public private partnerships (ppp) a few tax implication presented by johan kotze

PUBLIC PRIVATE PARTNERSHIPS (PPP)

A few tax implication

Presented by JOHAN KOTZE

YOUR OWN ATTEMPT …

YOUR CLIENT’S SCENARIO

Your client is Egoli Health Services (Pty) Ltd

It is party to a PPP

And queries the tax implications of the money it is receiving pursuant to its obligation in terms of the PPP

YOUR CLIENT’S SCENARIO

Department of Health required an psychiatric unit

Tender terms:

‘Design, construction, maintenance, operation and finance’ of an institution / facility for psychiatric patients

Private party should design and construct the facility

Private party should finance the facility

Private party should then maintain and operate the facility

YOUR CLIENT’S SCENARIO - Continue

Tender terms continue:

Facility is to be provided on government land

Maintenance and operating period 25 years

Facility should accommodate 400 patients

Tender consideration: would be a fixed amount for the design and construction of

the facility and a variable amount for the maintenance and operation


Egoli Patient Services (Pty) Ltd was awarded the tender

Fixed portion for the design and construction: R120 million, payable over 10 years in equal installments

Variable portion for the maintenance and operation: R50 per patient per day, indexed annually

Facility was brought into use on 1 March 2009

Financial year 1 March 2009 – 28 February 2010:Fixed portion – R12 millionVariable portion – R7,3 million


Tax advice required by Egoli Patient Services (Pty) Ltd

How should

the fixed portion (R12 million) and

the variable portion (R7,3 million)

be treated for income tax purposes.

No other information provided and no advice pertaining CGT, VAT etc. required

WHAT IS A PPP ?

Defined in section 1‘a Public Private Partnership as defined in Regulation16 of the Treasury Regulations issued in terms of section 76 of the Public Finance Management Act, 1999 (Act No.1 of 1999)

Loosely: An arrangement between the Public Sector and Private Sector

Public Sector represented by a specific Department of Government

Private Sector normally represented by Special Purpose Company, on behalf of shareholders, financiers and other stakeholders

Could be for use of public assets or to perform institutional function

INCOME TAX ACT APPLICATION

A PPP is a normal taxpayer, but has TWO provisions in the Income Tax which specifically deals with it:

Section 10(1)(zI): Exemption

Section 11(g): Leasehold improvements

All other provisions equally important

Because the query is about income, the exemption is the only specific provision to be dealt with herein

LET’S START AT THE BEGINNING:BASIC FORMULA FOR TAX CALCULATION

Gross income XXX

Less: Exempt Income (XXX)

Income XXX

Less: Allowable deduction (XXX)

Taxable Income XXX

ARE THE AMOUNTS GROSS INCOME?

The first question about any amount which a taxpayer receives is whether the amount constitutes gross income?

Therefore does Egoli’s fixed portion of R12 million, in respect of design and construction, constitutes gross income?

And, does the variable portion R7,3 million, in respect of maintenance and operation, constitutes gross income?

GROSS INCOME - DEFINED

Section 1 – Definition:“gross income” in relation to any year or period of assessment, means –

(i) in the case of any resident, the total amount, in cash or otherwise, received by or accrued to or in favour of such resident; or

(ii) [in the case of any non-resident]

during such year or period of assessment, excluding receipts and accruals of a capital nature …

GROSS INCOME – PER FORMULA

Total amount in cash received by a resident XXX

Total amount in cash accrued to a resident XXX

Total amount in cash receive by, in favour of a resident XXX

Total amount in cash accrued to, in favour of a resident XXX

Total amount otherwise received by a resident XXX

Total amount otherwise accrued to a resident XXX

Total amount otherwise receive by, in favour of a resident XXX

Total amount otherwise accrued to, in favour of a resident XXX

XXX

LESS: Receipts of a capital nature (XXX)

LESS: Accruals of a capital nature (XXX)

GROSS INCOME XXX

GROSS INCOME – AMOUNT RECEIVED

Is the fixed portion of R12 million, in respect of design and construction, an amount?

YES

Is the fixed portion of R12 million, in respect of design and construction, received?

YES

Is the variable portion of R7,3 million, in respect of maintenance and operation, an amount?

YES

Is the variable portion of R7,3 million, in respect of maintenance and operation, received?

YES

GROSS INCOME – PER FORMULA - APPLICATION

Total amount in cash received by Egoli - in respect of design and construction

R12 million

Total amount in cash received by Egoli - in respect of maintenance and operation

R7,3 million

No other received or accrual

R19,3 million

LESS: Receipts of a capital nature ???

GROSS INCOME XXX

IS IT A RECEIPT OF A CAPITAL NATURE?

No definition of the phrase ‘of a capital nature’

In the normal course there is no difficulty to determine whether a receipt or accrual is income or capital in nature

Popular distinction is that capital is the income-producing machine, and the product is income

Capital = Tree; Income = apples

Position is not always so simple or clear, and the reported cases have introduced a wealth of subtle distinctions

IS IT A RECEIPT OF A CAPITAL NATURE? - Continue

It is necessary to consider the nature of the fixed portion of R12 million, in respect of the design and construction

It is also necessary to consider the nature of the variable portion of R7,3 million, in respect of the maintenance and operation

Are they grants or subsidies in nature?


What is a grant or subsidy?

No definition in Income Tax Act of ‘grant’ or ‘subsidy’

Can be described as: A sum of money given by a government or public body for a

particular purpose

A sum of money granted from public funds to help an industry or business, or to keep the price of a commodity or service low

To advance policy decision


‘Government grant’ defined as: ‘an appropriation, grant in aid, subsidy or contribution, in cash or kind, paid by a department listed in Schedule 1 to the Public Service Act, 1994 (Proclamation No. 103 of 1994), (other than a provincial administration), but does not include any amount paid in respect of the supply of any goods or any services to that department’

But only in relation to section 10(1)(y) – not relevant for this discussion


Two tax cases dealt with grants / subsidies:

Moolman v CIR (19 SATC 127)

ITC 1633


Moolman v CIR

Moolman was a wool-farmer

In 1940 the UK and SA had an arrangement and via this arrangement Moolman had to sell his wool to the UK

After the war in 1945 the UK had large stock of wool, sold in Australia

Profits were remitted to SA and Moolman received pro-rata share - agterskot

Was it capital or revenue in nature?


Moolman v CIR

Centlivres CJ said that:

’[it] is therefore clear that the amount was paid to the appellant in respect of wool sold by him in the course of his occupation as a wool-producer and was a profit made by him as a result of his operations as a wool-producer, and must be regarded as an addition to the purchase price which he obtained from the wool which he sold …

This being so that amount cannot be regarded as a receipt of a capital nature’


ITC 1633

The taxpayer was a manufacturer of motor vehicles and enjoyed certain excise duty rebates

Two main categories were taken into account - the foreign exchange saved by the use of local components and the foreign exchange earned by exports

The taxpayer contended inter alia that the rebates were capital in nature


ITC 1633Wunsh J:

The excise duties were normal deductible expenses and if an amount received has the effect of recouping expenditure, the recoupment is gross income and not capital in nature

There was no foundation to claim that if the ‘payment’ was intended ‘as an incentive to achieve certain economic, socio-economic, or political aims of the State, such payment would … constitute a capital accrual’


ITC 1633Wunsh J:

The rebate was not granted to finance the costs of capital items such as building and plant

There was no evidence that by opting to subscribe to the local content programme the taxpayer restricted its freedom to trade as it deemed fit

The taxpayer did not surrender any rights


ITC 1633Wunsh J:

The taxpayer was not contractually or in any way restricted from its right to trade

The taxpayer participated in the scheme in order to enable it to receive the rebates and so increased its profits

There was no substance in any of the arguments for the proposition that the rebates were of a capital nature


Therefore:

Subsidies may be receipts or accrual of a capital or income nature depending upon the purpose for which they are granted

If, for example, it is granted to establish an industry, it will be of a capital nature, since the subsidy goes towards the:

fixed capital or

income earning machine


But:

If the grant or subsidy is granted in respect of the taxpayer’s trading as such, for example:

to manufacturers or producers to encourage production

to encourage export

to compensate a taxpayer for keeping prices low

the grant or subsidy is income in nature


Is the fixed portion of R12 million, in respect of the design and construction, a receipt of a capital nature?

YES / NOYES

Is the variable portion of R7,3 million, in respect of the maintenance and operation, of a capital nature?

YES / NONO

GROSS INCOME – PER FORMULA - APPLICATION

Total amount in cash received by Egoli - in respect of design and construction

R12 million

Total amount in cash received by Egoli - in respect of maintenance and operation

R7,3 million

No other received or accrual

R19,3 million

LESS: Receipts of a capital nature by Egoli – in respect of design and construction

(R12 million)

GROSS INCOME R7,3 million

LET’S START AT THE BEGINNING:BASIC FORMULA FOR TAX CALCULATION

Gross income R7,3 million

Less: Exempt Income (XXX)

Income XXX


Taxable Income XXX

IS THE AMOUNT EXEMPT FROM TAX

Section 10(1)(zI) – Exemption provides the following

10. There shall be exempt from normal tax-(zI) any amount received by or accrued to or in favour of any

person from the Government, where-

(i) the amount is granted for the performance by that person of its obligations pursuant to a Public Private Partnership; and

(ii) that person is required in terms of that Public Private Partnership to expend an amount at least equal to that amount in respect of any improvements on land or to buildings owned by any sphere of government …

ANALYSIS OF SECTION 10(1)(zI)

Did Egoli receive any amount from Government?

Yes

ANALYSIS OF SECTION 10(1)(zI) - Continue

Is Egoli in a PPP, as defined?

Yes


Was such amount granted to Egoli for the performance of its obligations pursuant to the PPP?

Yes


How much was granted to Egoli for the performance of its obligations pursuant to the PPP?

A total of R19,3 million, i.e.:

R12 mllion in respect of the design and construction, and

R7,3 million in respect of the maintenance and operation


Did the PPP require Egoli to expend an amount in respect of improvements on Government land?

YESIt was required to construct a psychiatric unit on Government land


How much was expend on the psychiatric unit constructed on Government land?

Egoli advised that it spent R60 million on the psychiatric unit


THEREFORE:The amount Egoli was granted pursuant to its obligations R19,3 millionThe amount Egoli expended on the improvements R60 million

The requirement in par. (ii) is that Egoli has to expend an amount at least equal to the amount it receives pursuant to the obligations

Did Egoli expend an amount at least equal to the amount received?

No, therefore the full amount falls wihin the requirement

Is it fair to say that Egoli could have an exemption up to R60 million on an annual basis?

TAX CALCULATION


Less: Exempt Income (R19,3 million)

Income / (loss) (R12 million)

Is the above position correct?

Can the deduction of exempt income from gross income create a loss?

INCOME

Section 1 – Definition:“income” means the amount remaining of the gross income of any person for any year or period of assessment after deducting therefrom any amounts exempt from normal tax under Part I of Chapter II

How much would therefore remain from Egoli’s gross income after deducting the exempt PPP amount?

ANSWER TO EGOLI


Less: Exempt Income (R19,3 million)

Income NIL


Taxable Income XXX

REALITY CHECK

Are you sure this is correct?

You have just given Egoli a double deduction?

1.By deducting the capital receipt in respect of the design and construction?

2. By deducting it as exempt as well?

You have also given Egoli an exemption for its operating income

CORRECT APPROACH

No magic to the term, contractor

Egoli was contracted to design and provide a psychiatric unit

The fixed portion of R12 million, in respect of the design and construction, is therefore a receipt for services rendered and revenue in nature

The exemption is still applicable

Cost of psychiatric unit should be considered in terms of section 11(a) & 23(f)

The key is that thepsychiatric unit is ‘trading stock’ as defined

THANK YOU

public private partnerships (ppp) a few tax implication presented by johan kotze

Documents

facility slide

ppp slide

operation slide

facility private party

tender fixed portion

fixed portion r12

variable portion r7

income tax purposes