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) June 2018 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 Mrs Palmer Finn Paper and Plywood (FPP) Letter Mrs Palmer Address South Africa Post code 7 June 2018 Dear Mrs Palmer Taxation queries received With reference to the correspondence received, I have addressed your queries with respect to the various transactions of FPP during the year ended 28 February 2018, as well as those relating to the proposed sale of FPP. For ease of reference, my answers are stratified into sub-headings. (a) Tax implications of transactions during the year ended 28 February 2018 (i) Shipment destroyed due to ship running aground The destroyed shipment clearly represents a real loss, however, it is important to assess whether such loss is deductible for direct tax purposes and, as the goods did not arrive at a port of entry in South Africa, whether or not any indirect tax consequences arise. As the goods were not cleared through a port of entry in South Africa, no input value added tax (VAT) may be claimed on the import. Similarly, no output VAT or customs duties are leviable. The time of supply rules for VAT indicate that VAT is only leviable on clearance of the goods from customs. However, the goods were shipped with all risks and rewards passing to FPP as the purchaser. There is therefore no claim for the loss of the goods from the supplier. For income tax purposes, the goods acquired became deductible for FPP on the goods being shipped from Finland. The cost of the goods as charged by the supplier (R804,000 = 360,000 x 13 40) is therefore deductible. This is because it is considered a reasonable risk to the business that goods may be damaged or destroyed during the shipping process. (ii) Delivery of goods to customers The VAT treatment for the deliveries by Transient Ltd on behalf of FPP may be incorrect. While it is certainly correct that Transient Ltd charges VAT at the standard rate for deliveries within South Africa, the delivery to addresses outside South Africa relate to the supply of exported goods. It is for such deliveries that the VAT treatment may differ as outlined below. As the FPP goods are exports (which are zero rated), the related transport of those goods is, subject to certain conditions, also zero rated. While FPP is effectively tax neutral with respect to VAT being charged or not (as a claim for the VAT paid may be made), from a timing and cash flow perspective, the payment of the VAT on the delivery of the exports is detrimental to the business. It is therefore important to understand what those conditions are for zero rating and, if applicable, to inform Transient Ltd that the VAT should be at the zero rate. Charging VAT at the zero rate is certainly beneficial to Transient Ltd, as the company may still claim all inputs. Notifying Transient Ltd of this advantage will certainly strengthen the business relationship. The delivery charges levied by Transient Ltd for the delivery of the goods from FPP to customers outside South Africa are currently being invoiced at the standard rate of VAT. These charges could, however, carry VAT at the zero rate, conditional upon the following evidence of export being provided: A copy of FPP s zero rated tax invoice to its customer; The customer s order or the contract between FPP and the customer; The transport documentation as required for the relevant mode of transport; Export documentation as prescribed under the Customs and Excise Act (for example, the South African Revenue Service (SARS) customs declaration); Proof of payment in respect of the supply of the movable goods; Proof of payment of the transport costs by FPP to Transient Ltd; and Where the goods are transported by road or rail, proof that the goods were received by the customer in the export country. 13

3 Provided these evidence requirements are met, transportation services offered by Transient Ltd to FPP for international deliveries should be zero rated for VAT purposes. (iii) Export of goods to various African countries The export of goods is zero rated for VAT purposes, provided a number of conditions are met: the movable goods must be exported via a designated commercial port; and the movable goods must be exported from the Republic of South Africa within 90 days from the earlier of the date an invoice is issued by FPP or the time any payment of consideration is received by FPP. The turnover of R500,000 will be gross income for income tax purposes. (iv) Export of goods to South Sudan government institution The export of goods to South Sudan will be zero rated for VAT purposes as long as the conditions stated in (iii) above are met. Similarly, the amount invoiced will be gross income for income tax purposes. However, in this case, tax amounting to R40,000 (20,000 South Sudanese Pounds (SSP) x 2) has been withheld in South Sudan. This withholding tax will qualify for unilateral relief in South Africa against the South African tax levied on this foreign income. As the rate of 20% is likely to be lower than the rate applicable to FPP, full relief from withholding tax is likely. (b) Tax implications of the proposed sale of FPP and minimisation of tax liabilities The two main taxes to consider in the context of this sale are VAT and income tax. (i) VAT You are planning to dispose of your entire enterprise, FPP. As you plan to sell FPP to a registered VAT vendor and all the assets necessary to continue the enterprise are subject to the sale, this transaction would be the disposal of a going concern. The disposal of a going concern may be zero rated for VAT purposes. The advantage of such zero rating in this instance is not only with respect to the minimisation of taxes, but it provides a significant benefit to you allowing you to achieve a higher sales price than would otherwise be the case. While the purchaser does not have, in this case, the added advantage of not needing the cash to fund the VAT on the purchase, prior to reclaiming the VAT as input tax on the next VAT return (as the purchase price agreed is inclusive of any relevant sales tax), the purchaser does benefit from a higher base cost on the acquisition. The zero rating would be subject to meeting the following conditions: the supplier and the recipient must both be registered vendors; the supplier and the recipient must agree in writing that such enterprise is supplied as a going concern; the sale agreement must provide that the enterprise will be an income-earning activity on the date of transfer from the supplier thereof to the recipient; the assets which are necessary for carrying on such enterprise must be disposed of by the supplier to the recipient; and the supplier and the recipient must agree in writing that the consideration for the supply of the enterprise is inclusive of tax at the zero rate. From a documentary evidence perspective, the following information must be retained: seller s copy of the zero rated tax invoice; contract of sale between the purchaser and the seller confirming the disposal as a going concern and any other agreements applicable; and purchaser s notice of registration (VAT103). (ii) Income tax On the sale of your business, the trading stock will be stock to the new owner. This will result in gross income of R2,000,000 against which opening stock and acquisition costs of stock (currently R1,200,000) would be deducted. This will result in a taxable amount of R800,000, before capital gains tax. Furthermore, recoupments arise in the context of the depreciable assets. Your accountant has supplied the figures. The recoupments add a further R550,000 (R500,000 + R50,000) to taxable income. However, in the case of the computers, which sold for less than the tax value of R40,000 (R60,000 cost less R20,000 capital allowances), a scrapping allowance of R10,000 (R40,000 tax value less the sales price of R30,000) arises. This reduces the taxable income. The above recoupments and scrapping allowance, further, have the effect of proceeds matching base cost for capital gains tax purposes for the computers and furniture, leaving only the warehouse and contract generating a capital gains tax liability (see appendix below). As you are also operating a business where the market value of the total assets is less than R10 million, and you are over 55 years of age, you may make use of a partial exemption on the disposal of these business assets for capital gains tax purposes. All of your business assets are classified as active business assets, being both immovable and moveable property used exclusively for business purposes and not being financial instruments or assets generating passive income. 14

4 You will therefore qualify for the lifetime limit of R1,800,000 exclusion for the disposal of small business assets. Assuming you have not previously used this limit, the full R1,800,000 is available to you. On the sale of your business, you will have total capital gains of R5,270,000. See Appendix 2 for detailed workings. Assuming you pay tax at the marginal rate of 45%, your income tax liability arising on the sale of FPP will be R1,220,400. Please refer to Appendix 1 for detailed workings. No transfer duty is applicable to the sale of the warehouse as VAT was applied. The above documents the key tax implications of the information as supplied. Should there be any further queries, I will be happy to assist. Yours faithfully ACCA Student Appendix 1 Tax calculations R Stock sold (R2,000,000 R1,200,000) 800,000 Recoupment on furniture 50,000 Recoupment on warehouse 500,000 Less scrapping allowance (10,000) Taxable income before CGT 1,340,000 Add capital gains (see Appendix 2 below) 1,372,000 Taxable income 2,712,000 Tax at 45% 1,220,400 Appendix 2 Capital gains tax calculations R R Warehouse Proceeds 5,000,000 Less recoupment (500,000) 4,500,000 Less base cost: Cost 2,400,000 Less allowances (500,000) (1,900,000) Capital gains 2,600,000 Contract Proceeds 2,000,000 Less base cost 0 Capital gain 2,000,000 Sub-total 4,600,000 Goodwill Proceeds (R9,900,000 R5,000,000 R30,000 R200,000 R2,000,000 R2,000,000) 670,000 Less base cost: 0 670,000 Total capital gains 5,270,000 Less small business asset exclusion (1,800,000) Sub-total 3,470,000 Less annual exclusion (40,000) Aggregate capital gain 3,430,000 Inclusion in taxable income (40%) 1,372,000 15

5 2 Mr Zulu (a) Tax implications of the share transactions and interest-free loans for the 2018 year of assessment Share transactions The share options and shares in Prince Ltd were obtained through the company share scheme by virtue of Mr Zulu s employment. Any gain realised when the equity instrument vests must be included in income. Similarly, any loss incurred when the equity instrument vests must be deducted from income. The options, when granted, are restricted equity instruments as the options are subject to a condition preventing their immediate vesting and therefore disposal at market value. Even when the options are exercised and the shares acquired, no gain or loss will be determined as the shares acquired are equally restricted equity instruments by virtue of the restriction imposed on the disposal of the shares. As a result, no vesting takes place on acquisition of the shares. In the 2018 year of assessment, in April 2017, the shares acquired in April 2016 (through the exercise of the options granted in April 2015) vest. The gain to be included in Mr Zulu s income for the 2018 year of assessment in respect of these options vesting in April 2017 is R6,500,000 [100,000 shares x (R75 per share (market value in April 2017) R10 (price paid per share noting no price paid for the option))]. Mr Zulu then sold these shares on 31 May The sale after vesting is subject to capital gains tax, assuming a capital intention with respect to the shares. The capital gain arising from the sale is R500,000 [100,000 shares x (R80 (sale price) R75 (base cost the vesting above steps the base cost up to the market value as at the vesting date))]. This capital gain will be aggregated with Mr Zulu s other capital gains and losses for the 2018 year of assessment. Mr Zulu also sold 200,000 shares acquired on 30 April 2017 (through the exercise of the options granted in April 2016) back to the company share trust on 31 July On resale back to the company share trust, the shares are considered to vest. Mr Zulu had to sell the shares back at R7 per share having paid R10 per share. As a result, Mr Zulu incurs a deductible loss of R600,000 [200,000 shares x (R7 (market price) R10 (price paid))]. Interest-free loans Mr Zulu also took out interest-free loans from Prince Ltd with respect to each acquisition of shares. Since the loans do not bear interest, a fringe benefit in respect of each loan is generated as follows: Loan in respect of options exercised in April 2016 (Loan 1): This loan would have been repaid in May 2017, when Mr Zulu sold the shares. The fringe benefit for the 2018 year of assessment is therefore R20,164 [100,000 shares x R10 per share x 8% (official rate of interest) x 92 days/365 days]. Loan in respect of options exercised in April 2017 (Loan 2): For the 2018 year of assessment, this loan would have been repaid when the shares were sold back to the share trust on 31 July The fringe benefit is therefore R67,068 [200,000 x R10 x 8% x 153/365]. (b) The nature of the lump sum and the process to be followed to object to the assessment by the South African Revenue Service (SARS) Mr Zulu is correct in his belief that the lump sum is a severance benefit as: (i) It is received from his employer on termination of his employment, and (ii) Mr Zulu is over the age of 55. Prince Ltd should have applied for a directive for employees tax on the basis that the lump sum is a severance benefit. As this was not done, it is likely that the employees tax withheld is in excess of the actual normal tax liability. As a severance benefit, the lump sum received is subject to the same tax rates as applicable to a retirement lump sum from a retirement fund. The R1,000,000 lump sum should therefore only be subject to tax as follows: (R1,000,000 R700,000) x 27% + R36,000 = R117,000. This is substantially less than the R450,000 tax which would have been withheld from the lump sum (being R1,000,000 x 45% maximum marginal rate). Mr Zulu should first request reasons for the assessment within 30 days of the assessment before objecting to the assessment. (c) Tax implications of the disposal of the stables and acquisition of the Hermanus property The disposal of the stables is a part disposal of immovable property. Mr Zulu has sold 10% of the family estate. However, the improvements made to the property to convert it into a luxury bed and breakfast do not apply to the stables. The part disposal requires a portion of the base cost to be allocated to the portion disposed of. No portion of the improvements made are allocated to this part disposal as they may be specifically allocated to the part retained. 16

6 The capital gain will be determined as follows: R Proceeds 3,000,000 Base cost (R12,000,000 (inheritance value) x 10/100 (portion of property)) (1,200,000) Legal fees (50,000) Capital gain 1,750,000 This capital gain would be aggregated with Mr Zulu s other capital gains and losses for the 2018 year of assessment. The Hermanus property acquired would have been subject to transfer duty. The transfer duty paid would have been R328,000 [(R4,500,000 R2,250,000) x 11% + R80,500]. The transfer duty could have been reduced if a separate contract had been drawn up for the acquisition of the furniture in the property of R600,000. Should this have been done, the transfer duty would have been R66,000 less (R600,000 x 11%). 3 Adam Balewa (a) Final distributions to be made to Joseph and Innocence The estate duty liability must first be determined before the final distribution can be determined. Estate duty liability R Primary residence (realisation value) 6,300,000 Investments (realisation value) 4,200,000 Motor car (realisation value) 70,000 Furniture, etc (realisation value) 850,000 Life insurance (cash) 7,000,000 Pension cash (before tax) 6,000,000 24,420,000 Less tax liabilities (R814,736 + R1,912,500) (2,727,236) Less executor s fees (1,200) Selling costs (R30,000 + R170,000) (200,000) 21,491,564 Less abatement (R3,500,000 for Adam + R2,000,000 unused from predeceased spouse) (5,500,000) Dutiable estate 15,991,564 Estate duty at 20% R3,198,313 As all the assets were sold and realised for cash, the final distribution to each child is: (R21,491,564 R3,198,313)/2 9,146,626 (b) Tax implications with respect to the award by the directors of Miller Ltd to Joseph and Innocence (i) Adam The amount awarded by the directors to Adam s children cannot form part of the final tax return for a number of reasons. First, the amount does not accrue to Adam as it was awarded (and decided) after the date of death. Second, as the decision was taken after the date of death, and despite being in recognition of long service, it is not in respect of those services. (ii) The deceased estate The deceased estate is tasked with receiving amounts which would have been received or accrued by the deceased had he remained alive. This lump sum was only decided after death. Had Adam lived, no award would have been made to his children. The amount cannot accrue to the deceased estate as gross income. (iii) Joseph and Innocence Joseph and Innocence will each receive their respective amounts as a capital cash payment (which is not an asset for capital gains tax purposes). The amount does not constitute gross income for them either as it is fortuitous. Joseph and Innocence are also not receiving this amount in respect of services rendered. (iv) Miller Ltd It is doubtful that the lump sums paid to Adam s children will qualify for deduction for the company. The amount, while incurred, is certainly not incurred in the production of (future) income. Whether the amount is of a capital nature or not is irrelevant in this context. As a cash payment, it is not an asset for capital gains tax purposes. 17

7 (c) Effective estate planning An estate plan is not generic, but individual to the objectives of the party making such a plan. These objectives could include providing for the family after death, donating to key charities, ensuring liquidity in the estate, minimising estate duty and any combination of these or other objectives. An estate plan is therefore considered effective when it can both minimise tax liabilities on death and achieve the aims of the deceased. The estate plan must also be flexible in that objectives may change over time, e.g. the estate plan of a single person is different to that of a married couple or a person with children. From the determinations in (a) above, the gross estate amounted to R24,420,000 and the estate had cash expenses of R2,928,436 (being the tax liabilities, estate costs and selling costs). The large value items in the estate were the primary residence, life insurance policy, pension and investments. It can therefore be determined whether Adam (and/or his spouse) could have provided for an estate plan to meet the final objectives of providing wealth to their children after death in a more tax efficient manner. Adam (and his wife) could have transferred the primary residence to an inter vivos trust at the point at which the combined gain on the property was to exceed R2 million. In this way, they could have maximised the capital gains tax exclusion for the primary residence while preventing further growth in value in their respective estates. If this had not been done, Adam s wife could have provided that her share of the primary residence passed to a testamentary trust on death. This would have facilitated the capital gains tax exclusion being increased to R2 million for Adam (as the only natural person owner) after her death. However, as the primary residence interest would have passed to a trust, there may have been estate duty. Adam s wife s share of the property value at death was R2,500,000 (R5,000,000/2). As her unused estate duty abatement was R2,000,000, the estate duty impact of such a change would have been R100,000 (R500,000 x 20%). If this had been done, Adam would only have included R3,250,000 in his estate, thereby reducing his estate duty liability by R650,000 (R3,250,000 x 20%). At any point the property was worth less than R6,500,000, the transfer duty on transfer to the trust would have been less than the estate duty incurred [{(R650,000 Adam s potential saving R100,000 Adam s wife s potential estate duty liability) R80,500}/11% + R2,250,000]. Little could be planned in respect of the pension. The only reduction for the life insurance policies would be the premiums and interest at 6% on those premiums if they had been paid by a third party. The growth in the investments may have been mitigated by their ongoing sale to a trust when acquired, but R3,000,000 (the cost of the investments) would have remained an asset in Adam s hands. This would still have provided an estate duty saving of R300,000 ((R4,500,000 R3,000,000) x 20%). All the above could still have effectively provided for Adam s children while reducing the tax burden at death. 4 Patience Mbonane (a) Retaining control over Calm (Pty) Ltd As any transfer of the Calm (Pty) Ltd shares to the trust will trigger capital gains tax, Patience should consider converting sufficient ordinary shares in the company into non-participating preference shares which would not be transferred to the trust, to secure a majority voting interest. As the rights attaching to the shares would have been substantively changed, a disposal for capital gains tax would be deemed to take place. The trust could then subscribe for the remaining ordinary shares in the company. The preference shares could guarantee a dividend income stream for Patience, while providing voting rights sufficient for her to exercise control of the company (i.e. if the voting rights attributed to the preference shares (and the number of those shares) exceed those of the ordinary shares). As the preference shares would not participate in the capital, growth in the value of the shares would be limited relative to the ordinary shares. (b) Creation of beneficiary rights As Patience would like to retain the dividend income from Calm (Pty) Ltd, she could be created as a vested beneficiary as regards the dividend income on the shares. This facilitates ownership of the company remaining with the trust (and the associated capital growth on the shares) whilst providing the dividend income to Patience. It is submitted that the remaining rights should be discretionary as regards both income and capital. Such classification will prevent the growth of the beneficiary estates. (c) Transfer of the assets to the trust (i) By donation Donation of the assets to the trust will result in an immediate donations tax of 20% of the market value of the assets donated. While a R100,000 exemption is available, the impact of this exemption would be minimal given the current asset values. This would have immediate cash flow implications. Future income in the trust would be attributed to Patience (unless distributed to a major resident beneficiary) until her death. In addition, the donation would also trigger capital gains tax on the disposal of the assets. While the donations tax would add, in part, to the base cost, there would be a negative impact on liquidity. 18

8 (ii) By sale on loan account Sale on loan account without reference to interest would not trigger donations tax (being a sale and not a donation). As with a donation of the assets, capital gains tax would arise on the sale of the assets. However, for as long as the loan remains unpaid, an amount equal to the amount of interest which would have been incurred by that trust at the official rate of interest must be treated as a donation made to that trust by Patience on the last day of that year of assessment of that trust. Unless the trust vests both income and assets in Patience (which negates the use of the trust for estate planning purposes), this deemed donation must take place. As an alternative, Patience could sell the assets on loan account, with the account bearing interest at a market related rate. However, such a sale, while capping capital growth, still results in the growth of her estate by virtue of the interest accruals. Furthermore, assuming the beneficiary rights are created as suggested in (b) above, the only income stream for the trust would be the rental income of R20,000 (R30,000 R10,000) monthly, which may be insufficient to cover the interest on the loan. The transfers of the immovable property will also result in transfer duty of R383,000 for the rental property ((R5,000,000 R2,250,000) x 11% + R80,500) and R245,500 for the 50% of the primary residence ((R7,500,000/2 R2,250,000) x 11% +R80,500). Tutorial note: The sale of the shares on loan account would also trigger securities transfer tax but this is outside the scope of the syllabus. (d) Subsequent tax consequences and mechanisms to reduce the tax burden Apart from the possible anti-avoidance provision with respect to the sale of the assets on loan account not bearing interest (as discussed in (c) above), once the assets are successfully transferred, the following tax implications should be considered: Except for the dividend income vesting in Patience, any other income remaining in the trust will be attributable to her as the creator of the trust. This income attribution may be mitigated if the income vests in the other beneficiaries (other than the non-resident beneficiary) as all are majors. Any income vested in the non-resident beneficiary will be attributed back to Patience as the creator. Similar to the income provisions, assets or capital gains would be attributed back to Patience unless vested in the other beneficiaries (other than the non-resident beneficiary). The income and capital gain attributions to Patience may be further mitigated if the loan to the trust is repaid to Patience. This is, however, doubtful as the only other income stream is rental income on only one property. Apart from the last bullet point, the donation of the assets would result in similar subsequent tax implications. A further tax implication for Patience is that only 50% of the primary residence was transferred to the trust. As the only natural person owner and assuming that to the date of sale the property is used by Patience as a primary residence, the full R2 million exclusion for the primary residence remains available to her. On death, the remaining balance of the loan will be included for estate duty purposes. The loan may possibly be waived on death with no capital gain for the trust or capital loss for Patience. (e) Non-disclosed offshore investment and income Patience should be immediately advised to utilise the permanent voluntary disclosure programme to disclose her offshore investment income. Her non-disclosure of this income would amount to tax evasion, which could result in criminal proceedings and penalties. Provided the information disclosed is not yet subject to an audit by the South African Revenue Service (SARS), the default does not pertain to a period older than five years before the disclosure and full and complete disclosure is now made, the voluntary disclosure programme may be pursued. The reliefs offered under this scheme include: (i) No criminal prosecution for any tax offence arising from this default; (ii) Relief from under-estimate penalties; (iii) Relief from administrative non-compliance penalties. Patience must also pay the tax owing (plus interest) to SARS. Tutorial note: If Patience refuses to disclose her offshore investment income to SARS, then the professional adviser must cease to act for her and inform the firm s money laundering reporting officer. 5 Mr Rich (a) Tax implications of proposed emigration and remote management of Prop (Pty) Ltd (PPL) and Manu (Pty) Ltd (MPL) The immediate tax implication for Mr Rich on emigration to Mauritius is that of an exit tax to be levied on his shareholdings in PPL and MPL. His year of assessment would be deemed to end on the day before he ceases to be resident with the disposals taking place on that day. A new year of assessment, as a non-resident, would begin the next day. Despite PPL containing mainly immovable property, the shares are not excluded from this deemed disposal on emigration. It is equally unlikely that the 19

9 shareholdings represent a permanent establishment in South Africa and therefore there appears to be no relief from this exit tax. After emigration, the shares in MPL would no longer fall within the scope of South African capital gains tax. However, in terms of the domestic South African income tax law, the shares in PPL would remain subject to capital gains tax on any future disposal as the company s value is mainly derived from immovable property in South Africa. For PPL and MPL, the remote management of the companies from Mauritius by Mr Rich as sole shareholder may trigger a change in the place of effective management from South Africa to Mauritius. Should this be confirmed by the competent authorities, the change of residence of the companies will result in exit taxes being applicable at that level. This may be mitigated should the management of the companies remain in South Africa (see (b)(ii) below). The change of residence for these companies will have a number of tax implications. First, PPL and MPL will be deemed to have disposed of all their assets to a resident at their market value. For PPL, however, there is some relief in that the bulk of the assets comprise immoveable property in South Africa, which is excluded from the deemed disposal for exit tax purposes. Second, both companies are deemed to, the day before ceasing to be resident, declare a dividend in specie (i.e. placing the withholding tax liability on the company rather than the shareholder) of the difference between the market value of all assets held in that company less the contributed tax capital (in proportion to a shareholder s holding). This results in a 20% tax on the capital appreciation of the assets in the company (apart from the capital gains tax Mr Rich would have already incurred in his personal capacity on the market value of the shares). One possible reduction in the exit taxes on the MPL assets and any PPL assets not being immoveable property would be the extent to which the assets can be said to be part of a permanent establishment of the companies in South Africa. As the operations remain in South Africa, it is likely that these operations will constitute permanent establishments of the (now) non-resident companies, rendering the profits taxable in South Africa. It seems that such classification would also adjust the determination of the deemed dividend in specie. (b) (i) Minimisation of taxes on transfer of PPL and MPL shares into Hold (Pty) Ltd (HPL) and associated limitations Mr Rich could utilise the corporate rules to facilitate a disposal of the shares in PPL and MPL to HPL. The only applicable rule is that of a disposal of an asset for shares. In this case, the assets sold are the shares in PPL and MPL to be sold to HPL in exchange for shares in HPL. As Mr Rich holds 100% of the shares in each of PPL and MPL, he holds a qualifying interest in each company. Essentially, this rule will facilitate the sale of the shares in PPL and MPL to take place at Mr Rich s base cost for these shares. The implication is that no capital gain occurs on the disposal. The shares in HPL then carry the same base cost as the combined base costs of PPL and MPL. Mr Rich is required to have a qualifying interest in HPL at the end of the transaction, which he will as the sole shareholder of HPL. However, a number of limitations arise under the application of this rule. First, ignoring any change of residence, any disposal of the shares in HPL within 18 months of the application of the rule to the transfer to HPL will result in a deemed disposal of the shares of PPL and MPL at the market value at the time of the disposal to HPL, i.e. this anti-avoidance provision reverses the deferral benefit the application of the rule achieves. It is unclear whether the deemed disposal of the assets as a result of emigration would be considered a disposal for the purposes of the corporate rules anti-avoidance rule, but it seems likely to be the intention. This means that interposing a holding company and utilising the corporate rules would result in a disposal within 18 months and therefore negate the benefits associated with this rule. Furthermore, the exit tax would then have to be applied to HPL in addition to PPL and MPL. Tutorial note: Securities transfer tax would also be payable on the transfer of the PPL and MPL shares into HPL but this is out of the scope of the syllabus. (ii) Retaining residence for the companies Mr Rich could prevent the change in residence of the companies if he were to retain the place of effective management of the companies in South Africa. He could do this by ensuring that all key management and commercial decisions necessary for the running of the business as a whole are made in South Africa. Remotely managing the operations from Mauritius is not conducive to proving that the key decisions are, in substance, made in South Africa. It is clear that, as a minimum, the board meetings should take place in South Africa. Vesting key decision making authority to a director operating from South Africa could also support the demonstration of no change in residence of the companies. (iii) Use of the assessed loss in HPL The use of the assessed loss in HPL may be prevented by means of an anti-avoidance rule. This rule provides that as a result of an agreement (the sale) where a change of shareholding has taken place (Mr Rich s acquisition of HPL) which will result in income accruing to the company or proceeds accruing to the company from the disposal of any asset and the sole or main purpose was the utilisation of the assessed loss, the use of the assessed loss will be denied. If there is no remaining income to offset against the assessed loss, it will be lost in the following year of assessment. In Mr Rich s particular circumstances, no income is likely to arise as the dividends HPL will receive will be from South African companies and will therefore be exempt and not generate income. 20

10 Professional Level Options Module, Paper P6 (ZAF) Advanced Taxation (South Africa) June 2018 Marking Scheme 1 Mrs Palmer Available Maximum (a) Tax implications of events/transactions during year ended 28 February 2018 (i) Shipment destroyed due to ship running aground Identification no VAT/customs duty is levied/claimable on import 1 Since the goods did not arrive at a port of entry Identification of time of supply rule 1 Recognising income tax deduction 1 Addressing the risk of stock loss to the business to qualify for the deduction 1 (ii) Delivery of goods to customers Standard rating is correct for deliveries within South Africa Identification of the conditions/evidence required for a cartage contractor to zero rate the cartage supply for exported goods of another supplier 3 (iii) Export of goods to various African countries Recognising zero rating of the exports and the conditions to be met 2 Turnover of R500,000 gross income for income tax purposes (iv) Export to South Sudan government institution VAT implications Income tax implications Withholding tax and implications for unilateral tax relief (b) Tax implications of proposed sale and minimisation of tax liabilities VAT Identification of disposal of a going concern 1 Disposal of a going concern zero rated 1 Benefits of zero rating 1 Conditions to be met for zero rating 2 Documentary requirements 1 Income tax Treatment of trading stock 1 Treatment of depreciable assets 1 Only warehouse and contract subject to capital gains tax 1 Identify exemption available for capital gains tax and qualifying conditions 2 Consider the nature of the assets being sold 1 Calculation of capital gains tax 4 Recognition of goodwill 1 Calculation of tax liability 3 No transfer duty Professional marks Format and presentation of the letter 1 Effectiveness of communication

11 Available Maximum 2 (a) Tax implications of the share transactions and interest-free loans for the 2018 year of assessment Identification of share option scheme 1 Any gain/loss included in/deducted from income 1 Application of restricted equity instrument definition to facts 2 Determination of gain for shares vested in April Capital gains tax implications for sale in May Determination of fringe benefit on interest-free loans 4 Implications of resale of shares back to scheme (b) The nature of the lump sum and process to object to the assessment by SARS Identification criteria (applicable to the facts) of severance lump sum 2 Noting the employer deficiency with respect to the lump sum 1 Determination of the tax per the severance table 1 Comparison to tax actually withheld 1 Objection process (c) Tax implications of sale of stables and acquisition of Hermanus property Identification of part disposal 1 Consideration of improvements and implication for disposal 2 Determination of capital gain on part disposal 1 Determination of transfer duty on acquisition of Hermanus property 1 Recognition and determination of how transfer duty could have been mitigated (a) Calculation of final distributions Gross value of the estate 3 Deductions against the estate 2 Abatement 1 Estate duty 1 Distribution to each child (b) Tax implications of award by directors (i) Adam 1 (ii) The deceased estate 1 (iii) Joseph and Innocence (iv) Miller Ltd (c) Effective estate planning Explanation of an effective estate plan 2 Identification of tax burdensome assets 2 Possibility for the primary residence 4 Possible plan for the pension Possible plan for the life policies 1 Possible plan for the investments

12 Available Maximum 4 (a) Retaining control over Calm (Pty) Ltd Conversion of shares to non-participating preference shares 1 Capital gains consequence Dividend stream protection 1 Growth of capital limited 3 3 (b) Beneficiary rights Vested beneficiary in dividend income secures Patience her rights 1 Discretionary rights for balance 1 Ownership of company retained by trust 2 2 (c) Transfer of the assets to the trust By donation: Donations tax and consequences Capital gains tax and consequences By sale on loan account: Sale on loan does not trigger donations tax Capital gains tax applicable Deemed donation impact 2 Sale on interest bearing loan account and implications 2 Transfer duty (d) Subsequent tax consequences and mechanisms to reduce tax burden Attribution of retained income and possible mitigation 1 Attribution of vested income in non-resident 1 Attribution of capital gains 1 Mitigation of attribution if loan repaid 1 Difference if transfer by donation Future capital gains tax implication 1 Implications on death (e) Non-disclosed offshore investment and income Advise of permanent voluntary disclosure programme Identify conditions to utilise programme Identify the relief offered Implications on approval

13 Available Maximum 5 (a) Tax implications of proposed emigration and remote management of Prop (Pty) Ltd (PPL) and Manu (Pty) Ltd (MPL) Identify exit tax implication 1 Impact on year of assessment 1 Explain the lack of relief for PPL 1 Discuss subsequent capital gains tax effects post emigration 1 Identify issue with change of effective management 1 Discuss the exit tax implications for the companies 3 Discuss possible limitations to the exit taxes (b) (i) Minimisation of taxes on transfer of PPL and MPL shares to Hold (Pty) Ltd (HPL) and associated limitations Identify relevant corporate rule asset for shares 1 Identify how rule may be applied 2 Explain the limitations applicable anti-avoidance 1 Identify factors against utilising this rule under these facts 2 Possible triggering anti-avoidance rule in corporate rule through change in residence (ii) Retaining residence for the companies Retain place of effective management in South Africa Provide suggestions (iii) Use of the assessed loss in HPL Recognise anti-avoidance rule and conditions 2 Implications based on facts