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Overhaul of provisional tax
An important change to provisional tax was recently introduced via the Revenue Laws Second Amendment Bill, 2008 relating to estimates of taxable income.
Currently, the second provisional tax payment may be based on an estimate of the basic amount – essentially taxable income for the year last assessed. Provided the estimate of taxable income does not fall below the lesser of the basic amount or 90% of actual taxable income, no penalty is imposed for an underestimate. Such estimations, based on the basic amount, are commonly made by taxpayers where they do not have accurate information regarding their anticipated taxable income.
However, with effect from the second provisional tax payment for the 2009-year (for individuals due 27 February 2009) the concept of a basic amount will be dispensed with for second provisional payments. Moreover, an underestimate of provisional tax will lead to a penalty of 20% of the tax on the difference between 80% of the actual taxable income and the estimate.
Consequently, estimates, encompassing all sources of taxable income, including any capital gains, of the actual taxable income for the year will need to be made very carefully –
Although the requirement for the first provisional tax payment to be not less than the basic amount remains for the first provisional tax payment, an estimate of less than the basic amount for the first provisional tax payment still needs to be justified.
Interestingly, in a downward business cycle the change will have the effect of removing the need to justify an estimate lower than the basic amount at the time of submission of the provisional tax return.
Notwithstanding, this change in the tax rules places significant pressure on taxpayers to keep their accounting records up-to-date to make estimates of their anticipated taxable income as accurate as possible.
M&A continues to grow despite market conditions
Although 2008 has witnessed a sharp decline in general M&A activity, Mazars Moores Rowland Corporate Finance’s M&A division maintains its position as a leading M&A platform both regionally and nationally.
The current political and economic climate makes the successful execution of transactions precarious at best. Managing the expectations of parties during the negotiation phase is proving to be a common hurdle. This is largely because:
- Buyers are currently under pressure to deploy funds against significantly expensive costs of capital and are therefore seeking very low multiples for acquiring “unlisted equity”.
- Most owners of “unlisted equity” do not believe that their companies should be pegged against the listed stocks (believing listed stocks to be undervalued), resulting in asking prices that far exceed the market’s interest.
Notwithstanding, a sustained increase in M&A activity is expected in 2009 as highly geared businesses begin to experience distress. These businesses will provide ideal targets for “cash-flush” investors to acquire with a view to restructuring the debt. Moreover, many offshore institutions and funds are under pressure to invest in triple bottom line investments and are actively looking for investments in the high-growth “frontier markets” of developing economies. Consequently, 2009 promises to be a busy year as transactions are driven by offshore investors.
How Mazars Moores Rowland’s M&A division assists its clients
With the development of an extensive network of buyers across the country, supported by close working relationships with institutions, private equity funds, high net worth individuals and listed entities, the M&A team is able to quickly assess the marketability of a business and determine who the most likely suitor might be.
Even though the main focus is on transactions of between R20 million and R500 million, all clients receive the same level of attention when seeking to divest of smaller businesses with services such as:
- Facilitating of acquisitions and disposals
- Sourcing of funding
- Identifying and introducing strategic investment partners
- Due diligence reviews
- Broader transaction support services
This diverse and quality approach to M&A continues to boost activity with 11 transactions currently in process and a further 9 in the initial stages of negotiation. The M&A division is also marketing around 35 mandates, yet still has the capacity to pursue new opportunities for clients.
Materiality and Disclosure
When auditors sign off an audit opinion, they confirm that it complies with a reporting framework (e.g. SA GAAP or IFRS).
Careful consideration should be given to disclosures an auditor disagrees with.
In such situations, one of the most common responses from management, “What is your materiality; doesn’t this amount fall below that level?”
Although the auditor assesses disclosures based on their materiality, used, among other things, to determine what level of testing will be performed and what the tolerable error is for certain accounts, the client must use their own materiality in determining what disclosures are to be made.
A transaction is material, according to the definition, because of its size, nature or ability to influence the economic decision of users. If the treatment and/or disclosure of an item in the financial statements has the ability to influence users, it can be regarded as material.
Disclosure does not fall within the definitive characteristics of materiality, but other considerations must be made.
By nature of its disclosure, an item becomes clearly visible in the financial statements and must therefore be treated in line with the reporting framework, no matter what its size or nature. Non-material items may be aggregated on the face of the financial statements or in the notes thereto (IAS 1.30). If this option is not taken, the disclosures are assumed to be material.
Materiality is not an accounting policy, but it can be invoked when applying accounting policies. Consequently, clear distinction between the application and the wording of an accounting policy needs to be drawn.
An accounting policy that states non-compliance with IFRS cannot be deemed to be in accordance with IFRSs. Inappropriate accounting policies or disclosures are not rectified by disclosure of the policy or explanatory notes, including a statement that the items are not material. (IAS 1.16)
An error, even if immaterial, may not be left uncorrected. “It is inappropriate to make, or leave uncorrected, immaterial departures from IFRS to achieve a particular presentation…” (IAS 8.8). “Financial statements do not comply with IFRSs if they contain either material errors or immaterial errors made intentionally to achieve a particular presentation…” (IAS 8.41).
To summarise: if an item is separately disclosed anywhere in the financial statements, it is deemed to be material, and must be treated correctly in line with the reporting framework.
Clients often react with horror when told their transaction would result in a negative equity reserve. There seems to be a general sentiment when this is the case that they would rather recognise it as an expense. This is, however, often not permitted through the application of IFRS.
Let’s look at some examples.
Obviously, a loss making entity can easily end up with a debit equity balance.
A foreign currency translation reserve can result in a negative equity balance.
Company A, a South African company, is required to prepare a Euro-based set of financial statements for shareholders. This conversion is made in terms of IAS 21; the assets and liabilities at balance sheet spot rate and income and expenses at the transaction date or, when allowable the average rate for the year. Any difference resulting from the translation must be taken to equity. As the Rand / Euro exchange rate has dropped considerably during the year, it creates a debit equity reserve.
Another transaction that can result in a negative equity balance is the application of the pooling of interests method to a common control business combination.
Company B entered into a restructuring plan whereby it purchased a fellow subsidiary, paying an extra R10 million to its holding company. This is considered a common control transaction; the company wishes to apply the pooling of interest method through the application of IAS 8 in the absence of an IFRS that specifically applies to a transaction. The pooling of interest method does not allow for the recognition of goodwill, but the excess paid is to be recognised in equity. This transaction often results in a debit equity balance.
The amendment to IAS 27 could also result in a negative equity balance. Minority interests, now non-controlling interests, are to absorb all losses. A holding company will no longer allocate losses to minority interests until they reach a zero balance, with the holding company absorbing any additional losses. The minority interest balance can therefore be a negative equity balance where there is an investment in a loss-making subsidiary.
The foregoing highlights how some equity balances can be negative and could possibly result in a total negative equity. My advice: don’t be negative!
[Footnote]  Note that this article is written purely from an IFRS standpoint; the impact of negative equity on local company law and regulations has not been considered.
Partner profile: Dave Bates
Dave Bates is managing partner of Mazars Moores Rowland’s Durban office, comprising 75 staff and 4 partners. Despite the challenges of the economy and a changing regulatory landscape, he still manages to enjoy trout fishing with his fellow partners on occasion.
Dave, what role do you play within the firm?
As well as managing the Durban office, which I represent on Mazars Moores Rowland’s South African Board, I am also the contact person for referrals around the country and for international work.
How would you define your approach?
Historically, our partners have managed their own clients and built up the practice with a hands-on service. This has been a cornerstone of the development of the Durban office and the Mazars ethos makes it easy for us to carry this on.
Any particular challenges facing clients these days?
Yes, the new Companies Act is due to come out in 2010, bringing big changes in terms of who needs to be audited. We have started preparing for this already and have found that we will be specialising in three distinct areas: 1) public interest entities, 2) companies that require audits and 3) owner-managed businesses. Also, the whole range of services such as accounting, consulting, and tax will become separate and specialist areas to best service all our clients.
How will this change things within the firm?
What I see happening is that we require more specialisation and technical excellence from partners and staff – moving away from being a general practitioner.
What advice can you offer clients in the current economic climate?
Try not to panic. It’s more a case of sticking to the basics and making sure that business carries on with sound principles and practices to see out the next 12 to 18 months while building a platform for when the economy turns around.
With so much going on do you get a chance for a personal life?
I do. I’m happily married with two kids. My daughter just finished school and is at university and my son has just started high school. We still take time to travel when we can, though, which we enjoy immensely.
WHISTLEBLOWING AND THE COMPANIES BILL 61 OF 2008
Gill Bolton examines the significant implications of the new Companies Bill 61 of 2008, which promises greater protection to corporate whistleblowers than those in the public sector.
Whistleblowing in South Africa
Simply put, a whistleblower is someone who passes on information about conduct he/she believes to be illegal or unethical in some way within an organisation. Such an individual could be an employee or an outsider like a potential supplier.
In South Africa, whistleblowers in both the public and private sector are protected under the Protected Disclosures Act (PDA). Alas, to-date this Act has proven to be rather ineffective. Consider the recent high-profile examples of Harry Charlton and Dr Paul Theron who blew the whistle on Travelgate and conditions at Pollsmoor Prison respectively to see just how far the PDA was able to protect them.
The new Companies Bill 61 of 2008
The new Bill provides additional protection for whistleblowers than is provided by the PDA to include information provided in good faith about:
- Contraventions of the Act [the Bill]
- failure to comply with any statutory obligation of the company
- Conduct that had endangered or was likely to endanger an individual’s health or safety or damage the environment
- Unfair discrimination
- Contravention of any other legislation that could expose the company to an actual or contingent risk of liability or is inherently prejudicial to the interests of the company
As well as employees, protection is extended to shareholders, directors, company secretaries, prescribed officers, registered trade unions and suppliers (including their employees) of goods or services to the company. Such persons will be immune from any civil, criminal or administrative liability as a result of the disclosure and entitled to compensation for damages suffered as a result.
How will things change for companies?
It seems likely that both public and state owned companies will be required to establish and maintain systems to receive disclosures – a hotline being the most effective tool for such a purpose. Of course, a hotline can also provide significant business benefits. For example, in organisations where fraud hotlines are administered by an independent third party, whistleblowers can pass on their information either anonymously or with their identity kept from the organisation. This often uncovers wrongdoing at an earlier stage than would otherwise have been the case.
For further information about any issue raised in this article, fraud prevention programmes or the setting up of hotlines, please contact Gill Bolton on 021 405 4128.
Corporate Tax: Assessed losses and income from trade
Recent court rulings on the carrying forward of tax losses threaten confusion for businesses and tax practitioners alike.
It’s general knowledge that taxpayers can carry forward the balance of an assessed tax loss from one year to the next. Although the law requires an income to also be earned during the period of loss, SARS’ Interpretation Note (IN33) states that, among other things, SARS will allow the balance of an assessed loss to be carried forward if it is proven that a trade was carried on even in the absence of income.
A surprising turnaround …
Great must have been the taxpayer’s surprise, then, when SARS recently disallowed the balance of the assessed loss from one year to be carried forward to another despite not earning income. The impact of this move was further emphasised when a court ruling confirmed that section 20 of the Income Tax Act requires both the carrying on of a trade as well as the earning of income from that trade for the balance of an assessed loss to be carried forward. The court further held that, despite IN33, SARS cannot make concessions on the written law to address possible anomalies or practical problems created by the legislation.
There are three main areas of concern relating to this judgement:
- The practical impact on companies that have incurred expenditure but are not yet able to generate trade income, as is often legitimately experienced in industries such as property, farming and construction.
- SARS’ apparent disregard for its own Interpretation Note. SARS’ inconsistency in applying the tax law and especially their own interpretations creates a minefield of confusion for taxpayers and tax practitioners who believe they are transacting and advising in ways acceptable to SARS.
- Erosion of the credibility of SARS’ documentation. A ruling indicating that SARS cannot change the written law through its own interpretation and practice does not bode well for the perceived quality of other SARS Interpretation Notes.
While the courts adhere to the letter of the law, this case could set the tone for a questioning look at all of SARS’ publications on its interpretations and practice – past, present and future.