreements that are based on international tax rules. There is also the issue of the 1998 World Trade Organization (WTO) Moratorium, in which WTO members agreed not to impose customs duties on electronic transmissions or cross-border digitizable products and services.

Dr Jantjies pointed out that the oversight processes of Members can be strengthened by more research on the impact of the South African tax system on the digital economy and accompanying socio-economic issues.

(See presentation)

Briefing by National Treasury (NT)
Mr Ismael Momoniat, Deputy Director General: Tax and Financial Sector Policy, NT, stated that in an increasingly digitised world, taxation needs to go beyond the idea of taxing the revenue of a company that is physically present in a country. The digital world has other jurisdictions and requires agreements. A small country like South Africa cannot go about doing this unilaterally as it could face countervailing actions such as what happened in France. After it announced that it would tax digital commerce, the United States (US) immediately threatened to take action and France had to pull back from implementing its policy.

South Africa has been a key player in the OECD digital taxation process, an approach supported by the Group of 20 (G20).  The challenge with implementing digital taxation is not only administrative but also ensuring there is sufficient global corporation to be able to enforce the tax.

Briefing by the South African Revenue Services (SARS)
Mr Franz Tomasek, Group Executive: Legislative Research and Development (R&D), SARS, said the existing treaty network government agreed to restricts its right to tax foreign businesses in the digital space. This is because the agreement is framed on the old nexus of having a degree of physical presence in South Africa in order for the foreign business to be subject to income tax. Due to the Constitution, South Africa does not have the option to override its treaty agreements with domestic law. Our treaties are also incorporated into domestic law. Another option would be to design a tax that falls outside of what the treaty covers; however, this comes at a cost of losing the opportunity to use the treaty to enforce the tax. For instance, many of South Africa’s treaties have information sharing provisions which will not apply if the tax is outside of the treaty. There is also the risk of double taxation on company operations. 

Taxation of domestic e-commerce is relatively easy for SARS because it has information on the size of the transaction, the supplier and consumer. When both the client and the supplier are in South Africa, the normal tax rules apply and can be enforced. The issue arises primarily when transactions between client and supplier cross international borders.

SARS is currently in the process of auditing well-known e-commerce players with a physical presence in South Africa. One of the issues being considered is whether a permanent establishment (PE) exists in South Africa or not. SARS was successful in arguing in the tax court that the extended provision of technical services to a client in South Africa and use of the client’s boardroom gave rise to a PE in South Africa and thus to taxable income of R64 million. In order to assist in identifying future risks in this regard, a reporting obligation was created under the reportable arrangements provisions of the Tax Administration Act, 2011.

He stated that SARS has responded to some of the challenges with digitisation through improved controlled foreign company (CFC) rules, which are one of the benchmarks in the international community. In wanting to improve the efficiency of VAT collection, SARS found that significant foreign businesses had not registered. It made contact to determine what the reasons were and to encourage foreign businesses to do so if the businesses fell within the regulations. This produced positive results in which the revenue collected had grown to R1 billion in 2018/19. In February 2018, revised draft regulations were published, which substantially expanded the range of electronic services covered, and took effect from 1 April 2019. As a result, the revenue collected grew to R5.4 billion in 2019/20. SARS is in the process of reviewing the outcomes to determine the need for further outreach and adjustments to its risk rules. SARS’ strategy for the coming years is to encourage voluntary compliance and enforce where it is lacking,

The OECD process shows that the dividing lines between developed and developing countries are blurred. Within the OECD, there are differing views on the approach, complicating the discussions. The process is essentially looking at reallocating tax rights to the market jurisdiction. This requires careful consideration of market jurisdictions and think of who does it benefit. The US has been protective of its players in the international space, which is another factor to bear in mind. Last week, the US announced that it has initiated investigations regarding digital services tax against Austria, Brazil, the Czech Republic, India, Indonesia, Italy, Spain, Turkey, the United Kingdom and the European Union.

(See SARS Input notes)

Discussion

Mr F Shivambu (EFF) said the discussions on the digital economy and tax collection should involve the Department of Trade and Industry (DTI). This is because the types of goods and services being traded in the digital economy fall under certain regulatory aspects of the DTI. Since South Africa has opened itself to trading goods in the digital space, the obligation of the democratic constitutional state is to ensure that it uses its domestic law and systems to ensure consumers in the digital space are maximally protected.

There must be correct interpretation on sections 231,232, 233 of the Constitution regarding international and domestic law. The interpretation that international law takes prominence over domestic law is improper as section 231 states that whenever there is conflict between the two, national legislation overrides laws that are inconsistent with domestic law. He proposed that Parliament and the revenue collector initiate a unilateral process to ensure maximal tax collection from digital services, and not wait for the OECD. Most of the members in the OECD are beneficiaries of tax evasion in the e-commerce platform, such as Luxembourg and the whole of Europe. A lot of economic activity is going to happen in the digital space and lacking a clear guideline on tax collection on digital services undermines the legitimacy of the state, as it will completely erode revenue and the state will not have resources to fulfil its basic commitments, such as paying public salaries. Government needs to pursue national legislation.

Mr Tomasek agreed that the DTI needs to be involved as it is the leading representative in the WTO when it comes to the moratorium and the taxation of intellectual property. It is not confined to the digital space as it is tax on the medium not the content. There are attempts to make the moratorium permanent however, South Africa and India are not in favour of this. 

Dr Jantjies responded that the current has not been geared up to deal with the digital economy. In its current form, the Draft Policy Framework makes it impossible for small countries such as South Africa. It is expensive and duplicates the international tax system, which will lead to parallel systems working at the same time.

Mr K Morolong (ANC) asked if government was to take the unilateral route, should it entertain the concern of an internationally accepted approach discouraging investment. Is there a comprehensive cost and benefit analysis if we go with the unilateral route?  Waiting for the WTO impacts government’s mandate and its potential revenue collection. He stated that it would help the Committees to receive a balanced view on the trade-offs.  

The state should endeavour to build human capacity for tax administration. It would be wrong to assume the country does not have the capacity when it’s sitting in finance and accounting advisory, when it should be in the public sector.

Dr Jantjies agreed with Mr Morolong that South Africa has capacity however, it is more about the whole value chain system and understanding how the digital process works, not only just understanding how tax works, This requires skills enhancement and support in institutions. He stated that legislation has not been the biggest factor in disincentivising investment. It is mostly about being able to make more profit in a country. It is more complex than the idea of a unilateral approach deterring investment.

Mr D Ryder (DA, Gauteng) asked Treasury if exchange control regulations are being applied fairly. He pointed out that with the move towards a digitised economy there is still a legacy of the old exchange control regulations in which some are applied strongly and others are not.

Mr Momoniat responded that Annexure E in the Budget Review shows that government has moved on from the exchange control practices.

Mr D George (DA) asked if SARS or National Treasury (NT) are contemplating changing the tax system dramatically such that engagement will not be physical. The crisis has shown the informal economy is a lot bigger than anticipated. Government has an opportunity to measure it more effectively and tax it. Is there a plan to do so? Do we have a plan to tax it? Is there a plan to create a package in preparation for the post COVID-19 world?

Mr Tomasek explained that as a result of the challenges posed by COVID-19, government has made relief packages available. One of the requirements to receive the relief packages is to complete a revenue loop, which has created a useful data source for SARS. This can assist with bringing people on board the more formal part of the economy.

Mr Shivambu said the danger of not having legislation that maximally collects from the digital economy is that businesses with a physical presence can claim they are digital and set up a tax evasion accounts, leading to an erosion of the existing revenue base. Where do stores such as Woolworths and Shoprite collect revenue for their online trade? Revenue will be significantly challenged if government does not have a clearer framework on goods and services traded in South Africa.

Chairperson Carrim asked Treasury if it has presented the WTO Memorandum on the disadvantages experienced in South Africa, in March 2020. If not, when is this going to happen? If it has been presented, what was the outcome? He stated that there is a link between the elicit economy and the digital economy. Government cannot tackle the former without tackling the latter as well. What does the protection of SMME’s mean or look like with the current e-commerce and COVID-19 developments? For its contribution to the Medium Term Fiscal Framework, Parliament needs to focus more on the digital economy. The Joint Committee report needs to give more attention to this and make mention of having more inputs on the digital economy in the Bill.

Mr Momoniat said the term ‘digital economy’ covers many things. There are e-books, applications and some are goods that require delivery. The different activities are currently being taxed; however there is difficulty with service provision by a company overseas. In this case, tax collection requires an international agreement such as multilateral and double tax agreements.  He stated that he is optimistic on the OECD process as it is in the interest of many countries to push for its conclusion. There is currently a collection of taxes from e-services however, the coverage is not comprehensive.

Chairperson Maswanganyi asked if the acceleration of the fourth industrial revolution comes with negative implications for tax revenue collection. He stated that it would be wrong for the state to be a bystander and leave the digital economy to market forces. The state should be an active player and so the attitude of starting a conversation by saying “America will not allow this…” is not advisable. South Africa still has its own sovereignty and takes its mandate from the people from South Africa. This should be guarded jealously. Leaving things as they are will have a negative socio-economic impact. South Africa is currently chairing the African Union (AU), how is the state taking advantage of such platforms? The AU should be an accessible force in the multilateral discussion. He said it is incorrect to say that government cannot do anything about legislation. For instance the Department of Transport amended legislation to regulate Uber. NT and SARS should come back with clear recommendations on policy and legislative framework for regulating the digital economy. Government can eventually deal with the multilateral proposals of the WTO.  

Ms Yanga Mputa,  Chief Director: Legal Tax Design, NT, stated that the challenge with implementing an income tax in the digital economy, is the lack of a nexus in the country. The taxation basis of VAT is the sale of goods. For income tax, the nexus is physical presence in the country. International digital companies do not have physical presence in the countries they operate in. This requires a change in the basis of international taxation. She noted the request of Members to look into unilateral approaches. Treasury hopes that there will be a consensus among countries by the end of 2020 or early next year.

Chairperson Carrim pointed out to NT and SARS that Members are saying more needs to be done, more assertively and urgently, and in a more progressive way.

Mr Geordin Hill-Lewis (DA) stated that the digital economy also includes online gambling. The DTI has taken the view that online gambling should be illegal and is not taxed. Online gambling happens everywhere in South Africa and so this gives online gambling companies a free run.

Mr Momoniat agreed that Treasury would prefer it if South Africa’s system did not allow payment for overseas online gambling. Treasury has identified some ways to do this; however, it is possible to do more. The legislation on this sits with the DTI. Government also needs to have limits on domestic online gambling and intensify its efforts in this regard.  Digital commerce involves other Departments in addition to the DTI, such as the Department of Communications. There are processes that take place between departments.

Mr Tomasek stated that the South African income tax system looks at the income of a South African resident. Regardless of how one receives income, as a resident one is subject to tax. If the payments are dropped into off-shore accounts, it is now easier to follow-up on it. . Whether the income was derived legally or illegally does not impact on its taxability. For instance, SARS has been successful in taxing pyramid schemes.

Mr Shivambu said government needs a legislative framework that can put in a requirement for having some physical presence, so that there is a place to raise concerns if regulatory specifications are not being met, for consumer protection and for maximal revenue collection.. If a legislative framework on the digital economy is not established, the state’s revenue base will be threatened significantly.

Mr Momoniat said government needs to look at what exactly it will regulate. The challenge is not on the tax side because tax is looking at the income generated. Big countries like China are able to regulate internet access to companies like Amazon through firewalls. He warned that regulation needs to be very carefully approached. Regulating the digital economy is a complex matter that goes beyond Treasury.

Chairperson Carrim stated that Members are aware of the complexity of the issues and agree that it is something that needs to be looked at urgently given the COVID-19 circumstances.

Closing remarks
Chairperson Carrim, in closing, remarked that the meeting was stimulating and interesting, with quality responses in the discussion. He thanked all Members and participants for their cooperation.

Chairperson Maswanganyi proposed that colleagues from the DTI be present in the next meeting. He remarked that this meeting was about being reminded of international protocol and government’s frustrations and did not meet his expectations. A follow-up meeting is required on an action-plan for government. He thanked all Members and presenters for their presentation.

The meeting was adjourned.

 

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