Professional Level Options Module, Paper P6 (ZAF)

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1 Answers

2 Professional Level Options Module, Paper P6 (ZAF) Advanced Taxation (South Africa) December 2015 Answers Note: ACCA does not require candidates to quote section numbers or other statutory or case references as part of their answers. Where such references are shown below [in square brackets] they are given for information purposes only. 1 Julius Hamilton and Afri Report To: Julius Hamilton From: ACCA Candidate Subject: Questions pertaining to AfrInvest (Pty) Ltd Date: December 2015 This report considers the various tax implications arising from the investment by Julius in AfrInvest (Pty) Ltd ( Afri ) and the acquisition by Afri of certain shareholding investments. (a) (i) Residence of Afri The first issue to consider is the residence status of Afri. As Afri will be incorporated in South Africa, this is sufficient to classify the company as resident in South Africa. Any tie-breaker of place of effective management is irrelevant in this instance as there is no comprehensive tax treaty between South Africa and the Cayman Islands (where Julius is resident) or between South Africa and any of the African states in which Afri will make acquisitions. In any event, it would appear that the place of effective management is in South Africa (where the single executive director Helen resides and where the board meetings will take place). For the rest of this report, the place of residence of Afri will be assumed to be South Africa. (ii) Controlled foreign company rules The stated intention of Afri is to hold between 20% and 51% of the equity shares and voting rights in each acquisition as well as have a seat on the board of directors. To be a controlled foreign company (CFC), the basic rule provides that more than 50% of the participation rights of the foreign company must be held by residents. None of the variations to the basic rule apply to the investments proposed and the parties involved. It therefore appears from the proposed structure that controlled foreign companies (CFCs) would be created as a result of any acquisition in which Afri acquires more than 50% of the equity shares and voting rights in a foreign company. However, despite such classification as a CFC, there is likely to be little impact. This is because the acquisitions would appear, from the information provided, to meet the requirements of a foreign business establishment. Under the CFC legislation, the net income of a CFC which is attributable to a foreign business establishment of the CFC conducted in a foreign country does not require to be accounted for as notional income. Without further information, this exception would appear likely to reduce the net income of such CFCs to nil resulting in no inclusion in taxable income. The interest payable (in the event that Afri has loaned money to the acquisition company) would not taint this principle. (iii) Transfer pricing interest For the transfer pricing rules to apply, the parties to the transaction must be connected persons. Certainly Julius, Helen and Afri are connected persons. Julius and Helen are connected to Afri by virtue of their shareholding size as they both will hold more than 20% of the equity shares/voting rights. Any company whose shares Afri purchases will be a connected person if more than 50% of the equity shares or voting rights are held. Even if the shareholding acquired is less than 50%, it is still possible that the companies would be considered to be connected persons of Afri should no other majority shareholder exist (assuming that an equity holding of at least 20% is acquired). As connected persons, the transfer pricing rules will apply to the loans made from Afri to the companies whose shares it acquires. From the information provided, it would appear that the rate of interest charged will be market related (being related to the risk of the loan). If the interest rate is deemed to be excessive, there would be no adjustment by the South African tax authorities as Afri (the resident company) is the recipient of the income. However, if the interest rate is deemed to be less than a comparable arm s length rate, there will be a risk of an adjustment by the South African tax authorities to increase the taxable income in Afri. A risk of a transfer pricing adjustment also arises with respect to the interest payable by Afri to Julius. The fixed rate of interest has not been specified and, in the absence of further information, it is not possible to quantify the potential adjustment. Should the deduction of interest expense in Afri (in respect of the interest payable to Julius) be deemed to be excessive, such excessive interest will be deemed (as Julius is a natural person) to be a loan, which of itself will be an affected transaction. This will require a circular calculation of the effect of the affected transactions. Tutorial note: The effect of the transfer pricing adjustment was recently amended from being classified as a loan (which of itself is an affected transaction) to a donation, for persons other than companies. Both will be accepted in the marking for this examination. Transfer pricing management services and advice A transfer pricing adjustment in South Africa would only arise in respect of the managerial services if the price charged was less than an arm s length price. Charging an inflated price would be unlikely to result in a transfer pricing adjustment 17

3 (iv) (v) (vi) in South Africa but would only be worthwhile if the effective rate of tax in the payor country was higher than that in South Africa. Even then, there would be a danger of a transfer pricing adjustment on the payor by the payor s country. Where the prices charged are below market related rates for the services rendered, such deflated prices may be considered to be a tax benefit (being a reduction, postponement or avoidance of tax) and so a transfer pricing adjustment may be possible. As the tax benefit would be achieved by a non-resident company, the adjustment would be a deemed loan which of itself would be an affected transaction for transfer pricing purposes (see earlier tutorial note). Exchange differences As the loans made to the African acquisitions will be denominated in the relevant local currency, a significant risk exists in Afri for an exchange loss on both the interest and capital repayments where the relevant local currency weakens relative to the South African rand. Such an exchange loss would be deductible from Afri s taxable income. Foreign tax credits A credit against South African tax is allowed in respect of foreign taxes paid on income also subject to tax in South Africa. As no double tax treaties are in existence between South Africa and the relevant countries, the only foreign tax credit relief available will be unilateral relief under the South African legislation. With respect to such relief, the foreign tax must have arisen on a foreign source of income, the gross amount of which is subject to tax in South Africa. The relevant sources of foreign income which will be received by Afri and are also subject to foreign tax are the interest on the loans to the African companies and the fees for the management services and advice given. Tutorial note: There is no withholding tax suffered on any dividend income received by Afri from the African companies in which it holds an investment. In any case, as this dividend income would be exempt from South African tax due to the size of Afri s shareholding, there is no issue of double taxation. Interest on loans The interest received by Afri from the African companies will be fully taxable in South Africa and will arise from a foreign source. It is understood that a 20% withholding tax will be levied on this interest by the paying company. Therefore, a credit for the foreign withholding tax suffered on this interest will be available to Afri against the South African tax on this same income. Fees for management services The management services and advice will be rendered from South Africa and thus would be from a South African source. Therefore, unilateral relief will not be available in respect of the 10% withholding tax levied on these payments by the paying company. However, currently a second unilateral relief exists for such foreign taxes withheld on amounts from a South African source. Therefore relief would still be possible on the withholding taxes raised on the managerial service fees and advice fees. Tutorial note: This section is soon to be repealed. Value added tax (VAT) The management services and advice will be rendered from South Africa but may still represent an exported service chargeable to VAT at the zero rate. In the absence of such an exported service categorisation, the standard rate of VAT of 14% would apply to such services. (b) Headquarter company (i) Application to Afri It is likely that Afri will qualify for the headquarter company regime given: Afri is a resident company in which the shareholders are all natural persons holding 10% or more of the equity shares and voting rights of the company. It is likely that at least 80% of Afri s assets (excluding cash) will consist of interests in foreign companies or debt owed by those companies in which there is a holding of at least 10% of the equity shares and voting rights. Afri s gross income is likely to exceed R5 million, of which more than 50% of the gross income will consist of dividends, interest and service fees from the foreign companies in which there is a holding of at least 10% of the equity shares and voting rights. Exchange differences are ignored for the purposes of the gross income determination. Election An election to be classified as a headquarter company can be submitted at any time and is effective from the start of the year of assessment in which the qualifying election is made. There is an additional requirement to submit a report to the Minister of Finance as prescribed from time to time. (ii) Impact of headquarter company status The classification of Afri as a headquarter company would impact in a number of ways on the tax analysis presented above as follows: Controlled foreign company rules After classification as a headquarter company, Afri will be exempt from the South African CFC rules. 18

4 Transfer pricing Management services and advice The transfer pricing rules generally apply to headquarter companies and thus the analysis in relation to the management services and advice is unaffected. Interest Special exclusions exist for headquarter companies with respect to financial assistance received and made to connected persons. Specifically, no transfer pricing adjustment can arise with respect to the financial assistance offered by Julius to Afri as the financial assistance received is directly applied to providing financial assistance to the African acquisitions. Similarly, no transfer pricing issue can arise with respect to Afri and the African acquisition companies as Afri will hold at least 10% of the equity shares and voting rights. Other None of the other tax advice presented in this report would be affected by the classification of Afri as a headquarter company. 2 Phillip Letsimo and Rachel Sintu (a) (b) Overall tax payable in respect of fabric dyeing business As Phillip and Rachel will hold equal shares in the fabric dyeing business and have the same quantum of other income, their personal tax liabilities will be the same. Partnership/company taxable income R Turnover 3,000,000 Dyeing equipment (process of manufacture) R300,000 x 40% (new: first year) (120,000) Office furniture (R1 million/3 years) (333,333) Undyed fabric purchases (1,750,000) Add: Closing inventory 230,000 Generator (R200,000/15 years (assuming not classified as part of the process of manufacture)) (13,333) Taxable income 1,013,334 Partnership R Share of partnership income at 50% 506,667 Tax at 40% (as each partner has other income in excess of the maximum of the tables) 202,667 Payable by each partner total income tax payable 405,334 Marking note: Alternatively, the calculation could have been performed by taxing all the taxable income at 40%. Company R Standard company tax at 28% (R1,013,334 x 28%) 283,734 Post tax profits available for distribution Net profits per the accounts 1,166,667 Less: Company tax (above) (283,734) Available for distribution 882,933 Dividends tax on maximum dividend (R882,933 x 15%) 132,440 Total tax payable (R283,734 + R132,440) 416,174 Tutorial note: No further income tax is payable by Phillip or Rachel in respect of the dividends received from the company as the dividends would be exempt for normal tax purposes. As can be seen from the above analysis, based on the first year s expected results, a lower total tax charge arises if the fabric dyeing business is operated as a partnership. This is because, despite the partners being subject to income tax at a rate of 40% on their share of the partnership s taxable profits, the combined effective tax rate for a company structure (including the corporate tax and dividends tax incurred to extract the profits) results in a higher effective tax rate where the profits are fully extracted as a dividend. This analysis ignores any preferential tax regimes which may exist. Value added tax (VAT) From a VAT perspective, the obligations are the same whether the business is operated through a company or a partnership. While a partnership is transparent from an income tax perspective, it may be registered as a person and vendor for VAT purposes. Therefore, notwithstanding that Phillip and Rachel are both already registered as VAT vendors in respect of their current business activities, the partnership will be required to separately register as a VAT vendor as a result of the fabric 19

5 dyeing business given that the taxable turnover is expected to exceed the registration threshold of RM1 million within the next 12 months. Similarly, if the fabric dyeing business was operated as a company, the company would have to register for VAT based on the estimated taxable supplies to be made in the first 12 months. As it is understood that all supplies will be exports and thus zero rated for VAT purposes, the business (whether operated as a company or a partnership) will be in a repayment position as regards VAT. This is because output VAT will be payable at 0% but local input VAT will still be reclaimable by the business (as it is engaged in the making of taxable supplies). It would therefore be advantageous to register at the start of the operations (provided the estimated turnover for the coming 12 months is within the registration requirements). (c) (d) Loan financing company As the company will be a closely held private company, even if Phillip and Rachel s equity contribution is minimal, they will still be able to extract the full value of dividends (as shown in the above calculations). The tax advantage of them introducing the majority of their capital by way of loan finance is that this will give rise to an interest deduction in the company, saving combined corporate and dividends tax at the higher effective tax rate as calculated in (a). The interest income taxable on Phillip and Rachel will be subject to tax at only 40% (after the interest exemption of R23,800), thus resulting in an overall reduction in the total tax payable. Special tax incentives company If the fabric dyeing business were operated through a company, it would not qualify for the micro-business regime as the turnover is higher than the maximum of R1 million for such registration. However, the company may qualify as a small business corporation. This regime offers progressive tax rates and accelerated allowances on capital assets. In order to qualify for this regime, the following conditions must be met: (i) The business must be in the form of a company (including close corporations or co-operatives); (ii) The shareholders of the company must be natural persons; (iii) The gross income of the business must not exceed R20 million (apportioned for periods of less than 12 months); (iv) None of the shareholders can hold an interest in the equity of another company, excluding shares in listed companies or participation interests in collective investment schemes; (v) Not more than 20% of the receipts or accruals of the company may consist of investment income or the rendering of personal services; (vi) The company must not be classified as a personal service provider. As a result of such classification, manufacturing assets acquired qualify for a 100% deduction in the year of acquisition and other assets qualify for deductions in the ratio of 50:30:20 over three years of assessment (unless the wear and tear regime applicable to all companies provides a swifter write off for tax purposes). The impact on the total tax payable in the first year of operation can be calculated as follows: R Turnover 3,000,000 Dyeing equipment (process of manufacture) 100% (300,000) Office furniture (R1 million x 50%) (500,000) Undyed fabric purchases (1,750,000) Add: Closing inventory 230,000 Generator (R200,000 x 50% (assuming not classified as part of the process of manufacture)) (100,000) Taxable income 580,000 Company tax at SBC rates (R59,451 + (28% x (R580,000 R550,000))) 67,851 Post tax profits available for distribution Net profits per the accounts 1,166,667 Less: Company tax (above) (67,851) Available for distribution 1,098,816 Dividends tax on maximum dividend (R1,098,816 x 15%) 164,822 Total tax payable (R67,851 + R164,822) 232,673 Reduction in tax payable (compared with tax under company structure as calculated in (a)) (R416,174 R232,673) 183,501 Tutorial note: A portion of this tax saving is due to accelerated capital allowances under the small business corporation regime. Therefore, depending on the company s future capital expenditure, the tax savings in future years may be smaller. 20

6 3 GenCo Ltd Sales of generators While GenCo Ltd may sell moveable goods to non-resident customers located outside South Africa, not all of the sales can be classified as exports as the requirement for the sale to be an export is that the goods must be delivered to an address outside South Africa. For the goods delivered by GenCo Ltd (i.e. type (a) sales), such sales do meet the definition of an export for VAT purposes. However, the sales where the customer arranges their own transport from GenCo Ltd s warehouse in South Africa (i.e. type (b) sales) cannot be classified as exports for VAT purposes. As a result, GenCo Ltd must charge VAT at the standard rate on these type (b) sales (also known as indirect exports ). The sales made to local customers (whether VAT vendors or not) will all carry VAT at the standard rate. Therefore, GenCo Ltd will charge output VAT to its customers as follows: Zero rated supplies: R13,000,000 x 0% = R0 Standard rate supplies: (R4,000,000 + R23,000,000) x 14% = R3,780,000 Delivery costs The delivery charges paid to a local transport company to deliver the goods to GenCo Ltd s customers outside South Africa would also carry VAT at the zero rate from the transport company. The VAT input claim for GenCo Ltd is therefore R0. However, the delivery charges paid for delivery to addresses within South Africa will carry VAT at the standard rate of 14%. Zero rated supplies received: R250,000 x 0% = R0 VAT claim Standard rate supplies received: R600,000 x 14% = R84,000 Import of generators A VAT output is generated on the import of the generators which is collected by the Department of Customs and Excise. The output VAT is calculated on the customs value plus the customs duty plus a 10% uplift of the customs value which in this case would be: (R27,000,000 + R0 + (10% x R27,000,000)) x 14% = R4,158,000 The output VAT paid on importation may then be claimed as a VAT input by GenCo Ltd in its VAT return. Financial services division As financial services are an exempt supply, when GenCo Ltd begins the financial services division, it will move from being a vendor dealing exclusively in taxable supplies (albeit both zero rated and standard rate supplies) to being a vendor dealing in mixed supplies (i.e. taxable and exempt supplies). An adjustment is only required to a vendor s output tax where there is a decrease of more than 10% in the extent to which capital goods or services are used or applied in the course of making taxable supplies. The adjustment is made on an annual basis. Here, the financial services interest income will amount to 13% of total revenue, facilitating the need for an adjustment. Computers The VAT input on the computers would have been claimed in full at the time of acquisition as, at that time, GenCo Ltd was only engaged in taxable supplies. To take account of the decrease in the extent of taxable use of the computers, an adjustment is determined by the formula: A x (B C) Where: A represents the lesser of: (i) the adjusted cost of the computer system, namely, R342,000 (R300,000 x 114/100); or (ii) the open market value of the computer system, namely, R250,000. B represents the extent of taxable use of the computers at the time of the acquisition or in the prior 12-month period, namely, 100%. C represents the extent of the taxable use of the computer system during the current 12-month period, namely, 87%. GenCo Ltd s calculation will be R250,000 x (100% 87%) = R32,500. In order to calculate the output tax which must be accounted for, GenCo Ltd would then apply the VAT fraction to the amount determined by the formula, being: 14/114 x R32,500 = R3,991 VAT output payable. Rental of premises As the rented premises is now being used partly by the staff of the financial services division, a proportion of the input VAT in relation to this expense will be disallowed, being the proportion incurred for the making of exempt supplies. Only 87% of the input VAT in relation to this expense can be recovered as 13% of the turnover is generated from the making of exempt supplies (the financial service). Therefore, the recovery of input VAT will be restricted to R280,000 x 14% x 87% = R34,104 input VAT recoverable. 21

7 New computers Goods acquired exclusively for the making of exempt supplies will result in the VAT incurred not being claimable. In this instance, the input VAT on the computers acquired exclusively for the financial services division for R100,000 would not be claimable. Similarly the input VAT on the R50,000 of costs incurred to adapt the existing computers to be able to process financial services transactions as well as sales of generators will not be recoverable (as the adaption was necessary to add functionality for the making of exempt supplies). Motor car No input VAT reclaim would have been allowed on the motor car when it was originally purchased in June Therefore, it is not subject to any change in use adjustment when it is transferred for use by the new director of the financial services division. However, the VAT output for the fringe benefit which the car generates will continue and this is calculated as: R450,000 x 0 3% x 14/114 x 12 = R1, Sipho Sicamba (a) (b) Tax liabilities on death Normal income tax liability R Salary 640,000 Employer contributions to provident fund 0 640,000 Capital gains on death: None as the assets are subject to rollover relief as all left to his wife 0 Taxable income excluding retirement benefits 640,000 Tax on R640,000 (R140,074 + (38% x (R640,000 R528,000))) 182,634 Less: Primary rebate (12,726) Normal tax liability excluding retirement fund benefits 169,908 This normal tax liability would have been prepaid in full to the South African Revenue Service (SARS) in the form of employees tax during the year of assessment Tax on retirement lump sums of R3 million (R2 million + R1 million) (R130,500 + (36% x (R3,000,000 R1,050,000))) 832,500 The tax on the lump sums will be deducted by way of a directive before payment of the benefit to Sipho s wife (the beneficiary under his will). Estate tax liability The estate duty liability would be nil as, irrespective of any deductions from the estate, Sipho s current will provides that the entire estate is left to his wife. This is a deduction from the estate for estate duty purposes rendering a dutiable estate of nil before the application of the R3 5 million abatement. Estate and liabilities On Sipho s death, all assets would be accumulated by the executor except for the lump sum from the provident and retirement annuity funds (which are paid directly to Sipho s wife). The total assets in the estate would therefore amount to: At market value R Family home 5,800,000 Motor vehicle 405,000 Rubberduck boat 65,000 Furniture and personal effects 1,000,000 Life insurance policy 7,000,000 Collective investment scheme 500,000 Foreign bank account 250,000 15,020,000 The executor s fees are calculated as 3% of the gross asset value of the estate being R15,020,000 x 3% = R450,600. In addition, various fees and funeral expenses amounting to R300,000 (R200,000 + R100,000) will have to be settled from the amount in the estate as well as the mortgage over the family home of R1 5 million. 22

8 The normal tax liability will not require to be settled from the estate as it would have been settled through payment of employees tax and under the directive as noted in (a), above. Therefore, the total expenses to be settled from the estate amount to R2,250,600 (R450,600 + R300,000 +R1,500,000). As the liquid (cash) assets contained within the estate amount to R7,250,000 (being the life policy and foreign bank account), there is sufficient cash to settle the liabilities arising on death. These liabilities will be paid before the residue of the estate passes to Siphos wife under the terms of his will. (c) Estate Should Sipho die, leaving his wife and minor children, the practical reality dictates that the family home, furniture and personal effects are unlikely to be sold and should be left to his wife for her use. The motor vehicle and rubberduck boat could be sold if needed. The investments, unless required, could remain invested. Leaving the current will unchanged A key advantage of this approach is its simplicity. Although the maximum use may not be made of the R3 5 million abatement for estate duty purposes (based on the current market values of assets owned), Sipho s unused abatement will be passed to his wife and increase the abatement available on her death. In addition, as noted in (a), rollover relief will be available for capital gains tax purposes. Therefore, this option appears to be a tax efficient one based on Sipho s current estate. Creation of an inter vivos trust An inter vivos trust could be created during Sipho s lifetime and certain assets transferred into it. This trust would then continue after death. The advantage of creating an inter vivos trust would be that the value of the estate can be frozen at the point of transfer to the trust thereby potentially reducing the estate duty payable on death if the value of the estate exceeded the R3 5 million abatement. To be effective, the transfer should be by way of a sale on loan account and the loan agreement should make no mention of interest or repayment terms. This would be necessary to prevent a charge to donations tax at 20%. The balance of the loan account would then become an estate asset so what would be transferred out of the charge to estate duty on Sipho s death would be any capital growth. The loan account could also be left to Sipho s wife on death (negating any estate duty) or, if under R3 5 million, the abatement could be utilised and the loan account left to the trust. Irrespective of whether the transfer was carried out by way of a donation or a sale on loan account, capital gains tax would arise on the capital growth of the assets up to the date of transfer. There would be no capital gains tax on these assets on Sipho s death. The attraction of the freezing of the estate value becomes more significant if it is anticipated that Sipho may have a long remaining life span and that the assets he currently owns may appreciate in value over time. The assets most likely to appreciate in value are the family home and the investment in the collective investment scheme. The foreign bank account would not be a significant growth asset and the retirement benefits are only accessible on retirement or death. Placing the family home in the trust assumes a level of permanence, that is, that the property should continue beyond the life of the current owner, but does come with complications as, if the property were sold when it was held in the trust, the primary residence exclusion of R2 million would not be available. The collective investment scheme is likely not of sufficient value to warrant the creation of a trust for its sake alone. Therefore, for practical reasons, the immediate creation of an inter vivos trust is unlikely to be appropriate. Creation of a testamentary trust Unlike an inter vivos trust, a testamentary trust is only created on death. When creating a testamentary trust, it is important to be mindful of the needs of the surviving beneficiaries. It is suggested that R3,500,000 of the cash benefits received could be used to create a testamentary trust which would list Sipho s wife and children as beneficiaries. The trustees would have a mandate to ensure the maintenance of Sipho s wife and children. From a tax perspective, the creation of a testamentary trust does not change the charge to estate duty as the transfer from the estate to the trust would only be made after Sipho s death. Therefore, it does not achieve the advantage of removing capital growth from the estate for estate duty purposes. Furthermore, by leaving the assets to a trust, the deduction from estate duty which could be achieved by leaving the assets to his spouse is lost and may now result in an estate duty charge. Capital gains tax would arise on disposal to the testamentary trust on death. If the cash benefits alone were used to create the trust, no capital gains tax would arise as currency is excluded from the definition of asset for capital gains tax purposes. Therefore, unless there was a clear (non-tax) need for a trust, a testamentary trust would not be advantageous. Tutorial note: Any other valid arguments raised would attract marks. 23

9 5 Anton du Toit (a) Anton du Toit and ABC (Pty) Ltd (i) Brought forward assessed loss Normally, an assessed loss brought forward by a company carrying on a trade may be set off against future income derived from that trade. In this situation, there is a real risk that anti-avoidance rules will preclude the offset of the R2 million assessed loss against the R7 million profits anticipated for the year of assessment Under these rules, any change in the shareholding of a company which introduces income into that company with the sole or main purpose of utilising the assessed loss will result in the disallowance of the set-off of the assessed loss against the introduced income (and trade). In this case, Anton appears to be acquiring ABC (Pty) Ltd with the express purpose of trading in MoonBright products and not in StarBright products. Therefore, the intention behind his acquiring ABC (Pty) Ltd appears to be to obtain the use of ABC (Pty) Ltd s assessed loss. Here, it is likely that the Commissioners would hold that ABC (Pty) Ltd s old trade (the StarBright trade) has ceased and a new trade (the MoonBright trade) has commenced, as a direct or indirect result of Anton s acquisition of the shares. This would result in the assessed loss of R2 million being lost on the cessation of the old StarBright trade. (ii) Residence of ABC (Pty) Ltd and Anton ABC (Pty) Ltd As no double tax treaties are applicable, the residence of the company would remain in South Africa by virtue of incorporation, irrespective of the company s place of effective management. Anton Anton will become resident in South Africa under the physical presence test if, during any year of assessment, he spends 91 days in total in South Africa and has spent at least 91 days in total during each of the five years of assessment preceding the year of assessment as well as having spent 915 days in total during those five preceding years of assessment. Therefore, Anton will have to monitor the time he spends in South Africa. Should he, over a period of six years, spend 915 days or more in South Africa, he may be deemed to be a resident for income tax purposes. Consequences of Anton becoming resident Should Anton become resident, he will be subject to South African tax on his worldwide income and gains (including any interest income receivable on the loan receivable accounts with ABC (Pty) Ltd). He will also be deemed to have acquired all of his assets at their market value on the day before he becomes resident for the purpose of determining their base cost for capital gains tax on a future disposal. Once resident, Anton runs a risk that his shareholdings in XYZ Co and any other overseas companies may be deemed to be controlled foreign companies. Should Anton later cease to be resident, a deemed disposal of his worldwide assets would occur for South African capital gains tax purposes. (iii) Acquisition of equity and loan receivable accounts Loan receivable accounts Any interest received by Anton will be fully exempt from tax in South Africa provided he remains non-resident (refer to (ii), above). This is because Anton will not have spent more than 183 days in South Africa nor will he be conducting business through a permanent establishment in South Africa. Tutorial note: From 1 March 2015, a 15% withholding tax will be applied to interest paid from a South African source to a non-resident. Whilst knowledge of this new law is not required in the 2015 exams, candidates mentioning this new rule will be awarded equal credit. The introduction of this withholding tax will negate the income tax advantage of interest income over dividend income for Anton. Equity shares Dividends received by non-residents from South African resident companies are currently subject to withholding tax of 15%. As no double tax treaties are relevant in this situation, the 15% rate cannot be adjusted through the application of a double tax treaty. Advice It would not be tax efficient for Anton to increase his equity holding in ABP (Pty) Ltd due to the preferential tax treatment awarded to the interest income. Another advantage of retaining a high balance on the loan receivable accounts is that the interest charged will be available as a deduction in calculating ABC (Pty) Ltd s taxable profits, whilst dividends are not a tax deductible expense. 24

10 (b) VentureSA Ltd (i) A special provision in the income tax legislation permits an investor in a qualifying venture capital company to obtain an immediate income tax deduction equivalent to 100% of the expenditure incurred in subscribing for new shares in a venture capital company. Therefore, Anton should obtain a tax deduction of R5 million if he subscribes for the shares in VentureSA Ltd in cash. However, special rules apply when the investor borrows funds in order to subscribe for shares in a venture capital company. In this case, the expenditure which qualifies for an immediate tax deduction is limited to the portion of the subscription price which is considered to be at risk. The definition of at risk looks at whether the subscription would result in an economic loss to the taxpayer were no income to be received by the taxpayer in the future from the disposal of the venture capital company shares. Under the rules, amounts are not considered to be at risk to the extent that the loan is not repayable within five years from the date the loan is taken out. Therefore, provided Anton has the necessary funds to do so, it would be preferable for him to subscribe for the shares in cash to avoid a restriction on the allowable income tax deduction. (ii) The four conditions which must be met before the Commissioner of SARS will approve a company as a venture capital company are as follows: (a) The company must be resident in South Africa. (b) The sole object of the company must be the management of investments in qualifying companies. (c) The tax affairs of the company must be in order and the company must have complied with all the relevant provisions of the laws administered by the Commissioner. (d) The company must be licensed under the terms of the Financial Advisory and Intermediary Services Act (FAIS) legislation. 25

11 Professional Level Options Module, Paper P6 (ZAF) Advanced Taxation (South Africa) 1 Julius Hamilton and Afri December 2015 Marking Scheme Marks (a) Specific questions (i) Residence of Afri In the absence of tax treaties, incorporation is sufficient 1 In any event, place of effective management appears to be SA 1 2 (ii) Controlled foreign company (CFC) rules Requirement to be a CFC basic rule 1 Inapplicability of variations to the rule 1 CFCs exist with respect to holdings meeting basic rule 1 Impact of classification and consideration of foreign business establishment 1 Net income likely to be nil 1 5 (iii) Transfer pricing interest Need for connected persons and consideration as to parties in this instance 3 Risk of adjustment for interest charged to African acquisitions 2 Risk of adjustment for borrowings from Julius 1 Identifying need for further information 1 Impact of a transfer pricing adjustment arising 2 Transfer pricing management services and advice No adjustment likely from SA if excessive fees charged to African acquisitions 1 Deflated prices may cause adjustment 1 Nature of adjustment as a deemed loan 1 Available 12 Maximum 11 (iv) Exchange differences Exchange risk based on denominating the loans in the African acquisition local currency tax treatment 1 (v) Foreign tax credits Unilateral relief only applies to non-sa source income included in taxable income 1 Relief for withholding tax on interest possible 1 No relief for withholding tax on management fees and advice 1 Second relief exists for management fees and advice (despite SA source) 1 4 (vi) Value added tax Management services and advice may be exported service therefore subject to zero rate or alternatively, the standard rate 1 (b) Headquarter company (i) Qualifying requirements for election to be a headquarter company 3 (ii) Impact on CFC rules 1 No impact on transfer pricing on management service fees 1 Impact on transfer pricing on interest 2 No impact on any of the remaining advice given Available 4 Maximum 4 Professional marks Format and presentation of the report 1 Effectiveness of communication 3 Total 35 27

12 2 Phillip Letsimo and Rachel Sintu Marks (a) (b) (c) (d) New business activity legal structure Calculation of taxable income for the partnership and standard company 4 Total tax on partnership profits 1 Company tax 1 Profits available for distribution and dividends tax 2 Conclusion higher effective tax rate on the profits for a company (company tax and dividends tax) 2 10 Value added tax (VAT) VAT obligations and implications are the same whichever legal structure chosen Partnership is required to register as a VAT vendor distinct from Phillip/Rachel 1 Company would also be required to register Consideration of registration threshold 1 VAT registration advantageous for zero rated trades 1 Available 4 Maximum 3 Loan financing company Closely held private company so equity contribution can be minimal 1 Interest deduction saving tax (company and dividends) at higher marginal rate 1 Interest income taxable on individuals at 40% after interest exemption 1 3 Special tax incentives company Small business corporation (SBC) regime identified as relevant relief 1 Conditions for SBC registration mark per condition 3 Effect of small business corporation status on rates and capital allowances 1 Calculation of tax saving if opt for SBC regime 5 Available 10 Maximum 9 Total 25 28

13 3 GenCo Ltd Marks Sales of generators Identifying the requirements to be an export 1 Type (a) sales export 1 Type (b) sales not an export 1 Sales to local customers (whether vendors or not) standard rated 1 Overall impact for VAT (calculations) 1 5 Delivery costs Delivery charges on exports will be zero rated 1 Local deliveries will be charged at the standard rate 1 Calculations 1 3 Import of generators Calculation of output VAT payable on import 2 VAT input claim of same output VAT paid 1 3 Financial services division Financial services are an exempt supply Company now operating in mixed supplies Change in use adjustment required for 10% change Adjustment made on annual basis Change in use calculation for the existing computers 2 Calculation of recoverable input VAT on rental 1 No input VAT recoverable on computers acquired for making exempt supplies 1 Conversion costs and exempt supply link nil recovery 1 Motor car no change in use as input denied Motor car fringe benefit output VAT and calculation 1 9 Total 20 29

14 4 Sipho Sicamba Marks (a) (b) (c) Calculation of normal tax liability and estate duty liability Calculation of employees tax 1 Explanation of why there is no capital gains tax liability on death 1 Payment of employees tax Calculation of tax on retirement lump sums 2 Payment of tax on retirement lump sums by directive Explanation of why estate duty is nil 1 6 Estate and liabilities Executors gathering of assets and remuneration, exclusion of provident fund and retirement annuity 1 Determination of liabilities to be settled in the estate 2 Conclusion on liquidity 1 4 Estate tax planning Current will left unchanged No CGT liability or estate duty, as previously concluded Abatement not fully used Impact for wife of lack of abatement use 1 Conclusion Creation of an inter vivos trust Explanation of inter vivos trust Estate duty advantage value frozen 1 Sale via loan account to prevent charge to donations tax 1 Consideration of appreciating assets in Sipho s estate 1 CGT considerations on transfer 1 CGT implications of holding family home in trust 1 Conclusion Creation of a testamentary trust Explanation of testamentary trust Need to consider beneficiaries access to cash 1 No impact on estate duty position but benefit of leaving assets to a spouse lost 1 CGT considerations on transfer 1 Conclusion Available 13 Maximum 10 Total 20 30

15 Marks 5 (a) Anton du Toit and ABC (Pty) Ltd (i) Use of assessed loss General rule assessed loss may be used against future trading profits Identification of anti-avoidance rules issue Overview of the rules for the anti-avoidance provision to be effected 2 Application to scenario facts 1 Conclusion likely the use of the assessed loss is lost 1 5 (ii) Residence Residence of ABC (Pty) Ltd 1 Anton Physical presence test and application to Anton 2 Effect of becoming a resident 2 Effect on ceasing to be a resident 1 Available 6 Maximum 5 (iii) Acquisition of equity and loan accounts Tax treatment of interest income for non-resident 2 Tax treatment of dividend income 15% WHT (no DTA) 1 No double tax agreement available to reduce rate Conclusion not tax advantageous to increase equity holding Additional tax benefit interest expense tax deductible in ABC (Pty) Ltd 1 5 (b) VentureSA Ltd (i) Income tax relief for Anton Immediate tax deduction for 100% of the acquisition price possible 1 Borrowings may limit deduction to at risk amount 2 Conclusion which method of finance preferable 1 Available 3 Maximum 2 (ii) Qualifying venture capital company criteria mark per condition 2 Total 20 31